Judgment

HANSARIA, J.:- In this batch of appeals, we are concerned with the question as to how interest accruing on sticky advances has to be taxed. The appellants being various leading financial institutions of the country, the answer has to be not on sticky ground but on terra-firma. We would not, however, be required to labour hard to base our conclusion on firm ground because much of the ground has already been covered by a three - Judge Bench of this Court which decided the case of State Bank of Travancore v. Commr. of Income-tax, (1986) 2 SCC 11: 158 ITR 102.

2. Those advances are called "sticky" in commercial parlance whose recovery becomes highly improbable or doubtful. The interest accruing on such advances are debited to the concerned parties by those institutions which maintain their accounts on mercantile system, and at the same time instead of carrying such an interest to the Profit and Loss Account, the same is credited to a separate account styled as Suspense Account or Interest Suspense Account.

3. In State Bank of Travancores case (AIR 1986 SC 757) this Court was called upon to decide as to how accrual of interest on such advances has to be taxed under the Income-tax Act, 1961 (hereinafter referred to as the Act). The Bench differed in its ultimate conclusion and the majority view was taken by Mukharji, J. as he then was, with whom Misra, J. as he then was, agreed. Tulzapurkar, J. was in minority. As leading legal luminaries of the taxation world had appeared to assist this Court in answering the aforesaid question, all that could reasonably be said on both the sides was done by persuasive and forceful arguments advanced, inter alia, by Shri Palkiwala, Shri Desai and Dr. Pal. Fundamentals of law and principles of taxing income were brought to the notice of the Court along with many decided cases of various Courts of the country and the English law.

4. The crux of the argument on behalf of the assessee was that accrual of interest on such advances does not produce real income, and so, despite the mercantile system of accounting such interest should be taxed only when it is really recovered. The majority too had no reservation in accepting the submission that the income which really accrues can be taxed. The question examined was when can such an income be said to have really accrued? Mukharji, J. observed in para 67 (of 1986 (2) SCC 11) of the judgment that whether an accrual has taken place or not must be judged on the principles of real income theory; and in determining whether the income is hypothetical or real various factors have to be taken into account. The learned Judge observed that it would be difficult and improper to extend the concept of real Income to all cases depending upon the ipse dixit of the assesses which would then become a value judgment only. It was opined that the question has to be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner and dovetailing of these factors together; but once the accrual takes place, on the conduct of the parties subsequent to the year of closing, an income which has accrued, cannot be made no income.

5. The learned Judge thereafter formulated eight propositions which according to him emerged as a result of the discussionsundertaken. These propositions mentioned in para 69 (of 1986 (2) SCC 11) read as below:-

"(1) It is the income which has really accrued or arisen to the assessee that is taxable. Whether the income has really accrued or arisen to the assessee must be judged in the light of the reality of the situation.

(2) The concept of real income would apply where there has been a surrender of income which in theory may have accrued but in the reality of the situation no income had resulted because the income did not really accrue.

(3) Where a debt has become bad deduction in compliance with the provisions of the Act should be claimed and allowed.

(4) Where the Act applies the concept of real