JUDGEMENT
A. Kalyanasundharam, Accountant Member -
(1.)THE assessee, a government owned bank, has filed these two appeals for the two assessment years 1980-81 & 1981-82 and has raised the common issue regarding the taxability of interest on sticky advances which have been debited to the party but credited to an account styled interest suspense account.
(2.)Appearing for the assessee the learned counsel Sh. Manian, submitted the bank had been consistently adopted a hybrid system of accounting of interest income. He pleaded that in respect of customers, who have been regular in payment of their instalments together with the interest, the system of mercantile was adopted. However in respect of parties who have defaulted in repayments of principal and the interest thereon, the system of cash was adopted. The bank regularly keeps watch on the defaulting parties and in respect of those who have not only been irregular in their repayments but also whose financial positions appear to be bad, as per enquiries made by the bank's staff, these are treated as sticky advances, in the sense that there is every likelihood of the debt becoming bad. In such cases, the bank had formulated a rule of debiting the parties account with the normal interest but took the credit to the interest suspense account, meaning that the extent of. interest lying to the credit of this suspense account is either income that might be lost and irrecoverable and which requires a careful watch to be kept. The past practice in such cases had been that most of it were not recovered either due to reconciliation with the party on the basis of possible recovery of the principal and many such factors. This practice of mixed accounting method was followed for a number of years and this fact was accepted by the Tribunal in the case of the assessee for the asst. years 1975-76 & 1976-77, vide order dated 16th August, 1982, a copy of which has been placed at pages 4 to 20 of the paper book. His plea further was that the hybrid or the mixed accounting having been recognized and so accepted by the Tribunal, and the same system having been consistently followed by the bank, it is not open to the department now to contest against it and to treat the interest suspense account as income accrued to the assessee. He did not rest his arguments here, but went further to draw the distinction between the assessee bank's case and the case of State Bank of Travancore v. CIT [1986] 158 ITR 102/24 Taxman 337, decided by Supreme Court. His main bone of contention remained throughout his arguments was that the Supreme Court concerned itself to the mercantile system of accounting and as the Supreme Court was never confronted with the case of hybrid system of accounting, the said ruling was clearly distinguishable as regards the facts of the assessee bank's case. He made reference to several passages as was observed by their Lordships of the Supreme Court, where in the entire emphasis was laid on the mercantile system of accounting adopted by that bank, which was why the conclusion had been arrived in that case that notwithstanding the fact that the assessee had not credited the interest income to its profit and loss account, the income having accrued to it for the reason of it following mercantile system of accounting, the interest income was includible as its income. He pleaded vehemently that had that bank followed the mixed system of accounting as is the case of the assessee bank, the conclusion of the Supreme Court would have been that the interest lying to the credit of interest suspense account could not be taxed on accrual basis but on receipt basis only. In support of his arguments, he placed reliance on several authorities which shall be dealt by us while drawing our conclusions. In addition to these arguments, the learned counsel Sh. Manian, submitted the amounts included some portion which have infact become fully bad and should have been allowed as a deduction out of its total income. He further placed reliance on the Board's circular issued in Sep.' 84, a copy of which he had placed at pages 22-23 of his paper book and submitted that as per para 3 of this circular the interest credited to the suspense account and which has not been received for a period of three consecutive years, then from the fourth year onwards such interest income would be includible on receipt basis only and assessed on that basis alone from asst. year 1979-80 and onwards. His plea was that the CIT(A) had failed to appreciate that when the ITO had concluded the assessment for the asst. year 1980-81, the said circular was not issued and therefore could not have been considered by the ITO. His further grievance was that the CIT (A) a subordinate authority to the Central Board of Direct Taxes could no! refuse to apply the circular, especially a beneficial circular such as the one issued by the Board. He pleaded that the CIT(A) went beyond his jurisdiction in refusing to follow the circular. He therefore pleaded that the circular has a binding force on the revenue.
The learned Senior DR Sh. Shah vehemently supported the orders of the authorities below and contended that the Board not being a superior authority when compared to the Supreme Court, the law pronounced by the Supreme Court would have to be applied. He pleaded by referring to the Calcutta High Court ruling in James Finlay & Co. v. CIT [1982] 137 ITR 698, that, the character of the transaction does not change by subsequent by crediting the interest to the suspense account.
(3.)WE have given our very careful considerations to the contentions of either side.
4.1 The assessee has sought to draw distinction of the assessee's case with Stale Bank of Travancore's case (supra) and the main distinguishing feature as per the counsel for the assessee Sh. Manian is the assessee having adopted consistently a hybrid or mixed system of accounting while in the case considered by the Supreme Court the system was mercantile and in support of this argument he drew our attention to the Tribunal's order in the assessee's case for the asst. years 1975-76 & 1976-77. To begin with, we therefore propose to deal with this proposition laid by the assessee.
4.2 The concept of income has been defined in Section 5 of the Income-tax Act, 1961. The Legislatures have classified it into two broad categories, viz., incomes received or deemed to be received and incomes which accrues or arises or is deemed to accrue or arise. This classification of income has been adopted from the business and the trade practices. The business or the trade generally followed the two basic or fundamental methods in the conduct of its business transaction. These are broadly classified as, mercantile or accrual or that which arises and the receipt or the cash or that which is received. The former represented those businesses in which the right of enforcement was the substratum of each and every transaction, while the latter covered the businesses in which the right of enforcement was left to the parties to be agreed to and is not the basis of the contract. The root of the term income lies in the transaction of the business or the trade itself and accordingly, the income, either accrual or cash would emanate from such business or trade transaction. Thus, the income generated of any business or trade is the result of its transactions and therefore, it is only proper, that, the transaction alone should be the basis in the determination of the true character of the income, i.e., is it on accrual or receipt based. The accounting of any transaction is evolved so as to enable the business or the trade to collect the historical aspects of its transaction, so as to act as a guide for the future. The accounting therefore, has to give a true reflection of the business transactions as it happened or occurred. The accounts can be said to reflect the transactions only when it bears the same characteristics as the business transactions itself. It is therefore obvious that the accounting follows the transaction of the business and not the reverse, i.e., the transaction following accounts. It is therefore wholly improper even to suggest that the manner of accounting would be the deciding factor as to the true nature of the business transaction.
The pulse of the operations of any bank is its right to demand interest on its advances, which is why the interest meter starts running the moment the advance or loan has been utilised by the party. The bank also adjusts to begin with the interest amount whenever any party makes a lump sum repayment or even where the party says the repayment is towards principal though the interest had not been paid and whatever balance is remaining is given credit towards capital account. The bank only allows the outer time limit of payment of interest, like every quarter, half year or annual etc., after which the bank starts its second meter of charging interest on delayed payment of interest. All these factors go clearly to indicate that right from the stage go, the bank's income on account of interest on loans advanced by it commences as per its generally followed trade practice. If it were to follow the system of allowing the parties to pay as and when they are willing and capable of payment of interest, the entire banking business would collapse, as the basic and the fundamental strength of the banking business lies in its right to demand and recover interest. The method of accounting under no circumstance can be different from its business practice, for the reason that accounting is recording of the transactions of the business only. In case the accounting of transactions do not represent the true business practice followed, then the books of account cannot be said to reflect the true state of affairs of the business of either its profits or its assets. For purposes of accounting of interest in respect of sticky advances, the bank does not lose its right to recover the interest but feels shy to treat it as its income for fear of they being not received subsequently. This practice has been adopted on a prudent banking practice and is in fact identical to providing for doubtful interest income. As is normally followed by all businesses, all expected losses are taken note of, which is why the business circles evolved the system of providing for such losses like provision for bad and doubtful debts etc. The crediting of interest to interest suspense account, in respect of the parties who are treated as sticky is a method adopted by the banks to provide for the contingency of non-receipt of interest.
This practice had been so evolved so as to ensure the safe liquidity of the bank's finances and also to keep a check on the bank's income vis-a-vis its receipts. It must be appreciated that to the extent of the interest credited to the interest suspense account, the bank had not forfeited its right of enforcement which is clear from the fact of the party's account being debited with the like amount. It has never been the case that bank takes a soft corner to those parties who do not pay the interest for three consecutive years, and that they would waive all the interest from the fourth year onwards provided the parties pay off the interest for the first three years. Therefore, it is obvious that whatever is the state of affairs of the transaction of the business, the same shall have to be for its accounting as well, failing which the accounting could not be said to represent the transactions as it had happened.
The above have been brought out for appreciating the fact that the accounting method adopted should be in consonance with the trade practice followed by the bank and if it is not so then the system of accounting followed by it cannot be said to reflect the true state of affairs. The Legislatures have recognized this feature of the trade practice, which is why as a guide to the assessing authority, Section 145 has been enacted by them. The words "method of regularly employed by the assessee" used in Section 145 has to be read in conjunction with Section 5, for otherwise, it might lead to conflicting situations of items being treated as income per Section 5 but as per Section 145, since the assessee has adopted to follow a particular system of accounting of the transaction, which might be just the opposite of the one in Section 5, then the very meaning of the term income, its manner of earning by an assessee, would be taken to a ridiculous extent, making the statue a laughing subject. This is aptly clear by the reading of Sub-clause (2) to Section 145, which gives the power to the assessing officer to determine the true income of the business, in cases where the true income could not be deduced from the manner or the method of accounting followed by an assessee. Therefore the concept of the true or the real income cannot be foreign to its normal business or trade practice rights but has to be one that arises to it from such trade practices rights.
When we examine the issue before us of accounting of interest on sticky advances on receipt basis, we see absolutely no merit in the argument of the assessee, for the reason the bank on its own, i.e. unilaterally cannot modify the terms of the contract as was agreed to with the parties and if the argument of the bank were to the effect that it reserves the right to modify the contract by itself without the concurrence of the party, then the bank would be so doing at its own peril, but even then it cannot alter the true nature of the transaction of its business, which always remains, the right to enforce recovery, i.e. accrual. Therefore, the adoption of the hybrid system of accounting, which system had been accepted for an up to asst. year 1979-80, even by the Tribunal, cannot be insisted upon by the assessee, for it would be totally contrary to the concept of income defined under Section 5 of the Act. WE have also observed that crediting of interest to interest suspense account is another way for providing for doubtful interest income and the Income-tax Act does not recognize allowing of deduction of anything which is doubtful but recognizes one and the only item which has become bad and this deduction is allowed for the reason of income having been taxed in an earlier year. A debt can become bad in the same year of transaction and can also allowed to be deducted from the total income but his proposition would not apply to a situation of every likelihood of the debt becoming bad. The IT Act does not allow deduction in respect of any provision for bad and doubtful debts, for the reason that such provisions are in the nature of reserves, which reserves are normally appropriated from out of the profits remaining after the payment of taxes under the I.T. Act.
WE are fully alive to the fact the Delhi Bench of the Tribunal, in the assessee's case for the asst. years 1975-76 and 1976-77 had not only recognized the hybrid system followed by the assessee to be reasonable but had also come to the conclusion that the interest on sticky advances, credited to the interest suspense account cannot be treated as the bank's income. The Tribunal had adopted three reasonings to come to that conclusion. First, the Board's circular issued in 1952, which was withdrawn in June, 1978, was fully applicable for the two asst. years 1975-76 & 1976-77. Secondly, the method of crediting the interest to suspense account and accounting for it in the year of receipt was consistently followed, which method once having been accepted, the department could not raise its objection against such method in a subsequent year. The third reason which weighed in the minds of the Members was that the bank had acted on the advice of its auditors and the Reserve Bank of India.
As observed earlier, the crucial factor which would determine the character of income being the transaction itself, the accounting necessarily has to conform to the nature of transaction, in relation to the true concept of income as defined Under Section 5 of the I.T. Act, not having been dealt with by the tribunal for the two asst. years 1975-76 & 1976-77, these being material factors for deciding the issue under consideration and all the more necessary to be dealt in by us presently, for the assessee had sought to point out the distinctive feature of its case and the one decided by the Supreme Court in the case of State Bank of Travancore (supra), we have re-examined the issue in extenso. The reconsideration of the issue in the assessee bank's case based on additional materials and factors not considered by the Tribunal for the earlier years, has the full sanction of the ruling of the Supreme Court in CIT v. Brij Lal Lohia & Mahabir Prasad Khemka [1972] 84 ITR 273. In that case the Supreme Court upheld the action of the Tribunal in accepting the gifts to be genuine based on certain additional factors though for the earlier years, the gifts were held to be non-genuine.
4.3. WE shall begin with the Supreme Court ruling in State Bank of Travancore's case (supra). In this case, the question that was raised by the bank was whether the interest on sticky advances which has been credited to interest suspense account was includible in its total income. The fact which was observed by the Supreme Court was that the system followed by the bank was normally mercantile but in respect of the interest on the sticky advances the bank had followed the method of crediting to interest suspense account, instead of crediting to the interest account. The Supreme Court took upon itself to examine the concept of real verus hypothetical income, its time of accrual, the change if any, in the nature of income by lapse of time, to what extent the method of accounting could be said to be relevant to decide the issue of real income concept, and, is the chargeability of an income is to be decided on the basis of their being high probability of the income not being received at all.
The Supreme Court observed that the chargeability or otherwise of an item of income and at what point of time the income accrues or arises, is dependent on the Section 5 of the I.T. Act, which has defined the scope of income. They then considered the difference between the two systems of accounting, viz., cash and the mercantile. The Supreme Court also considered whether the legalistic approach to the income should prevail over the doctrine of real income and whether the concept of computation of income as per Sections 28 and 56 could enlarge the content of the taxable income under the Act. Justice Shri Tulzapurkar, in this case took the view that the debit to the parties account with the element of interest was not at all fatal to the scope of real income for the credit to the suspense account only meant that it remains to be disposed of and therefore it is in the nature of hypothetical income, thus needs to be excluded from the total income. Justice Shri Sabyasachi Mukharjee and Justice Shri Ranganath Mishra were of the view that the concept of real income would be applicable and that this must be applied with circumspection and must not be called upon to defeat the fundamental principles of the law of income-tax as developed.
They observed "mere improbability of recovery where the conduct of the assessee is unequivocal, cannot be treated as evidence of the fact that income has not resulted or accrued to the assessee. After debiting the debtor's account and not reversing that entry - but taking the interest merely in suspense account cannot be such evidence to show that no real income has accrued to the assessee or been treated as such by the assessee. With a problem like the present one, it is better to adhere to the basic fundamentals of the law with clarity and consistency rather than to be carried away by common cliches. Though the concept of ' real income' is a well recognized one, it cannot be introduced as an outlet of income from the taxman's net for the assessment on the plea that though shown in account books as having accrued, the same became a bad debt and was not earned at all. It is well settled that the citizen is entitled to benefit of every ambiguity in a taxing statute but where the law is clear, considerations of hardship, injustice or anomaly do not afford justification for exempting income from taxation.
4.4 The reading of the Supreme Court's majority judgment indicates that the concept of real income needs to be given due weightage, when considering the income from the point of view of taxation. WE have only made our observation to the effect that the business transaction determines the true character of income and it is that income which is relevant for the purposes of taxation. WE have also observed that when the manner or the method of accounting followed does not bring out the true income of the assessee, as it transpired under the business climate, then such method of accounting has to be held as not proper because the accounts are expected to be the true replica of the transactions as they happened. The Ld. counsel Sh. Manian made a valiant attempt to distinguish the assessee's case on the ground of it was following hybrid method of accounting of interest income, which was so accepted by the Tribunal for the earlier years. As brought out above, it is not disputed by the assessee that but for the fact that the bank had felt the probability of irrecovery of the interest due to several indicative factors, such as the financial position of the debtor, etc., it would have the least hesitation of including the interest as its regular or normal income. Thus is clear that the factors in regard to the advances and the sticky advances in so far as it relates to the banking business is concerned remained the same in every aspect of the term, excepting for the feeling of the bank in regard to the possible incapability of payment by the sticky parties, which factor has compelled it to adopt the method of accounting of debiting the parties account with the amount of interest but credit being given to interest suspense account, and awaiting the actual receipt of interest amount for treating them as its income. When every aspect of the transaction in respect of all the parties, including the liabilities of the parties remaining the same, on a mere probability of irrecoverability, the income arising from some of them would be dependent on their actual receipt, goes clearly to the contrary to the basic concept of banking business where the core of the transaction is the right to enforce and receive, whether it is paid or not by the party. As observed earlier, the Tribunal for the earlier years had no occasion to consider this concept of income, the transaction being the starting point and it is that which would determine the method of accounting to be followed and not vice versa, we have to necessarily, in the light of these factors to take the contrary view of the matter. The view in this regard is that notwithstanding the manner or the method of accounting followed by the assessee consistently and so accepted by the revenue in the earlier years, and if such a method does not reflect the true income of the business transactions of the assessee then the revenue cannot be precluded from computing of the income to include the income based on the true concept of income in the subsequent assessment years. WE as the creatures of law and expected to apply the law as it stands and have to necessarily apply the law in its proper perspective and it is the duty of the courts to ensure that the fundamental concepts of business and incomes are not lost sight of especially when considering the circumstances from the point of view of statute made law, like taxation. Therefore, it is only proper for us to hold that whatever be the method of accounting adopted or followed by an assessee, the true income has to be determined based on its business alone. It is immaterial as to whether it is mercantile or mixed or cash system of accounting, if as per the business transaction the income gets accrued to the business, then, it has to be included as its income. The observations of their Lordships in that case brings out clearly the concept of real or true income, "Though the concept of 'real income' is a well recognized one, it cannot be introduced as an outlet of income from the taxman's net for the assessment on the plea that though shown in account books as having accrued, the same became a bad debt and was not earned at all", would hold the field in respect of every transaction of the business and not necessarily to the mercantile system of accounting for the reason that the method of accounting followed or adopted must follow the transaction and not that the method of accounting alone would be the deciding factor as to the nature of transaction.
4.5 The assessee placed reliance on the Madras High Court ruling in S. Planiandi Mudaliyar & Sons v. CIT [1975] 99 ITR 231, which has no relevance to the issue before us, for in that case the issue under consideration was about deduction of remuneration where nature of services were not specified.
The assessee for his proposition that the method of accounting which was consistently followed, and accepted by the department, the department cannot reject the same in a subsequent year and it is not for the department to thrust its method on the assessee, placed reliance on the rulings of - (a) Madras High Court in CIT v. K. Sankarpandia Asari & Sons [1981] 130 ITR 541 & CIT v. Sankarapandia Asari & Sons [1987] 165 ITR 616/30 Taxman 236 (Mad.) and (b) Calcutta High Court in Snow White Food Products Co. Ltd. v. CIT[1983] 141 ITR 847. The above rulings emphasise the point that the system of accounting followed by the assessee and accepted by the revenue in the earlier years, it being not established that the profits and gains could not be properly deducted therefrom, the revenue cannot but continue to accept the method of accounting followed by the assessee. WE have observed earlier that the method of accounting has to follow the business transaction and since the accounting of the interest on sticky advances when excluded from the profits, the true profits and gains could not be deduced therefrom and therefore, even as per these rulings, in the circumstances of the case, the rejection of the accounts is only proper. The learned DR had placed reliance on James Finlay & Co, 's case (supra) for the proposition that by mere debiting of interest to suspense account without giving up of the claim, the income cannot be said to not to accrue to the assessee. This ruling supports the view we have taken that the accrual or otherwise of income would depend on the transaction and not the accounting method followed. WE accordingly reject the argument that the hybrid system of accounting followed by the assessee, accepted by the Tribunal as well in the earlier years, should be accepted as proper method and on that basis only the income of the assessee should be computed, as totally baseless, for the detailed reasonings given above.
4.6 The learned counsel Sh. Manian had drawn our reference to the Board's circular issued in Sept. 84 and had placed reliance on a number of rulings for the proposition that the beneficial circular issued by the Board would be of a binding nature on the revenue and the department must have to give effect to the same. The Central Board of Direct Taxes issued a circular in Sept. 84, detailing out the manner of taxing of interest income from out of sticky advances in relation to the assessment of the banks. For the sake of facility, we shall bring out the circular.
F.No. 201/21/84-ITA. II GOVERNMENT OF INDIA CENTRAL BOARD OF DIRECT TAXES
New Delhi, Sept. 84
To,
All Commissioners of Income-tax
JUDGEMENT_2343_TLIT0_19890.htm
Sir,
Attention is invited to Board's instruction No. 1186 (F. No. 201/7/78/-ITA. II) dt. 20-6-1978 wherein it was clarified that interest on doubtful debts credited to a suspense account by the banking companies is includible in the taxable income. It was further stressed that all pending assessments may be completed keeping in view the said instructions and an immediate review be undertaken and remedial action by way of initiation of proceeding Under Section 147(b) or Section 263 be taken in respect of assessments which have been completed not including such interest in the taxable income in accordance with the Board's earlier instructions.
2. These instructions have resulted in increased litigation between the I.T. Deptt. and the Banking companies. On a subject like this, it appears futile that two organisations of the Government both functioning under the Ministry of Finance, should resort to litigation over extended periods of time. Obviously, this leads to delays and other consequential difficulties. Hence, the matter has been re-examined.
3. It has been decided that interest in respect of doubtful debts credited to suspense account by the Banking Companies will be subjected to tax but interest charged in an account where there has been no recovery for three consecutive accounting years will not be subjected to tax in the fourth year and onwards. However, if there is any recovery in the fourth year or later, the actual amount recovered only will be subjected to tax in the respective years. This procedure will apply to the asst. year 1979-80 and onwards. The Board's instruction-No. 1186 dt. 20-6-78 is modified to that extent.
4. Courts of Law have held that subsequent withdrawal of beneficial circulars/instructions can be with prospective effect only. As such the question of taxability of interest of doubtful debts credited by Banking Companies to suspense account will have to be decided upto asst. year 1978-79 in the light of the Board's circular No. 41(V6) dt. 6-10-52 as the said circular was withdrawn only in June, 1978. The new procedure as laid down in para 3 above will be applicable for and from asst. year 1979-80. All pending disputes on this issue should be settled in the light of these instructions.
4.7. The reading of the above circular/instructions issued by the Board indicates that 3the interest on doubtful debts which have been credited to the interest suspense account, which represented items or parties from whom there had been no recovery in the three consecutive earlier years, from the fourth year onwards, such interest would not be added to the income but would be includible in the total income of the year of their actual receipt. This circular so issued by the Board did not exist when the ITO made the assessment for the asst. year 1980-81, i.e. on 26-7-84. The circular was very much in existence when the CIT(A) heard the appeal for the asst. year 1980-81 and when the ITO made the assessment for the asst. year 1981-82.
The CIT(A), in the appeal for the asst. year 1980-81 observed :
However, the appellant itself, in its letter dt. 27-12-84 at page 3 has stated that the circular is based on the rule of thumb. It does not elaborate or explain any rationale for a differential treatment in the fourth year vis-a-vis the earlier years. Besides this point was not examined by the ITO. The particulars of the calculation are not available. Above all, the matter having been decided by the Supreme Court, it is not possible to make a departure therefrom. It is not open for me to take a different view on the ground that the circulars were not considered by the Supreme Court.
4.8 The two rulings of the Supreme Court relied upon by the assessee clearly answers the doubt of the CIT(A). they are Navnit Lal C. Javeri v. K.K. Sen, AAC [1965] 56 ITR 198 and Ellerman Lines Ltd. v. CIT [1971] 82 ITR 913. In both of these cases the Supreme Court had clearly emphasised that the circular issued by the Board would be binding on all officers and persons employed in the execution of the I.T. Act. Thus, it is clear that neither the ITO nor the CIT(A) can refuse to follow the Board's circular. Therefore, we are of the view that there is force in the argument of the counsel Sh. Manian that the Board's circular has a binding force on the department, especially when it is a beneficial one to the assessee, similar to the one issued in the case of the Banking Companies, reproduced above. In a situation like as was observed by the CIT(A) about the calculations not being available and not examined by the ITO, it is only proper for him to restore the matter for the ITO's examination for applying the Board's circular in connection with the interest on doubtful debts credited to interest suspense account, of which there might be parties from whom there had been no recovery for the past three consecutive years, and if the interest represents for the fourth year, then the same may be excluded from the total income. The only safe precaution to be adopted by the ITO in this regard is to include the incomes on this account even from the fourth year On actual receipt basis. WE therefore, accepting this plea of the binding nature of the circular by the Board, remand the issue back to the files of the assessing officer to apply the circular as observed above.
4.9 Connected with the above is the issue relating to the allowing of deduction of bad debts or the interest included and assessed as income in the past on accrual basis, which debt and interest has become bad and has been written off, the ITO shall examine these items as well and allow deduction of such bad debts.
The common issue for both the assessment years under appeal is accordingly disposed of.