V.K. Singhal, J. - (1.) THE Income-tax Appellate Tribunal has referred the following question arising out of its order dated April 23, 1981, in respect of the assessment year 1977-78 under Section 256(1) of the Income-tax Act : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that there was no error prejudicial to the Revenue for the Commissioner of Income-tax to invoke his powers under Section 263 of the Income-tax Act, 1961 ?"
(2.) THE facts of the case as found by the Tribunal are that there was a footnote in the printed report of the directors disclosing that the accumulated interest accrued on amounts decreed or under litigation amounting to Rs. 21,43,395 had not been taken into consideration for the purpose of arriving at the income. This amount included a sum of Rs. 9,85,821 relating to the assessment year 1977-78. THE Income-tax Officer did not include the amount of Rs. 9,85,821 in the income of the assessee while passing the assessment order. The Commissioner of Income-tax issued notice under Section 263 as to why the amount should not be included in the total income of the assessee. Objections were filed by the assessee. The Commissioner of Income-tax found that the order passed by the Income-tax Officer is erroneous and prejudicial to the interests of the Revenue by not including the amount of Rs. 9,85,821 in the assessable income of the assessee. The Commissioner of Income-tax, therefore, directed the Inspecting Assistant Commissioner (Assessment) (who then held jurisdiction over the case) to include the sum of Rs. 9,85,821 in the income 6f the assessee and to issue a revised notice of demand. The assessee challenged the order of the Commissioner of Income-tax before the Income-tax Appellate Tribunal and contended that the assessee is maintaining the hybrid system of accounting. It was stated that starting from the very beginning this system was followed and accepted by the Revenue and, therefore, there was no reason to depart for the assessment year 1977-78. The decision in the case of State Bank of Travancore v. CIT [1977] 110 ITR 336 (Ker) could not have been the basis for the exercise of the powers under Section 263. According to the Commissioner, in order to deduce the income properly, it is essential that receipts and payments should be worked out on one and the same basis or the same basis of accountancy should be adopted for working out the receipts and expenditure. According to the system of accounting of the assessee, i.e., accounting for interest on sticky advances on receipt, while interest on other advances were accounted for on accrual basis, the interest was not being accounted for on the mercantile system and the hybrid system had been followed since last number of years. Reliance was placed on the Board's Circular No. 41(V-6)-D of 1962, dated October 6, 1962, which was subsequently withdrawn on June 20, 1978. The Tribunal found that the assessee followed the hybrid system from the beginning and no reason has been shown for the departure in the assessment year 1977-78. The decision in the case of CIT v. Motor Credit Co. P. Ltd. [1981] 127 ITR 572 (Mad) was also taken into consideration and it was found that in that case, the assessee Was doing the business of financiers for purchase of motor vehicles on hire purchase. It advanced moneys to two firms whose business was taken aver by the State. There was no prospect of recovering even the principal amount, the company did not credit the interest on the outstanding from the two companies although it was following the mercantile system of accounting. The accrued interest was added by the Income-tax Officer but the addition was deleted by the Appellate Assistant Commissioner. The Tribunal upheld the order of the Appellate Assistant Commissioner. The High Court agreed with the Tribunal holding that no interest income could be assessed in the hands of the company on accrual basis as it would be very unrealistic on the part of the assessee to take credit for highly illusory interest. On the basis of this judgment it was considered that even an assessee following the mercantile system of accounting under certain circumstances need not account for interest on advances considered doubtful. Therefore, the assessee could maintain the hybrid system of accounting. We have considered over the matter. From the findings which have been recorded by the Tribunal it is evident that the assessee was following the hybrid system of accounting right from the beginning which was accepted by the Revenue in the past. The decision which was given by the apex court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102 was in respect of a case where the assessee was maintaining the mercantile system of accounting. It has to be seen whether the maintaining of accounts in a hybrid system is (i) consistently followed by the assessee, and (ii) bona fide action, and (iii) ,the system is recognised on the basis of accounting principles. The entire action has been taken on the basis of the order passed by the Commissioner under Section 263 of the Income-tax Act wherein it was found that the assessee is a financial corporation and derives income mainly from interest on moneys advanced. The interest payable on loans and deposits is calculated on the basis of the mercantile system or on double entry basis. The interest is said to be credited to the profit and loss account, but in respect of those cases where litigation proceedings have been initiated the interest is not credited to the profit and loss account on the ground that such loans are sticky or doubtful of realisation. It was also found that on finalisation of litigation proceedings from such sticky advances/loans, the interest which accrued due is offered for taxation. The Tribunal has also taken into consideration these findings and found that the assessee was following the hybrid system right from the beginning and this was accepted by the Revenue. No reason was given for the departure. On the basis of the findings which have been recorded, it is found that the assessee was maintaining the hybrid system of accounting in respect of sticky loans and advances. In the preceding assessments, it was never objected to. The action of the assessee cannot , be said to be lacking in bona fides. The hybrid system of accounting was also a recognised system of accountancy and, therefore, the decision, in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102 (SC) and State Bank of Travancore v. CIT [1977] 110 ITR 336 (Ker) has no application where the decision was given in a case where the assessee was maintaining the mercantile system of accounting. In the case of CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144 (SC) it was observed that (page 148) : "Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is; attracted, viz., the accrual of the income or its receipt ; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a 'hypothetical income', which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax. may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account"
(3.) IF the assessee has continued with the system of accountancy which is a recognised one and has consistently been followed and even accepted by the Revenue and has not been found lacking in bona fides, the power under Section 263 cannot be exercised. In CIT v. U.P. Financial Corporation [1996] 217 ITR 191 (All), it was held that the interest due on the interest bearing loans did not accrue or arise to the assessee during the accounting year because suits were pending for the recovery of the loans. The fact that the assessee followed the mercantile system of accounting and the loans were interest bearing was irrelevant. In the case of CIT v. Uttar Pradesh Financial Corporation [1992] 194 ITR 282 (All) it was held that the interest did not accrue because during the whole of the period suits filed for recovery of the loans were pending and the awarding of interest for the period was within the discretion of the court which was yet to pronounce its judgment. In CIT v. Citibank N. A. [1994] 208 ITR 930, the Bombay High Court also accepted the principle of hybrid system of accounting by the bank which was following the mercantile system, but keeping a separate account for problem loans and it was held that the said system of accounting was accepted by the income-tax authorities in the earlier years and the interest on problem loans was credited only on actual receipt, and, therefore, was not assessable on the basis of accrual. A similar view was taken by the Orissa High Court in the case of CIT v. Orissa State Financial Corporation [1993] 201 ITR 595. Consequently, we are of the opinion that the Tribunal was justified in holding that there was no error prejudicial to the Revenue for the Commissioner of Income-tax to invoke his powers under Section 263 of the Income-tax Act, 1961. ;