COMMISSIONER OF INCOME TAX Vs. MOTOR CREDIT COMPANY PRIVATE LIMITED

JUDGEMENT

(1.) THE assessee is a private limited company carrying on business as financiers for purchasing of motor vehicles on hire-purchase agreement. Under the hire-purchase agreement it advanced money to M/S. P. N. Swamy Naidu and Company and M/s. Prakash Transports. At the beginning of the accounting year relevant to the assessment year 1973-74, a sum of Rs. 5,30,113 was outstanding as against M/s. P. N. Swamy Naidu and Company and a sum of Rs. 34,000 was found outstanding as against M/s. Prakash Transports. THE assessee did not account for any interest either in accrual or receipt basis from these two firms on the ground that it was not possible even to recover the capital from these two firms. THE ITO did not accept the assessee's contention and included a sum of Rs. 56,163 by way of accrued interest on the amounts outstanding from these two firms. On appeal, the AAC held that though under the mercantile system of accounting accrued interest should be treated as income, in the peculiar facts and circumstances of the case, even where the capital was not capable of being realised, there was no point in making a debit entry in respect of a hypothetical unrealised interest and on this ground, he deleted the addition of Rs. 56,163. On further appeal to the Tribunal it was contended for the revenue that as the assessee was following the mercantile system of accounting it was bound to account for accrued interest even nothing was received during the year of account and it is always open to the assessee to write off such of the interest as became irrecoverable in the year in which it was found to be so. THE Tribunal, rejecting the contention, held that on the facts and circumstances of the assessee could not have expected to get any interest income on the outstandings found due from these two firms and it would be wholly unrealistic on the part of the assessee to take credit for a highly illusory interest income and the Tribunal, accordingly, confirmed the order passed by the AAC.

(2.) AT the instance of the revenue, the following question of law has been referred to this court for opinion under s. 256(1) of the I.T. Act, 1961 :

(3.) IN the mercantile system of accounting credit entries are made in respect of amounts as soon as they because due and even before they are actually received and similarly the expenditure for which legal liabilities has been incurred, are immediately debited even before the accounts in question are actually disbursed. The point of time at which has liability is attracted depends upon the system of accounting regularly employed by the assessee and in the case of mercantile system of accounting, liability to tax is attracted as soon as the income accrued. Regular mode of accounting only determines the mode of computing taxable income and the point of time at which the tax liability is attracted. It cannot determine or effect the range of taxable income to the ambit of taxation. Where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following the mercantile system of accounting. Even if the assessee makes a debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has to materialised there can be no liability to tax a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account but, what should be considered is, whether the income has really materialised or resulted to the assessee. The question whether real income has materialised to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to the system of accounting. IN the present case, in the routes in which the buses of the two firms, M/s. P. N. Swamy Naidu and Company and M/s. Prakash Transports, were playing were taken over by the Cheran Transport Corporation Ltd. It is on account of the taking over the routes by the Cheran Transport Cooperation Ltd., that the two firms defaulted in making the payment of the hire-purchase instalments and this has led to the seizure of the buses by the assessee. The legal opinion taken by the assessee also indicated that there was no prospect of any recovery of the amount lent to these two firms by initiating legal proceeding against them. When the facts and the circumstances of the case clearly indicated that there is not even the remotest possibility of any interest income materialising in favour of the assessee in respect of the outstanding for the accounting year relevant to the assessment year in question, no liability to tax can be imposed on the ground that interest has accrued because of the mercantile system of accounting employed by the assessee. The mercantile system of accounting can be only relevant only to determine the point of time at which tax liability is attracted and it cannot be relied on to determine whether income has, in fact, resulted or materialised in favour of the assessee merely because the assessee has been maintaining his accounts on the basis of mercantile system of accounting, the interest income on the outstanding in the two firms cannot be held to have accrued at the end of the accounting year. Viewed against the background of commercial business realities of the situation in which the assessee was placed, the Tribunal came to the conclusion that it would be very unrealistic on the part of the assessee to take credit for a highly illusory interest. The Tribunal was fully justified in arriving at this conclusion. The question referred to us is answered in the affirmative and in favour of the assessee. The assessee is entitle to costs. Counsel's fee Rs. 500.