Income Tax Appellate Tribunal - Allahabad
Abbas Wazir (P.) Ltd. vs Inspecting Assistant Commissioner on 5 December, 1985
Equivalent citations: [1986]16ITD210(ALL)
ORDER
Prakash Narain, Accountant Member
1. Since the above appeals relate to the same assessee and also involve a common contention, they are disposed of by this consolidated order, for the sake of convenience.
2. The common issue in these appeals relates to the chargeability of income from interest to tax. The assessee, which, is a company, is engaged in the manufacture and export of carpets. The IAC, who had made the original assessment, had found that while the assessee had paid interest on its own borrowings, it had not charged any interest in the assessment years under appeal from its sister concerns, Carpet Traders and Bhadohi Cold Storage. It will be relevant to mention here that such interest had been charged on the advances made to Bhadohi Cold Storage in the assessment years 1975-76 to 1977-78. Such charge in these years amounted to Rs. 1,07,700. As stated, no such interest was charged in the two years under appeal either from Bhadohi Cold Storage or from Carpet Traders. The IAC was of the view that the interest had actually accrued from these two concerns according to the mercantile system of accounting followed by the assessee and was, therefore, includible as its income in the assessment. In the assessment year 1978-79 he, thus, brought to tax the interest of Rs. 1,07,700. In the assessment year 1979-80, he estimated such interest at Rs. 60,000 and included it in the assessment.
3. The assessee appealed to the Commissioner (Appeals). The Commissioner (Appeals) found that the figure of Rs. 1,07,700 brought to tax by the IAC was incorrect as it related to the arrear interest for the assessment years 1975-76 to 1977-78. He, thus, proceeded to correct the order of the IAC. On the basis of the average amount of advance to Carpet Traders, he held that only a sum of Rs. 4,500 could be included in the assessment. He, however, held that there was no question of taxing any such interest from Bhadohi Cold Storage as there was no hope of any recovery of even substantial portion of the principal amount. He also took note of the fact that the assessee had passed a resolution in the meeting of its board of directors held on 26-12-1977 that serious efforts should be made to realise the principal amount and in the meantime no interest should be charged. Observing that keeping in view the financial position of Bhadohi Cold Storage and the fact that even the principal amount was doubtful of recovery and no interest had actually been credited by the assessee in respect of the advances made to the above concern, he held that no income could be said to have accrued to the assessee-company. Accordingly, he held that no interest could be charged from Bhadohi Cold Storage and, therefore, none could be assessed to tax in the assessment of the assessee. In the circumstances, he reduced the addition to Rs. 4,500 in the assessment year 1978-79. Following these findings, the Commissioner (Appeals) held in the assessment year 1979-80 that Rs. 10,500 could be treated as interest due from Carpet Traders and that no such interest was chargeable from Bhadohi Cold Storage.
4. Against the above findings of the Commissioner (Appeals), there were appeals to the Tribunal. In the appeal for the assessment year 1978-79, the Tribunal observed that the facts of the case were not clear and, therefore, it was not possible to come to any conclusion. The Tribunal also found that the Commissioner (Appeals) had not considered whether there was any agreement for charging any interest from Bhadohi Cold Storage and further that he had also not considered the principle laid down by the Hon'ble Supreme Court in the case of Morn Industries Ltd. v. CIT [1971] 82 ITR 835. The Tribunal, accordingly, set aside the matter and directed the Commissioner (Appeals) to deal with it afresh in accordance with law. Following this finding, the Tribunal set aside the order of the Commissioner (Appeals) in the assessment year 1979-80 also. The orders of the Tribunal were passed on 30-10-1982 and 7-1-1984 in the above two years, respectively. It will be relevant to mention here that the assessee had not challenged the addition of Rs. 4,500 as sustained by the Commissioner (Appeals) in the assessment year 1978-79. That addition was, therefore, not the subject of setting aside by this Tribunal.
5. The Commissioner (Appeals) has now passed a fresh order on 1-6-1985. It was submitted before him that there was no agreement for charging interest between the assessee and Bhadohi Cold Storage. An affidavit was also filed before the Commissioner (Appeals) in support of this argument of the assessee. Since the counsel for the assessee failed to produce the deponent of the affidavit, the Commissioner (Appeals) ignored it. Since the assessee had charged interest in the earlier years, as mentioned above, the Commissioner (Appeals) held that there was an agreement for charging interest even though it was an unwritten one. He rejected the assessee's contention that the directors had made of their mind not to charge interest much earlier to 28-12-1977, when a resolution to that effect was passed in their meeting. He finally held that the assessee was entitled to charge interest from Bhadohi Cold Storage for the entire previous year relevant to the assessment year 1978-79 and up to 28-12-1977 relevant for the assessment year 1979-80. This worked out to Rs. 37,776 in the first year and Rs. 21,060 in the second year. He upheld the additions to this extent. He similarly held that there was also no agreement for charging any interest from Carpet Traders. We have already stated above that an interest of Rs. 4,500 was brought to tax in the assessment year 1978-79 relating to this party. There was no appeal from the side of the assessee against this charge. The Commissioner (Appeals) held that the interest from this party in the assessment year 1979-80 amounted to Rs. 10,500. He upheld the addition to this extent in the assessment year 1979-80.
6. The above findings of the Commissioner (Appeals) have now been challenged before us by the counsel for the assessee. His main submission was that the financial position of both Bhadohi Cold Storage and Carpet Traders had become bad and they were unable to repay even the principal amounts and, therefore, there was no question of either charging any interest from them or of paying any such interest to the assessee. The counsel, in this connection, invited our attention to the fact that even the interest of Rs. 1,07,700 due from Bhadohi Cold Storage for the assessment years 1975-76 to 1977-78 remained unpaid till 30-6-1979 being the accounting year relevant for the assessment year 1980-81. In this connection, he also invited our attention to two letters of the assessee written to the IAC. One of these letters does not bear any date, while the other is dated 3-3-1981. In the undated letter, it is clearly stated that the interest had not been charged on the advances given to the above two sister concerns of the assessee for the reason that their financial condition had deteriorated to such an extent that they had closed down their business activities. It was also stated that the provision of the interest could be nothing but an entry of hypothetical nature, which was neither an accrual nor actual receipt of income. In the letter dated 3-3-1981, the above position was repeated. It was also stated that the board of directors of the assessee had considered the proposal of taking over the cold storage belonging to Bhadohi Cold Storage in discharge of its debts.
7. The learned counsel for the assessee submitted before us that small amounts of about Rs. 55,000 had been advanced to Bhadohi Cold Storage in the assessment year 1979-80 only with a view to enable it to pay its taxes and other liabilities to relieve it of these burdens and facilitate the taking over of its cold storage by the assessee-company. About the advances to Carpet Traders, he pointed out that there were no such fresh advances to this party in the assessment year 1979-80 or in the assessment year 1980-81.
8. On the basis of the above facts, the learned counsel placed his legal arguments. The first argument was that in fact there was no agreement even with Bhadohi Cold Storage or Carpet Traders for charging of any interest and that the charge of interest by the assessee was an unilateral act. He specifically pointed out that no such interest was credited by Bhadohi Cold Storage in its books of account. His second submission was that there was no accrual of interest in either of the above two cases when their financial position was bad and the assessee had not charged any interest and, subsequently, it had passed a resolution for non-charge of interest from Bhadohi Cold Storage on 28-12-1977. His third submission was that the assessee was entitled to change its method of accounting regarding charge of interest and it had actually done so, change being from mercantile system to cash system. He also referred to the following authorities-CIT v. Ferozepur Finance (P.) Ltd [1980] 124 ITR 619 (Punj. and Har.), CIT v. Motor Credit Co. (P.) Ltd. [1981] 127 ITR 572 (Mad.), CIT v. Cosmopolitan Trading Co. [1979] 116 ITR 815 (All.) and Beni Prasad Sidh Gopal v. CIT [1983] 15 Taxman 191 (All.).
9. The learned departmental representative, on the other hand, submitted that an agreement for charge of interest could either be an express or an implied one. According to him, in this case there were implied agreements for charge of interest both from Bhadohi Cold Storage and Carpet Traders. This, in his opinion, could be inferred from the fact that the assessee had charged interest from these parties in the past. He referred to the decision of the Allahabad High Court in the case of Shiv Prasad Ram Sahai v. CIT [1966] 61 ITR 124 in support of his contention. It was held in this case that if the assessee has once chosen the mercantile system for a transaction and has regularly employed that system, it is not open to him unilaterally at any time during a subsequent accounting year to change that system. The variation could be by mutual consent. The next submission of the learned departmental representative was that the assessee had been making advances to Bhadohi Cold Storage even in the assessment year 1979-80 and, therefore, it was not proved that its financial position had become bad. He submitted that in view of this fact, the principle laid down by the Punjab and Haryana High Court in the case of Ferozepur Finance (P.) Ltd.''s case (supra) had no application to this case His further submission was that the IAC had also observed in his order for the assessment year 1978-79 that some of the loans taken by the assessee were being utilised for non-business purposes and, therefore, he argued, a part of the interest payable by the assessee on its own borrowings, in any case, required to be disallowed. He also argued that the Bhadohi Cold Storage and Carpet Traders were the sister concerns of the assessee, which meant that the directors of the latter were interested as partners in the former and, therefore, it was a colourable transaction not to have charged any interest. He argued that this fact by itself justified the disallowance of interest. He supported this submission by referring to the decision of the Allahabad High Court in Govan Bros. v. CIT [1963] 48 ITR 930. He also referred to two other cases, one of the Allahabad High Court in Balraj Virmani v. CIT [1974] 97 ITR 69 and the other of the Bombay High Court in CIT v. Confinance Ltd. [1973] 89 ITR 292.
10. We have carefully considered the submissions placed before us. We have already stated above that the orders of the lower authorities were set aside by the Tribunal mainly on the ground that the facts of the case were not clear and, therefore, it was not possible for the Tribunal to come to either conclusion. It was in this connection that the Tribunal had also suggested that it may also be found whether there was any agreement for charging of interest with the parties and whether the principle laid down by the Hon'ble Supreme Court in the case of Morvi Industries Ltd. (supra) applied to the case. This, therefore, makes it clear that the Tribunal did not lay down any conclusive test for deciding the issue by the Commissioner (Appeals). It only directed him to ascertain the full facts and follow certain guidelines. We are mentioning this fact to clarify the issue before us, which in our opinion, is open for a fresh decision by us.
11. We will then go into the facts of the case. A perusal of the accounts of the debtors makes it clear that their financial positions were certainly not good. The interest of Rs. 1,07,700 due from Bhadohi Cold Storage for the assessment years 1975-76 to 1977-78 remained unrecovered till the end of the assessment year 1980-81. This is an indication of the position. The advance to the above debtor stood at Rs. 2,51,840 as on 30-6-1976. It was Rs. 2,53,023 as on 30-6-1977 and increased to Rs. 3,08,599 as on 30-6-1978. We have examined the accounts of this year. It shows advances of small amounts in cash and by cheques. We have already stated above that these advances were made to enable the debtor to clear off its taxes and other liabilities, as the assessee wanted to take over this cold storage in satisfaction of its debts. The amount as on 30-6-1979 stood at Rs. 3,11,366. Similarly, the advance to Carpet Traders stood at Rs. 69,774 as on 30-6-1977. There was only a marginal change in this amount till 30-6-1979. In view of these facts, we do not agree with the submissions of the learned departmental representative that the financial position of the debtors could be held to be good, as canvassed by him before us. In this connection, we will refer to the two letters written by the assessee to the IAC. We have already pointed out that in both these letters it was emphasised that the financial position of the debtors had deteriorated to such an extent that even the recovery of the principal amount was in doubt and further that the assessee's board of directors had considered the proposal of taking over the cold storage from Bhadohi Cold Storage in discharge of its debt. These facts have not been controverted by the department at any stage. Our finding, therefore, is that the financial position of the debtors had certainly deteriorated and the recovery of even the principal amounts had become doubtful, leave aside the recovery of the interest.
12. We will now discuss the legal aspect of the case. In our opinion, the assessee's case is covered by the decision of the Punjab and Haryana High Court in Ferozepur Finance (P.) Ltd.'s case (supra) relied on by the learned counsel for the assessee before us. We are referring to this case in particular, as the department's application for leave to appeal to the Hon'ble Supreme Court was also rejected by the latter -- [1983] 144 ITR St. 50. It was held in this case that income-tax is levied on income, whether the accounts are maintained on mercantile system or on cash basis. If income does not result at all, there cannot be levy of tax. Even if an entry of hypothetical income is made in the books of account, where the income does not result at all, as there is neither accrual nor receipt of income, no tax can be levied. In this case also, the financial position of the debtor had become bad and there was no hope of recovery of even the principal amount and, therefore, it was not considered necessary to charge any interest and for that reason no interest was added to the amount due from the debtor during the relevant previous year. It was held that even in mercantile system of accounting, an assessee could forego the whole or part of a debt, which was irrecoverable and the same could not be added to the income of the assessee. Since it was not possible for the assessee to recover the principal amount from the debtor, the assessee was justified in not charging any interest thereon and the interest was rightly foregone by it. The Court held that the Tribunal, therefore, was right in deleting the addition of interest during the relevant accounting year on the amounts due from the debtor. In coming to this conclusion, the Tribunal relied on the decision of the Hon'ble Supreme Court in CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144.
13. The above principle is also supported by a decision of the Madras High Court in Motor Credit Co. (P.) Ltd.'s case (supra). In this case also, the financial position of the debtor had become bad. The assessee-com-pany, therefore, did not credit the interest on the outstandings from the debtors, even though it was adopting the mercantile system of accounting. It was held that the Tribunal was correct in its conclusion that though the assessee had adopted the mercantile system of accounting, no interest income could be assessed in its hands on accural basis as it would be very unrealistic on the part of the assessee to take credit for a highly illusory interest. In this connection, we will refer to the following observations :
... 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 affect the range of taxable income or 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 debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialised there can be no libility 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 his system of accounting. In the present case, the routes in which the buses of the two firms, P.N. Swamy Naidu and Prakash Transports were plying were taken over by the Cheran Transport Corporation Ltd. It is on account of the taking over of the routes by the Cheran Transport Corporation 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 proceedings against them. When the facts and 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 outstandings 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 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 outstandings in the two firms cannot be held to have accrued at the end of the accounting year. Viewed against the background of commercial and 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.... (p. 576)
14. The very same above principles were also enunciated by the Allahabad High Court in the cases of Cosmopolitan Trading Co. {supra) and Beni Prasad Sidh Gopal (supra). In the case of Cosmopolitan Trading Co. {supra), in one of the years, it was found that the financial position of the debtor had become bad and the assessee acted in response to the call of commercial expediency and sound business methods in changing over to the mercantile system of accounting insofar as the commission and interest receivable were concerned. It was held that the above finding could not be said to suffer from any error of law and, therefore, the decision of the Tribunal that the interest and commission due by the debtor could not be included in the income of the assessee, was correct.
In the case of Beni Prasad Sidh Gopal (supra), the Allahabad High Court held that mere entitlement could not result in income and, consequently, the interest and commission which was not actually realised, could not be assessed as income on accrual basis.
15. We will now refer to some of the cases which have taken a contrary view. The first case is of the Allahabad High Court itself, in Shiv Prasad Ram Sahai's case (supra) In this case, interest was not charged on the ground that the financial condition of the debtor had become bad. The ITO added the interest to the income of the assessee, which was upheld by the Tribunal. It was held by the High Court that the Tribunal had rightly held that the interest had accrued to the assessee during the previous year and was liable to be included in the assessee's total income. This decision was strongly relied on by the learned departmental representative. The same view has been taken by the Allahabad High Court in Balraj Virmani's case (supra). This case, of course, stands distinguished here as there was no finding that the financial condition of the debtor had become bad. It was only held that the income of an assessee had to be assessed according to the system of accounting followed by him. Therefore, where the assessee follows the mercantitle system of accounting, interest on loans accrued becomes assessable even if it has not been received. The same view was taken by the Bombay High Court in Confinance Ltd.'s case (supra). It may, however, be mentioned that in this case, there was no evidence to show that the interest in respect of the debits had actually been given up.
16. The fact that there is divergence of opinion on the issue, is clear that the Punjab and Haryana High Court in the case of Ferozepur Finance (P.) Ltd. (supra) had dissented from the decision of the Bombay High Court in Confinance Ltd's. case (supra). It is also noticed that the decision of the Hon'ble Supreme Court in Morvi Industries Ltd.'s case (supra) and of the Allahabad High Court in Shiv Prasad Ram Sahai's case (supra) were also referred to by the Madras High Court in Motor Credit Co. (P.) Ltd.'s case (supra). The Court, however, followed the principle laid down by the Hon'ble Supreme Court in Shoorji Vallabhdas & Co.'s case (supra).
17. It may be clarified here that practically all the above decisions relate to accrual of interest according to mercantitle system of accounting or in other words accrual of interest, as if there is an agreement for the same. The cases then dealt with the chargeability of such interest to tax. As noticed above, there is divergence of opinion by the Court on the issue. The Hon'ble Supreme Court in CIT v. Vegetable Products Ltd. [1973] 88 ITR 192 has held that if the Court finds that the language of a taxing provision is ambiguous or capable of more meanings than one, then the Court has to adopt that interpretation which favours the assessee. Respectfully following this principle, we have no alternative but to hold that the assessee cannot be charged on the interest which it has not debited to the accounts of the debtors on the ground that their financial position is bad. This principle will apply to both the above assessment years now under appeal before us.
18. Before we conclude this matter, we may deal with two other issues, which were canvassed before us by both the parties. The first was raised by the learned departmental representative that the non-charge of interest was a colourable and illusory scheme to reduce the tax liability. In this connection, he pointed out that the directors of the assessee-company were interested in the debtors as partners. In our opinion, there is hardly any merit in this contention at this late stage. No authority at any lower stage charged the assessee with entering into a colourable and illusory scheme to reduce its tax liability. It was at all stages admitted that the directors of the assessee were interested as partners in the debtor concerns, but then the case throughout was that the transactions were at an arm's length. Further, no evidence has been brought to our notice to come to any such finding. We, therefore, hold that the decision of the Allahabad High Court in Govern Bros', case (supra) has no application to the facts of the present case particularly when the issue is taken up only at our stage.
19. The other issue is raised by the Commissioner (Appeals). He has held that the interest had accrued up to 28-12-1977 in the case of Bhadohi Cold Storage which falls in the assessment year 1979-80. The accounting year of the assessment year 1979-80 ends on 30-6-1978. According to him, therefore, interest accrued for part of the year in the assessment year 1979-80 also. In our opinion, that is not a correct approach. The Hon'ble Supreme Court in ED. Sassoon & Co. Ltd. v. CIT [1954] 26 ITR 27 had held that the right to receive the commission (it would apply to interest also) would arise and the income, profits or gains would accrue only at the end of the calendar year which was the terminus a quo for making up of the accounts and ascertaining the net profits earned by the company. Such a terminus a quo in the case of the assessee is on 30-6-1978. The question of accrual of the interest before this date, therefore, does not arise, unless the accounts are made up on any particular date. There is no evidence in this case that the accounts of any party or of a debtor had been made up earlier to 30-6-1978. In that case, there is no question of accrual of any interest during the assessment year 1979-80, even in the case of Bhadohi Cold Storage. About the accrual of interest in the case of Carpet Traders, the principles, which we have already discussed above, will apply.
20. We, therefore, hold that no interest accrued to the assesse e either in the assessment year 1978-79 or in the assessment year 1979-80 (except the sum of Rs 4,500 already brought to tax in the assessment year 1978-79) from either Bhadohi Cold Storage or Carpet Traders, We, therefore, delete the additions of Rs. 37,776 in the assessment year 1978-79 and Rs. 10,500 and Rs. 21,060 in the assessment year 1979-80.
21. There is one more contention in the assessment year 1979-80 relating to disallowance of car expenses. The ITO disallowed Rs. 10,000 out of the claim of Rs. 89,226 on the ground that the car was also used by the directors for their personal purposes. This issue had also been set aside by the Tribunal for fresh consideration by the Commissioner (Appeals). The Commissioner (Appeals), while confirming the disallowance in principle, enhanced the disallowance to Rs. 17,845 following the finding in the assessment year 1978-79. In the assessment year 1978-79, there was disallowance of one-fourth of the expenses. The Commissioner (Appeals) brought the disallowance to this level in the assessment year 1978-79 also.
22. The assessee is now in appeal against the above finding. After hearing the parties, we find no justification for enhancing the disallowance. The IAC had disallowed only Rs. 10,000. Obviously, he was satisfied that the car was used only partly by the directors for which a disallowance of Rs. 10,000 was in order. The Commissioner (Appeals) had no evidence or material before him to take a different view and enhance the disallowance merely by following the disallowance in the earlier year. In the earlier year, the use of the car might be on a higher level. Each year is a different year and the use of the car might be more or less in different years. We, therefore, delete the disallowance of Rs. 7,845 also.
23. In the result, while the appeal for the assessment year 1978-79 is partly allowed, that for the assessment year 1979-80 is fully allowed.