Madras High Court
Commissioner Of Income-Tax vs Tamil Nadu Small Industries ... on 23 November, 1998
Equivalent citations: [2000]246ITR110(MAD)
Author: R. Jayasimha Babu
Bench: R. Jayasimha Babu
JUDGMENT R. Jayasimha Babu, J.
1. The assessee is a company fully owned by the Government of Tamil Nadu, The object of the assessee-company is to help the rapid industrialisation of the State of Tamil Nadu, especially to establish small industries all over the State of Tamil Nadu. It provides financial assistance to small industries in the form of loans at concessional rates of interest. The agreement between the assessee and its borrowers provided for payment of interest on the amount so advanced as also payment of penal interest in case of failure to pay interest in the manner and within the time permitted under the contract between the parties.
2. For the assessment year 1979-80 as also for the year 1980-81, the Income-tax Officer added a sum of Rs. 27,87,113 and Rs. 25,04,368, respectively, to the income of the assessee as the amount of penal interest on over due instalments of loan repayable by the borrowers, but for which no credit in the profit and loss account has been given by the assessee. The method of accounting followed by the assessee, on its own showing, for all the earlier assessment years was the mercantile system of accounting. For these two years, it was the claim of the assessee that the penal interest had not been collected and had not been taken into account in the profit and loss account statement. The amount of the penal interest was however set out in a note in the annual report of the company. The note so made in the balance-sheet relevant for the assessment year 1979-80 reads as under:
"Penal interest on the instalments due but not collected before March 31, 1979, in respect of loan granted and hire purchase instalments has not been taken into account. Such penal interest amounts to Rs. 27,87,113 (previous year Rs. 14,92,749)".
3. The assessee's appeal to the Commissioner having been unsuccessful, the assessee filed a further appeal before the Income-tax Appellate Tribunal. It was contended by it before the Tribunal that the assessee was following the mercantile system of accounting up to the assessment year 1973-74 ; that during the previous year ended on March 31, 1974, for the relevant assessment year 1974-75, the assessee-company had changed its method of accounting from the mercantile system and adopted a hybrid system from that year ; that though it had not changed the system of accounting from the mercantile system to the cash system, it had started making a note in the annual report without passing any entries in its books of account in respect of the interest on loans and H. P. instalments from the year ending March 31, 1974. It was also the stand of the appellant that the Comptroller and Auditor-General of India had approved that method of accounting by certifying the correctness of the balance-sheet and profit and loss account.
4. It was not disputed before the Tribunal, as indeed it could not be, that for all the assessment years preceding the assessment year 1979-80, the penal interest though not shown in the profit and loss account, had been treated for the purpose of assessment under the Income-tax Act as forming part of the assessee's income, the same having accrued to the assessee, during the relevant previous years in view of the fact that the assessee had been following the mercantile system of accounting,
5. It may be noticed at this stage that in tax references arising out of the order of the Tribunal for the earlier assessment years, this court in T. C. No. 1102 of 1983 (Tamil Nadu Small Industries Development Corporation Ltd. v. CIT [2000] 242 ITR 122, decided on February 17, 1998) for the assessment year 1977-78 held that the assessee was following the mercantile system of accounting and that the penal interest having accrued to the assessee during the previous year relevant to that assessment years, the same formed part of the total income for the purpose of taxation.
6. In T. C. No. 1115 of 1985 (Tamil Nadu Small Industries Development Corporation Ltd. v. CIT [2000] 243 ITR 823, decided on February 27, 1998), similar findings were recorded for the assessment year 1978-79. For the assessment years 1974-75, 1975-76 and 1976-77 also, it is submitted by counsel at the Bar that there were references to this court with regard to the same, that the Tribunal had held that penal interest and accrued interest were to be treated in similar manner for the purpose of taxation and that this court held that they were to be so treated and penal interest must be held to have accrued to the assessee in the previous year relevant to the assessment years, as the assessee was following the mercantile system of accounting.
7. The argument similar to the one advanced before the Tribunal on behalf of the assessee for those two years, had been advanced before the Tribunal in the appeal for the assessment year 1978-79 also and such argument had been rejected by the Tribunal. As mentioned earlier, the reference arising from that order was answered in favour of the Revenue by this court in T. C. No. 1115 of 1985, decided on February 27, 1998.
8. The Tribunal despite the fact that for all these assessment years, it had itself found that the penal interest had accrued having regard to the mercantile system of accounting that was being followed by the assessee, it has held that the penal interest did not accrue to the assessee in the previous year relevant to these two assessment years, as the system of accounting followed in respect of penal interest was the cash system. While so holding, it had relied upon the notes to the balance-sheet for the year relevant to the assessment years. The Tribunal's finding rested on the fact that the amount of penal interest had not been brought into the profit and loss account and the fact that in the note included in the annual report, it had been mentioned that such penal interest had not been taken into account, though the amount was quantified and set out.
9. Learned counsel for the Revenue submitted that the findings so recorded by the Tribunal are wholly unsustainable in law as the assessee had consistently followed the mercantile system of accounting, and it was immaterial as to whether the accrued penal interest was not shown in the profit and loss account, as the taxability of the income is not dependent upon the assessee's decision as to whether or not to disclose the same in the profit and loss account. Counsel relied upon the decision of the Supreme Court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102, wherein it was held that though the interest on sticky advances was not taken into the profit and loss account of the bank but was entered in a separate book under suspense account, such interest having accrued, the same was required to be treated as part of the income of the bank.
10. Counsel also submitted that there was nothing to show that the assessee had changed the system of accounting from mercantile to cash system. The plea of the assessee before the Tribunal also was not that there was a change in the system of accounting during the previous year relevant to the assessment year. The alleged change in the manner of treating the penal interest though said to be from the year 1974, for all the assessment years from 1974-75 to 1978-79 such penal interest had in fact been treated as having accrued and had been taxed as such, references made to this court also having been answered in favour of the Revenue. Having regard to the finding of this court in the earlier references that the assessee had throughout been following the mercantile system of accounting, and in the absence of anything to show that that system of accounting had been given up, and a different system had been adopted during the previous year relevant to the assessment years, the assessee's claim to treat the penal interest in a different manner cannot be accepted in law.
11. Counsel also invited our attention to the decision of the Allahabad High Court in the case of Shiv Prasad Ram Sahai v. CIT [1966] 61 ITR 124, wherein that court held that in the absence of direct authority, but on the first principles it is clear that once the assessee had adopted the mercantile system of accounting, there is no alternative for the Income-tax Officer but to compute the assessee's income on that system, i.e., on the accrual and not the receipt basis. It was also held that though the choice is entirely that of the assessee, the assessee having chosen one method, the assessee cannot unilaterally refuse to follow that system in respect of a particular transaction.
12. Learned counsel for the assessee, on the other, submitted that it was open to the assessee to treat the penal interest in a manner different from its other income and the fact that it had adopted the mercantile system of accounting did not have the effect of preventing the assessee from adopting a different system for certain, transactions and a hybrid system of accounting is permissible in law. Counsel relied on the decision of the Bombay High Court in the case of CIT v. Citibank N. A. [1994] 208 ITR 930 wherein it was held that the fact that the assessee in that case for its convenience kept a separate note of those parties in whose case the mercantile system of accounting had not been followed, and the interest on the amounts due from them had not been debited to their accounts, could not in any way militate against the fact that the assessee was not following the mercantile system of accounting in respect of the loan in question. The system of accounting followed in respect of interest on such loans was in fact the cash system. The court found that the Income-tax Officer had been accepting the system of accounting and that such system of accounting has been the proper method of accounting in the past. The assessee therein was following a policy of classifying the loans into ordinary loans and problem loans. The loan account in respect of which interest payments were not received for a period of 180 days or more and in respect of which, the principal amounts were in jeopardy were placed on non-accrual basis in the books of account of the assessee and the interest thereon was not debited in the books to such accounts or credited to the profit and loss account. If any interest recorded in the memorandum record was subsequently received by the assessee, it was taken into account as interest received. The court held in that case that, besides the mercantile and cash system of accounting, there are other methods commonly known as hybrid system of accounting, and that the assessee followed the hybrid system of accounting. The Income-tax Officer in such cases, it was held, has the power under the proviso to Section 145(1) of the Act which permits him on being satisfied that the method employed by the assessee is such that its income cannot be properly deduced therefrom, to compute his income upon such basis and in such a manner as he may determine.
13. Counsel for the assessee also placed reliance on the decision of this court in the case of CIT v. Jayalakshmi Trading Co. [1995] 214 ITR 660. In that case, the court held that the income which can be included for the purposes of taxation is only the income which has really arisen or accrued. In a case where the assessee had followed the same system of accounting" throughout the years, and where the Assessing Officer has no difficulty in ascertaining the correct income of the assessee for those earlier years, it could not be held that the true profit and loss account cannot be ascertained from the method of accounting followed by the assessee in the accounting years relevant to the assessment years.
14. In this case, there can be no doubt about the fact that the system of accounting adopted by the assessee is the mercantile system for all the assessment years till 1978-79. The claim made for the subsequent assessment years 1979-80 and 1980-81 that the assessee had in respect of penal interest alone adopted the cash system of accounting, in the circumstances, cannot be accepted as even according to the assessee the cash system of accounting had been adopted by it from the year 1974-75. For the assessment years 1974-75 to 1977-78, it has been held by this court in the earlier references that the method of accounting adopted by the assessee was the mercantile system and that penal interest has accrued in those years.
15. There was no change in the system of accounting followed by the assessee during the years relevant to the assessment years 1979-80 and 1980-81. The manner in which the penal interest was treated in the assessment years 1974-75 to 1977-78 is also the manner in which it is required to be treated for the assessment years 1979-80 and 1980-81.
16. The system of accounting must disclose the true extent of the income. The systems of accounting are many. The cash system and the mercantile system being the two common systems of accounting are followed. An assessee may choose to follow a hybrid system of accounting. The assessee cannot however even while following the mercantile system over the years, choose to make a claim with respect to one type of transaction alone, that the system of accounting followed in the year is not the mercantile system but the cash system, especially when even according to the assessee, the change was not effected in the previous year relevant to the assessment year but several years prior thereto and in those earlier years, it had been found that there was only one system of accounting followed by the assessee.
17. The fact that the assessee had not included the amount of penal interest in the profit and loss account does not, on that score alone, render this amount incapable of being part of the assessee's income during the years relevant to these assessment years. Having regard to the method of accounting that had been followed by the assessee, which was mercantile, interest that had accrued was necessarily to be regarded as part of the income of the assessee.
18. The penal interest moreover is of the same character as interest. Penal interest becomes payable on account of the delay in payment of the interest and the interest is treated on accrual basis. It is difficult to find justification in law for treating the penal interest in a different manner--the two go together.
19. The Tribunal, therefore, was in error in holding that the assessee was employing the actual receipt basis or cash system of accounting in respect of the penal interest, and deleting the addition of penal interest amount of Rs. 27,87,113 in 1979-80 and of Rs. 25,04,368 in 1980-81 as not liable to tax in the hands of the assessee-company. The question referred to us is therefore answered in favour of the Revenue and against the assessee.