INCOME TAX OFFICER v. KWALITY TRADERS
[Citation -1984-LL-0308-2]

Citation 1984-LL-0308-2
Appellant Name INCOME TAX OFFICER
Respondent Name KWALITY TRADERS
Court ITAT
Relevant Act Income-tax
Date of Order 08/03/1984
Assessment Year 1980-81
Judgment View Judgment
Keyword Tags mercantile system of accounting • cash system of accounting • method of accounting • trading transaction • hypothetical income • subsidiary company • loan transaction • mercantile basis • registered firm • managing agent • cash basis
Bot Summary: The ITO declined to accept the statement of the assessee stating that for the simple reason the loan did not become bad by the end of the financial year and the assessee was maintaining mercantile system of accounts and there was no reason not to charge the interest in terms of the agreement. According to the assessee, the assessee could employ different methods of accounting and the profit would be computed in accordance with the respective methods, while referring to the decisions in the cases of Fatehchand Chhakodilal v. CIT 1945 13 ITR 198, J.K. Bankers v. CIT 1974 94 ITR 107 and CIT v. E.A.E.T. Sundararaj 1975 99 ITR 226. T h e assessee's learned counsel further refers to the decision of the Hon'ble Bombay High Court in the case of H.M. Kashiparekh Co. Ltd. v. CIT 1960 39 ITR 706, in which, inter alia, it was held that the two rules that income-tax is annual in its structure, meaning thereby that for computation each year is a distinct self-contained unit, and the other that the income to be taxed is the real income of the assessee are not incompatible or irreconcilable and they permit of harmonious application. As pointed out on behalf of the revenue, in the relevant part of the return filed by the assessee, the method of accounting followed by the assessee for the year under consideration was mercantile. From the papers placed before us, it is seen that as per agreement made between the assessee and MPD Productions, the entire amount of Rs. 1,00,000 plus interest at the rate of 2 per cent would be repaid back to the 1,00,000 plus interest at the rate of 2 per cent would be repaid back to the assessee on or before 25-7-1979 or before release of the picture ' Chambal Ki Kassam ', whichever date is earlier. The facts before us are distinguishable, inasmuch as there is no material to say that the assessee has foregone or waived the interest due from the assessee as in fact the principal amount, though claimed to be in jeopardy, was realised subsequently. Under the managing agency agreement the commission was due to the assessee by the end of the accounting year and it was payable immediately after the annual accounts of the managed company had been passed in the general meeting, which was held subsequently, during which the assessee relinquished its commission on sales and office allowance because the managed company had been suffering heavy losses in the past years.


only ground of appeal in present departmental appeal is that AAC erred in deleting Rs. 21,500 added by ITO in respect of interest on loan advanced by assessee. assessee is firm consisting of two partners having equal shares. assessee was being assessed in status of registered firm and method of accounting was noted in assessment order to be mercantile. accounting period ended on 31-3-1980. ITO noted in assessment order that assessee disclosed income from commission and interest on loans and advances to various parties. He found that assessee advanced Rs. 1,00,000 to MPD Productions, distributor of films on 25-4-1979 and 20-5-1979 for Rs. 75,000 and Rs. 25,000, respectively. He observed that in terms of agreement, interest at rate of 2 per cent was payable by said concern to assessee. He found that assessee had not charged interest although assessee's system of accounting was mercantile. assessee explained that t h e money was advanced to MPD Productions, Bombay, against security of picture, ' Chambal Ki Kassam ' in eastern unit at rate of 2 per cent interest and, since picture was not released in eastern circuit due to bad picture, money was not realised and assessee did not know whether Rs. 1,00,000 would be realised at all and interest on loan was not credited in account. ITO declined to accept statement of assessee stating that for simple reason loan did not become bad by end of financial year and assessee was maintaining mercantile system of accounts and there was no reason not to charge interest in terms of agreement. Before ITO, copy of pleader's notice dated 10-5-1980 was produced, by which concerned parties were forbidden not to have any dealings with MPD Productions in respect of release of said picture till loan due to assessee together with interest were fully paid up. According to ITO, this pleader's notice had no relevancy at all. In circumstances, interest calculated at Rs. 21,500 was included in assessment. 3. assessee preferred appeal before AAC contending that when recovery of principal amount of loan itself was in jeopardy, there was no reason to show unreal income from interest every year. It was further stated that as debtor was unable to pay even principal amount, there was no question of receiving any interest from said debtor. It was also argued before AAC that assessee maintained cash system of accounts in connection with said loan transaction whereas in respect of other incomes of assessee, mercantile system of accounting has been followed. According to assessee, assessee could employ different methods of accounting and profit would be computed in accordance with respective methods, while referring to decisions in cases of Fatehchand Chhakodilal v. CIT [1945] 13 ITR 198 (Nag.), J.K. Bankers v. CIT [1974] 94 ITR 107 (All.) and CIT v. E.A.E.T. Sundararaj [1975] 99 ITR 226 (Mad.). It was also argued that it was quite evident that in connection with said loan, assessee maintained cash basis of accounts and that was why when no amount of interest was received, assessee did not show it in accounts. It was also submitted that if accounts were maintained on cash basis, income would be chargeable only when same was received, referring to decisions in cases of CIT v. Maharajadhiraja Kameshwar Singh of Darbhanga [1933] 1 ITR 94 (PC) and Raja Raghunandan Prasad Singh v. CIT [1933] 1 ITR 113 (PC), etc. 4. AAC considered arguments made on behalf of assessee. He found k force in those arguments. AAC further observed that in various decisions, it had also been decided that choice of method of accounting lics with assessee B.C.G.A (Punjab) Ltd. v. CIT [1937] 5 ITR 279, 299 (Lahore). He also noted that department was bound by assessee's choice of method of accounting which could not be rejected merely because it gives assessee some benefits in certain year--CIT/EPT v. Chari & Ram [1949] 17 ITR 1 (Mad.), Juggilal Kamlapat, Bankers v. CIT [1975] 101 ITR 40 (All.) and CIT v. K . Doddabasappa [1964] 54 ITR 221 (Mys.). AAC observed that in instant case, there was no doubt regarding fact that realisation of principal amount of loan had become very much doubtful and assessee n d gone to extent of taking legal help for realisation of principal amount and unless there was some doubt in realisation of principal amount, it was not expected of anybody that he would go to seek legal help. He also noted that since assessee was maintaining cash system of accounts in connection with this particular loan transaction (as is evident from fact that assessee stopped showing amount of interest as same was not realisable), AAC felt that unrealised interest should not be treated as income of assessee during year under consideration. He was, therefore, of opinion that alleged interest of Rs. 21,500 cannot be treated as part of taxable income of assessee. He, however, indicated that ITO would be free to tax same in year of actual receipt. Hence, this appeal before us by revenue. 5. It is urged by learned departmental representative that there was no justification for AAC on facts of case to delete above sum which was income of assessee from computation of income as made by ITO. It is vehemently urged on behalf of revenue that AAC acted erroneously in coming to conclusion that assessee was maintaining cash system of accounting in respect of loan transaction. It is pointed out before us that assessee in return of income for year at Annexure ' D ', in which certain particulars were to be furnished by assessee, has clearly indicated that method of accounting for year was mercantile. Photostat copy of that page of return is placed in our file. It is urged further that before ITO assessee never took plea that cash system was adopted in respect of loan transaction, as this would be contrary to facts of case. It is kly urged on behalf of revenue that assessee had been following mercantile system regularly and only for year under consideration, it was claimed for first time before AAC that cash system was followed in respect of that particular transaction and that too without any supporting evidence or materials. It is pointed out that ITO considered pleader's notice issued by assessee to debtor, which is stated to have been made after close of accounting year. It is pointed out that no step had been taken by assessee to recover loan as in fact loan had not become bad or doubtful as claimed before AAC. It is pointed out that in accounts of assessee, said loan of Rs. 1,00,000 was still shown as recoverable. It is, therefore, urged that it was not understood as to how assessee claimed that interest was not recoverable in spite of agreement made between parties. It is also urged on behalf of revenue that AAC has simply accepted statement of assessee without bringing any material fact or evidence on record. It is also pointed out that principal amount was actually realised subsequently, i.e., after accounting year. It is, therefore, submitted that all these facts would show that AAC has allowed appeal by assessee erroneously and, therefore, his order requires to be reversed and that of ITO may be restored. 6. assessee's learned counsel, however, resists submissions made on behalf of revenue contending that loan was given to above Bombay party in two instalments with stipulation that same would be returned within period of three months. According to him, entire loan was due to be repaid by 25-7-1979. It is urged that as per terms of agreement, debtor should have paid amount before date or before release of above film, whichever is earlier. It is stressed that as interest was not received, real income was not shown in return. In respect of declaration made by assessee in return that method of accounting during year was mercantile, it is urged that return form was filled up by employee, whereas in fact account in respect of loan transaction was maintained on cash basis. It is urged that even interest was not credited in accounts and same was not reflected in balance sheet. In fact, before us, arguments made before AAC are repeated and stressed on behalf of assessee. In course of his arguments, assessee's learned counsel refers to decision in case of CIT v. Ferozepur Finance (P.) Ltd. [1980] 124 ITR 619 (Punj. & Har.) in order to stress that if income did not result at all, there cannot be levy of tax and even if entry of hypothetical income is made in books of account, where income does not result at all as there is neither accrual nor receipt of income, no tax can be levied. It is further pointed out by assessee's learned counsel that in that decision, similar claim of assessee was allowed and departmental special leave application [SLP (Civil) No. 8158 of 1981] before Hon'ble Supreme Court was rejected as reported in 144 ITR St. 50. It is, therefore, urged that in view of this situation, claim of assessee was validly allowed by AAC. Further, reference is made to decision of Hon'ble Supreme Court in case of CIT v. Raman & Co. [1968] 67 ITR 11, in which, inter alia on facts of that case, it was held that law does not oblige trader to make maximum profit that he can out of his trading transaction and that income which accrues to trader is taxable in his hands. It was held that income which he could have, but has not earned, is not made taxable as income accrued to him. T h e assessee's learned counsel further refers to decision of Hon'ble Bombay High Court in case of H.M. Kashiparekh & Co. Ltd. v. CIT [1960] 39 ITR 706, in which, inter alia, it was held that two rules that income-tax is annual in its structure, meaning thereby that for computation each year is distinct self-contained unit, and other that income to be taxed is real income of assessee are not incompatible or irreconcilable and they permit of harmonious application. At time of hearing, assessee's learned counsel refers to various pages of paper book in order to stress stand taken by assessee before us. In brief, it is urged that on facts of case and in view of decision in various cases, claim of assessee was rightly allowed by AAC, whose order requires to be confirmed. 7. We have perused orders of authorities below along with other papers placed before us for our consideration. It is seen that ITO has given finding in assessment order that he declined to accept explanation of assessee for simple reason that loan did not become bad by end of financial year and assessee was maintaining mercantile system of account. However, before AAC, it was urged that assessee maintained cash system of accounting in respect of loan transaction. AAC accepted this part of argument of assessee. But he has not indicated on what basis, fact or material, above conclusion was arrived at. As pointed out on behalf of revenue, in relevant part of return filed by assessee, method of accounting followed by assessee for year under consideration was mercantile. contention of assessee before us is that form was filled up by advocate, who computed income. In our opinion, this stand of assessee cannot be accepted, as in declaration part of return, correctness, completeness, etc., of return has authenticated by assessee itself. 8. From papers placed before us, it is seen that as per agreement made between assessee and MPD Productions, entire amount of Rs. 1,00,000 plus interest at rate of 2 per cent would be repaid back to 1,00,000 plus interest at rate of 2 per cent would be repaid back to assessee on or before 25-7-1979 or before release of picture ' Chambal Ki Kassam ', whichever date is earlier. In agreement dated 26-5-1979, debtor also agreed to undertake that he would not release or caused to be released said picture until above principal and interest amount was fully and finally paid to assessee and above arrangement is stated to be irrevocable. But claim of assessee is that debtor was in bad financial position and in fact recovery of principal amount itself was in jeopardy. This, in our opinion, is only assertion of assessee. Assertion remains assertion. It has not been shown before us that financial position of MPD Productions was bad or MPD Productions itself was declared insolvent. That apart, in undertaking dated 26-5-1979, it was stated that arrangement was irrevocable. On other hand, assessee has placed letter of assessee dated 25-11-1982 in which debtor informed assessee that Damani Pictures (P.) Ltd., Calcutta (Distributors on behalf of MPD Productions) was instructed to make payment to assessee in full and final settlement of above loan taken including payment of principal amount and interest, etc. It was further stated that MPD Productions shall not be liable to make any further payment on account of interest, etc. According to assessee, amount of Rs. 1,00,000 was received from above distributors on 27-11-1982. But in spite of terms of undertaking noted earlier and in terms of agreement made between parties, it is seen that no further step was taken by assessee in this regard. 9. In books of assessee Rs. 1,00,000 was shown to be due as balance from MPD Productions even up to assessment year 1983-84, during which receipt of Rs. 1,00,000 on 1-12-1982 was noted. From copies of correspondences placed before us, it is seen that loan was recoverable during year and in fact same was subsequently recovered as discussed b y us above. In our opinion, ITO was justified in coming to conclusion that assessee had not shown said loan to be bad or doubtful during accounting year itself, as in fact loan was recoverable. In our opinion, facts relating to year under consideration should only be taken into account as far as income-tax matters are concerned. That apart, in instant case, there is no indication that debtor was in bad financial position. In case of Ferozepur Finance (P.) Ltd. relied on behalf of assessee, facts are completely different. Briefly speaking, facts of that case were that ITO called for explanation of assessee for not charging any interest on amount due from one party. It was claimed that financial position of that party was bad and there was no hope of recovery even of principal amount and, therefore, it was not considered necessary to charge any interest. ITO added interest at rate of 12 per cent in total income of assessee. On appeal by assessee, AAC sustained action of ITO. When matter was taken up before Tribunal (Chandigarh Bench), claim of assessee was allowed and addition made by ITO was deleted on basis that department did not seriously dispute fact that financial position of that debtor was weak. Tribunal took note of financial position of that debtor for those years and it noticed that there was sale of all properties of debtor in order to satisfy certain obligation, which would show that financial position of debtor was not sound. Ultimately, on facts of that case, Hon'ble High Court sustained decision of Tribunal in allowing claim of that assessee. facts before us are different. Apart from assertion that recovery of principal amount was in jeopardy, no material fact or evidence has been placed before lower authorities or before us. There is absolutely no basis for us to say that financial position of MPD Production was bad and, therefore, it would not be necessary also by assessee to show interest as income during year. 10. In case of H.M. Kashiparekh & Co. Ltd. relied on by assessee, facts were different. It was noted in that Bombay High Court case that under managing agency agreement, that assessee was under duty to forego up to one-third of its commission, etc., payable and, therefore, amount foregone by assessee could not be included in real income of assessee for accounting year. facts before us are distinguishable, inasmuch as there is no material to say that assessee has foregone or waived interest due from assessee as in fact principal amount, though claimed to be in jeopardy, was realised subsequently. In our opinion, assessee's claim on facts of case was wrongly allowed by AAC. 11. In this connection, we may refer to decision of Hon'ble Supreme 11. In this connection, we may refer to decision of Hon'ble Supreme Court of India in case of Morvi Industries Ltd. v. CIT [1971] 82 ITR 835, which was not considered by Hon'ble Punjab and Haryana High Court in case of Ferozepur Finance (P.) Ltd. Briefly speaking, facts of that case were that assessee, which was managing agent of subsidiary company, maintained accounts on mercantile system and it was entitled to receive office allowance, commission at rate of 12 1/2 per cent of net profit of managed company in addition to additional commission. During accounting year concerned, managed company suffered losses and assessee earned only commission on sale of cloth. Under managing agency agreement commission was due to assessee by end of accounting year and it was payable immediately after annual accounts of managed company had been passed in general meeting, which was held subsequently, during which assessee relinquished its commission on sales and office allowance because managed company had been suffering heavy losses in past years. Tribunal held that relinquishment by assessee after it had become due was of no effect. As result of relinquishment, financial position of managed company did not become ker while that of assessee-company became weeker and, therefore, relinquishment was not for benefit of assessee. On reference, High Court agreed with view of Tribunal. Hon'ble Supreme Court affirmed decision of Hon'ble High Court. Inter alia, it was also held that where accounts are kept on mercantile basis, profits or gains are accrued though they are not actually realised and entries those made really show nothing more than accrual or arising of said profits at material time. 12. Having regard to facts of case, as found by authorities below and as discussed by us above, and having regard to submissions made before us and in view of what we have discussed in preceding paragraph, we are of clear view that AAC erred in deleting addition made by ITO in respect of above sum of Rs. 21,500. In this view of matter, action of AAC cannot be sustained. His order is, therefore, reversed and that of ITO is restored. 13. In result, appeal by revenue is allowed. *** INCOME TAX OFFICER v. KWALITY TRADERS
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