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In the case of Commissioner of Income-tax Vs. Modi Rubber Ltd. (No.1) (230ITR817) the assessee sold goods on credit to a customer. The buyer did not promptly pay the sale price. On the amount outstanding the assessee-company raised a debit note for interest and taken such credit to the profit and loss account. The debtor did not honor the debit notes raised by the assessee-company. In the subsequent year amount was actually waived off by directors and therefore written off in the books. The Revenue relied on the majority judgment in State Bank of Travancore v. CIT [1986] 158 ITR 102. The Delhi High Court however followed the Supreme Court decisions in the cases of Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 and CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144 which laid down that if income does not result at all, there cannot be a tax, even though in bookkeeping, an entry is made about a “hypothetical income”, which does not materialize.

In Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 the Supreme Court examined the cash system and the mercantile system of accounting in the context of hypothetical income. The Court held that the computation of income is made in accordance with the method of accounting regularly employed by the assessee. It may be either the cash system where entries are made on the basis of actual receipts and actual outgoings or disbursements; or it may be the mercantile system where entries are made on accrual basis, that is to say, accrual of the right to receive payment and the accrual of the liability to disburse or pay. However, in both cases unless there is real income, there cannot be any income tax. Considering the facts before it, the court said that although the assessee-company was following the mercantile system of accounting and had made entries in the books regarding enhanced charges for the supply of electricity made to its consumers, no real income had accrued to the assessee-company in respect of those enhanced charges in view of the fact that soon after the assessee-company decided to enhance the rate, representative suits were filed by the consumers which were decreed by the court and ultimately, after various proceedings which took place, the assessee-company was not able to realise the enhanced charges. The court held that no real income had accrued to the assessee-company and hence the entries in respect of enhanced charges did not reflect the real income of the assessee and could not be brought to tax by the Income-tax Officer.

Immediately prior to that the Supreme Court in CIT v. Shiv Prakash Janak Raj & Co. Pvt. Ltd. (222 ITR 583) the Supreme Court inferred that the case laws on the subject of real income had always indicated that under mercantile system of accounting, accrual of income had involved tax liability. The fact, that such income was not realised later, is not a determining factor. In following their earlier ruling in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC) the Apex Court pronounced that where it is found that the assessee retains the right to recover such accrued income as at the end of the year, it cannot retrospectively claim that such income is not taxable.

In the Commissioner of Income-tax v. Bokaro Steel Ltd. (SC) the entry, which was initially made as interest was reversed in the next year because in fact the nature of the transaction was changed, and the assessee did not receive any real income. There was a resolution of the assessee-company in this regard and the income from interest did not result at all as the original agreement ceased to be operative ab initio. The entry in the books, which was made, was about a hypothetical income, which did not materialize, and the entry was reversed in the next year. Both the Tribunal as well as the High Court held that since this entry reflected only hypothetical income, it could not be brought to tax as income. Only real income can be brought to tax.

In another case of Saraswati Insurance Co. Ltd. v. CIT (252ITR430) the assessee made a waiver of interest in favour of its subsidiary. It claimed that it had not charged interest due to its financial condition. A resolution to this effect was passed a few days before the end of the previous year. In a total shift of stand the Delhi High Court followed the Supreme Court ruling in State Bank of Travancore case (supra) without acknowledging their stand taken in the past (Godhra case as per supra). The High Court reiterated the eight parameters laid down in this regard by the Apex Court in 158ITR102 (supra).

Thus there is a very thin line between the accrual of income and accrual of real income. One has to take a very cautious and proactive measure to convert an accrual of income into no income situation.

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