Arijit Pasayat, C.J. 1. At the instance of the Revenue, the following questions have been referred to this court under section 256(1) of the income-tax Act, 1961 (in short, "the Act"), by the Income-tax Appellate Tribunal, Cochin Bench (in short, "the Tribunal") :
"(1) Whether, on the facts and in the circumstances of the case and also going by the test of prudence and human probabilities, the Tribunal is right in law and fact in holding that the entries evidencing the payment of interest and deposit of interest in the loan account of the minor in instalments cannot be dismissed as mere journal entries or book entries and is not the above finding wrong and against realities ?
(2) Whether, on the facts and in the circumstances of the case, is not the so called transactions of payment of interest, deposit of interest in the loan account of the minor hit by the provisions contained in section 40A(3) of the Income-tax Act ?
(3) Whether, on the facts and in the circumstances of the case :
(a) the payment of interest in cash was justified under rule 6DD(j) of the Income-tax Rules ?
(b) the circular relied on by the Tribunal has application to the facts of the case ?"
2. It is to be noted that the prayer in respect of some other issues was not acceptable.
3. The factual position, as delineated in the statement of the case, runs as follows : The assessee is a partnership firm carrying on business as money lenders. It has been crediting interest at the rate of 18 per cent, per annum in the interest account on the loans advanced. In view of the provisions of the Kerala Money Lending Act (in short, "the Money Lending Act"), excess interest collected was credited into the partners' account and the same was included as income of the assessee in the return filed by it. In the course of the assessment proceedings for the assessment year 1990-91, the Assessing Officer made enquiries with five parties, who had taken loans from the assessee. He found that they had paid interest at the rate of Rs. 2.50 per Rs. 100 per month, which worked out to interest of 30 per cent, per annum. Taking the said rate of interest, the Assessing Officer made an addition of Rs. 1,94,217 for the assessment year 1990-91 to the income disclosed. Though no such enquiries were made for the other two assessment years, viz., 1989-90 and 1991-92, he was of the view that the assessee must have charged interest at 30 per cent, per annum and made an addition of Rs. 2,93,911 for the assessment year 1991-92, the period to which this petition relates. In first appeal, the Commissioner of Income-tax (Appeals) (in short, "the CIT(A)") did not find substance in the asses-see's contention that enquiries made with five borrowers could not be used against it in respect of other borrowers and for a period other than the assessment year 1990-91. He was, however, of the view that the statement of five persons from out of a large number of borrowers could not be sufficient to warrant the estimate of income at 30 per cent, per annum on all advances. He directed the Assessing Officer to compute interest at the rate of 27 per cent, per annum on all advances. As the assessee had offered income at the rate of 24 per cent., a direction was issued to make addition to the extent of 3 per cent. The Tribunal deleted the addition on the ground that in the absence of independent enquiries, the addition could not be sustained for the assessment year 1991-92 merely because of some enquiries relating to the assessment year 1990-91. The same was treated to be a finding of fact. A reference sought for by the Revenue as noted above was held to be not acceptable in relation to that issue. For the relevant assessment year, it was found that in the central books of account of the assessee, a sum of Rs. 10,60,000 was debited to interest account as interest paid to Ms. Anna Thomas, minor daughter of partner, Shri George Thomas. This payment was recorded on March 30, 1991, not in a single sum. but in several sums on the same day as follows :
(a) Rs. 2,60,000
(b) Rs. 4,00,000
(c) Rs. 4,00,000
4. Against each payment, Ms. Anna Thomas' account stood credited for the corresponding sum. The Assessing Officer was of the view that these were mere book entries not representing any cash outlay, and as the assessee was maintaining books on cash basis, it could not be said that the assessee had paid interest to Ms. Anna Thomas in the above manner to the extent of Rs. 10,60,000. It was held that there was no genuine payment of interest to be allowed as a deduction in computing the assessee's income with the accounts maintained on cash basis. The Assessing Officer also held that the payment was hit by section 40A(3) of the Act as the claim was regarding payment in cash in excess of Rs. 10,000. The Commissioner of Income-tax (Appeals) affirmed the conclusions. In second appeal, the Tribunal observed as follows :
"Merely because the entries were passed representing the payment of interest and redeposit of such interest, it cannot be said that the assessee was claiming the interest payment on mercantile basis unless it is shown that the impugned amounts have become legally due to the payees. This has not been established. Therefore, we hold that the entries passed by the assessee in its books do not partake of the nature of mercantile system of accounting, in the light of the pronouncements of the apex court.
15. This takes us to examine whether there has been cash payment of interest to the assessee. It is in this context that the submissions of Shri Srinivasan, the learned chartered accountant, acquire significance. The person to whom the interest is paid is none other than the minor daughter of a partner of the firm, who has a share of interest in the business of the firm. As a father, he is the natural guardian of the minor daughter. Therefore, he was within his authority to receive the payment and to redeposit the same with the firm. If he had not redeposited the interest, the Revenue would not have possibly any objection against the payment of interest. But it is remembered that the person receiving the payment on behalf of a minor was competent to act on her behalf in a manner not prejudicial to the interest of the minor it can be very well said that there is no bar for the guardian to redeposit the amount with the firm with which he is associated. Such deposit or redeposit was only in the account of the minor and not in his personal account. Therefore, merely because the depositing of the interest either preceded its payment or succeeded its payment, it cannot be said that there had been no movement of cash.
16. The next objection of the Revenue is that because there was no adequate cash balance, the payments were made in instalment basis in smaller sums though aggregating to Rs. 10,60,000, and if the available cash balance is taken into account, the assessee could not have paid the interest in an extent of Rs. 10,60,000. We have carefully considered the objection of the Revenue. If the aggregate of the cash balance in a sum of Rs. 5,83,283.56 is taken into account together with the outgoings in respect of other persons or parties effected during the day and the closing balance as at the end of the day is taken into account, the assessee could not have made the payment of interest in a sum of Rs. 10,60,000 but the assessee could have only effected the payment in an extent of Rs. 4,28,948.20. In order to avert such a contingency, the assessee has paid the amounts in instalments and the partner acting on behalf of the minor daughter has received the amounts in instalments. The amounts thus received were redeposited then and there, thus enabling the assessee to make the payment of interest of Rs. 10,60,000. To make payments of interest in instalments keeping an eye on the cash balance and to receive back the interest as deposit in the loan accounts are (not ?) prohibited transactions in the commercial parlance. It only represents efficient cash management, it cannot be considered as a tax avoidance scheme because the interest received by the minor daughter has been admitted in her return of income, and the interest payment was for the use of the funds deposited with the assessee. Therefore, we hold in the facts of the case, that the entries evidencing the payment of interest and deposit of interest in the loan account of the partner cannot be dismissed as mere journal entry or book entries.
17. The next objection of the Revenue that the payment of interest in excess of Rs. 10,000 has been made in cash to Miss Thomas, the minor daughter of the partner and, therefore, the provisions of section 40A(3) stood attracted. This line of stand of the Revenue conflicts with its earlier stand that there has been no genuine payment of interest. Perhaps the provisions of section 40A(3) were invoked as an additional ground to support the disallowance made earlier. It is not in dispute that the minor daughter to whom the interest was paid did not have any bank account. Circular No. 220 (see [1977] 108 ITR (St.) 8), dated May 31, 1977, issued by the Central Board of Direct Taxes states that if the payments are made on a bank holiday, it would be an exceptional or unavoidable circumstance within the ambit of clause (j) of rule 6DD relevant to the provisions of section 40A(3) of the Act. It has been admitted before us that March 30, 1991, the day on which the transactions took place in cash happened to be the last working day of the accounting year of the banks and, therefore, it was a bank holiday and no business was transacted on that date. In the circum-
stances, the payment of interest in cash in excess of Rs. 10,000 in the case of the assessee in a sum of Rs. 10,60,000 was justified under rule 6DD(j) of the Income-tax Rules. Hence, disallowances cannot be made under section 40A(3) of the Act. Disallowance of interest is deleted."
5. According to learned counsel for the Revenue, the entries were in the nature of debits and credits, and physical movement of cash was not there. The assessee did not have adequate cash balance to make payment. That is why, disallowances were made. There was, in fact, no genuine interest payment. Though the payee has admitted interest to have been received, in her income-tax return, the amount of interest was shown to be below the taxable limit. The assessee was following the cash system of accounting and was not following the mercantile system of accounting. Therefore, the Tribunal was not justified in its conclusion.
6. Learned counsel for the assessee, on the other hand, submitted that by effective cash management, the transactions have been done and there is nothing illegal in it. As has been rightly observed by the Tribunal, the father of the minor, who was a partner, was within his authority to receive payment and to redeposit the same with the firm.
7. The first question that arises for determination is whether the assessee, who was maintaining the cash system of accounting, could claim interest payment on the mercantile system of accounting. In Morvi Industries Ltd. v. CIT [1971] 82 ITR 835, the apex court had an occasion to deal with the system of accounting. It was observed that there is a basic difference between the cash system and the mercantile system of accounting. Under the former system, it is only actual cash received and actual payments which are recorded as credits and debits, whereas under the latter system, credit entries are made in respect of the amounts due immediately they become legally due and before they are actually received. Similarly, the expenditure items, for which legal liability has been incurred, are immediately debited even before the amounts in question are actually disbursed. Under the latter system, the profits and gains are credited though they are not actually realised and the entries thus made really show nothing more than an accrual or arising of the same at the material time. It is to be noted that the Tribunal observed at one place that merely because the depositing of interest either preceded its payment or succeeded its payment, it cannot be said that there had been no movement of cash. The Tribunal held that merely because the entries were passed representing the payment of interest and redeposit of such interest, it cannot be said that the assessee was claiming the interest payment on mercantile basis, unless it is shown that the impugned amounts have become legally due to the payee, and the same has not been established. It is not the case of the assessee that something was being paid which was not due. The onus was on the assessee to show it. It is not clear from the order of the Tribunal as to who, according to it, was to establish the same. As payment has been made and claimed as expenditure, the assesses was required to show how it was not due. The Tribunal has not discussed this aspect. It is not the definite case of the assessee, as has been conceded by learned counsel for the assessee, that there was physical disbursement of cash. The Tribunal itself, in the portion quoted above, had observed that the entries were representing the payment of interest and redeposit.
8. Learned counsel for the assessee submitted before us that even if no cash payment was actually made and there were mere book entries, it would not make a difference. Reliance was placed on a decision of the apex court reported in Badri Prasad Jagan Prasad v, CIT [1985] 156 ITR 430. Physical cash did not actually pass to the minor or someone else. It has to be kept in mind that the availability of cash was much less than the payment of interest shown. If the plea is accepted in a hypothetical case with a cash balance of Rs. 100, interest payment of a crore rupees can be claimed. Going by the views recorded by the Tribunal, the assessee could have made payment to the extent of Rs. 4,28,948.20 as against the claim of Rs. 10,60,000.
9. A few factors, which throw considerable light in the factual aspects, need to be noted, so far as the dispute regarding section 40A(3) is concerned. The extract of the cash book filed shows that there was really no necessity for the assessee to take money from Anna Thomas. The opening balance of cash on March 30, 1991, was Rs. 1,34,283.56. The first receipt of Rs. 2,60,000 was shown from Anna Thomas. An identical amount was shown as interest given to her. The total expenditure made excluding the payments made to Anna Thomas was Rs. 1,57,681.85. In addition to the opening cash balance of Rs. 1,34,283.56, a sum of Rs. 1,15,151.80 was shown to be available from the Alleppey branch, which was sufficient to meet the expenditure. Further, apart from the amount of Rs. 2,60,000, which was shown to have been received from Anna Thomas for the purpose of making payment to her, there were two other entries of receipts and payments each of Rs. 4,00,000, as amount received from Anna Thomas and the amount paid as interest to Anna Thomas. All these lead to only one conclusion, i.e., there was actually (no ?) need for taking money from Anna Thomas and paying it back to her. According to learned counsel for the assessee, the interest amount was required by Anna Thomas and, therefore, it was paid to her. This plea gets falsified in view of the explanation given at the time of assessment, which, inter alia, reads as follows :
"It is not correct to state that interest has been provided in the case of Anna Thomas. Merely because her account is credited with interest would not lead to the conclusion that interest has been provided, In fact, whatever interest has been paid to Anna Thomas, has been returned by Anna Thomas to the firm since if was not immediately required by her, so that such interest would also earn further interest in the ensuing years."
10. A claim of payment of interest, as the factual position would go to show, is deviced in a novel way of redeposit of payment.
11. Further, if the Revenue's stand is accepted, there was no payment by cash and there were mere book entries. Alternatively, section 40A(3) is pressed into service. One thing is crystal clear that if cash payment is not there, section 40A(3) will have no application. Then the question of urgent need to attract exclusions enumerated in rule 6DD has to be considered. If there is no urgent need, desirability of making payment by the prescribed modes has to be adjudicated.
12. We are of the considered opinion that the factual aspects have not been considered by the Tribunal in the background of the relevant statutory provisions and applicable principles. This is a fit case where the Tribunal is to rehear the case on the merits and deal with the points involved afresh. We, therefore, do not answer the questions referred.
13. The reference application is accordingly disposed of.