JUDGMENT M. Katju J.
1. Heard learned counsel for the parties. These two income-tax appeals under Section 260A of the Income-tax Act, 1961, are being disposed of by a common judgment.
The questions of law involved in these two appeals are as follows :
"(i) Whether, in the facts and circumstances of the case, the receivable amount of interest which has been credited by the assessee-appellant to the account, named as 'Deferred credit interest on overdue interest bills account and debited to the account named as 'Deferred credit interest receivable account' was merely hypothetical income and not real income of the assessee-appellant and was taxable under the Income-tax Act, 1961 ?
(ii) Whether, the Income-tax Appellate Tribunal erred in law in appreciating and applying the correct concept of real income (either actually received or accrued), as laid down by the Supreme Court in various cases to find out the taxability of the aforesaid amount under the Income-tax Act, 1961 ?"
2. These two appeals relate to the assessment years 1990-91 and 1991-92. The facts of the case as alleged by the assessee are as follows :
The assessee is a company and is a wholly owned Central Government undertaking. It has been incorporated with the object of improving the economic lot of weavers by development and promotion of handloom in the country. The main activity of the assessee consists of supply of handloom inputs (i.e., yarns, dyes, chemicals, etc.), to various handloom agencies and apex societies (hereinafter called user-agencies) throughout the country at a reasonable rate. These inputs are supplied against confirmed orders. The assessee sends those orders to the producers/suppliers of inputs who directly despatch the items to the user-agencies who have placed the orders. The producers and suppliers of these inputs send their bills for the supplies to the assessee and not to the user-agencies. The assessee, in turn, draws bills against the user-agencies and sends them for payment to it (assessee). The assessee gets only a commission, either in the form of subsidy from the Central Government or from the user-agencies for the suppliers made through it. The bills are paid by the user-agencies to the assessee. There is no agreement with the user-agencies either in respect of the period within which the bills are to be paid by them or interest to be paid by them for the delay in the payment of the bills. However, there is an informal practice that the user-agencies are supposed to pay the bills within thirty seven days, though there is no agreement or stipulation between the assessee and the user-agencies for payment of interest on the amount of the bills for the period beyond thirty-seven days. However, in the bills drawn by the assessee, which are printed, it is mentioned on the back side "interest will be charged at the rate of 17.5 per cent. per annum on over due amount". The assessee has printed this note unilaterally and not on the basis of any agreement. It is to be noted that the bills do not specify the due date for payment, although there is a column to mention the due date of payment. The printed bills, which contain the aforesaid condition for payment of interest, are sent to the user-agencies without any prior stipulation or agreement for payment of the same. There is no acknowledgment or acceptance of the above printed note on the bills by the user-agencies. Many times the request for payment is wholly denied or disputed by the user-agencies.
3. The assessee maintains its accounts according to the mercantile system. As regards the interest, it is alleged by the assessee that it does not have any legal or customary right enforceable against its customers for recovery of interest. The assessee does not, and cannot, debit the same to the account of the user-agencies from whom it may be received on account of delay in payment. In fact, no entry is made with regard to such interest during the currency of the year. At the end of the year such interest, which is not received but the assessee thinks might be receivable from the user-agencies, is totalled. For making entries of this amount, the assessee has opened two accounts in its ledger : (1) "Deferred accrued interest" ; and (2) "Deferred accrued interest receivable". The aforesaid interest, which is not received and is only treated as receivable, is credited to the aforesaid account, namely, "Deferred accrued interest" and, according to the mercantile system of accounting, its corresponding entry is debited to the account, namely, "Deterred accrued interest receivable". The assessee makes the entries in such manner so that its accounts may not reflect non-existent income (cash or accrued) and may not give an incorrect picture of inflated profit. As regards the interest, which is received during the year, it is credited to the account under the heading "Interest from parties on overdue bills" in the profit and loss account. It becomes a taxable income of the assessee and is offered by the assessee to be taxed.
4. The assessee credited an amount of Rs. 1,69,14,552 to the account of "Deferred accrued interest" in the assessment year 1990-91. Similarly, an amount of Rs. 1,97,39,358 was credited to the same account in the assessment year 1991-92. These amounts were not included by the assessee in its taxable income because they were neither real nor accrued income of those assessment years. As regards as the amount of interest actually received in the two assessment years, it was treated by the assessee to be its income, and offered for taxation.
5. The Assessing Officer in both the years treated the credited amount of Rs. 1,69,14,552 and Rs. 1,97,39,358 credited to the account of "Deferred accrued interest", to be income of the assessee for the two years. The assessee filed appeals against these orders before the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal but could not succeed. Hence, these appeals before this court.
6. The question is whether the aforesaid amounts of Rs. 1,69,14,552 and Rs. 1,97,39,358 credited to the account of "Deferred accrued interest" in the two years, are the taxable income of the assessee.
7. In our opinion, they are not, and hence these appeals deserve to be allowed. It may be noted that there was no stipulation or agreement between the assessee and the user-agencies to pay any interest. The user-agencies were not under any legal obligation to pay any interest. The assessee never debited that amount of interest to the account of the user-agencies. The amount of interest never became a debt due from the user-agencies to the assessee. The assessee unilaterally, of its own accord, quantified the total amount of interest, which it thought to be receivable to it in those two years at the end of the year, credited it to the account of "Deferred accrued interest" and as stated above, debited it to the account of "Deferred accrued interest receivable". The assessee did not debit any interest to the account of any of the user-agencies nor credited it to any account to treat it as accrued income. Hence, in our opinion, the aforesaid amounts do not represent either the accrued income or real income of the assessee. The Tribunal has treated the aforesaid amounts to be the income of the assessee on the ground that "The assessee has himself kept the issue of interest alive in the form of deferred interest liability; the assessee has not accounted the same as per amended provision of the Companies Act." The Tribunal has further observed "nothing prevented the assessee to write off the interest which was not forthcoming and to disclose subsequently in part/whole of it if received in the subsequent years as per the mercantile system of accounting". The Tribunal relied upon the judgment of the hon'ble Supreme Court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102.
8. It is well settled that income cannot be generated, actual or accrued, by mere entries in the accounts of the assessee. Further, income cannot be said to be generated merely because the assessee has not written off the amount of interest, which was not forthcoming. The decision in State Bank of Travancore v. CIT [1986] 158 ITR 102 (SC), which has been relied upon by the Tribunal has not been followed and has not been treated to be the correct enunciation of law in the judgment of the Supreme Court in the case of Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 and UCO Bank v. CIT [1999] 237 ITR 889, 900. The case of State Bank of Travancore v. CIT [1986] 158 ITR 102 (SC) has also been distinguished in the case of Keshavji Ravji and Co. v. CIT [1990] 183 ITR 1 (SC). In our opinion, the case of the assessee is directly covered by the judgment of the Supreme Court in the case of Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 in which the Supreme Court referred to its earlier decision in CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144, 148 in which it was observed (page 757 of [1997] 225 ITR) :
"'Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping an entry is made about a hypothetical income, which does not materialise."
9. The Supreme Court in Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 also quoted with approval the following observation in Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521, 530 (page 757 of [1997] 225 ITR) :
"'Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act." In Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746, the Supreme Court observed (page 760) :
"The question whether there was real accrual of income to the asses-see-company in respect of the enhanced charges for supply of electricity has to be considered by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light, it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the Income-tax Officer while passing the assessment orders in respect of the assessment years under consideration. The Appellate Assistant Commissioner was right in deleting the said addition made by the Income-tax Officer and the Tribunal had rightly held that the claim at the increased rates as made by the assessee-company on the basis of which necessary entries were made represented only hypothetical income and the impugned amounts as brought to tax by the Income-tax Officer did not represent the income which had really accrued to the assessee-company during the relevant previous years. The High Court, in our opinion, was in error in upsetting the said view of the Tribunal."
10. A basic concept in income-tax law is that the assessee must have received or have acquired a right to receive the income before it can be taxed. There must be a debt owed to it by somebody, if the amount is to be taxed on mercantile (accrual) basis. Unless a debt has been created in favour of the assessee by somebody it cannot be said that the income has accrued to it or it has a right to receive the income vide E.D. Sassoon and Co. Ltd. v. CIT [1954] 26 ITR 27 (SC); Seth Pushalal Mansinghka (P.) Ltd. v. CIT [1967] 66 ITR 159 (SC) and CIT v. Ashokbhai Chimanbhai [1965] 56 ITR 42 (SC), etc.
11. When one refers to the right of an assessee to receive an income so as to make it taxable, it necessarily means a right enforceable under law. If the claim is not legally enforceable the assessee cannot be said to be vested with a right to claim the amount. The enforceability of the right to receive the income is therefore, in our opinion, embedded in the concept of accrual of the income vide Sarupchand Hukamchand Pvt. Ltd. v. CIT [1982] 133 ITR 295 (MP) and E.D. Sassoon and Co. Ltd. v. CIT [1954] 26 ITR 27 (SC), etc.
12. In the present case the assessee itself has not treated the amount of interest to be due from any of the user-agencies as a debt or a legal claim. There was neither any agreement nor customary practice in support of that claim. In our opinion, the amount of interest did not constitute a debt due to the assessee. The assessee did not debit the account of any of the user-agencies with the interest, which has been treated by the Tribunal as the income of the assessee. The Tribunal has not held that the assessee had a legally claimable right against the user-agencies in regard to the interest under consideration. Nor has the Tribunal held that the user-agencies were under obligation to pay the interest and it had become a debt due to the assessee. The Tribunal held the two amounts to be the assessee's income on the ground that (1) the assessee kept the issue of interest alive in the form of deferred interest liability, (2) the assessee has not accounted for the same as per the amended provisions of the Companies Act and (3) the assessee has not written off the interest as per mercantile system of accounting. In our opinion none of these grounds is valid to make the amount credited to the account of "Deferred accrued interest" to be income, actual or accured, of the assessee. This is so even if the accounts are according to the mercantile system of accounting. In Sarupchand Hukamchand Pvt. Ltd. v. CIT [1982] 133 ITR 295 (MP); Ondal Investments Co. Ltd. v. CIT [1979] 116 ITR 143 (Cal); CIT v. Nadiad Electric Supply Co. Ltd. [1971] 80 ITR 650 (Bom) and CIT v. Hindusthan Housing and Land Development Trust Ltd. [1977] 108 ITR 380 (Cal), etc., it was held that an unenforceable claim by the assessee to receive a sum, even though based on tentative entries in the books of account, is not assessable as accrued income.
13. The assessee itself did not treat the amount to be a legal claim, or legally claimable amount, due from the user-agencies. That is why it was not debited to the account of the user-agencies. As regards the interest which the assessee actually received in any of the years, the assessee itself treated it to be its income of that year. This practice does not even constitute a mixed or hybrid method of accounting because the interest received by the assessee was never legally due or claimable from the user-agencies ; and nothing had been debited to their account. However, even if it is treated to be a mixed/hybrid method of accounting, adopted by the assessee, it is permissible as a method of accounting vide UCO Bank v. CIT [1999] 237 ITR 889 (SC). Merely because such amount is treated by the assessee to be its income and surrendered for tax in the year of actual receipt, it would not lead to the conclusion that similar receivable amounts which the user-agencies were not under legal obligation to pay and which never became debt due to the assessee, would also become income of the assessee, accrued or otherwise only because they have been cumulatively credited to the "Deferred accrued interest" account.
14. A Division Bench of this court in Income-tax Application No. 30 of 2000 (CIT v. Sahara Investment India Ltd. [2004] 266 ITR 641 decided on November 18, 2003), has held following several decisions of the Supreme Court that mere entries in the account books are not determinative of the true character of the transactions. The Division Bench followed the decisions of the Supreme Court in CIT v. India Discount Co. Ltd. [1970] 75 ITR 191 and Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746.
15. Learned counsel for the Department has contended that in 1989 there was an amendment in the Companies Act, 1956, and thereafter all the companies are liable to maintain accounts on mercantile basis only. Hence, he submitted that the assessee cannot claim to maintain the transactions relating to interest on cash basis. It is well settled that before an amount can be taxed there must be an income, and when there is no income at all then it can neither be taxed on mercantile basis nor on cash basis. In our opinion there was no income at all in the present case, and mere entry regarding interest would not make it an income. As rightly contended by learned counsel for the assessee, even in the mercantile system of accounting it is only the accrual of the real income which is chargeable to tax and not the theoretical, doctrinaire or legalistic approach regarding the same vide Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746 (SC).
16. It has not been shown that there was any agreement to charge interest nor any customary right to do so. Hence, when there is no income at all, either accrued or received, by the assessee it cannot be charged at all. Income-tax is a tax on real income and not on imaginary or hypothetical income, whether the system of accounting is cash or mercantile. The making of an entry in the assessee's account books is not decisive of the matter and the income-tax authorities must first find whether there was a real income before it can be taxed.
17. It is well settled that a mere claim by the assessee does not make income accrue, and income or profit must actually become due before it can be taxed, vide CIT v. O.P.N. Arunachala Nadar [1983] 141 ITR 620 (Mad). Conversely, a mere claim against the assessee by another person is not sufficient to justify deduction. A liability must have definitely arisen, vide CIT v. Central Wines [1988] 174 ITR 316 (AP); CIT v. Devatha Chandraiah and Sons [1985] 154 ITR 893 (AP) ; CIT v. Ratlam Strawboard Pvt. Ltd. [1985] 152 ITR 425 (MP) ; Swadeshi Cotton Mill Co. Ltd. v. CIT [1980] 125 ITR 33 (All); CIT v. Lachhman Das Mathura Das [1980] 124 ITR 411 (All); CIT v. Oriental Motor Car Co. (P.) Ltd. [1980] 124 ITR 74 (All); CIT v. Nirmal Kumar Bose and Bros. [1979] 119 ITR 537 (Patna); National Newsprint and Paper Mills Ltd. v. CIT [1978] 114 ITR 172 (MP); CIT v. Roberts McLean and Co. Ltd. [1978] 111 ITR 489 (Cal); CIT v. Swadeshi Cotton and Flour Mills Pvt. Ltd. [1964] 53 ITR 134 (SC); Seth Champalal Ramswarup v. CIT [1964] 52 ITR 201 (All) ; Pankaja Mills Ltd. v. CIT [1963] 50 ITR 665 (Mad) ; CIT v. Shewbux Jahurilal [1962] 46 ITR 688 (Cal); CIT v. Mathulal Baldeo Prasad [1961] 42 ITR 517 (All) and Kanpur Tannery Ltd. v. CIT [1958] 34 ITR 863 (All).
18. In CIT v. Oriental Motor Car Co. (P.) Ltd. [1980] 124 ITR 74 (All) although the principal had made a claim for infringement compensation the assessee was contesting the rate and not admitting his liability. The Allahabad High Court held that the liability would become crystallised only when the assessee agreed to make the payment, and not earlier. In Swadeshi Cotton Mill Co. Ltd. v. CIT [1980] 125 ITR 33 (All), there was a dispute about the contractual amount payable by the assessee. It was held that the amount paid could be included in the income only in the assessment year in which the dispute was settled.
19. Before a credit or debit entry can legitimately be made in the accounts it must be shown that a certain enforceable liability has accrued or arisen. Such liability must be one that has been ascertained and is capable of being enforced by the person in whose favour the debit has been raised. The mercantile system can never be stretched to embrace all sorts of provisional, notional or contingent payments, which an assessee thinks he might ultimately be entitled to receive, or called upon to pay. It is well settled that anticipated losses and contingent liabilities cannot be claimed under the mercantile system of accounting. The liability must be definite and real vide New Victoria Mills Co. Ltd. v. CIT [1966] 61 ITR 395 (All) and CIT v. Tata Chemicals Ltd. [1986] 162 ITR 556 (Bom), etc. Thus, even under the mercantile system of accounting, it is not left to the sweet will of the assessee to debit in its accounts any amount towards its expenses and claim that the provision made will have to be allowed by the tax authorities, vide Kanpur Tannery Ltd. v. CIT [1958] 34 ITR 863 (All).
20. Regarding the submission of learned counsel for the Department that under the amended Companies Act account has to be maintained on mercantile basis, in our opinion the mandate of the Companies Act would not be determinative of transactions under the Income-tax Act. There was no enforceable right in the assessee to charge interest, as there was neither agreement nor any customary rule to that effect. Mere effort on the part of the assessee to realise interest by sending a bill or even filing a suit would not in our opinion make it an income vide CIT v. Burlop Commercial Pvt. Ltd. [1988] 173 ITR 522 (Cal).
21. For the reasons given above these appeals are allowed. The impugned order of the Tribunal so far as it upholds the addition of Rs. 1,69,14,552 for the assessment year 1990-91 and the addition of Rs. 1,97,39,358 for the assessment year 1991-92 is set aside and it is directed that these amounts shall be deleted from the assessee's income.