Commissioner Of Income-Tax v. Hindusthan Motors Ltd.

The Judgment of the Court was delivered by

Ajit K. Sengupta, J.:— In this reference at the instance of the Revenue, the following questions have been referred by the Tribunal under section 256(2) of the Income-tax Act, 1961:

“1. Whether, on the facts and in the circumstances of the case and in view of the fact that the resolution to forgo interest was passed after the close of the accounting year, the Tribunal was right in law in allowing the interest forgone as business expenditure in computation of the income of the assessee for the assessment year 1971–72?

2. Whether, on the facts and in the circumstances of the case, the Tribunal misdirected itself in law in holding that interest on the balance outstanding money advanced to its subsidiary company was not part of the real income of the assessee and was, therefore, not liable to be assessed to tax?”

2. The facts as found by the Tribunal are as under:

The assessee is a company and the relevant assessment year is 1971–72. The corresponding accounting year ended on March 31, 1971. The method of accounting followed was mercantile. The assessee-company is a manufacturer and dealer in motor cars, trucks, flanges, steel sheet castings, spare parts and also scrap. For the relevant assessment year, it returned a loss of Rs. 3,72,26,065. The assessment was, however, completed on a total loss of Rs. 3,36,33,197. In the course of the assessment proceedings, the Income-tax Officer noticed that the assessee-company did not charge interest for the relevant previous year on the outstanding amount of Rs. 24,24,124 due to it by its 100 per cent. subsidiary, namely, the Hindus-than Motor Corporation Ltd. It was explained to the Income-tax Officer that, owing to the difficult financial position of the subsidiary company, the board of directors decided not to charge interest in order to enable the subsidiary to tide over the financial crisis. The Income-tax Officer held that interest accrued day to day whereas the decision not to charge interest was taken by the assessee-company after the end of the relevant accounting year, i.e, long after the accrual of interest. He further held that it was only on compassionate grounds and not on considerations of commercial expediency that the assessee-company had decided not to charge interest. Thus, he estimated the amount of interest on the outstanding advance of Rs. 24,24,124 at Rs. 2,18,341 and added interest income as estimated in the relevant assessment.

3. On appeal, the learned Appellate Assistant Commissioner deleted the addition holding that, according to decided cases, it was not necessary in all cases that interest should be charged and that interest that was not charged for proper reasons could not be treated as accrual of income and added to the assessee's total income. Being dissatisfied with the Appellate Assistant Commissioner's decision, the Income-tax Officer preferred an appeal to the Appellate Tribunal. It was pointed out by the Revenue that the board of directors of the assessee-company passed a resolution on August 26, 1971, i.e, after the end of the relevant accounting year on March 31, 1971, deciding not to charge interest owing to the stringent financial position of the subsidiary. The Revenue contended that the interest which accrued from day to day would not be wiped out by the unilateral act of the creditor and that long after the accounting period, the director's resolution would not have any effect upon the interest that had already accrued. In this connection, reliance was placed upon the cases reported in Rungta Sons (Private) Ltd. v. Commissioner Of Income-Tax, [1964] 54 ITR 447 (Cal), Rungta Sons (P.) Ltd. v. CIT, [1966] 62 ITR 468 (Cal), Morvi Industries Ltd. v. Commissioner Of Income Tax (Central) Calcutta, [1971] 82 ITR 835 (SC) and CIT v. Confinance Ltd., [1973] 89 ITR 292 (Bom). Further, it was contended that there was no proof that the debtor-company had approached the assessee-company for waiver of interest. The submissions put forward by the Revenue were strongly contested by the assessee's learned counsel before the Appellate Tribunal. According to him, the waiver of interest by the assessee-company was in the nature of expenditure incurred for the purpose of business on consideration of commercial expediency and was, therefore, allowable under section 37(1) of the Income-tax Act, 1961. It was mentioned that the subsidiary company was exclusively in charge of sales of the motor trucks manufactured by the assessee-company, that the subsidiary company was pushing up the sales on hire purchase system and that the assessee-company had, therefore, a vital stake in the sound financial position of the subsidiary company. The attention of the Tribunal was also drawn to the balance-sheet of the subsidiary company in order to show that its financial affairs were in doldrums. During the previous year, the subsidiary sustained a huge loss of Rs. 10,29,338 as against its share capital of Rs. 25 lakhs only and the report of the directors to the shareholders for the year ended March 31, 1971, presented a very gloomy picture in support of the proposition that the relinquishment by an assessee of an amount due to it by another party could be allowed as a deduction under section 37(1) if such a relinquishment had been made on grounds of commercial expediency. The assessee's learned counsel relied upon the authorities in CIT v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266 (SC) and CIT v. Chandulal Keshavlal and Co., [1960] 38 ITR 601 (SC). It was urged by him that interest on the balance outstanding never formed part of the real income of the assessee and that there was an arrangement between the subsidiary company and the assessee-company not to charge interest. Learned counsel pointed out to the resolution passed by the board of directors of the assessee-company at a meeting held on May 10, 1971, and again on August 26, 1971. The Appellate Tribunal upheld the Appellate Assistant Commissioner's decision after scanning the factual position in the light of the decision in CIT v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266 (SC). After elaborately dealing with the relevant aspects, it upheld the action of the Appellate Assistant Commissioner in deleting the addition made by the Income-tax Officer on account of interest on the loan given to the subsidiary company.

4. In the course of hearing before us, counsel appearing for the assessee as well as for the Revenue reiterated their respective submissions as were made before the Tribunal. We have considered the rival submissions. It appears from the Tribunal's order that the Tribunal was of the view that the original transaction under which the subsidiary company was liable to pay interest to the assessee-company was substituted or novated by a subsequent agreement concluded between the two. By virtue of this subsequent agreement, the Tribunal observed that the subsidiary company was not liable to pay interest to the assessee-company for the year under reference. In that view, the Tribunal held that the interest on the balance outstanding was not part of the real income of the assessee. Considering the alternative submission of the assessee-company, the Tribunal also held that the waiver of interest receivable by the assessee-company from its subsidiary company can also be treated as expenditure incurred by the assessee-company for the purposes of its business and was, therefore, allowable as a deduction in computing the assessee's business income.

5. The Tribunal, in recording its aforesaid conclusion, referred to and relied upon the decision of the Supreme Court in CIT v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266. We, however, do not find ourselves in agreement with the approach adopted by the Tribunal. There is nothing on record to show that the arrangement not to charge interest by the assessee-company on the amounts due and payable by the subsidiary company and/or to waive such interest had been entered into during the previous year under reference. The ribunal has not referred to any material in this respect. None of the resolutions passed by the board of directors of the assessee-company on May 10, 1971, as well as on August 26, 1971, makes any reference to any such agreement having been concluded between the assessee-company and its subsidiary within the previous year relevant to the assessment year 1971–72. The assessee-company is, admittedly, following the mercantile system of accounting. Interest on monies advanced accrue from day to day and, in any event, such interest definitely accrues and becomes payable at the end of the accounting year. If the assessee-company and its subsidiary would have agreed before the close of the accounting year relevant to the assessment year 1971–72 not to charge any interest and/or to waive such interest otherwise chargeable, one could have said that, in view of the substitution or novation by a subsequent agreement, the original liability to pay interest to the assessee-company by its subsidiary does not subsist any longer. This is, however, not the situation in this case. The decision of the Supreme Court in CIT v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266, is clearly distinguishable and has no application in this case. There, the Supreme Court was considering the accrual of managing agency commission receivable at 12 per cent of the net profits of the managed company. Although no due date was fixed for the payment of the commission under the managing agency agreement, the commission receivable could have been ascertained only after the managed company made up its accounts. It was an admitted position that the assessee had given up the commission in that case long before the managed company made up its accounts. In the case before us, we are concerned with accrual of income by way of interest on monies advanced by the assessee-company to its subsidiary. Accrual of interest takes place normally on day to day basis and even when there is no due date fixed for payment of interest, interest certainly accrues on the last day of the previous year. Accrual of interest does not depend upon the making up of accounts. Forgoing of interest after its accrual cannot enable the assessee-company to claim that the same should not be included in the total income for the year under reference and/or the amount in question should be considered as business expenditure for the assessment year 1971–72.

6. It was contended on behalf of the assessee that the doctrine of real income shall apply in the case of the assessee and it is not mere accrual that renders an income taxable but what accrues must be real and not illusory. It was urged that, in this case, the interest forgone never formed part of the real income of the assessee. It is submitted that, by reason of the arrangement between the assessee and the subsidiary company before the accounts of the relevant previous year were adjusted and made up, the liability of the subsidiary ceased, and such cessation prevented accrual. In our view, this doctrine of real income is not appropriate on the facts of the case. It applies in a limited segment of cases where the reality of the situation prevents the accrual of real income whose accrual alone is material from the view-point of its taxability. It is not the case here that the subsidiary was under no obligation to pay or the deteriorating financial condition of the subsidiary blotted out the last ray of hope so that we can accept the interest income as unreal. The view we have taken is fortified by the approach that has been taken by the Supreme Court in State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102. The following passage from the separate judgment of Sabyasachi Mukharji J. (as his Lordship then was), which is also the majority view, throws light on the scope of the prevention of accrual of income even where the assessee follows the mercantile system of accounting (at page 145):

“It may be reiterated that in some limited fields where something which, in the reality of the situation, prevents the accrual of the income, then the notion of real income, i.e, making the income accrued in the real sense of the term, can be brought into play.”

7. There is some distinction in the manner of accrual of interest income and the accrual of managing agency commission. The accrual of the managing agency commission depends upon the terms of the agreement. In the case of Birla Gwalior (P.) Ltd., [1973] 89 ITR 266 (SC), the date on which the commission was receivable was stipulated in the managing agency agreement. It was receivable by the managing agent only after ascertainment of the profits of the managed company. The Supreme Court emphasised that, as the managing agency commission receivable would have been ascertained only after the managed company had made up its accounts, the commission could accrue not on the expiry date of the accounting year but on the date on which the accounts are made up. In connection with the decision in Birla Gwalior (P.) Ltd.'s case, [1973] 89 ITR 266 (SC), Justice Mukharji observed in State Bank of Travancore's case, [1986] 158 ITR 102 (SC), at page 149 of the Reports:

“It is clear that the facts of the case were that the managing agency commission receivable by the assessee could have been ascertained only after the managed company had made up its accounts and as it had not made up its accounts, the commission did not accrue to the assessee-company and, therefore, the giving up which was for valid reasons was not given up after the accrual of income.”

8. From this observation, it becomes abundantly clear that the assessee following the mercantile system of accounting, the giving up of the income after the income has accrued will not make the income unreal.

9. We may also add that our view is, to all intents and purposes, covered by the decision in James Finlay and Co. v. CIT, [1982] 137 ITR 698 (Cal). There, it has been held that, unless there was material to show that there was any agreement with the debtors to waive the interest during the previous year, i.e, the year of account, the claim for interest cannot be stated to have been given up so as to call for exclusion from the total income. Once the income accrues, it continues to remain as income accrued and, therefore, income assessable to tax.

10. It is by now well-settled that waiver or relinquishment of income after it has accrued or has become due is of no effect. In our view, the income by way of interest in the facts and circumstances of this case had already accrued from day to day and, in any event, on March 31, 1971, being the last day of the previous year relevant to the assessment year 1971–72. Therefore, the passing of resolutions subsequently on May 10, 1971, and/or on August 21, 1971, in the meeting of the board of directors of the assessee-company is of no effect.

11. In this view of the matter, we answer the first question in the negative and the second question in the affirmative and both in favour of the Revenue. There will be no order as to costs.

K.M Yusuf, J.:— I agree.