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Commissioner Of Income-Tax v. National Insurance Co. Ltd.

Calcutta High Court

Apr 21, 1995

Judgment

Subsequent
References

CaseIQ

Smart Summary (Beta)

Summary of the Opinion (K.C. Agarwal, C.J.)

Factual and Procedural Background

This is a reference pursuant to a statement by the Commissioner of Income-tax, West Bengal, Calcutta, referring two questions posed by the Income-tax Appellate Tribunal (dated May 25, 1988) to the High Court for decision.

The assessee is a general insurance company. For the assessment year 1983-84, the Assessing Officer observed that interest of Rs. 37.35 lakhs on certain mortgage loans (where mortgagors were defaulters or the rate of interest was disputed) had been kept in an interest suspense account. The Assessing Officer, relying on the Supreme Court decision in State Bank Of Travancore v. Commissioner Of Income Tax, Kerala ([1986] 158 ITR 102), added this amount to the assessee's total income.

The assessee contested the addition, relying on section 44 of the Income-tax Act read with the First Schedule (in particular Rule 5 applicable to non-life insurance business) and argued that inclusion of the suspense interest was arbitrary and illegal. Copies of annual accounts and an extract of the interest suspense account were placed before the appellate authority. The Commissioner directed a fresh computation and inspection of the suspense account. On appeal the Tribunal held that section 44 and the First Schedule applied and that the State Bank of Travancore decision was not applicable. The Commissioner referred two questions to the High Court for decision.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that interest credited to the suspense account cannot be added to the income of the assessee?
Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the decision of the Supreme Court in the case of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala, [1986] 158 ITR 102 cannot be applied to the facts of this case?

Arguments of the Parties

Department's Arguments (Revenue)

The charging section relevant to taxable income is section 5 of the Income-tax Act (as relied upon by Departmental counsel), and having regard to that section mortgage loans and difficult ("sticky") loans could be added and interest thereon could be added to the total income of the assessee.
Reliance was placed on the majority decision of the Supreme Court in State Bank Of Travancore (1986) to support the proposition that accrual, once shown in accounts, cannot be negated by placing amounts in a suspense account.

Assessee's Arguments

The assessee contended that section 44 of the Income-tax Act (a non obstante clause) read with the First Schedule (Rule 5) governs computation of income for insurance companies, and consequently the profits as disclosed by the annual accounts furnished under the Insurance Act are determinative of taxable income for a non-life insurer.
It was argued that Rule 5 only permits certain specified adjustments (expenditures under sections 30 to 43B, amounts written off or reserved for depreciation or loss on realisation of investments, and amounts carried to reserve for unexpired risks), none of which include treating interest receivable and placed in suspense as an item to be added by the Assessing Officer.
The assessee pointed out that the required annual accounts had been furnished to the Controller of Insurance and that under Rule 5 the disclosed balance of profits (as accepted under the Insurance Act regime) was binding on the Income-tax authorities except for the limited adjustments allowed by the rule.
Assessee also sought to distinguish State Bank Of Travancore on its facts and on the basis that the charging section in that decision related to section 4 (contention that section 4 rather than section 5 was the charging section in that context), and that the charging section itself makes applicability "subject to the provisions (including provisions for the levy of additional income-tax) of this Act."

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
State Bank Of Travancore v. Commissioner Of Income Tax, Kerala, [1986] 158 ITR 102 (SC)	The majority principles (headnote) that: (i) taxable income content derives from substantive provisions (section 5) and related sections; (ii)-(iv) the "real income" concept applies only in limited fields and cannot be used to negate accrual once income has accrued and been entered in the books (suspense account does not negate accrual); (v) various propositions as to real income and accrual; (vi) circulars cannot alter Act provisions.	The court considered these principles but held that the State Bank decision is not applicable to the present case of a non-life insurance company whose computation is governed by section 44 and Rule 5 of the First Schedule; accordingly the State Bank authority was not applied to add the suspense interest in this case.
L.I.C. of India v. CIT, [1978] 115 ITR 45 (Bom)	Held that section 44, starting with a non obstante clause, directs that the rules in the Schedule prevail notwithstanding contrary provisions elsewhere in the Act; where Schedule rule (rule 2 in that case, analogous to rule 5 here) applies, provisions referred to in section 44 are excluded.	Cited to support the proposition that section 44 and the applicable rule in the First Schedule (Rule 5) govern the assessment of an insurance business and exclude the Assessing Officer's power to make adjustments inconsistent with those rules.
L.I.C. of India v. CIT, [1964] 51 ITR 773	Held that assessment of profits of an insurance business is completely governed by the rules in the Schedule to the Income-tax Act and that the Income-tax Officer has no power to do anything not contained in those rules; no general right to correct errors in insurance accounts.	Relied upon to reinforce that the Schedule's rules (as applied via section 44) control computation for insurance companies and limit Assessing Officer's powers.
CIT v. Calcutta Hospital and Nursing Home Benefits Association Ltd., [1965] 57 ITR 313 (SC)	Interpreted the rule (rule 6 under the 1922 Act) to mean that profits as disclosed by annual accounts submitted to the Superintendent/Superintendent of Insurance are binding on the Income-tax Officer except for specified exclusions (expenditure not allowed under the Act).	Applied to show that where annual accounts are furnished to the insurance regulator, the Income-tax Officer is bound to accept the balance of profits subject only to the specific adjustments permitted by the applicable rule.
Pandyan Insurance Co. Ltd. v. CIT, [1965] 55 ITR 716 (SC)	Considered the Insurance Act in connection with the Schedule and concluded the Insurance Act makes detailed provisions to ensure true valuation of assets and the true balance of profits; rule to be construed in that background.	Used to support the view that the Schedule rules must be construed in the context of the Insurance Act's valuation and reporting regime, and that accordingly the accounts submitted under the Insurance Act carry binding effect.
South India Insurance Co. Ltd. v. CIT, [1977] 106 ITR 969 (Bom)	Court observations reflecting the view that Assessing Officer has no jurisdiction to make adjustments to profits and loss disclosed in accounts forwarded to the Superintendent of Insurance.	Cited to reinforce that Assessing Officer lacks jurisdiction to make adjustments inconsistent with the Schedule rules; the court observed that State Bank of Travancore has no application in such insurance-account governed cases.

Court's Reasoning and Analysis

The court analyzed the matter by focusing on the special charging and computation regime for insurance businesses under the Income-tax Act. Key elements of the court's reasoning, derived from the text, are:

The dispute turns on whether the Supreme Court's decision in State Bank Of Travancore (1986) — which emphasized accrual according to accounts and limited application of the "real income" concept — applies to an insurance company whose income is computed under section 44 and the First Schedule.
The Assessing Officer had added Rs. 37.35 lakhs, being interest placed in an interest suspense account, to the assessee's income relying on the State Bank case.
The assessee's central counter was that section 44 is a non obstante provision making the First Schedule rules (Rule 5 for non-life insurance) determinative of computation; Rule 5 prescribes that profits for non-life insurance are the balance disclosed in the annual accounts furnished to the Controller of Insurance, subject only to specific, limited adjustments.
The court reviewed authority (including L.I.C. cases, Pandyan, and Calcutta Hospital) establishing that where the Schedule's rules apply and accounts have been furnished under the Insurance Act, the Income-tax Officer is generally bound by the balance disclosed and has no general jurisdiction to make adjustments not contemplated by the rule.
Applying these principles, the court concluded that the adjustments contemplated by Rule 5 did not include adding interest merely because it had been placed in a suspense account; interest receivable is an item of income and no permitted adjustment justified the Assessing Officer's addition.
Consequently, the court held that the State Bank Of Travancore decision, which addresses accrual and the real income concept in a different factual and statutory context, was not applicable to a case governed by section 44 and Rule 5 of the First Schedule.
The Tribunal's conclusion (that interest credited to suspense account could not be added to the assessee's income and that State Bank was not applicable) was found to be correct and was affirmed by the High Court.

Holding and Implications

Holding: Both questions referred were answered in favour of the assessee and against the Department. Specifically, the court held that interest credited to the suspense account cannot be added to the income of the assessee, and that the decision in State Bank Of Travancore (1986) is not applicable to the facts of this insurance-company case. The reference is dismissed with costs.

Implications:

Direct effect: The Assessing Officer's addition of Rs. 37.35 lakhs (interest credited to the suspense account) to the assessee's income was disallowed; the assessee succeeds on the reference and the Tribunal's decision is upheld.
Scope and precedent: The court confined the applicability of State Bank Of Travancore to its proper factual/statutory context and affirmed that, where section 44 and the First Schedule (Rule 5) apply to an insurance business and annual accounts have been furnished under the Insurance Act, the Assessing Officer's power to make adjustments is limited to those expressly permitted by the applicable rule. The opinion does not purport to lay down a wider new principle beyond applying established authorities to the facts before the court.

Disposition: Reference dismissed with costs. Mukul Gopal Mukherji, J. concurred.

Show all summary ...

K.C Agarwal, C.J:— This is a reference made at the instance of the Commissioner of Income-tax, West Bengal, Calcutta, referring the following two questions of the Income-tax Appellate Tribunal, dated May 25, 1988, for decision of the High Court:

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that interest credited to the suspense account cannot be added to the income of the assessee?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the decision of the Supreme Court in the case of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 cannot be applied to the facts of this case?”

2. The brief facts of the case are that the assessee is an insurance company, carrying on general insurance business. For the assessment year 1983-84, interest on loans was kept in suspense account and according to the assessee credit for the same would be taken in the year of realisation. The question that arises in this reference for determination is whether the decision of the Supreme Court in the case of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 could be applicable to the case of an insurance company.

3. The assessee is the insurance company. In the proceeding for assessment of tax for the accounting year relating to the assessment year 1983-84, the Assessing Officer noticed that an amount of interest of Rs. 37.35 lakhs on certain mortgage loans where the mortgagors were defaulters or where the rate of interest is disputed had been kept in suspense account. The Assessing Officer relying on the decision of the Supreme Court in the case of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 added the aforesaid amount to the total income of the assessee. The assessee relied upon the provision of section 44 of the Income;tax Act read with the First Schedule thereto and it was argued that inclusion of Rs. 37.35 lakhs was arbitrary and illegal. Before the appellate authority, the following copy of interest suspense; account was furnished:

Rs. P. “Opening balance as on 1-1-1982 41,80,124.89 Add: Interest accrued and interest outstanding for the year 1982: Interest accrued Interest O/S Rs. P. Rs. P. Dansingh Bawa 18,551.86 3,65,260.20 Empire Investment 1,541.10 88,762.84 Kiran Theatres 4,315.07 3,67,497.96 Ravi Industries 1,590.41 66,107.79 25,998.44 8,87,648.79 9,13,647.23 50,93,772.12 Less: Interest received during the year 1982: Onkarmal Ishardas (P.) Ltd. 4,39,800.32 Dady Tej (P.) Ltd. 2,50,000.00 K.R Kothandaraman 37,179.16 7,26,979.48 43,66,792.64 Less: Due to compromise approved by HD amount removed from interest suspense account: Onkarmal Ishardas (P.) Ltd. 20,325.32 Dady Tej (P.) Ltd. 6,11,723.86 6,32,049.18 Balance as on 31-12-1982 37,34,743.46”

4. The Commissioner sent back the case and directed the Inspecting Assistant Commissioner to compute afresh the amount assessable in the year under consideration after examining the accounts of interest on mortgage loans kept in suspense account.

5. Being aggrieved the assessee came up on appeal before the Tribu-nal and the Tribunal considered the provisions of section 44 of the Income-tax Act read with the First Schedule and held that the decision of the Supreme Court in State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 is not applicable.

6. Now, the question that was raised was about the applicability of section 44 of the Income-tax Act, 1961, read with the provisions of the First Schedule along with the charging section 5 of the Income-tax Act. Reliance was placed by learned counsel for the Department that having regard to the charging section 5 the mortgage loans and sticky loans could be added and interest thereon could also be added to the total income of the assessee. The majority decision of the Supreme Court referred to above had sup-ported his submission. In the majority decision of the Supreme Court law laid down was (headnote):

“(i) For the content of taxable income, one has to refer to the substantive provisions of the Income-tax Act, 1961, mainly section 5 read with the other relevant sections.

(ii) In some limited fields where something which is the reality of the situation prevents the accrual of the income, then the notion of real income, i.e, making the income accrue in the real sense of the term, can be brought into play but the notion of real income cannot be brought into play where income has accrued according to the accounts of the assessee and there is no indication by the assessee treating the amount as not having accrued. Suspended animation following inclusion of the amount in the suspense account does not negate accrual and after the event of accrual, corroborated by appropriate entry in the books of account, on the mere ipse dixit of the assessee, no reversal of the situation can be brought about.

(iii) The concept of reality of the income and the actuality of the situation are relevant factors which go to the making up of the accrual of income but once accrual takes place and income accrues, the same cannot be defeated by any theory of real income. The concept of real income cannot be so used as to make accrued income non-income simply because after the event of accrual, the assessee neither decides to treat it as a bad debt nor claims deduction under section 36(2) of the Act, but still enters the same with a diminished hope of recovery in the suspense account. Extension of the concept of real income to this field to negate accrual after the amount had become payable, is contrary to the postulates of the Act.

(iv) Where interest has accrued and the assessee has debited the account of the debtor, the difficulty of recovery would not make its accrual non-accrual.

(v) The following propositions emerge in relation to the theory of real income: (1) It is the income which has really accrued or arisen to the assessee that is taxable. Whether the income has really accrued or arisen to the assessee must be judged in the light of the reality of the situation. (2) The concept of real income would apply where there has been a surrender of income which in theory may have accrued but in the reality of the situation, no income had resulted because the income did not really accrue. (3) Where a debt has become bad, deduction in compliance with the provisions of the Act should be claimed and allowed. (4) Where the Act applies, the concept of real income should not be so read as to defeat the provisions of the Act. (5) If there is any diversion of income at source under any statute or by overriding title, then there is no income to the assessee. (6) The conduct of the parties in treating the income in a particular manner is material evidence of the fact whether income has accrued or not. (7) Mere improbability of recovery, where the conduct of the assessee is unequivocal, cannot be treated as evidence of the fact that income has not resulted or accrued to the assessee. After debiting the debtor's account and not reversing that entry—but taking the interest merely to a suspense account cannot be such evidence to show that no real income has accrued to the assessee or has been treated as such by the assessee. (8) The concept of real income is certainly applicable in judging, whether there has been income or not but, in every case, it must be applied with care and within well-recognised limits.

(vi) Circulars which are executive in character cannot alter the provisions of the Act. Circulars which are in the nature of concessions can always be prospectively withdrawn.”

7. Learned counsel for the assessee tried to distinguish the Supreme Court judgment of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 by submitting that the law laid down in that case was to be read on its own facts. It is submitted that the charging section is section 4 and not section 5 and further that such charge is determined “subject to the provisions (including provisions for the levy of additional income-tax) of this Act.” The charging section having itself stipulated that its applicability would be subject to the provisions of the Act, counsel's submission that section 44 should not be relied upon is not correct.

8. Section 44 is a non obstante provision and it clearly provides that the income charged to tax for an insurance company has to be computed in accordance with the rules contained in the First Schedule. According to him, the provisions relied upon by the Department did not apply in the present case. He submitted that section 44 expressly makes the First Schedule to the Income-tax Act applicable to the case of an insurance company. Rule 5 of the said Schedule is the particular rule which is applicable in the present case. It states clearly that the profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938, to be furnished to the Controller of Insurance, subject to certain adjustments. These adjustments at the material time were only in respect of amounts of expenditure inadmissible under the provisions of sections 30 to 43B, amounts written off or reserved to meet depreciation of or loss on the realisation of investments, and amounts carried over to a reserve for unexpired risks as may be prescribed in this behalf.

9. There cannot be any question that the adjustments referred to in rule 5 have no application in regard to any amount of interest due to the insurance company as no question of expenditure arises in the present case. Interest is an item of income in the present context.

10. It is a fact that copies of annual accounts, as required under the Insurance Act, had been furnished to the Controller of Insurance. Under rule 5, therefore, the profits as disclosed in such accounts are the only profits which are chargeable to tax. In the present case, the question of any adjustment under rule 5 cannot at all arise.

11. In L.I.C of India v. CIT, [1978] 115 ITR 45 (Bom), the Bombay High Court had held in relation exactly to the same rules as provided for nonlife insurance that section 44 of the Income-tax Act having started with a non obstante clause directs that the provisions of section 44 will prevail notwithstanding the fact that there are contrary provisions in the Act relating to computation of income chargeable under the four heads mentioned in the section. The only other overriding effect of the Act is that its provisions operate notwithstanding the provisions of section 191 or sections 28 to 43A. According to the court, the effect of section 44 is that the operation of the provisions referred to therein is excluded in the case of an assessee who carries on insurance business and in whose case the provisions of rule 2 (the case was that of a life insurance business and rule 2 was similar to rule 5) of the First Schedule are attracted.

12. In CIT v. Calcutta Hospital and Nursing Home Benefits Association Ltd., [1965] 57 ITR 313 (SC), the Supreme Court had occasion to consider the case of a mutual insurance where also similar provisions relating to computation of income from insurance business had to be computed. The referable rule under the Indian Income-tax Act, 1922, was rule 6 the terms of which were as follows (page 317):

“The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938, to be furnished to the Superintendent of Insurance after adjusting such balance so as to exclude from it any expenditure other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business”

13. At page 320, the Supreme Court observed that the Income-tax Officer is bound to accept the balance of profits disclosed by the annual accounts, copies of which have been submitted to the Superintendent of Insurance. He can only adjust this balance so as to exclude from it any expenditure other than expenditure which may under the provisions of section 10 be allowed for in computing the profits and gains of a business. We are not concerned here with the latter part of rule 6 dealing with profits and losses on the realisation of investments, and depreciation and appreciation of the value of investments. This court examined the provisions of the Insurance Act in connection with the Schedule in Pandyan Insurance Co. Ltd. v. CIT, [1965] 55 ITR 716 (SC) and arrived at the conclusion that the Insurance Act ‘makes detailed provisions to ensure the true valuation of assets and the determination of the true balance of profits of an insurance business’ and that rule 6 should be construed in the light of this background.

…it seems to us that the intention of the rule is that the balance of profits as disclosed by the accounts submitted to the Superintendent of Insurance and accepted by him would be binding on the Income-tax Officer, except that the Income-tax Officer would be entitled to exclude expenditure other than expenditure permissible under the provisions of section 10 of the Act.”

14. Section 44 of the Act of 1961, corresponds to section 10(7) of the Indian Income-tax Act, 1922. In interpreting the provisions thereof, the Supreme Court had decided in L.I.C of India v. CIT, [1964] 51 ITR 773 that the assessment of the profits of an insurance business is completely governed by the rules in the Schedule to the Income-tax Act and the Income-tax Officer had no power to do anything not contained in the rules to be found in the Schedule. It was held that there is no general right to correct the errors in the accounts of an insurance business. These observations were applied and the principle reiterated and carried forward to its logical extension by the Supreme Court in the case of Pandyan Insurance Co. Ltd. v. CIT, [1965] 55 ITR 716 referred to earlier.

15. The Bombay High Court had an occasion to consider these aspects in South India Insurance Co. Ltd. v. CIT, [1977] 106 ITR 969 and the court's observations at page 973 onwards reflect the views expressed by the Supreme Court and some High Courts and the observations made by the courts in the different decisions make it clear that the Assessing Officer has no jurisdiction to make any adjustment to the profit and loss disclosed in the accounts forwarded to the Superintendent of Insurance. The case of State Bank of Travancore and Cochin v. CIT, [1986] 158 ITR 102 (SC) referred to earlier has, therefore, no application in the present case.

16. We have considered the rival submissions and find no merit in the argument of the Department. In our view, the case reported in State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102 (SC) is not applicable to the present case. The Tribunal was justified in deciding the controversy against the Commissioner of Income-tax, we are in agreement with the same.

17. For the reasons stated above, the first question referred for decision is answered in the affirmative by holding that interest credited to the suspense account cannot be added to the income of the assessee and the controversy involved in this reference which is question No. 2 is not covered by the decision of the Supreme Court in the case of State Bank Of Travancore v. Commissioner Of Income Tax, Kerala , [1986] 158 ITR 102. Both the questions, therefore, are answered in favour of the assessee and against the Department.

18. The reference is, therefore, dismissed with costs.

Mukul Gopal Mukherji, J.:— I agree.