Income-tax---

----Income---Accrual---Mercantile system of accounting ---Assessee a financial corporation---Interest on doubtful loans not credited to profit and loss account to kept in suspense account ---Assessee filing suits for recovery of loans and its pending---Awarding of interest within discretion of Court and Court yet o pronounce judgment---Interest did not accrue during pendency of suit-- Interest not includible in total income.

A reading of section 34(1) of the Civil Procedure Code, 1908, makes it clear that awarding of interest from the date of the suit till the date of decree is within the discretion of the Court and it can prescribe such rate of interest as it thinks just and proper in the circumstances. According to this provision, the plaintiff is entitled to interest even for the period pendente lite, but the rate could not be fixed until the Court determines the same.

During the assessment year 1973-74, the previous year being the financial year 1972-73, the assessee, a financial corporation which maintained its books on the mercantile system of accounting, did not credit to the profit and loss account interest on certain advances on the ground that those loans had become doubtful (sticky loans), but carried the interest to a suspense account. The assessee had also filed suits for recovery of the loans even prior to the commencement of the relevant previous year and the suits were pending. The Income-tax Officer held that there was no sufficient reason for not crediting the interest to the profit and loss account and added the same to the assessee's income. The Appellate Assistant Commissioner held that merely because the assessee was maintaining its accounts on the mercantile system, it did not follow that income of a doubtful nature should be taken into consideration while assessing its income and that once a suit was filed, the matter had become sub judice and so long as the Court did not award interest for the period subsequent to the institution of the suit, the assessee had no right to interest and interest could not be said to accrue during the period of pendency of the suit. The Tribunal affirmed the order of the Appellate Assistant Commissioner. On a reference:

Held, that the Tribunal was right in holding that during the relevant previous year, interest did not accrue, because during the whole of this period, suits filed for recovery of the loans were pending and the awarding of interest for the period was within the discretion of the Court which was yet to pronounce its judgment.

CIT v. Naskarpara Jute Mills Co. Ltd. (1983) 141 ITR 384 (Cal.) applied.

State Bank of Travancore v. CTT (1986)158 ITR 102 (SC) ref.

JUDGEMENT

A common question arises in these two references made under section 256(1) of the income Tax Act, 1961, at the instance of Revenue. They are being disposed of under a common order. For the sake of convenience, we shall refer to the facts in ITR No.1083 of 1978. The three questions referred are:

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the interest did not accrue or arise to the assessee during the accounting year because the suits were pending for recovery of the loans?

(2) Whether the Tribunal was justified in putting off the fact of accrual of the interest in spite of the fact that the assessee followed the mercantile system of accounting and the loans were interest-bearing?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the amount of Rs.24,716 as interest accrued was not includible in the total income of the assessee in the assessment year 1973-74?"

The assessee, the U.P. Financial Corporation, is a financial institution lending money to others. The assessment year concerned herein is 1973-74, the "previous year" being the financial year 1972-73. The assessee maintained its books of account on the mercantile system of accounting. During the said accounting year, the assessee did not credit to its profit and loss account, interest amount of Rs.42,716 on certain advances for the reason that, according to the assessee, those loans had become doubtful what are generally known as "sticky loans". While it credited the said interest amount in its books, it carried over the same to a suspense account. Indeed, the assessee had filed suits for recovery of those loans even prior to the commencement of the relevant "previous year", which suits were pending during the said "previous year". The Income-tax Officer was, however, of the opinion that there was no sufficient reason for not crediting the said interest amount to the profit and loss account and, accordingly, added the same against which the assessee filed an appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner allowed the appeal. He was of the opinion that merely because the assessee was maintaining its accounts on the mercantile system, it does not necessarily follow that even that income which is of doubtful nature, should be taken into consideration while assessing its income. Moreover, he said, once a suit is filed, the matter becomes sub judice and so long as the Court does not award interest for the period subsequent to the institution of the suit, the appellant has no right to interest and interest cannot be said to accrue during the period of pendency of the suit. Aggrieved by the order of the Appellate Assistant Commissioner, the Revenue carried the matter in appeal to the Tribunal. The Tribunal dismissed the appeal following its decision in an appeal relating to the assessment year 1969-70. The Tribunal too was of the opinion that once a suit is filed, interest pendente lite falls in jeopardy. It cannot be said that, during the period a suit is pending, interest accrues to the assessee. Hence, the mere fact that the assessee was maintaining its accounts on the mercantile system cannot mean that the interest accrued or that it should be added to its income. Thereupon the Revenue applied for and obtained this reference.

Learned counsel for the Revenue relied upon the decision of the Supreme Court in State Bank of Travancore v. CIT (1986) 158 ITR 102; AIR 1986 SC 757, which, according to learned counsel concludes the issue against the assessee. In that case too, the, assessee was maintaining its books of account on the mercantile system. It advanced loans to several persons and charged interest thereon, some of these loans had become doubtful of recovery which it terms as "sticky advances". Interest accruing on such advances was credited to a separate account called "interest suspense account" instead of crediting it to the profit and loss account. According to the assessee, this was done to avoid displaying inflated profits or by including hypothetical and unreal income. It claimed that the said interest was not its real income and was, therefore, not taxable in its hands. This contention was rejected by the Supreme Court. It held that once accrual takes place and income accrues, the same cannot be defeated by any theory of real income. The Court observed that interest in that case had accrued and the assessee had debited the account of the debtor and if so, the mere difficulty in recovery of the loan cannot make the accrual a case of non-accrual. In such a situation, the Court held, the theory of real income has no place. It also observed that carrying the interest on such loans to a suspense account, without treating the loans as bad debts and/or without treating the interest as irrecoverable, is repugnant to section 36(1)(vii) read with section 36(2) of the Act. The Court observed that the concept of real income cannot be read so as to defeat the object and the provision of the statutory enactment.

Learned counsel for the assessee, however, sought to distinguish the said decision on the ground that the case before the Supreme Court was not one where a suit (or suits as the case may be) was filed to recover the doubtful loan(s). He submitted that, in the case before us, suits were filed prior to the commencement of the relevant "previous year" and that they were pending during the course of the said "previous year". He submitted that awarding of interest pendente lite was within the discretion of the Court, as provided in section 34 of the Code of Civil Procedure. In the light of the language o section 34, Civil Procedure Code, counsel submitted, the plaintiff assessee cannot claim any right to interest or a particular rate of interest until and unless it is awarded by the Court. In support of this proposition, he relied upon a decision of the Calcutta High Court in CIT v. Naskarpara Jute Mills Co. Ltd. (1983) 141 ITR 384. We are inclined to agree with learned counsel. Section 34, Civil Procedure Code, deals with interest pendente lite and interest subsequent to the decree in suit. It of course does not deal with interest for the period prior to the institution of the suit. Subsection (1) of section 34 in so far as it is relevant reads as follows:

"34(1) Where and in so far as a decree is for the payment of money, the Court may, in the decree, order interest at such rate as the Court deems reasonable to be paid on the principal sum adjudged, from the date of the suit to the date of the decree, in addition to any interest adjudged on such principal sum for any period prior to the institution of the suit, with further interest at such rate not exceeding six per cent. per annum as the Court deems reasonable on such principal sum, from the date of the decree to the date of payment, or to such earlier date as the Court thinks fit..."

A reading of section 34(1) makes it clear that awarding of interest from the date of the suit till the date of decree is within the discretion of the Court and it can prescribe such rate of interest as it thinks just and proper in the circumstances. It may be that, according to this provision, the plaintiff is entitled to interest even for the period pendente lite, but at what rate, he cannot say, until the Court determines the same. In such a situation, it would not be possible for the plaintiff assessee to say that interest is accruing to him from year to year, pending the suit, at a particular rate. It accrues to him on the date of the decree. This feature, as pointed out by learned counsel for the assessee, was not present in the case before the Supreme Court in State Bank of Travancore v. CIT (1986) 158 ITR 102. It is, therefore, not possible to apply the principle of the said decision of the Supreme Court to the facts of this case. We accordingly, hold that the Tribunal was right in holding that, during the relevant "previous year" interest did not accrue because during the whole of this period, suits filed for recovery of the said loans were pending and the awarding of interest for this period was within the discretion of the Court which was yet to pronounce judgment. The view taken by us is supported by the decision of the Calcutta High Court in CIT v. Naskarpara Jute Mills Co. Ltd. (1983) 141 TTR 384.

For the above reasons, all the three questions referred are answered in the affirmative, that is, in favour of the assessee and against the Revenue. The questions referred in ITR No.106 of 1979 are the following:

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the interest due on the interest bearing loans did not accrue or arise to the assessee during the accounting year because the suits were pending for the recovery of the loans?

(2) Whether the Tribunal was justified in putting off the date of accrual of interest in spite of the fact that the assessee followed the mercantile system of accounting and the loans were interest bearing?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the amounts of Rs.53,807, Rs.54,228, Rs. 55,138 as interest accrued were not includible in the total income of the assessee in the assessment years 1970-71, 1971-72 and 1972-73, respectively?"

All the relevant facts in this case are identical including pendency of suits.

For the reasons recorded hereinabove, these three questions are also answered in the affirmative, that is, in favour of the assessee and against the Revenue.

The references are answered accordingly. There shall be no order as to costs.

M.B.A./1981/TQuestions answered in affirmative.