Commissioner Of Income Taxchennai v. M/S.shriram Investments Ltd

In the High Court of Judicature at Madras Dated: 15.06.2015 Coram The Honourable Mr.JUSTICE R.SUDHAKARand The Honourable Ms.JUSTICE K.B.K.VASUKI Tax Case (Appeal) Nos.1222 and 1225 to 1228 of 2007 Commissioner of Income TaxChennai .... Appellant in the above T.C.(A)s) Vs. M/s.Shriram Investments Ltd. Mookambika Complex,4 Lady Desika Road,Mylapore, Chennai - 600 004. .... Respondent in the above T.C.(A)s) APPEALs under Section 260A of the Income Tax Act against theorder dated 21.04.2006 in I.T.A.No.126/Mds/2004, 327/02, 1899/03,127/04 and 804/03 on the file of the Income Tax Appellate TribunalMadras 'B' Bench, Chennai. For Appellant : Mr.J.Narayanasamy Standing Counsel for Income Tax For Respondent: Mr.R.Sivaraman -------- C O M M O N J U D G M E N T(Judgment of the Court was delivered by R.SUDHAKAR,J.) All the above Tax Case (Appeals) are filed by the Revenue asagainst the order of the Income Tax Appellate Tribunal raising acommon issue. The key issue that needs to be decided in the aboveappeals is the manner in which the Additional Finance Charges (AFC)also known as Overdue Charges (ODC) has to be taxed in the light ofSection 145 of the Income Tax Act, which provides the method ofaccounting. 2. The brief facts of the case are as follows: The assessee is a engaged in the business of hire purchasefinancing, leasing and investments. The assessment years in questionare 1997-98 (T.C.(A)No.1228 of 2007), 1997-98 (T.C.(A)No.1226 of2007) 1998-99 (T.C.(A)No.1225 of 2007), 1999-2000 (T.C.(A)No.1222 of 2007) and 2000-2001 (T.C.(A) No.1227 of 2007). In allthese assessment years, the assessee was accounting AFC on accrualbasis in the books of accounts maintained for the purpose of theCompanies Act, whereas, for the purpose of Income Tax, it wasaccounted on cash basis. The Assessing Officer was of the view that the respondent/assessee was following mercantile system ofaccounting and therefore, it was bound to show income arising out ofAFC on accrual basis and therefore, additions on account of AFC wasmade in respect of each year. The Assessing Officer was also of theview that AFC should be included in the head 'profits and gains ofbusiness or profession' and therefore, subjected to tax. The Assessingfurther held that the AFC is an income accrued consequent on thefailure on the part of the person concerned to pay the Equated MonthlyInstalments (EMI). Further, since the assessee – company had shownthe said amount, namely AFC in the profit and loss account maintainedfor the purpose of Companies Act, that amount should be reflected forthe purpose of income tax as well. 3. Aggrieved by the said order of the Assessing Officer, theassessee preferred appeals before the Commissioner of Income Tax(Appeals). The Commissioner of Income Tax (Appeals) deleted theaddition on the ground that the assessee was entitled to show theincome arising out of AFC as and when the said income is received. Inother words, the Commissioner of Income Tax (Appeals) rejected thestand of the Assessing Officer that if the assessee was followingmercantile system of accounting, it was bound to show the income arising out of AFC even though the said amount was not actuallyreceived. 3. Aggrieved by the said order of the Assessing Officer, theassessee preferred appeals before the Commissioner of Income Tax(Appeals). The Commissioner of Income Tax (Appeals) deleted theaddition on the ground that the assessee was entitled to show theincome arising out of AFC as and when the said income is received. Inother words, the Commissioner of Income Tax (Appeals) rejected thestand of the Assessing Officer that if the assessee was followingmercantile system of accounting, it was bound to show the income arising out of AFC even though the said amount was not actuallyreceived. 4. Aggrieved by the order of the Commissioner of Income Tax(Appeals), the Revenue pursued the matter before the Tribunalprimarily contending that in the books of accounts maintained for thepurpose of Companies Act, the assessee has shown the AFC as incomeand therefore, the assessee cannot plead that for the purpose ofincome tax, it will show only the actual AFC amount received astowards income, more so, in a case where the assessee is admittedlyfollowing mercantile system of accounting. If it had accrued for thepurpose of profit and loss account submitted in terms of theCompanies Act, AFC should be deemed to have accrued for thepurpose of income tax. On this premise, the case was urged beforethe Tribunal. 5. The Tribunal, however, placed much emphasis on the earlierdecision of the Tribunal on the assessee's own case in respect of theassessment year 1996-97 in I.T.A.No.1222/MDS/1998 and also relyingupon the decision of the Tribunal in the Case of Annamalai FinanceLtd. V. Additional CIT in I.T.A.Nos.99 to 103 (Mds)/2002, which was later on upheld by this Court in the decision reported in [2005]275 ITR 451 (CIT V. Annamalai Finance). 6. On the core issue that there is no prohibition under theIncome Tax Act barring the assessee from maintaining the records aswell as accounts, one for the purpose of income tax and the other forthe purpose of compliance with the other Act, viz., Companies Act orCentral Excises and Salt Act, the Tribunal, referring to Section 115J,115JA and 115JB, came to hold that wherever such a situation arises,special provision has been made. 7. The Tribunal placing much reliance on the decision of thisCourt in the case of Annamalai Finance Ltd. (supra), held that theamendment to Section 145 of the Income Tax Act did not have anyeffect on the issue under consideration, namely, for the assessmentyear 1997-98 onwards, as the scope of such amendment wasconsidered by this Court in the above-said decision, in which case also,the assessment year involved is 1997-98, which is post amendment.The Tribunal, therefore, came to hold that AFC is an income arises onlyat the time of actual receipt. Holding so, the Tribunal dismissed theappeals answering the issue in favour of the assessee and against the Department. 8. As against the said order of the Tribunal, the Revenue isbefore this Court. 9. Mr.J.Narayanasamy, learned Standing Counsel appearing forthe Revenue argued in extenso as follows: In order to explain the nature of the Department's claim on thetax on AFC, he suggested an illustration as follows: If the assessee had financed a sum of Rs.1,20,000/- at the rate of interest at 20% per annum, the instalment will be Rs.10,000/- permonth; in case of default on the monthly instalment, the assesseecharges Rs.1,000/- as AFC or ODC. The assessee is reporting themonthly instalment of Rs.10,000/- on mercantile system of accountingin terms of Section 145 of the Income Tax Act. However, the assesseeshould have accounted the said Additional Finance Charges ofRs.1,000/- in the mercantile system of accounting; on the contrary,the assessee accounted the said AFC on cash/receipt system pleadingthat the recovery of AFC was doubtful and uncertain. The assesseewas reporting AFC as income for the purpose of the Companies Act inthe same year. However, for the purpose of income tax, the assessee If the assessee had financed a sum of Rs.1,20,000/- at the rate of interest at 20% per annum, the instalment will be Rs.10,000/- permonth; in case of default on the monthly instalment, the assesseecharges Rs.1,000/- as AFC or ODC. The assessee is reporting themonthly instalment of Rs.10,000/- on mercantile system of accountingin terms of Section 145 of the Income Tax Act. However, the assesseeshould have accounted the said Additional Finance Charges ofRs.1,000/- in the mercantile system of accounting; on the contrary,the assessee accounted the said AFC on cash/receipt system pleadingthat the recovery of AFC was doubtful and uncertain. The assesseewas reporting AFC as income for the purpose of the Companies Act inthe same year. However, for the purpose of income tax, the assessee is not maintaining or following mercantile system and has not offeredAFC for assessment on mercantile basis. In view of the specificprovisions of Section 145 of the Income Tax Act, the assessee oughtnot to have followed cash system of accounting for this transaction.Having opted to mercantile system of accounting, the AFC becomeliable to tax as in the case of EMI. In effect, as and when EMI fallsdue, AFC also falls due and when the EMI accrues as income, theassessee is not entitled to claim that AFC should be excluded for thepurpose of tax. It is not correct for the assessee to plead that AFCshould be subjected to tax as and when the assessee received thesame and not on the basis of accrual in the event of default of EMI. 10. The next contention of the learned Standing Counselappearing for the Revenue is that the decision in the case ofAnnamalai Finance Ltd. (Supra), on which reliance has been placedby the Tribunal stands distinguished on facts, inasmuch as theassessee during the assessment year did not account the AFC in thebooks of accounts maintained under the Companies Act as well asunder the Income Tax Act; therefore it stands on a different footing.Insofar as the present assessment years are concerned, the assesseehad accounted AFC under the Companies Act, but it did not account the same for the purpose of income tax. This distinguishing factor,therefore, makes the earlier order passed by this Court inapplicable tothe facts of the present case. 11. He further submitted that what applied to the assessmentyear 1996-97 would not apply to the subsequent year, namely, 1997-98, in view of the amendment by the Finance Act, 1995, with effectfrom 01.04.1997, where under, Section 145 of the Income Tax Actclearly mandates that the computation of income should be either cashor mercantile system of accounting regularly employed by theassessee and in accordance with sub-section (2) of Section 145 of theIncome Tax Act. 12. The further contention of the learned Standing Counselappearing for the Revenue is that the concept of real income ascontended by the assessee cannot be applied to the present case,since there is no material shown by the assessee that AFC income isimpossible of realisation; in any event, the assessee is entitled to claimit as bad debts in the subsequent years if the AFC is not realisable. 13. In support of his contention, learned Standing Counsel placed reliance on the decisions reported in [2010] 320 ITR 577(SC) (Southern Technologies Ltd. v. Joint Commissioner ofIncome-tax); [2010] 321 ITR 546 (Commissioner of IncomeTax & Anr. v. United Breweries Ltd.) and (2012) 210 Taxman62 (Madras) to state that if the assessee had not received the saidAFC, the same could be claimed as bad debts in the subsequent year. 13. In support of his contention, learned Standing Counsel placed reliance on the decisions reported in [2010] 320 ITR 577(SC) (Southern Technologies Ltd. v. Joint Commissioner ofIncome-tax); [2010] 321 ITR 546 (Commissioner of IncomeTax & Anr. v. United Breweries Ltd.) and (2012) 210 Taxman62 (Madras) to state that if the assessee had not received the saidAFC, the same could be claimed as bad debts in the subsequent year. 14. Countering the arguments of the learned Standing Counselappearing for the Revenue, Mr.R.Sivaraman, learned counselappearing for the assessee/respondent submitted that AdditionalFinance Charges is an enabling penal provision in the agreemententered into between the parties. It is the additional burden on theborrower who is not prompt in repaying the borrowed money and theinterest thereon in the form of Equated Monthly Instalments. AFC isonly a mechanism to ensure recovery of the amount lent by theassessee. He further submitted that when a normal EMI itself has notbeen paid by the defaulter and there is an uncertainty attached to thatrecovery, the additional burden, namely recovery of AFC, cannot becertain. He also submitted that technically, AFC does not accrue orarise to be recognised as income if there is default in EMI payments.It is well settled that when there is uncertainty in income, the same cannot be treated as income. As per the provisions of Income Tax Act,when an amount is uncertain of being received cannot be taxed asincome till it is realised. He further submitted that AFC does notpartake the character of income and there is no bar in the Income TaxAct that the profit and loss account and balance sheet prepared underthe Companies Act will have to be followed for the purpose of IncomeTax Act for computation of income. 15. In support of his contention, he relied on the decision of this Court reported in [2005] 275 ITR 451 (CIT V. AnnamalaiFinance), to submit that when the instalment itself is overdue and isnot collected, it is uncertain to recover the AFC. He further submittedthat the decisions relied on by the learned Standing Counsel aredistinguishable on facts, as they are dealing with bad debts. In thepresent case, there is no claim of deduction of bad debts. 16. Heard learned Standing Counsel appearing for the Revenueand the learned counsel appearing for the assessee and perused thematerials placed before this Court. 17. Before going into the merits of the case, the provision, viz., Section 145 of the Income Tax Act, which is necessary for the disposal of the case reads as follows: Post amendment: "Method of accounting. 145. (1) Income chargeable under the head “Profitsand gains of business or profession” or “Income fromother sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cashor mercantile system of accounting regularly employedby the assessee. (2) The Central Government may notify in the OfficialGazette from time to time accounting standards to befollowed by any class of assessees or in respect of anyclass of income." -Preamendment: ‘145. Method of accounting.—(1) Income chargeableunder the head “Profits and gains of business orprofession” or “Income from other sources” shall becomputed in accordance with the method of accountingregularly employed by the assessee : Provided that in any case where the accounts arecorrect and complete to the satisfaction of theAssessing Officer but the method employed is suchthat, in the opinion of the Assessing Officer, the incomecannot properly be deduced therefrom, then thecomputation shall be made upon such basis and in suchmanner as the Assessing Officer may determine : -Preamendment: ‘145. Method of accounting.—(1) Income chargeableunder the head “Profits and gains of business orprofession” or “Income from other sources” shall becomputed in accordance with the method of accountingregularly employed by the assessee : Provided that in any case where the accounts arecorrect and complete to the satisfaction of theAssessing Officer but the method employed is suchthat, in the opinion of the Assessing Officer, the incomecannot properly be deduced therefrom, then thecomputation shall be made upon such basis and in suchmanner as the Assessing Officer may determine : Provided further that where no method of accountingis regularly employed by the assessee, any income byway of interest on securities shall be chargeable to taxas the income of the previous year in which suchinterest is due to the assessee : Provided also that nothing contained in this sub-section shall preclude an assessee from being chargedto income-tax in respect of any interest on securitiesreceived by him in a previous year if such interest hadnot been charged to income-tax for any earlier previousyear. (2)Where the Assessing Officer is not satisfied aboutthe correctness or the completeness of the accounts ofthe assessee, or where no method of accounting hasbeen regularly employed by the assessee, theAssessing Officer may make an assessment in themanner provided in section 144." 18. It is seen from the records that the assessee, which is a non-banking financial company entered into a lease agreement with itscustomers. One of the clauses in the agreement provides for if themonthly instalments (EMI) have not been paid, it would carryadditional finance charges (AFC) in the prescribed rate. The assesseemaintain its accounts with respect to the AFC charges undercash/receipt system for the purpose of Income Tax. In the event of default in payment of instalments due on the due dates, the lessee orthe hirer is bound to pay AFC, otherwise, called as ODC and this claimis penal in nature imposed as a measure to ensure prompt payment ofEMI. Hence, the said clause was incorporated to ensure recovery. Theassessee in this case is following mercantile system insofar as EMI isconcerned. The provision of Section 145 is not deviated. Insofar asAFC charges are concerned, the amount is shown on cash/receipt basisfor tax purpose. The question is whether such a method is opposed tolaw. 19. In an identical circumstance, this Court had an occasion toconsider the issue in respect of overdue charges, in the case ofCommissioner of Income Tax V. M/s.Annamalai Finance Ltd.reported in [2005] 275 ITR 451 While dealing with the issue whetheron the facts and in the circumstances of the case, the Tribunal wasright in upholding the action of the assessee in changing the method ofaccounting of overdue interest alone on a cash basis, when the systemof accounting of the assessee was mercantile, this Court held asfollows: “ The change of method of accounting ofoverdue charges from the mercantile basis to cashsystem, method of accounting, as followed by an 19. In an identical circumstance, this Court had an occasion toconsider the issue in respect of overdue charges, in the case ofCommissioner of Income Tax V. M/s.Annamalai Finance Ltd.reported in [2005] 275 ITR 451 While dealing with the issue whetheron the facts and in the circumstances of the case, the Tribunal wasright in upholding the action of the assessee in changing the method ofaccounting of overdue interest alone on a cash basis, when the systemof accounting of the assessee was mercantile, this Court held asfollows: “ The change of method of accounting ofoverdue charges from the mercantile basis to cashsystem, method of accounting, as followed by an assessee, does not create any income; but themethod of accounting only recognizes income.Therefore, either to apply the accrual system or cashsystem, recognition of income is a paramount factor.In the present case, the disputed amount is theoverdue charges receivable `by the assessee fromvarious parties on the basis of hire-purchase andlease agreements. As per the terms of theagreements, overdue charges are payable by theparties concerned to the assessee when they makedefaults in paying the instalments as per the scheduleof payments. When the instalment itself isoverdue, is not collected, there is no basis formaking out a case that the additional overduecharges payable by the parties would becollectible with certainty. The terms of the-agreements which enable the assesseecompany to demand overdue charges is only anenabling provision and that enabling provisiondoes not guarantee the collection of overduecharges. It only gives a cause of action to theassessee. In such cases it is very difficult torecognize income against overdue charges. We are, therefore, of the considered opinionthat the Tribunal has rightly deleted the additionsmade towards overdue charges, acknowledging the change of method of accounting of overdue interestalone on cash basis.” (emphasis supplied) 20. The facts in the above-said decision was that during theassessment years in question, the Assessing Officer during the courseof reassessment found that the assessee had changed the method ofaccounting from mercantile system to cash system for overduecharges alone and held that the same is not permissible. Accordingly,the Assessing Officer added the overdue charges to the income of theassessee, which was upheld by the first Appellate Authority. Onappeal by the assessee, the Tribunal reversed the same in assessee'sfavour. On appeal by the Revenue, this Court accepted the plea of theassessee, thereby dismissed the Revenue's appeal holding that whenthe instalments itself is overdue and is not collected, there is no basisfor making out a case that additional overdue charges would becollectible with certainty. It is not an income accrued for the purposeof tax. 21. In the above-said decision reported in [2005] 275 ITR451 (CIT V. Annamalai Finance), this Court following the decisionof the Calcutta High Court reported in (2003) 263 ITR 129 (Hela Holdings Pvt. Ltd. v. CIT) wherein, the Calcutta High Court had laiddown certain general principles regarding tax avoidance and taxevasion, held that the Revenue was not in a position to demonstrateor satisfy that due to the change of accounting method adopted by therespondent/assessee, which is permissible in law, the Revenuesuffered any loss. 21. In the above-said decision reported in [2005] 275 ITR451 (CIT V. Annamalai Finance), this Court following the decisionof the Calcutta High Court reported in (2003) 263 ITR 129 (Hela Holdings Pvt. Ltd. v. CIT) wherein, the Calcutta High Court had laiddown certain general principles regarding tax avoidance and taxevasion, held that the Revenue was not in a position to demonstrateor satisfy that due to the change of accounting method adopted by therespondent/assessee, which is permissible in law, the Revenuesuffered any loss. 22. It is pertinent to note that the provisions of Section 145 ofthe Income Tax Act, namely, method of accounting had also came upfor consideration before this Court in the above-said decision and itwould be relevant to point out that the assessment years in that casewere 1992-93 and 1998-99, i.e., pre-amendment as well as postamendment to Section 145 of the Income Tax Act, was considered. Inthat case, the change of method of accounting in respect of AFC orODC from mercantile system of accounting to cash system ofaccounting was upheld by the Tribunal and by this Court. We find thelegal issue has been resolved in facts identical to the present case. 23. We find that what has been decided by this Court in theearlier decision is the manner in which the AFC charges should betreated for the purpose of income tax. We have extracted in the earlier portion of this order that it has been held that in respect ofAFC, there is an element of uncertainty and therefore, it has to betreated as income only on receipt. There is no departure on the partof the assessee from the mercantile system of accounting insofar asthe income that arises from EMI. Once the issue has been resolved bythis Court that AFC or ODC partakes the character of uncertain income,it cannot be brought within the purview of taxable income, unless anduntil it comes to the hands of the assessee. The department hasaccepted that proposition of law in the above cited case. No appeal isalso filed as conceded by the learned Standing Counsel for therevenue. 24. We find no reason to depart from the said view, which hasalso been accepted by the Department. The real income theorypropounded by the Department would be applicable only if there is ajustification to come to the conclusion that AFC has become income inthe hands of the assessee. When it has already been held otherwise inthe above-said decision and the Department having accepted such aprinciple, we find no reason to depart from that view in the presentcase. 25. The reliance placed by the learned Standing Counselappearing for the Revenue on the decisions reported in [2010] 320 ITR 577 (SC) (Southern Technologies Ltd. v. Joint Commissioner of Income-tax); [2010] 321 ITR 546(Commissioner of Income Tax & Anr. v. United Breweries Ltd.)and (2012) 210 Taxman 62 (Madras) are distinguishable on factsin the following manner: 25.1. In the case of M/s.Southern Technologies Ltd vs Joint Commissioner of Income Tax reported in [2010] 320 ITR 577(SC), while dealing with the concept of real income theory, theSupreme Court held as follows: Theory of "Real Income" An interesting argument was advanced before usto say that a provision for NPA, under commercialaccounting, is not an "income" hence the same cannotbe added back as is sought to be done by theDepartment. In this connection, reliance was placed on"Real Income Theory". We find no merit in the above contention. In thecase of Poona Electric Supply Co. Ltd. v. Commissionerof Income-Tax, Bombay City I, 57 ITR 521 at page 530,this is what the Supreme Court had to say: "Income Tax is a tax on the "real income", i.e., the 25.1. In the case of M/s.Southern Technologies Ltd vs Joint Commissioner of Income Tax reported in [2010] 320 ITR 577(SC), while dealing with the concept of real income theory, theSupreme Court held as follows: Theory of "Real Income" An interesting argument was advanced before usto say that a provision for NPA, under commercialaccounting, is not an "income" hence the same cannotbe added back as is sought to be done by theDepartment. In this connection, reliance was placed on"Real Income Theory". We find no merit in the above contention. In thecase of Poona Electric Supply Co. Ltd. v. Commissionerof Income-Tax, Bombay City I, 57 ITR 521 at page 530,this is what the Supreme Court had to say: "Income Tax is a tax on the "real income", i.e., the profits arrived at on commercial principles subject to theprovisions of the Income Tax Act. The real profit can beascertained only by making the permissible deductionsunder the provisions of the Income Tax Act. There is aclear distinction between the real profits and statutoryprofits. The latter are statutorily fixed for a specifiedpurpose". To the same effect is the judgment of the Bombay HighCourt in the case of Commissioner of Wealth-Tax,Bombay v. Bombay Suburban Electric Supply Ltd. 103ITR 384 at page 391, where it was observed as under:"Income Tax is a tax on the real income, i.e., profitsarrived at on commercial principles subject to theprovisions of the Income Tax Act, 1961. The real profitscan be ascertained only by making the permissibledeductions". The point to be noted is that the IT Act is a tax on"real income", i.e., the profits arrived at on commercialprinciples subject to the provisions of the IT Act.Therefore, if by Explanation to Section 36(1)(vii) aprovision for doubtful debt is kept out of the ambit ofthe bad debt which is written off then, one has to takeinto account the said Explanation in computation of totalincome under the IT Act failing which one cannotascertain the real profits. This is where the concept of"add back" comes in. In our view, a provision for NPAdebited to P&L Account under the 1998 Directions isonly a notional expense and, therefore, there would be add back to that extent in the computation of totalincome under the IT Act." 25.2. A plain reading of the above-said decision reveals that it isa case of bad debts. The facts in the above decision is that theassessee had made provision for NPA for the financial year ending31.3.1998 under the directions of the RBI and claimed deduction.Accordingly, the profit and loss account was debited and correspondingamount was shown in the balance-sheet. The Assessing Officerdisallowed the same and add back to the taxable income. On appeal,the Tribunal held that the assessee was entitled to deduction underSection 36(1)(vii), but the said view was not accepted by the HighCourt. On appeal, the Supreme Court held that provision for NPA interms of the directions of Reserve Bank of India did not consistute"expense"on the basis of which deduction could be claimed by the non-banking financial companies under Section 36(1)(vii) of the Act. Inthis decision, the Supreme Court held that the amount has to bewritten off as per the provisions of the Income Tax Act and not by theapplication of real income theory. 25.3. The facts in the present case are distinguishable. Here,the assessee has not recognised the AFC as income for the purpose of 25.3. The facts in the present case are distinguishable. Here,the assessee has not recognised the AFC as income for the purpose of Income Tax Act until it is received. But for the purpose of companiesAct, the assessee has accounted it. The provisions of the CompaniesAct require it to be so. Section 145 of the Income Tax Act providesthat the income has to be computed either under cash system orunder mercantile system. Whatever is termed as income will certainlyfall within mercantile system on accrual. It is important to note thatcollectability is different from accrual. Under the mercantile system ofaccounting, interest/hire charges, income (EMI) accrues with time. Insuch cases, interest charged and debited to the account of theborrower as income is recognized under the accrual system. But incash/receipt system, it is not so. AFC as has been held is clouded inuncertainty and on actual receipt becomes income. 25.4. In the decision reported in [2010] 321 ITR 546(Commissioner of Income Tax & Anr. v. United Breweries Ltd.) ,the High Court of Karnakata while dealing with the bad debts held thatthe deduction of bad debts was not regulated by real income theory.The facts in the said decision was the assessee in the course of activityof manufacture and sale of beer furnished guarantee for repayment ofcertain loans and advances taken by its subsidiary companies frombanks. On failure to repay the amount by the subsidiary companies, the assessee had to reimburse the same. The assessee claimed thatthe said expenditure qualified for deduction. The Assessing Officer aswell as the First Appellate Authority rejected the request of theassessee, but the Tribunal reversed the findings of both theAuthorities. On appeal, one of the issues raised before the KarnatakaHigh Court was whether the Tribunal was correct in holding that theamount should be excluded on the principle of real income. The HighCourt answered the issue in favour of the Revenue. 25.5. In the present case, there is no claim of deduction of bad debts. The claim of AFC, which is in penal nature, is uncertain ofrecovery and hence, the same is not recognized as income accrued tillit is realized. 25.6. In the decision reported in (2012) 210 Taxman 62 (Madras) (The United Nilagiri Tea Estates Co. v. DeputyCommissioner of Income Tax), this Court dealt with the issuewhether interest income, which it did not realise after some time, hasto be taxed on accrual basis in terms of Section 145. 25.7. The facts in the above-said decision was the assessee therein advanced certain amount in May 1995 to a company went intoliquidation and subsequently it received interest till August 1996. Theassessee company created contingency reserve, but did not write offprincipal amount till 2007. Subsequently, in the liquidationproceedings against the defaulting company, the assessee receivedcertain amount. The Assessing Officer assessed the income holdingthat since the assessee had not written off the principal amount as wellas interest on accrual basis. This was set aside by the Commissioner ofIncome Tax (Appeals). On appeal, the Tribunal reversed the same.On further appeal, this Court also held that the concept of real incomewould be applicable irrespective of whether the accounts aremaintained in cash system or in the mercantile system. If the accountsare maintained in the mercantile system, it is necessary to seewhether the income could be said to have really accrued takingprobability or improbability of realisation in realistic manner. 25.8. In the above-said decision, the claim is related to normalinterest which was received upto certain period and defaultedthereafter. In that case, the assessee created contingency reserve anddid not write off the principal amount. Therefore, in the absence ofspecific plea or claim by the assessee, there was no improbability or 25.8. In the above-said decision, the claim is related to normalinterest which was received upto certain period and defaultedthereafter. In that case, the assessee created contingency reserve anddid not write off the principal amount. Therefore, in the absence ofspecific plea or claim by the assessee, there was no improbability or realisation of interest income or for that matter, even the principal.This Court held that under the mercantile system of accounting,accrual had occurred and therefore it has to be treated as income. 25.9. In the above-said decision, in the absence of any materialto suggest as to the improbability or impossibility of the realisation ofthe amount even for accrual, this Court confirmed the order passed bythe Tribunal. 26. In the present case, the AFC is in penal nature. This Courtheld that what is to be looked at to test the real income is the chancesor probabilities of realisation and whether there was a real accrual ofincome to the assessee company. This Court further held that even inmercantile system, if the amount has actually accrued, the said incomehas to be taxed. The said accrual has to be taken in a realisticmanner. The observation of this Court in the above-said decisionwould make it clear that the decision of this Court in the case ofAnnamalai Finance (supra) on the theory of actual receipt of AFC asincome stands fortified. 27. In the light of the above, we hold that the decisions relied on by the learned Standing Counsel appearing for the Revenue aredistinguishable on facts. 28. It is to be noted that in the instant case, the Revenue is notin a position to show that due to the change of accounting method, theRevenue suffered loss. Admittedly, there is no finding to that effect inthe assessment order. We also find that the change in method ofaccounting has not caused any loss to the Revenue, because AFC onreceipt by the assessee-company has been offered to tax.Accordingly, we hold that the change of method of accounting ofoverdue charges from the mercantile basis to cash system insofar asAFC does not create any income, but the method of accounting onlyrecognizes income. 29. The decision relied on by the learned counsel appearing for the assessee reported in [2005] 275 ITR 451 (CIT V. AnnamalaiFinance) was followed by this Court in another decision in respect ofthe same assessee for the assessment year 1997-98 reported in[2009] 319 ITR 196 (Mad.), which is a post-amendment to Section145 of the Act and held in favour of the assessee. Therefore, thereis no distinction insofar as the present case is concerned. 30. The facts in the above-said decision, as narrated in theabove -decision are as follows: “2. The facts, as culled out from the memorandum ofgrounds, are as follows: During the previous year endedon 31.3.1997, the assessee Company had admittedoverdue financial charges on hire purchase and leasetransactions on cash basis i.e. on receipt basis and not onaccrual basis. In the course of the assessmentproceedings, the assessee Company was informed thatsince it had been following mercantile system ofaccounting for all incomes and expenses, the same has tobe adopted in respect of overdue financial charges asmandated by Section 145 of the Income-tax Act. 3. From the assessment year 1997-98, in the case ofCompanies, the method of accounting is to be followedstrictly the mercantile system of accounting i.e. on accrualbasis including that of overdue charges of hire purchaseand lease for standard and non-standard assets. Theassessee-Company filed the details and it is found that theoverdue charges on accrual basis in respect of hire chargesand lease in respect of the amount of Rs.82,23,892/- andRs.24,37,922/- respectively aggregating to an amount ofRs.1,06,61,814/- had not been admitted by the assesseeon accrual basis. 4. The assessee had submitted that in respect of overduecharges, the assessee Company, keeping in line with the 3. From the assessment year 1997-98, in the case ofCompanies, the method of accounting is to be followedstrictly the mercantile system of accounting i.e. on accrualbasis including that of overdue charges of hire purchaseand lease for standard and non-standard assets. Theassessee-Company filed the details and it is found that theoverdue charges on accrual basis in respect of hire chargesand lease in respect of the amount of Rs.82,23,892/- andRs.24,37,922/- respectively aggregating to an amount ofRs.1,06,61,814/- had not been admitted by the assesseeon accrual basis. 4. The assessee had submitted that in respect of overduecharges, the assessee Company, keeping in line with the norms of the Reserve Bank of India as well as the creditrating agency, has been recognising income by way ofoverdue charges only to the extent of actual collection i.e.the assessee is admitting income only on cash basis. Theassessee Company has also placed reliance upon theAccounting Standard 9 of ICAI which lays down that whenundertainties exist regarding determination of the amountor its collectability, the revenue shall not be treated asaccrued and hence shall not be recognised until collection. 5. The recognition of revenue on accrual basispresupposes the satisfaction of two conditions viz. Therevenue is measurable and that the revenue is collectablewithout any uncertainty. Taking into account thesestandards also, the assessee submitted that the overdueon financial charges on hire purchase and lease had beenadmitted only on cash basis. Rejecting the saidsubmission, the Assessing Officer passed the assessmentorder.” 31. Therefore, it would not be proper for the Department tocontend that post amendment to Section 145 of the Income Tax Act,the change in the method of accounting adopted by the assesseeshould be re-looked. In the light of the decision of this court in thecase of Annamalai Finance (supra), we find no justification or goodreason why we should reject the claim of the assessee. We have no hesitation to hold that collection and accrual of AFC happensimultaneously in the present case as and when received, as has beenheld by this Court. Hence, AFC cannot be treated as income on accrualbasis. 32. The various contentions raised by the learned StandingCounsel appearing for the Department, more particularly thecontention that the assessee should follow mercantile system for AFCdoes not merit consideration. 33. In the light of the above, following the decision of this Court reported in [2005] 275 ITR 451 (CIT V. Annamalai Finance Ltd.)and [2009] 319 ITR 196 (Mad.) (CIT V. Annamalai FinanceLtd.), we hold that the terms of the agreements, which enable theassessee to demand overdue charges (AFC) is only an enablingprovision and the recovery of overdue charges is not certain and istaxable on cash receipt basis and not accrual basis. 34. We, therefore, hold that the Tribunal was right in upholdingthe order of the Commissioner of Income Tax (Appeals) deleting theadditions made towards Additional Finance Charges, also known as Overdue charges. In the result, the issue is answered in favour of the assessee andagainst the Revenue. Consequently, the above Tax Case (Appeals) aredismissed. No costs. Index :Yes/NoInternet :Yessl/sasi (R.S.,J)(K.B.K.V.,J)15.06.2015 To The Registrar,Income Tax Appellate Tribunal Madras 'B' Bench, Chennai. R.SUDHAKAR,J.ANDK.B.K.VASUKI,J. Sl/sasi T.C.(A) Nos.1222 and 1225 to 1228 of 2007 15.06.2015