Karnataka H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in upholding the disallowance of Rs. 26,280 as representing expenditure in the nature of entertainment expenditure disallowable under s. 37(2B) of the Act ?

Counsel Appeared

G. Sarangan, for the Assessee : K. Srinivasan & H. Raghavendra Rao, for the Revenue

M. RAMA JOIS, J.:

These three references have been made by the Tribunal, Bangalore, under sub-s. (1) of s. 256 of the IT Act, 1961, seeking the opinion of this Court on the following three questions of law :

” (1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in upholding the disallowance of Rs. 26,280 as representing expenditure in the nature of entertainment expenditure disallowable under s. 37(2B) of the Act ?

(ii) Whether, on the facts and in the circumstances of the case, the assessee is entitled to deduction under s. 36(1)(viii) of 2/7ths of Rs. 51,29,454 as held by the Tribunal or 40 per cent of the same as claimed by the assessee ?

(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that interest of Rs. 11,40,862 on ‘ sticky loans ‘ is not includible in the total income of the assessee for the asst. yr. 1976-77? “

The first two questions have been referred at the instance of the assessee, the Karnataka State Financial

Corporation, Bangalore, and the third question is referred at the instance of the CIT, Karnataka-11, Bangalore.

As far as the first question is concerned, in view of the amendment of s. 37 (2 B) of the Act by the Finance Act, 1983 (Act I 1 of 1983), with retrospective effect from 1st April,1976, the question has to be answered in the affirmative and against the assessee, as by the said amendment the entertainment expenditure has been completely disallowed.

As far as the second question is concerned, the matter is concluded by the order of this Court in the case of Karnataka State Financial Corporation vs. CIT (1988) 174 ITR 206 (Kar). For the reasons stated in the said order, the view taken by the Tribunal has to be upheld and, consequently, the question is answered to the effect that the assessee was entitled to deduction under s. 36(1)(viii) of the Act to the extent of only 2/7ths of Rs. 51,29,454.

As far as the third question is concerned, the facts of the case are these : This relates to the question of deductibility of the amount of interest on what are known as “sticky loans”, kept in suspense account, instead of carrying it to the profit and loss account. During the relevant accounting year, namely, 1975-76, interest amounting to Rs.11,40,862 was credited to a suspense account on the ground that the said amount of interest was on sticky loans. The assessee claimed before the ITO that the said amount of Rs. 11,40,862 was not includible in the computation of the income of the assessee for the assessment year, having regard to the view expressed by the CBDT (“the Board” for short) in its letter dt. April 16, 1973, and the instructions issued by the Reserve Bank of India in its letter dt. November 21, 1973, based upon the letter of the Board (Annexure E). The letter of the Reserve Bank reads : ” To all SFCs (Except Haryana), Dear Sir, Levy of income-tax on the amounts held in ‘Interest suspense account’.

6. It is observed that there is no uniformity in the practice followed by SFCs in regard to the treatment of unrealised interest on suits filed and other sticky loans for the purpose of computing income. While some SFCs do not treat unrealised interest on such loans as income, others treat it as income and carry it to the profit and loss account. To the extent the unrealised interest is taken as a part of income, the figures of distributable profit get inflated and do not help to present a true picture of the actual income of the Corporation. It will, therefore, be preferable to credit the amount of unrealised interest to a special account (interest suspense account), instead of the Profit and loss account or make a specific provision for unrealised interest to the debit of the profit and, loss account equivalent to the amount of such interest credited to the profit and loss account. As you are aware, this matter was also discussed at the sixteenth conference of the representatives of SFCs held in April, 1973. In this connection, we forward for your information and record a copy of letter F. No. 207/10/73- I.T.A. 11 dt. 16th April,

1973, addressed by the CBDT, Government of India, to the Government of Haryana, wherein it is opined by the Board that the amounts kept in suspense account under the heads ‘ Interest, Commission, etc.’, will not be assessable to tax. However, it will be necessary for the assessee to maintain a systematic method of accounting in respect of doubtful debtors, subject to checks and counter-checks. We shall, therefore, be glad if you will please adopt an appropriate accounting procedure for unrealised interest on sticky loans, in consultation with your auditors. 2. Please acknowledge receipt. Yours faithfully, (Sd) Asst.Chief Officer.” The letter of the Board reads: “Sir I am directed to refer to your D.C. No. 30TTA (HR) 11864 dt. March 15, 1973, on the above subject the Board is of the view that the amounts kept in suspense account under the heads ‘Interest, Commission, etc.,’ will not be assessable to tax. However, the assessee must maintain a systematic method of accounting in respect of doubtful debtors subject to checks and counter checks. Yours faithfully, (Sd) Mr. S. K. Nigam, Under Secretary, CBDT.”

7. The ITO was of the View that as the assessee was following the mercantile system of accounting, the amount of interest credited to the suspense account was also to be regarded as interest accrued to the assessee during the accounting year and must have been included in the profit and loss account and, therefore, the said amount must be included in the computation of the income.

8. On appeal, the AAC upheld the contention of the assessee based on the letter of the Reserve Bank of India as also the directions contained in the letter of the Board. The relevant portion of the appellate order reads : ” 4. Regarding ground No. (iv), it is argued that the assessee- company has to follow the directions given by the Reserve Bank of India regarding the interest on sticky loans. As per the letter from the Reserve Bank of India, dt. November 21, 1973, addressed to the assessee, it would be proper to credit the amount of unrealised interest on these sticky loans to a special account (interest suspense account) instead of the profit and loss account. The Haryana State Financial Corporation has referred the matter to the CBDT which in its letter dt. April 16, 1973, has advised that the amounts kept in suspense account under the heads ‘Interest, Commission, etc.,’ will not be assessable to tax. The CBDT have, however, pointed out that the assessee should maintain a systematic method of accounting in respect of doubtful debtors subject to checks and counter-checks. It is argued by counsel for the assessee that in any banking companies of this type, there is a statutory audit and this will serve the purpose of checks and counter-checks. Hence, it is argued that the interest credited to the suspense account should not be treated as accrued income. The interest on such loans will be offered for taxation in the year of realisation. In the light of the views of the CBDT referred to above, the claim of the assessee is justified. This procedure of crediting the interest to suspense account has to be treated as a regular method of accounting employed by the assessee and as such it has to be differentiated from the mercantile system of accounting in so far as these sticky loans are concerned. The addition made is deleted.”

9. The Tribunal upheld the view taken by the AAC.

10. Questioning the correctness of the view taken by the Tribunal, the CIT sought for reference and accordingly, the third question has been referred for the opinion of this Court.

11. Sri Sarangan, learned counsel for the assessee, submitted that the direction issued by the Board was binding on all the authorities of the Department in view of s. 119 of the Act and that, therefore, the AAC was right in upholding the claim of the assessee for deduction of the amount of interest on sticky loans credited to the suspense account and the Tribunal was right in confirming the said view.

12. There is no doubt that the directions issued by the Board in its letter dt. April 16, 1973, extracted earlier, expressly states that the amount of interest kept in suspense account, is not assessable to tax. Learned counsel for the Revenue, however, submitted that the Circular issued was not in consonance with the provisions of the Act and, therefore, neither the AAC nor the Tribunal was right in upholding the claim of the assessee relying upon the said directions. He also submitted that the question has to be answered in favour of the Revenue in view of the decisions of the Supreme Court in State Bank of Travancore vs. CIT (1986) 50 CTR (SC) 290:(1986) 158 ITR 102 (SC).

13. As far as the binding nature of the circulars/directions issued by the Board is concerned, the matter is fully covered by the ratio of the decisions of the Supreme Court in Navnit Lal C. Javeri vs. K. K. Sen, AAC (1965) 56 ITR 198 and in K. P. Varghese vs. ITO (1981) 24 CTR (SC) 358:(1981) 131 ITR 597 (SC). Sec. 119 of the Act is a reproduction of sub-s. (8) of s. 5 of the Indian IT Act, 1922. The question as to whether a direction issued by the Board under s. 5(8) of the 1922 Act was binding on the Departmental authorities, was the subject-matter for consideration by the Constitution Bench of the Supreme Court in the case of Navnit Lal C. Javeri (1965) 56 ITR 198. The Supreme Court held that the direction issued by the Board was binding. In the case of K.P.Varghese vs. ITO (supra), the Supreme Court had occasion to consider the question regarding the binding nature of the direction issued by the Board under s. 119 of the 1961 Act which actually was found to be contrary to s. 52 of the Act providing for levy of tax on capital gains. The Supreme Court held that even if the direction issued by the Board under s. 119 of the Act was regarded as contrary to any of the provisions of the Act, still the direction issued by the Board which is entrusted with the responsibility of the administration of the provisions of the Act, was binding on all the authorities. The relevant portion of the judgment reads as under : ” But the construction which is commending itself to us does not rest merely on the principle of contemporanea expositio. The two circulars of the CBDT to which we have just referred are legally binding on the Revenue and this binding character attaches to the two circulars even if they be found to be not in accordance with the correct interpretation of sub-s. (2) and they depart or deviate from such construction. It is now well-settled as a result of two decisions of this Court, one in Navnit Lal C. Javeri vs. K. K. Sen. AAC (supra) and the other in Ellerman Lines Ltd. vs. CIT (1972) CTR (SC) 71:(1971) 82 ITR 913 (SC), that circulars issued by the CBDT under s. 119 of the Act are binding on all officers and persons employed in tile execution of the Act even if they deviate from the provisions of the Act.”

Sri K. Srinivasan, learned counsel for the Revenue, however, submitted that in view of the decision of the Supreme Court in State Bank of Travancore (1986) 50 CTR (SC) 290:(1986) 158 ITR 102 (SC), the circular issued by the Board cannot be regarded as binding on the Department and the assessee cannot enforce the said circular.

In the aforesaid case, the question which had been referred for the opinion of the Kerala High Court (ITR Nos. 27 to 29 of 1971 decided on March 22, 1973) was as follows ((1986) 158 ITR 107) : ” (1) Whether, on the facts and in the circumstances of the case, the addition of the sums of Rs. 67,170, Rs. 47,777 and Rs. 57,889, representing interest on ‘ sticky ‘ advances, as income for the asst. yrs. 1965-66, 1966-67 and 1967-68, respectively, was justified in law?”

16. The Kerala High Court answered the question against the assessee following its earlier judgment in State Bank of Travancore vs. CIT (1975) CTR (Ker) 72:(1977) 110 ITR 336 (Ker). The correctness of the said view was challenged before the Supreme Court. The view taken by the High Court was upheld. The contention of the bank based on the letter of the Board dt. April 16, 1973, on which the assessee relied in this case was negatived. The relevant portion of the judgment reads.(at pp. 138 to 155 of 158 ITR) : ” There is also a letter dt. April 16, 1973, from the Under Secretary, CBDT, referring to D.O. letter dt. March 15, 1973, reiterating that the amounts kept in suspense account under those circumstances would not be taxable. The assessee was, however, required to maintain a systematic method of accounting in respect of doubtful debts subject to checks and counter-checks. By letter dt. November 21, 1973, the Reserve Bank of India wrote that there was no uniformity in the practice followed by the State Financial Corporations on sticky loans where the same position was reiterated. A letter was written on June 20, 1978, by the CBDT to the CITs soon after the decision rendered in the assessee’s case in State Bank of Travancore (supra), referred to hereinbefore. In that letter, reference was made to the previous circulars and it was pointed out that the stand taken in these circulars was not acceptable to the Revenue Audit Department and it had objected to the exclusion of such amounts of interest from the total income. The Board advised that where accounts were kept on mercantile basis, interest was taxable irrespective of whether the same was credited to suspense account or to interest account. Reference was made to the decision of the Kerala High Court in (1977) 110 ITR 336, (supra) which has been followed in the instant case. The Central Board, therefore, directed that such interest should be includible in the taxable income, and all pending cases should be disposed of keeping the present instructions in view. It was further directed that immediate review should be undertaken under s. 147(b) or s. 263 of the Act in respect of assessments which had been completed in accordance with the Board’s earlier directions. In the last letter, the same position was reiterated but it was further clarified as to future course of action. In these appeals, we are not concerned with the actual effect of these circulars and these need not be set out and examined.

17. Several financial institutions sought to intervene as the question involved herein is of some importance to them. We have allowed them to make their submissions and have taken them into consideration. It was urged that the instructions contained in these circulars noted before were in consonance with the accepted principles of accountancy and these instructions have held the field for over 53 years. It was also submitted that as such claims have been allowed to be exempted for more than half a century and the practice had transformed itself into law, this position should not have been deviated from. This submission, of course, cannot be accepted. The question of how far the concept of real income enters into the question of taxability in the facts and circumstances of this case and how far and to what extent the concept of real income should intermingle with the accrual of income will have to be judged in the light of the provisions of the Act, the principles of accountancy recognised and followed and the feasibility. The earlier circulars, being executive in character, cannot alter the provisions of the Act. These were in the nature of concessions and could always be prospectively withdrawn. However, on what lines the rights of the parties should be adjusted in consonance with justice in view of these circulars is not a subject matter to be adjudicated by us, and, as rightly contended by counsel for the Revenue, the circulars cannot detract from the Act.

18. The profits and gains chargeable to tax under the Act are those which have been either received by the assessee or have accrued to the assessee during the period between the first and the last day of the year of account and are receivable. Income received or income accrued are both chargeable to tax under s. 28 of the Act. The computation of this income is provided for in s. 29 of the Act. While we are on the sections, it may be appropriate to refer to s. 36 also. Sec. 36(1) provides for certain deductions from the computation of income and cl. (vii) thereof deals with bad debts in these terms: ‘(vii) subject to the provisions of sub-s. (2), the amount of any debt or part thereof, which is established to have become a bad debt in the previous year ; ‘ Sec. 36(2) prescribes the conditions to be satisfied for earning deduction for a bad debt. There is no dispute in these appeals that such conditions are not satisfied. Sec. 56 of the Act deals with income from other sources and s. 57 deals with deductions in the computation of income from other sources. Sec. 145 deals with the method of accounting. Sub- s. (1) of the said section provides that income chargeable under the head ‘ Profits and gains of business or profession’ or ‘Income from other sources’ shall be computed in accordance with the method of accounting regularly employed by the assessee. The proviso in certain eventualities permits the ITO to adopt the mode for computation of income. Similar too is the position of sub-s. (2). It is settled that the income of the assessee will have to be determined according to the provisions of the Act in consonance with the method of accountancy regularly employed by the assessee. The method of accounting regularly employed by the assessee helps the computation of income, profits and gains under s. 28 of the Act and the taxability of that income under the Act will then have to be determined. The question is, whether the income which has been computed according to the method of accounting followed regularly by an assessee can be diminuted or diminished by any notion of real income. This has to be judged in the light of the well-settled principles …

As a result of the aforesaid discussion, the following propositions emerge : (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 in suspense account cannot be such evidence to show that no real income has accrued to the assessee or 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.

We were invited to abandon legal fundamentalism. With a problem like the present one, it is better to adhere to the basic fundamentals of the law with clarity and consistency than to be carried away by common cliches. The concept of real income certainly is a well-accepted one and must be applied in appropriate cases but with circumspection and must not be called in aid to defeat the fundamental principles of the law of income- tax as developed.

23. For the reasons aforesaid, with respect, it is not possible for me to agree with the answer proposed by my learned brother, Tulzapurkar J., on the first question. In the premises, question number (1) should be answered in the affirmative and in favour of the Revenue …” (Emphasis, italicised in print, supplied)We asked learned counsel for the Revenue to produce a copy of the 1978 Circular referred to in the judgment of the Supreme Court. It was produced. It reads : ” Instruction No. 1186. XXIV/1/30-Bad and doubtful debts/irrecoverable loans-Interest thereon-Suspense account maintained for the purpose of—Instructions regarding.

24. Attention is invited to Board’s Circular No. 41/V-6/D of 1952 (No. 27(44)/II/52) dt. 6th October, 1952 (printed below) wherein it was clarified that interest on doubtful debts credited to a suspense account by banks need not be included in the taxable income provided the ITO is satisfied that the recovery of the loan is practically improbable. The Board, vide its letter F.No. 207/16/71/-ITA II dt. 29th November 1972, informed the CIT, Delhi-I, that interest on doubtful debts credited to suspense account by the Industrial Finance Corporation of India should not be included in the taxable income. This view was reiterated in the cases of various other financial institutions. The Revenue Audit, however, did not agree with the views expressed by the Board and objected to the exclusion of such interest from the total income.

The Board have recently received a number of representations from other State Financial Corporations/Institutions seeking exemption of interest on such accounts from inclusion in the total income. The matter has, therefore, been re-examined in consultation with the Ministry of Law. The Board have been advised that where accounts are kept on the mercantile basis, interest thereon is taxable irrespective of whether the interest is credited to suspense account or to interest account. The Kerala High Court has also expressed the same view in the case of State Bank of Travancore vs. CIT (supra). The amount of such interest is, therefore, includible in the taxable income.

In view of this, Circular No. 41/V-6/D of 1952, dt. 6th October, 1952, and clarifications issued in cases of financial institutions are withdrawn with immediate effect. Immediate review may be undertaken and remedial action by way of initiation of proceedings under s. 147(b) or s. 263 may be taken in respect of assessments which have been completed in accordance with the Board’s instruction and clarification referred to in paras I and 2 above.”

From the contents of the above instruction, it is clear that the earner circular on which the assessee relies was withdrawn. Learned counsel for the Revenue pointed out that though the assessment order in respect of which the claim was made by the Travancore Bank was made before the withdrawal of the circular, the Supreme Court answered the question against the assessee and, therefore, this Court has to answer the question in favour of the Revenue.

Sri Sarangan, learned counsel for the assessee, however, submitted that the decision in Travancore Bank’s vs. CIT case (1986) 50 CTR (SC) 290:(1986) 158 ITR 102 (SC) is not binding on this Court for two reasons. Firstly, the question as to the binding nature of the circular was not at all considered by the Supreme Court in the said case and, therefore, the decision cannot be taken as an authority for the proposition that even if the circular was in force and applicable for the assessment year in question, the same was not binding on the authorities. Secondly, if the decision in Travancore Bank’s case (supra) is to be regarded as having decided the question to the effect that in cases where the directions issued by the Board is found to be contrary to the wording of the provisions of the IT Act, such directions are not binding on the Departmental authorities, such a view being contrary to the view taken

by the Supreme Court in Navnit Lal C. Javeri’s case (1965) 56 ITR 198 (SC) decided by a five-judge Bench, the said view taken by the larger Bench is binding on this Court.

As can be seen from the judgment of the Supreme Court in Travancore Bank’s case (supra), the question raised was similar to the one raised in this case. Secondly, it is clear from the question set out in the opening part of the judgment itself that the assessment year concerned in the said case was prior to the letter of the Board dt. June 20, 1978, by which the previous circular dt. April 16, 1973, on which the assessee relies was withdrawn. Even so, the Surpeme Court held that the interest on sticky loans credited to the suspense account by the Travancore Bank was includible in the income of the assessee and liable to tax during the relevant assessment year. What was left open was about the actual effect of the circular dt. June 20, 1978, in which in addition to the direction that pending cases should be decided without reference to the circular dt. April 16, 1973, there was also a direction to undertake a review under ss. 147(b) and 263 of the Act in respect of assessments completed prior to June 20, 1978. Therefore, this Court cannot answer a similar question differently.

27. If the circular dt. April 16, 1973, had not been withdrawn and the decision by the three judge Bench in Travancore Bank’s case (supra), was solely on the ground that the 1973 circular of the Board ran counter to the wording of the relevant sections of the Act, there would have been considerable force in the contention of the assessee that in view of the larger Bench decision of the Supreme Court in Navnit Lai C. Javeri’s case (supra) as explained and reiterated in the case of K.P. Varghese (supra), the circular must be held to be binding on the authorities. But, in the instant case, as the Board itself withdrew the said direction in its subsequent letter dt. June 20, 1978, the assessee could no longer rely on the earlier direction.

As can be seen from the relevant paragraph of the judgment, extracted earlier, though there is an observation that the earlier circular being executive in character cannot prevail over the provisions of the Act, the question was answered on an interpretation of ss. 28, 29 and 36 of the Act, for the reason that the Board itself had withdrawn its directions in the light of the judgment of the Kerala High Court in Travancore Bank’s case (supra), and the objection raised by the Revenue Audit Department. Learned counsel for the assessee contended that in the very paragraph of the judgment of the Supreme Court, on which the Revenue relies, the Supreme Court had observed that circulars could be withdrawn prospectively and, therefore, the withdrawal had no effect as it was subsequent to the assessment year in question. The contention cannot be accepted in view of the fact that the assessment year concerned in Travancore Bank’s case (supra), was also prior to withdrawal of the circular. Further, it should be pointed out that in this case, though the instruction was issued by the Board on June 20, 1978, withdrawing the earlier circulars, the Tribunal which made its order (Annexure-C) thereafter on October 25, 1978, followed the earlier circular, though it had already been withdrawn.

28. For the aforesaid reasons, we answer the third question in the negative and in favour of the Revenue.

[Citation : 174 ITR 212]