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PETITIONER:

UCO BANK, CALCUTTA

Vs.

RESPONDENT:

COMMISSIONER OF INCOME-TAX, WEST BENGAL

DATE OF JUDGMENT: 13/05/1999

BENCH:

Sujata V.Manohar, D.P.Mohapatra, R.C.Lahoti

JUDGMENT:

Mrs. Sujata V. Manohar, J.

Civil Appeal No.235 of 1996

Civil Appeal No.235 of 1996 pertains to the assessment

of the income of the appellant, United Commercial Bank Ltd.,

for the assessment year 1981-82. The assessee had credited

a total sum of Rs.49,15,435/- by way of interest to a

suspense account since recovery of the said amount was

doubtful and no recovery of the said amount or any part of

it which was by way of interest on loans advanced by it, had

been effected in the three previous years. The assessee

excluded the said sum of Rs.49,15,435/- while computing its

total income.

The Income-tax department completed the assessment for

assessment year 1981-82 on 28th of February, 1985, by

following the Central Board of Direct Taxes Circular

No.F.201/21/84 TTA-II dated 9th of October, 1984 excluding

from the total income of the assessee, the said sum of

Rs.49,15,435/- while computing the total income of the

assessee. The Commissioner of Income-tax on examination of

the assessment records considered the exclusion of the said

sum of Rs.49,15,435/- to be erroneous and prejudicial to the

interest of the revenue. By his order dated 5th of March,

1987 he included the said amount in the total income of the

assessee. On appeal, the Income-tax Appellate Tribunal, by

its order dated 14.10.1988, allowed the appeal of the

assessee. A reference was made to the High Court at the

instance of the revenue under Section 256(1) of the

Income-tax Act. The following question was referred to the

High Court:

"Whether, on the facts and in the circumstances of the

case, the Tribunal is justified in law in cancelling the

CIT's order under section 263 of the Income-tax Act holding

that when the assessment was completed, the only paper

available was the Board's circular dated 9th October, 1984

and, therefore, it cannot be said that the IAC's order of

assessment not taxing the interest in suspense of

Rs.49,15,435/- in view of that circular was erroneous and

prejudicial to the interest of revenue."

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The High Court has answered the reference in favour of

the revenue in view of the decision of this Court in State

Bank of Travancore v. Commissioner of Income-tax, Kerala

[(1986) 158 ITR 102].

We have to consider whether interest on a loan whose

recovery is doubtful and which has not been recovered by the

assessee-bank for the last three years but has been kept in

a suspense account and has not been brought to the profit

and loss account of the assessee, can be included in the

income of the assessee for the assessment year 1981-82. It

is the case of the assessee that in respect of loans which

are advanced by it to various customers, recovery of some

loans is very doubtful. It is doubtful whether even the

interest on the loans advanced will be recovered from the

customer. In such cases, the interest calculated on the

loan amount is credited in a suspense account. This amount

is not brought to the profit and loss account of the

assessee-bank because these are amounts which are not likely

to be realised by the bank. Hence they do not form a part

of the real income of the bank. If and when any such amount

or a part of it is recovered, it is included in that

assessment year in the total income of the assessee for the

purpose of payment of income-tax.

The method of accounting which is followed by the

assessee-bank is mercantile system of accounting. However,

the assessee considers income by way of interest pertaining

to doubtful loans as not real income in the year in which it

accrues, but only when it is realised. A mixed method of

accounting is thus followed by the assessee-bank. This

method of accounting adopted by the assessee is in

accordance with accounting practice. In Spicer and Pegler's

Practical Auditing the relevant passage occurring at page

186-187 has been reproduced in the minority judgment of this

Court in State Bank of Travancore v. Commissioner of

Income-tax, Kerala [(1986) 158 ITR 102 at p.120]. It is as

follows:

"Where interest has not been paid, it is sometimes

left out of account altogether. This prevents the

possibility of irrecoverable interest being credited to

revenue, and distributed as profit. On the other hand, this

treatment does not record the actual state of the loan

account, and in the case of banks and other concerns whose

business it is to advance money, it is usual to find the

interest is regularly charged up, but when its recovery is

doubtful, the amount thereof is either fully provided

against or taken to the credit of an Interest Suspense

Account and carried forward and not treated as profit until

actually received."

Similarly, referring to interest on doubtful debts,

Shukla and Grewal on Advanced Accounts, Ninth Edition at

page 1089 state as follows:

"Interest on doubtful debts should be debited to the

loan account concerned but should not be credited to

interest account. Instead, it should be credited to

Interest Suspense Account. To the extent the interest is

received in cash, the Interest Suspense Account should be

transferred to Interest account; the remaining amount

should be closed by transfer to the Loan account. This

treatment accords with the principle that no item should be

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treated as income unless it has been received or there is a

reasonable certainty that it will be realised."

(Vide State Bank of Tranvacore v. CIT [supra])

The assessee's method of accounting, therefore,

transferring the doubtful debt to an interest suspense

account and not treating it as profit until actually

received, is in accordance with accounting practice.

Under Section 145 of the Income-tax Act, 1961, 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; provided that in a case where the

accounts are correct and complete but the method employed is

such that in the opinion of the Income- tax Officer, the

income cannot properly be deduced therefrom, the computation

shall be made in such manner and on such basis as the

Income-tax Officer may determine. In the present case the

method employed is entirely for a proper determination of

income.

For this same reason, and to aid proper determination

of income, the Central Board of Direct Taxes had issued

Circular No.41(V-6)D of 1952 dated 6th October, 1952. The

circular, inter alia, stated that "interest accruing to a

money lender on loans entered in the suspense account

because of the extreme unlikelihood of their being recovered

need not be included in the assessee's taxable income if the

Income-tax Officer is satisfied that there is really little

probability of the loans being repaid. It is considered

desirable to extend this principle to banks which, instead

of transferring the doubtful debts to a suspense account,

credit the interest on such debts to that account provided

the Income-tax Officer is satisfied that recovery is

practically improbable." This circular was in force till

20th of June, 1978 when the Central Board of Direct Taxes

issued a circular dated 20th of June, 1978 withdrawing with

immediate effect the earlier circular of 6th of October,

1952. The reason for the withdrawal of the circular of 1952

is set out in the circular of 20th of June, 1978. The

reason is stated thus: "the Board has been advised that

where accounts are kept on 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 v. Commissioner of

Income-tax, Kerala [110 ITR 336]. The amount of such

interest is, therefore, includible in the taxable income."

The withdrawal of the circular of 6th of October, 1952 which

had been in force for thirty six years was on account of the

decision of the Kerala High Court in State Bank of

Travancore v. Commissioner of Income-tax, Kerala (Supra).

The Central Board of Direct Taxes, however, issued another

circular of 9th of October, 1984 under which the Central

Board of Direct Taxes decided that "interest in respect of

doubtful debts credited to suspense account by the banking

companies will be subjected to tax but interest charged in

an account where there has been no recovery for three

consecutive accounting years will not be subjected to tax in

the fourth year and onwards. However, if there is any

recovery in the fourth year or later the actual amount

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recovered only will be subjected to tax in the respective

years. This procedure will apply to assessment year 1979-

80 and onwards. The Board's Instruction No.1186 dated

20.6.78 is modified to this extent." The same circular has

also further clarified that upto assessment year 1978- 79

the taxability of interest on doubtful debts credited to

suspense account will be decided in the light of the Board's

earlier circular dated 6.10.1952 as the said circular was

withdrawn only in June, 1978. The new procedure under the

circular of 9th of October, 1984 will be applicable for and

from the assessment year 1979-80. All pending disputes on

the issue should be settled in the light of these

instructions. Therefore, upto the assessment year 1978-79,

the Central Board of Direct Taxes' circular of 6th October,

1952 would be applicable; while from the assessment year

1979-80, the Central Board of Direct Taxes' circular of 9th

of October, 1984 is made applicable. In the present case,

the assessment was made on the basis of the Central Board of

Direct Taxes circular of 9th of October, 1984, since the

assessment pertains to assessment year 1981-82 to which the

circular of 6th October, 1984 is applicable.

What is the status of these circulars? Section 119(1)

of the Income-tax Act, 1961 provides that, "The Central

Board of Direct Taxes may, from time to time, issue such

orders, instructions and directions to other income-tax

authorities as it may deem fit for the proper administration

of this Act and such authorities and all other persons

employed in the execution of this Act shall observe and

follow such orders, instructions and directions of the

Board. Provided that no such orders, instructions or

directions shall be issued (a) so as to require any

income-tax authority to make a particular assessment or to

dispose of a particular case in a particular manner; or (b)

so as to interfere with the discretion of the Appellate

Assistant Commissioner in the exercise of his appellate

functions". Under sub-section (2) of Section 119, without

prejudice to the generality of the Board's power set out in

sub-section (1), a specific power is given to the Board for

the purpose of proper and efficient management of the work

of assessment and collection of revenue to issue from time

to time general or special orders in respect of any class of

incomes or class of cases setting forth directions or

instructions, not being prejudicial to assessees, as the

guidelines, principles or procedures to be followed in the

work relating to assessment. Such instructions may be by

way of relaxation of any of the provisions of the sections

specified there or otherwise. The Board thus has power,

inter alia, to tone down the rigour of the law and ensure a

fair enforcement of its provisions, by issuing circulars in

exercise of its statutory powers under Section 119 of the

Income-tax Act which are binding on the authorities in the

administration of the Act. Under Section 119(2)(a),

however, the circulars as contemplated therein cannot be

adverse to the assessee. Thus, the authority which wields

the power for its own advantage under the Act is given the

right to forego the advantage when required to wield it in a

manner it considers just by relaxing the rigour of the law

or in other permissible manners as laid down in Section 119.

The power is given for the purpose of just, proper and

efficient management of the work of assessment and in public

interest. It is a beneficial power given to the Board for

proper administration of fiscal law so that undue hardship

may not be caused to the assessee and the fiscal laws may be

correctly applied. Hard cases which can be properly

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categorised as belonging to a class, can thus be given the

benefit of relaxation of law by issuing circulars binding on

the taxing authorities.

The question whether interest earned, on what have

come to be known as "sticky" loans, can be considered as

income or not until actual realization, is a question which

may arise before several income tax officers exercising

jurisdiction in different parts of the country. Under the

accounting practice, interest which is transferred to the

suspense account and not brought to the profit and loss

account of the company is not treated as income. The

question whether in a given case such "accrual" of interest

is doubtful or not, may also be problematic. If, therefore,

the Board has considered it necessary to lay down a general

test for deciding what is a doubtful debt, and directed that

all income tax officers should treat such amounts as not

forming part of the income of the assessee until realized,

this direction by way of a circular cannot be considered as

travelling beyond the powers of the Board under Section 119

of the Income Tax Act. Such a circular is binding under

Section 119. The circular of 9th of October, 1984,

therefore, provides a test for recognising whether a claim

for interest can be treated as a doubtful claim unlikely to

be recovered or not. The test provided by the said circular

is to see whether, at the end of three years, the amount of

interest has, in fact, been recovered by the bank or not.

If it is not recovered for a period of three years, then in

the fourth year and onwards the claim for interest has to be

treated as a doubtful claim which need not be included in

the income of the assessee until it is actually recovered.

In the case of Navnitlal C. Javeri v. K.K. Sen,

Appellate Assistant Commissioner of Income-Tax, 'D' Range,

Bombay (1965 (1) SCR 909), the legal effect of such

circulars is, inter alia, considered by a Bench of five

judges of this Court. Section 2(6A)(e) and Section 12(1B)

were introduced in the Income-tax Act by the Finance Act 15

of 1955 which came into force on 1st of April, 1955. The

Government, however, realised that the operation of Section

12(1B) would lead to extreme hardship because it would have

covered the aggregate of all outstanding loans of past years

and would impose an unreasonably high liability on the

shareholders to whom the loans might have been advanced.

The Minister, therefore, gave an assurance in Parliament

that outstanding loans and advances which are otherwise

liable to be taxed as dividends in the assessment years

1955-56 will not be subjected to tax if it is shown that

they had been genuinely refunded to the respective companies

before 30th of June, 1955. Accordingly, a circular was

issued by the Central Board of Revenue on 10th of May, 1955

pointing out to all income tax officers that it was likely

that some of the companies might have advanced loans to

their shareholders as a result of genuine transactions of

loans, and the idea was not to affect such transactions and

not bring them within the mischief of the new provision.

The officers, therefore, were asked to intimate to all the

companies that if the loans were repaid before 30th of June,

1955 in a genuine manner, they would not be taken into

account in determining the tax liability of the shareholders

to whom they may have been advanced despite the new section.

This circular was held by this court as binding on the

Revenue, though limiting the operation of Section 12(1B) or

excluding certain transactions from the ambit of Section

12(1B). It was so held because the circular was considered

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as issued for the purpose of proper administration of the

provisions of Section 12(1B) and the court did not look upon

this circular as being in conflict with Section 12(1B).

A similar view of CBDT circulars has been taken in the

case of K.P. Varghese v. Income Tax Officer, Ernakulam and

Ors. (1981 (4) SCC 173 [at page 188]), by a Bench of two

judges consisting of P.N. Bhagwati and E.S. Venkataramiah,

JJ. The Bench has held that circulars of Central Board of

Direct Taxes are legally binding on the Revenue and this

binding character attaches to the circulars even if they be

found not in accordance with the correct interpretation of

the section and they depart or deviate from such

construction. Citing the decision of Navnitlal C. Javeri

v. K.K. Sen (Supra), this Court observed that circulars

issued by the Central Board of Direct Taxes under Section

119 of the Act are binding on all officers and persons

employed in the execution of the Act even if they deviate

from the provisions of the Act. In Keshavji Ravji and Co.

v. Commissioner of Income-Tax (1990 [183] ITR 1) a Bench of

three judges of this Court has also taken the view that

circulars beneficial to the assessee which tone town the

rigour of the law and are issued in exercise of the

statutory powers under Section 119 are binding on the

authorities in the administration of the Act. The benefit

of such circulars is admissible to the assessee even though

the circulars might have departed from the strict tenor of

the statutory provision and mitigated the rigour of the law.

This Court, however, clarified that the Board cannot

pre-empt a judicial interpretation of the scope and ambit of

a provision of the Act. Also a circular cannot impose on

the tax-payer a burden higher than what the Act itself, on a

true interpretation, envisages. The task of interpretation

of the laws is the exclusive domain of the courts. However,

the Board has the statutory power under Section 119 to tone

down the rigour of the law for the benefit of the assessee

by issuing circulars to ensure a proper administration of

the fiscal statute and such circulars would be binding on

the authorities administering the Act.

In the case of C.B. Gautam v. Union of India and

Ors. (1993 (199) ITR 530 at page 546) a Bench of five

judges of this Court considered as enforceable, Instruction

No.1A88 issued by the Central Board of Direct Taxes relating

to the enforcement of the provisions of Chapter XX-C of the

Income-tax Act. The Central Board pointed out in the said

instruction that in administering the provisions of the said

Chapter, it has to be ensured that no harassment is caused

to bona fide and honest purchasers or sellers of immovable

property and that the power of pre-emptive purchase has to

be exercised by the appropriate authority only when it has

good reason to believe that the property has been sold at an

undervalue and there is payment of black money in the

transaction. The instruction that when the property is put

up for sale by the appropriate authority, the reserve price

should be fixed at a minimum of 15% above the purchase price

shown as the apparent consideration under the agreement

between the parties, was held to be binding on the

authority. The Constitution Bench in the above case also

approved of the decision of this Court in K.P. Varghese v.

Income Tax Officer (Supra).

There are, however, two decisions of this Court which

have been strongly relied upon by the respondents in the

present case. The first decision is the majority judgment

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in The State Bank of Travancore v. Commissioner of Income-

Tax, Kerala (1986 (158) ITR 102) decided by a Bench of three

Judges of this court by a majority of two to one. This

judgment directly deals with interest on "sticky advances"

which have been debited to the customer but taken to the

interest suspense account by a banking company. The

majority judgment has referred to the circular of 6th of

October, 1952 and its withdrawal by the second circular of

20th of June, 1978. The majority appears to have proceeded

on the basis that by the second circular of 20th of June,

1978 the Central Board had directed that interest in the

suspense account on "sticky" advances should be includible

in the taxable income of the assessee and all pending cases

should be disposed of keeping these instructions in view.

The subsequent circular of 9th of October, 1984 by which,

from the assessment year 1979-80 the banking companies were

given the benefit of the circular of 9th of October, 1984,

does not appear to have been pointed out to the Court. What

was submitted before the Court was, that since such interest

had been allowed to be exempted for more than half a

century, the practice had transformed itself into law and

this position should not have been deviated from.

Negativing this contention, the Court said that the question

of how far the concept of real income enters into the

question of taxability in the facts and circumstances of the

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 feasibility". The Court said that the earlier circulars

being executive in character cannot alter the provisions of

the Act. These were in the nature of concessions which

could always be prospectively withdrawn. The Court also

observed that the circulars cannot detract from the Act.

The decision of the Constitution Bench of this Court in

Navnitlal C. Javeri v. K.K. Sen (Supra), or the

subsequent decision in K.P. Varghese v. Income Tax Officer

(supra) also do not appear to have been pointed out to the

Court. Since the later circular of 9.10.1984 was not

pointed out to the Court, the Court naturally proceeded on

the assumption that the benefit granted under the earlier

circular was no longer available to the assessee and those

circulars could not be resorted to for the purpose of

overcoming the provisions of the Act. Interestingly, the

concurring judgment of the second judge has not dealt with

this question at all but has decided the matter on the basis

of other provisions of law.

The said circulars under Section 119 of the Income-

tax Act were not placed before the Court in the correct

perspective because the later circular continuing certain

benefits to the assessees was overlooked and the withdrawn

circular was looked upon as in conflict with law. Such

circulars, however, are not meant for contradicting or

nullifying any provision of the statute. They are meant for

ensuring proper administration of the statute, they are

designed to mitigate the rigours of the application of a

particular provision of the statute in certain situations by

applying a beneficial interpretation to the provision in

question so as to benefit the assessee and make the

application of the fiscal provision, in the present case, in

consonance with the concept of income and in particular,

notional income as also the treatment of such notional

income under accounting practice.

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In the premises the majority decision in the State

Bank of Travancore v. Commissioner of Income-Tax (Supra)

cannot be looked upon as laying down that a circular which

is properly issued under Section 119 of the Income-tax Act

for proper administration of the Act and for relieving the

rigour of too literal a construction of the law for the

benefit of the assessee in certain situations would not be

binding on the departmental authorities. This would be

contrary to the ratio laid down by the Bench of five judges

in Navnitlal C. Javeri v. K.K. Sen (Supra). In fact,

State Bank of Travancore v. Commissioner of Income- Tax

(Supra) has already been distinguished in the case of

Keshavji Ravji and Co. v. Commissioner of Income-Tax

(Supra) by a Bench of three judges in a similar fashion. It

is held only as laying down that a circular cannot alter the

provisions of the Act. It being in the nature of a

concession, could always be prospectively withdrawn. In the

present case, the circulars which have been in force are

meant to ensure that while assessing the income accrued by

way of interest on a "sticky" loan, the notional interest

which is transferred to a suspense account pertaining to

doubtful loans would not be included in the income of the

assessee, if for three years such interest is not actually

received. The very fact that the assessee, although

generally using a mercantile system of accounting, keeps

such interest amounts in a suspense account and does not

bring these amounts to the profit and loss account, goes to

show that the assessee is following a mixed system of

accounting by which such interest is included in its income

only when it is actually received. Looking to the method of

accounting so adopted by the assessee in such cases, the

circulars which have been issued are consistent with the

provisions of Section 145 and are meant to ensure that

assessees of the kind specified who have to account for all

such amounts of interest on doubtful loans are uniformly

given the benefit under the circular and such interest

amounts are not included in the income of the assessee until

actually received if the conditions of the circular are

satisfied. The circular of 9.10.1984 also serves another

practical purpose of laying down a uniform test for the

assessing authority to decide whether the interest income

which is transferred to the suspense account is, in fact,

arising in respect of a doubtful or "sticky" loan. This is

done by providing that non-receipt of interest for the first

three years will not be treated as interest on a doubtful

loan. But if after three years the payment of interest is

not received, from the fourth year onwards it will be

treated as interest on a doubtful loan and will be added to

the income only when it is actually received.

We do not see any inconsistency or contradiction

between the circular so issued and Section 145 of the

Income-tax Act. In fact, the circular clarifies the way in

which these amounts are to be treated under the accounting

practice followed by the lender. The circular, therefore,

cannot be treated as contrary to Section 145 of the

Income-tax Act or illegal in any form. It is meant for a

uniform administration of law by all the income tax

authorities in a specific situation and, therefore, validly

issued under Section 119 of the Income-tax Act. As such,

the circular would be binding on the Department.

The other judgment on which reliance was placed by the

Department was a judgment of a Bench of two judges of this

Court in Kerala Financial Corportion V. Commissioner of

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Income-Tax (1994 (4) SCC 375) where this Court, following

the majority view in State Bank of Travancore v.

Commissioner of Income-Tax (Supra) held that interest which

had accrued on a "sticky" advance has to be treated as

income of the assessee and taxable as such. It is said that

ultimately, if the advance takes the shape of a bad debt,

refund of the tax paid on the interest would become due and

the same can be claimed by the assessee in accordance with

law. For reasons set out above, we are not in agreement

with the said judgment. The relevant circulars of C.B.D.T.

cannot be ignored. The question is not whether a circular

can override or detract from the provisions of the Act; the

question is whether the circular seeks to mitigate the

rigour of a particular section for the benefit of the

assessee in certain specified circumstances. So long as

such a circular is in force it would be binding on the

departmental authorities in view of the provisions of

Section 119 to ensure a uniform and proper administration

and application of the Income-tax Act.

The appeal is, therefore, allowed and the question is

answered in favour of the assessee and against the

department.

Civil Appeal No. 9885-87 of 1996 and 10408 of 1996 :

These two appeals are filed by M/s Tamil Nadu

Industrial Investment Corporation Ltd. The question raised

is similar to the question which we have considered in Civil

Appeal No. 235 of 1996 pertaining to the United Commercial

Bank Ltd. In these two appeals the relevant assessment

years are 1972-73, 1973-74, 1974-75 and 1976- 77. During

these assessment years the circular which was in force was

the circular of 6th of October, 1952. This circular, unlike

the later circular of 9.10.1984 which applies to banking

companies, applies to interest accruing to a money lender on

loans entered in a suspense account because of the extreme

unlikelihood of their being recovered. The circular is

widely worded to include within its ambit a public financial

institution such as the assessee. In view of this circular

which was then in force and which was binding on the

assessing authorities, these two appeals also have to be

allowed for reasons which we have set out in Civil Appeal

No. 235 of 1996. These appeals are also, therefore,

allowed and the question referred is answered in favour of

the assessee and against the department.