# ' _, STATE BANK OF TRAVANCORE v. COMMISSIONER OF INCOME TAX, KERALA - **Citation:** [1986] 1 S.C.R. 25 - **Court:** Supreme Court of India - **Decided:** 1986-01-08 - **Bench:** Tulzapurkar, Sabyasaciu Mukharji, RANGAl'IATH MISRA - **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/state-bank-of-travancore-v-commissioner-of-income-tax-kerala-9252 - **Pages:** 69 ## Headnote Income Tax Act, 1961: 25 Sections 28, 29 & 145 - Banking Company - Advances considered doubtful of recovery-interest on such 'sticky' advances not carried in 'Profit and Loss Account' - Credited to separate account - 'Interest suspense ac;count' - Accrual of income - Whether arises - Interest amount - Whether exemption frorn tax. - Concept and notion of real income - Explained. Hethod of account;i.ng - How far relevant for computation of income, prof.its and gains - Mercantile and cash systems of accounting - Oif fererice between. Devaluation of Indian Rupee - Exchange difference arising therefrom - Whether income assessable to tax. The assessee, a subsidiary bank of the State Bank of India, used to maintain in the accounting years 1964, 1965 and 1966, its accounts in mercantile system making entries and calculating income and loss on accrual basis and adopted the calendar year as its previous year. The assessee, in the course of its banking business, used to charge interest on ~.. advances considered doubtful of recovery termed as 'sticky advances' by debiting the concerned parties but instead of carrying the same to its 'Profit & Loss Account', credited the same to a separate accqunt called 'Interest Suspense Account' as the principal amounts of these 'stic~y advances' themselves had become not bad or irrecoverable, but extremely doubtful of recovery. In its returns th~ assessee disclosed such interests separately and claimed that the same were not taxable in its hands as income for the concerned years. '\ The business of the assessee bank also included buying and selling of foreign exchange and before devaluation of the Indian Rupee on August 6, 1966, the assessee bank held foreign A B c D E F G H A B c D E F G P. 26 SUPREME COURT REPORTS (1986] 1 s.c.R. exchm\ge by way of cash balances available with their foreign ·i correspondents, forward contracts, items in transits, etc. in U.S. Dollars and in Sterling, which on devaluation of the Indian Rupee when converted back to rupees at the post devaluation rates gave rise to a profit of 57.5% in the transaction; the assessee bank-credited this surplus to an account designated "Provision for Contingencies". In the Assessment Year 1967-i>B the assessee bank claimed that profit by way of exchange difference on devaluation should not be taxed as it was of a casual and non-recurring nature. The claim of the assessee bank on both these aspects was rejected by the Income-tax Authorities, Income-tax Appellate Tribunal and the High Court. The High Court held: (a) the assessee was following the mercantile system of accounting; such interest, therefore, had accrued to the assessee at the end of the accounting year; and (b) the assessee itself had treated such income as accrual of interest by charging the same to the parties concerned by making debit entries in their respective accounts. However, if any part of these debits had r later on become irrecoverable in any year, the assessee could have, in that year, treated the same as such and claimed deduction under section 36(l)(vii) of the Income Tax Act, 1961. In the appeals to this Court on behalf of the assesseebank it was contended: (l) that the three sums representing interest on 'sticky' advances, i.e. advances in respect whereof there was high improbability of recovery of even the principal amounts, ought not to have been subjected to tax as income under the Act; that what are chargeable to income-tax in respect of a business are prof its and gains actually resulting from the transaction of the previous year, that is , to say, the real profits and gains and not hypothetical - profits or gains on a doctrinaire theory of accrual; that even under the mercantile system of accounting regularly adopted by an assessee it is only the acrual of "real income" in the commercial sense which is chargeable to tax, that accrual is a matter of substance to be decided on commercial principles having regard to business character of the transaction and ## Text _Characters 0–39,725 of 173,166. This is a partial read: ask again with offset=39725 for what follows._ - ' _, STATE BANK OF TRAVANCORE v. COMMISSIONER OF INCOME TAX, KERALA JANUARY 8, 1986 [V, D, TULZAPURKAR, SABYASACIU MUKHARJI AND RANGAl'IATH MISRA, JJ, ] Income Tax Act, 1961: 25 Sections 28, 29 & 145 - Banking Company - Advances considered doubtful of recovery-interest on such 'sticky' advances not carried in 'Profit and Loss Account' - Credited to separate account - 'Interest suspense ac;count' - Accrual of income - Whether arises - Interest amount - Whether exemption frorn tax. - Concept and notion of real income - Explained. Hethod of account;i.ng - How far relevant for computation of income, prof.its and gains - Mercantile and cash systems of accounting - Oif fererice between. Devaluation of Indian Rupee - Exchange difference arising therefrom - Whether income assessable to tax. The assessee, a subsidiary bank of the State Bank of India, used to maintain in the accounting years 1964, 1965 and 1966, its accounts in mercantile system making entries and calculating income and loss on accrual basis and adopted the calendar year as its previous year. The assessee, in the course of its banking business, used to charge interest on ~.. advances considered doubtful of recovery termed as 'sticky advances' by debiting the concerned parties but instead of carrying the same to its 'Profit & Loss Account', credited the same to a separate accqunt called 'Interest Suspense Account' as the principal amounts of these 'stic~y advances' themselves had become not bad or irrecoverable, but extremely doubtful of recovery. In its returns th~ assessee disclosed such interests separately and claimed that the same were not taxable in its hands as income for the concerned years. '\ The business of the assessee bank also included buying and selling of foreign exchange and before devaluation of the Indian Rupee on August 6, 1966, the assessee bank held foreign A B c D E F G H A B c D E F G P. 26 SUPREME COURT REPORTS (1986] 1 s.c.R. exchm\ge by way of cash balances available with their foreign ·i correspondents, forward contracts, items in transits, etc. in U.S. Dollars and in Sterling, which on devaluation of the Indian Rupee when converted back to rupees at the post devaluation rates gave rise to a profit of 57.5% in the transaction; the assessee bank-credited this surplus to an account designated "Provision for Contingencies". In the Assessment Year 1967-i>B the assessee bank claimed that profit by way of exchange difference on devaluation should not be taxed as it was of a casual and non-recurring nature. The claim of the assessee bank on both these aspects was rejected by the Income-tax Authorities, Income-tax Appellate Tribunal and the High Court. The High Court held: (a) the assessee was following the mercantile system of accounting; such interest, therefore, had accrued to the assessee at the end of the accounting year; and (b) the assessee itself had treated such income as accrual of interest by charging the same to the parties concerned by making debit entries in their respective accounts. However, if any part of these debits had r later on become irrecoverable in any year, the assessee could have, in that year, treated the same as such and claimed deduction under section 36(l)(vii) of the Income Tax Act, 1961. In the appeals to this Court on behalf of the assesseebank it was contended: (l) that the three sums representing interest on 'sticky' advances, i.e. advances in respect whereof there was high improbability of recovery of even the principal amounts, ought not to have been subjected to tax as income under the Act; that what are chargeable to income-tax in respect of a business are prof its and gains actually resulting from the transaction of the previous year, that is , to say, the real profits and gains and not hypothetical - profits or gains on a doctrinaire theory of accrual; that even under the mercantile system of accounting regularly adopted by an assessee it is only the acrual of "real income" in the commercial sense which is chargeable to tax, that accrual is a matter of substance to be decided on commercial principles having regard to business character of the transaction and the realities of the situation and cannot be determined on any , abstract theory of accrual or by adopting a legalistic ~ approach and that if regard is had to the commercial principles and realities of the situation it will be clear that in STATE BANK v. C.I.T. 27 ~-the case of banks, financial institutions and money-lenders, whose bulk profits mainly consist of interest earned by them, there is no accrual of real income so far as interest oil sticky advances and the debit entries made in re>1pect of such interest in the respective accounts Of the concerned debtors following the mercantile system of accounting merely reflected hypothetical income that does not materialise in the concerned accounting year or years during which the advances remain sticky and hence it is but proper to carry such interest to " "Interest Suspense Account' as carrying the same to 'Profit and Loss Account' would result in showing inflated profits and might even lead to improper and illegal distribution or remittance thereof; (2) that there is a clear,distinction between an irrevocable loan and a sticky loan; the former is a bad debt in respect whereof the chance of recovery is nil and as such can outright form the subject matter of deduction under section 36(i)(vii) of the Act while the latter is a loan to which a high degree of improbability of recovery attaches in a particular year or years depending upon the financial position " of the concerned debtor due to which interest thereon becomes hypothetical income during such year. or years and, as such, the same, not being real income, cannot be brought to tax; (3) that right from August 1924 onwards till the decision of the High Courts distinction between an irrecoverable loan and a sticky loan was recognised by the Central Board of Revenue as also by the Reserve Bank of India in ·their diverse Circulars in the case of banks, financial institutions and money-lenders regularly following the mercantiie system of accounting and that Instructions had been issued not to treat the unrealised interest on sticky loans as income by carrying it to 'Profit 'Cand Loss Account' so that the figure of distributable profits should not get inflated and preferably to credit the same to a special account 'Interest Suspense Account' and· that if the banks, financial institutions and money-lenders, who kept their accounts on mercantile system, maintained a suspense account in which the unrealised interest was entered, the same should not be included in the assessee's taxable income, if the Income Tax Officer was satisfied that there was really probability of the loans being repaid; (4) that the Instructions contained in Vartous Circulars were in consona~ce with the accepted principle that what was charg~abie under ~he '< Income Tax Act was the teal inconie of an assessee but these instructions which held field for over 53 years were changed, though wrongly, under fresh -circulars issued by the Central A B c D E F G H A B c 1J E F G 281 SUPREME COURT REPORTS [1986] t s.c.R. Board of Direct Taxes whereunder interest on doubtful or sticky loans became includible in the assessable income of the·~ assessee with effect from the assessment year 1979-80, and (5) that in the case of banks and financial institutions who regularly adopted mercantile system of accounting the practice of carrying interest on such sticky loans to 'Interest Suspense Account' or 'Reserve for Doubtful Interest Account' in stead of crediting the same to 'Interest Account' or 'Profit and Loss Account' is a universally recognised practice invariably adopted by them and being wholly consistent with the mercan- ;; tile system of accounting the Income Tax Officer was bound to give effect to it under section 145 of the Act and, therefore, the treatment of the three sums representing interest on sticky loans as the assessee's income for the concerned years would be unsustainable in law. On behalf of the Revenue it was contended: (1) that though it is the real income that is chargeable to tax under the Act and not any hypothetical income of an assessee and that under section 28 in respect of a business the chargeability must attach to real profits and gains arfaiitg from the~ transactions of the previous year, but under section 5 read with section 28 of the Act the liability .attaches to profits which have been either received by the assessee or which have accrued to him during the year of account and that income accrues when it "falls due", i.e. becomes legally recoverable irrespective of whether actually received or not and "accrued income" is that income which "the assessee has a legal right to receive" and since the assessee has been maintaining its accounts on mercantile basis the three sums being interest on loans, whether doubtful or sticky, fell due and became payable to the assessee at the end of each of the three accounting years and constituted its accrued income and, therefore., justifiably brought to tax in the concerned assessment years; (2).that though, while imposing the tax liability under the Act, the Courts have recognised the theory of real income by having regard to the business character of the transactions and realities of the situation but thes~ aspects have been taken into account for the purpose of determining whether the income could be said to have legally accrued or not and once it is found to have legally accrued it is brought to tax and that the theory of real income has been invoked and confined only to two types of cases (a) where there has been a surrender of income which may in theory have accrued, and (b):>' where there has been diversion of income at source either I' STATE HANK v. C.I.T. 29 A - under a statute or by over riding title but in none of the cases has the aspect of high improbability of recovery been regarded as sufficient to prevent accrual; therefore the theory of real income should not be extended so as to exclude from chargeability such income which has accrued but merely suffers from high improbability of recovery; because such B extention would be neither permissible nor advisable - not permissible because it goes against the very concept of .. accrued income and not advisable because if done it will apply to all cases and not merely to cases of interest accruing to banks and financial institutions. Such extension will moreover entrench upon section 36(1) (vii) which provides for deductions of a debt or part thereof on its becoming bad on fulfilC ment of c~rtain conditions specified in su~ection (2) thereof; for these reasons the extension of the theory of real income so as to take within its ambit the consideration of high improbability of recovery is not warranted. As regards the Circulars of C.B.R. and R.B. I., it was submitted that these merely granted a concession to and conferred no right in . Ii favour of the assessee which could be and has been withdrawn later by issuing fresh Circulars but since the benefit or the concession in favour of the assessee could not be withdrawn retrospectively, the withdrawal of concession has been effected prospectively from the assessment year 1979-80. Dismissing the appeals, E lllWl: Per ·Tulzapurkar, Mukharji and Rsnganath Misra, JJ. (concurring). The principle that if the stock-in-trade remains unused or unsold the mere book appreciation in the value thereof cannot be brought to tax is well accepted. However, in the , instant case, the asses see bank by carrying the surplus F · resulting from the devaluation of the Indian rupee to an account designated 'Provision for Contingencies' could be said to have clearly treated such surplus as its business income. Further, the Appellate Assistant Commissioner in his appellate order recorded a categorical finding that the stock fn trade in terms of foreign currency was sold and used by the assessee G in its normal business. Having regard to this factual position the exchange difference arising out of devaluation of the Indian rupee was rightly treated as income of the assessee in the· assessment year 1967-68. [65 C; 66 G-!I; 67 A & D] C.l.T. v. ~ Line Ltd., 46 I.T.R. 590 referred to. H A B c D E F G H 30 SUPREME COURT REPORTS [1986] l s.c.R. Per ltdbay Cit:y, I v. llessrs. Shoorji Vallabhdas and Co., 46 I.T.1'. 144, Coamissioner of ) Income-tax, llombay North Kutch and f.aurashtra, Ahmedabad v. Cbamanlal Hangaldas &: Co .. , 29 I~T.R. 987, &rvi lndustrU-S STATt: ~ANK v. C.1. T. 33 ·~ Ltd. v. Coamissioner of ~ (Central) Calcutta, 82 A I.T.R. 835, H.M. Kashiparekh & Co. U:d.'s case, 39 I.T.R. 706, Colllnissioner of Income-Tax, West Bengal, 11 v. llirla Gwalior (P) Ltd., 89 I.T •. R. 266, .Conmi.ssioner of Iru:ome-cax, Tamil Nadu-V v. Motor Credit Co. (P) Ltd., 127 l,T,R, 572, Coomi.ssioner of ~. Madras Central v. Devi Films (P) Ltd., 143 I.T.R. 386 and Que:l.ssioner of Income-Tax, B Amritsar-11 v. Ferozepur Fi.oance {P) Ltd., 124 I, T,R. 619 -,· distinguished. ) 10. The concept of real income cannot be so used as to making accrued income, non-income simply because after the ~ eve~t of accrual, the assessee neither decides to treat it as bad debt nor claims deduction under section 36(2) of the Act, but still enters the same with a diminished hope of recovery C in the suspense account. Extension of the concept of real income to this field to negate after the aioount had become payable is contrary to the postulates of the Act. [82 B-C] Per Ranganath Misra, J. (concurring) · , Section 36(2) of the Act covers the entire field regarding deduction for bad debt. Though the concept of 'real 0 income' is well recognised one, it cannot be introduced as an outlet of income fr~m taxman's net for assessment on the plea that though shown in the account book as having accrued, the same became a bad debt and was not earned at all. The citizen is entitled to the benefit of every ambiguity in a taxing statute but where the law is clear considerations of hardship, E injustice or anomaly do not afford justification for extempting income from taxation. [93 C-il] Mapp v. Oram, 1969 (Vol.Ill) All E.R. 219 (H.L.) "" referred to. Per Tulzapurkar, J. - (dissenting) 1. Under the Income Tax Act in order that income should accrue it should not merely fall due or become legally recoverable but should also be factually and practically realisable during the accounting year or years. In other words mere non-receipt of income, when it is reasonably realisable, will not affect accrual but factual or practical unrealis-, ability thereof may prevent its accrual depending upon the facts and circumstances attending upon the transaction. (59 F-G] F G H A B c 0 E F G H 34 SUPREME COURT REPORTS [1986] 1 S.C.R. 2. This theory of real income could be and should be extended to interest on sticky· loans and that on principle such interest being hypothetical cannot be brought to tax. (64 G-11] 3. That the stickiness of advances or loans objectively established to the satisfaction of the taxing authorities by producing proper material, is sufficient to prevent the accrual of interest thereon as real income and would have the effect of rendering such income hypothetical and t!le same cannot be brought to tax. (59 E-F] 4. Under ·section 145 the assessee 's regular method of accounting determines the mode of computing the taxable income but it does not determine or even affect the range of taxable income or the ambit of taxation. In other words, any hypothetical income which may have theoretically accrued but has not truly resulted or 'materialised in the concerned accounting year cannot be brought to charge simply because the assessee has been regularly employing the mercantile system of accounting and makes entries in his books in regard to such hypothetical income. (47 F-<;] I 5. The method of accounting regularly employed by an ' assessee is rel¢vant only for the purpose of computation of income, profits and gains under s. 28 of the Act and that it cannot enlarge or restrict the content of the taxable income under the Act and that under s. 145 the assessee's regular method of accounting determines the mode o>f computing taxable income but it does not determine or even effect the range of taxable income or ambit of taxation. (49 C-D] · 6. In the case of interest on sticky loans the practice of debiting the accounts of the concerned debtors with such interest and carrying the same to 'Interest Suspense Account' instead of to "Interest Account' or 'Profit and Loss Account' is a well recc;>gnised and accepted practice of col!lllercial accountancy, th'1t it is wholly consistent with mercantile method of accow\ting and that it prevents the wrong crediting and improper and illegal distribution or remittance of inflated and unreal profits. (52 D-E] 7. Under s. 5 taxability is attracted not merely when income is acutally received but also when it has 'accrued' and income accrues when it 'falls due', that is to say when it becomes legally recoverable irrespective of whether it is actually receiv~d or not and 'accrued income' is that income which 'the assessee has a legal right to receive.' (52 F-<;] STATE BANK v. C.I.T. 35 ~· 8. Where income or part thereof has theoretically __ ....:.,.. accrued but has been, either unilaterally or as a result of bilateral arrangement, voluntary relinquished or surrendered by the assessee before its accrual the same cannot be regarded as real income of the assessee and cannot be brought to tax. Such conclusion is reached having regard to the business character of the transactions and the realities of the situation notwithstanding that some entries have been made in the asses see' s books maintained in the mercantile system. [55 C-0] 9. Even under the mercantile system of accounting whenever adopted it is only the accrual of real income which is chargeable to tax, that accrual is a matter of substance and that is to be decided on commercial principles having regard to the business character of the transactions and the realities and specialities of the situation and cannot be determined by adopting purely theoretical or doctrinaire or legalistic approach. [58 H; 59 A] Catholic Baolt of India (In Liquidation) v. Comissiooer of Income-tax, Kerala, 1964 K.L.T. 653 = 1965 (1) Income-tax Journal 355, C.I.T. v. Confinance Ltd., 89 I.T.R. 292 & James Finlay & Co. v. C.l.T., 137 I.T.R. 698 overruled. C.l.T. v. Motor Credit Co. (P) Ltd., 127 I.T.R. 572, C.l.T. v. Devi Fillls (P) Ltd., 143 I.T.R. 386, C.l.T. v. Ferozepur Finance (P) Ltd., 124 I.T.R. 619, lllakesvar Prasad Narain singh v. Commissioner of Income Tax, 4 I.T.R. 71 at 74 & H.K. Kashiparekh Co. 's case, 39 I.T.R. 706 approved. C.I.T. v. Sarangpur Cotton Mfg. Co., 6 I.T.R. 36 at 40, C.l.T. v. Singari Bai, 13 I.T.R. 224 at 227, c.1.T. Ksdras v. A. Krislmaswa.t lludaliar & Ors., 53 I.T.R. 122, c.r.T. v. Shoorji Vallabhdas & Co. 46 I. T.R. 144, C.l.T. v. Birla Gwalior (P) Ll:d., 89 I. T.R. 266 and Kohler's Dictionary for Accountants 3rd Edn. relied on. C.I.T. v. Thiagaraja Chetty, 24 I.T.R. 525 at 531, llorvi Industries Ltd. v. C.l.T. Calcutta, 82 I.T.R. 835 at 840, C.l.T. v. Barivallabhadas Kalida& & Co., 39 I.T.R. 1, C.I.T. Ksdhya Pradesh v. Kaloor811l Govindr&lll, 57 I.T.R. 630, Poona Electric Supply Co. Ltd. v. C.I.T. llollbay, 57 I.T.R. 521, C,I.T, v. Sir S.K. Cidtnavis, 6 I.T. Cases 453 Shukla and Grewal referred to. A B c D E F G H A R c D E F G H 36 S~PREME COURT REPORTS [1986] 1 s.c.R. CIVIL APPELi.ATE JURISDICTION : Civil Appeal Nos, 1860-62 (NT) of 1973, From the Judgment and Order dated 22.3.1973 of the Kerala High Court in I.T.R. Nos. 27 to 29 of 1971. N,A, Palkhiwala, S,E, Dastur, M/s. J,B,Dadachandji, Ravinder Narain, Mrs, A, K, Verma and Jeol Peres for the Appellant, . i v.s. Desai, B,B, Ahuja and Miss A, Subhashini for the Respondent. ' N,A, Palkhiwala, S.E, Dastur, M/s. J.B. Dadachanji, Mrs. A.K. Verma a~d D.N. Mishra, for the Intervenors (M/s. Grindlays Bank, Calcutta and State Bank of Travancore), Dr. P. Pal and D,N, Gupta for the Intervenor (Chartered Bank), .. I F.N. Kai<'\, Mr. S.E. llastur, C,S, Shroff, S.S. Shroff and - S,A, Shroff for the Intervenor (Industiral Credit & Investment Corpn. , & American Express International Bank and City Bank Banking Corpn.) ... S.E. Dastur, S,N, Talwar and H.S. Parihar for the Intervenor (Mercantile Bank Ltd.). the K, Ram Kumar, . K, Ram Mohan and Mrs, J, Ramachandran for Intervenor {Indian Overseas Bank, Madras), The follol.ing Judgments were delivered TULZAPURKAR, J, These appeals by certificate from the , High Court raise the following two interesting questions of law for our determination: ( l) Whether on the facts and in the circumstances of the case the addition of the sum of Rs, 67,170, Rs, ~7,777 and Rs, 57,889, representing interest on 'sti~ky 1 advances, as income for the. assessment years 1965-66, 1966-67 an4 1967-68 respectively was justified in law? (2) Whether on the facts and in the circumstances of the case the exchange difference of Rs. l,66, 128 " ' STATE liANK v. C. l, T, [TULZAPURKAR, J,] 37 arising· on devaluation of the Indian rupee on 6. 6.1966 was rightly treated as income for the assessment year 1967-t>S? The facts giving rise to the first question He in a narrow compass and are these. The assessee is a subsidiary of the State Bank of India; it maintains accounts on mercantile system making entries on accrual basis; it adopts the ca~endar year as its previous year and the calendar years 1964, 1965 an7 and 1967-<>8 to which the question relates. In the course of its banking business the assessee charged interest on advance considered doubtful of recovery otherwise called sticky advances by debiting the concened parties but instead of carrying it to its 'Profit and Loss Account' er.edited the same to a separate account styled 'Interest Suspense AccoW1t' as the principal amounts of these stickly a~vances themselves had become, not bad or irrevocerable but extremely doubtful of recovery. However, in its returns the assessee disclosed such interest separately and claimed that the same was not taxable in its hands as income for the concerned years. The amounts so charged to the concerned parties but credited to the 'Interest Suspense Account' INere Rs. 67,170 Rs. 47,777 and Rs. 57,889 for the assessment years 1965-{)6, 1966-<>7 and 1967-{)8 respectively. Before the taxing authorities as also before the Tribunal and the High Court the assessee raised the contention that having regard to the deteriorating financial position of the concerned parties and history of their accounts, the recovery of even the principal amounts had become highly improbable and extremely doubtful rendering the advances 'sticky' and as such the interest thereon, though debited to them, was, following a well recognised principle of commercial accountancy, taken to 'Interest Suspense Account' so as to avoid showing inflated prof its by including hypothetical income and since such interest was not its real income, the same was not taxable in its hands. The contention was rejected at all the levels principally on two grounds - (a) since admittedly the assessee was following the mercantile system of accounting such interest had accrued to it at the end of each accounting year and (b) the assessee had itself shown the accrual of such interest by charging the same to the concerned parties by making debit entries in their accounts. It was observed that if any part of the debts later became irrecoverable in any A B c D E F G H A B c D E F G H 38 SUPREME COURT REPORTS [1986] I S.C.R. year the assel='see could in that year. tr.eat it. as such and clailil deducticif wider s. 36 (1) (vii) of the Income Tax Act 1961. In holding that these three sums were taxable as income in the hands df the assessee for the concerned years the High Court followed1, its ear lier decision in the, case of Catholic Banlt of India !(In IJ.quidation) v. Coami.ssioner of Income-tax, Kerala, (1964]', K.L.T. 653 = (1965] l Income-tax Journal 355 where despite the dir.ective isSued by the Reserve Bank of India to the assessee-bank. not to carry interest on such sticky advances to 'Profit and Loss Accowit' and despite the fact that the assessee-bank had in pursuance thereof ommitted such interest from its 'Profit and Loss Accowit' the Court had taken the view that such interest was taxable as income in the hands of the assessee-bank because of the mercantile system of accowiting that had been regularly employed by it, which had not. been changed even after receiving the directive from the Reserve Bank. The High Court was of the view that the facts of the instant case were indistinguishable from those obtaining in the Catholic Bank's case except that there was a directive from the Reserve Bank of India to the Catholic Bank which was absent in the case before it but in its opinion the presence or absence of such dir.ecti ve fr.om the Reserve Bank could not determine the question whehter. there was accrual of income or not and that in the case before it also there was accrual of income to the assessee considering the mercantile method of accowiting that had been regularly adopted by it. In this view of the matter the High Court answered the question against the assessee and in facour Of the revenue. Incidentally it may be stated in the 'case of this very assessee the High Court, following the i decision herein, took a similar view and answered a similar question against the assessee for the subsequent yea~ 1968-69 which decision rendered in 1975 is reported in 110', ITR 336. The assessee has challenged this view before us in these appeals. Mr. Palkhivala the learned cowisel for the assessee raised a two-fold contention in support of his plea that the three sums r.epr.esenting inter.est on 'sticky' advances, i.e. advances in respect whereof there was high impr.obability of recovery of even the principal amowits ought not to have been subjected to tax. as income under the Act. In the first place he contended that what are chargeable to income tax in respect of a business are profits and gains actually resulting from the transactions of the previous year, that is to say, the real profits and gains and not hypothetical profits or gains • - r ' .. STATE HANK v. c. r. T. [TULZAPURKAR, J.] 39 on a doctrinaire theory of accrual, that even under the mercantile system of accounting regularly adopted by an assessee it is only the accrual of real income in the commer- . cial sense which is chargeable to tax, that accrual is a matter of substance to be decided on commercial principles having regard to business character of the transactions and the realities of the situation and cannot be determined on any, abstract. theory of accrual or by adopting a legalistic approach and that if regard is had to commercial principles and realities of the situation it will be clear that in the case of banks, financial institutions and money lenders, whose bulk profits mainly consist of interest earned by them, there is no accrual of real income so far as interest on sticky advances is concerned, and the.debit entries made in respect of such interest in the respective accounts of the concerned debtors following the mercantile system of accounting merely reflect hypothetical income that does not materialise in the concerned accounting year or years during which the. advances remain sticky and hence it is but proper to carry such interest to '.Interest· Suspense Account' as carrying the same to 'Profit and Loss Account' would result in showing inflated profits and might even lead to improper and illegal distribution or remittance thereof. In this behalf counsel cited several decisions of this Court as also of the High Courts where the principle of real income has been recognised and invoked while considering the tax liability under the Act and in particular strong reliance was placed on two decisions of the Madras High Court in C.I.T. v. Motor Credit Co.(P) Ltd., 127 I.T.R. 572 and C.I.T. v. Devi Films (P) Ltd. 143 I. T.R. 386 and one decision of the Punjab and llaryana High Court in C.I.T. v. Ferozepur Finance (P) U;cl. 124 I.T.R. 619 where a view has been taken that it will be totally unrealis- '· tic to treat interest on sticky loans as income and· the same was excluded from computation of the assessee's income. According to Counsel there is a clear distinction between an irrecoverable loan and a sticky loan; the former is a bad debt in respect whereof the chance of recovery is nil and as such can out right form the subject matter of deduction under s. 36 (1) (vii) of the Act while the latter is a loan to whicn a high degree of improbability of recovery attaches in a particular year or years depending upon the financial position of the concerned debtor due to which interest thereon becomes °"" hypothetical income duringsuch year or years and, as .such, the same, not being real income, cannot be brought to tax. Counsel pointed out that right from August 1924 · onwards till the A B c D E F G H A B c D E F G H 40 ~UPREME COURT REPORTS [1986] 1 s.c.R. impugned decision herein as also the further decision in 110 ITR 336 were rendered by the Ker ala High Court in 197 3 and ,I 1975 respectiveiy the aforesaid distinction between an irre- ~ coverable, 104n and a stickly loan was recognised ·by the Central Board of P.evenue as also by the Reserve Bank of India in their diverse Circulars in the case of banks, financial institutions and money lenders regularly following the mercantile system of accounting and he further pointed out that Instructions 1had been issued not to treat the unrealised interest on such sticky loan as income by carrying it to 'Profit and Loss Account' so that the figure of distributable .,,, profits should not get inf lated and preferably to credit the same to a special account such as 'Interest Suspense Account' and that if the banks, financial institutions and money lenders, who' kept their accounts on mercaritile system, maintained such a suspense account in which the unrealised interest was entered, the same should not be included in the <>ssessee's taxable income, if the Income Tax Officer was satisfied that there was really little probability of the loans being jrepaid. (Vide C.B.R. Circular No. 37 /54 dated 25.8.1924, No. 4l(V-6) D of 1952 dated 6.10.1952, CBDT's >- Letter F.No. 207/10/73 ITA II dated 16.4.1973 and RBI Circular IFD No. O.P.R. 1076/1(5) to SFCs dated 21.11.1973, copies whereof were furnished to the Court). Counsel urged that such Instructions 1contained in these Circulars were in consonance with the. accepted principle that what was chargeable under the Income Tax Act was the real income of an assessee but according to him these Instructions which held field for over 53 years were changed, though wrongly, under fresh Circulars dated June 20, 1978 and October 9, 1984 issued by the Central Board of DirJct Taxes whereunder such interest on doubtful or sticky loans became includible in the assessable income of the assessee (subject to some relief specified therein) with effect from the assessment year 1979-80. Secondly, counsel contended that in any view of the matter in the case of banks and financial institutions who regularly adopt mercantile system of accounting the practice of carrying interest on such sticky loans to 'Interest Suspense Account' or 'Reserve for Doubtful Int~rest Account' instead of crediting the same to 'Interest Account' or 'Profit and Loss Account',. is a universally recoginsed practice invariably adopted by them and being wholly consistent with the mercantile system of accoun- . ting the Income Tax Officer was bound to give effect to it " under ~. 145 of the Act, and, therefore, the treatment of the three sums representing interest on sticky loans as the !>- STATE BANK v. C.I.T. [TULZAPURKAR, J,] 41 assessee's income for the concerned assessment years would be unsustainable in law; and in this behalf counsel placed reliance on the standard text books of accountancy of authors like · Spicer and Pegler, Shikla and Grewal and the Approved Text of International Accounting Standard 18. Since the issues raised before us have a vital bearing upon the tax liability and business interests and poli~ies of server.al financial institutions including foreign panks, six interverners, ruimely, American Express Inter.national Banking Corpn., Mercantile Bank Limited through its successors ~ Hongkong & Shenghai Banking Corporation, Citi Bank N.A., Chartered Bank, Gr.indlays Bank and Industrial Credit & Investment Corpn.