Real income doctrine prevents tax on doubtful interest from sick subsidiaries despite mercantile accounting.

Interest on loans and advances to sick subsidiary companies was held not taxable on accrual basis where the subsidiaries had ceased or severely curtailed operations, recovery was doubtful, and the surrounding commercial facts showed no real possibility of receipt. The principle applied was that income is chargeable on real income, not hypothetical accrual, even under the mercantile system. Mere continuance of the loan agreements did not by itself establish accrual when the interest was unlikely to be realised. The addition was deleted.

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Issues: Whether interest on loans and advances made to sick subsidiary companies, which had ceased operations and in respect of which recovery was doubtful, could be brought to tax on accrual basis merely because the assessee followed the mercantile system of accounting and the loan agreements remained in force.

Analysis: The assessee had advanced loans to two subsidiaries which had become sick industrial units and were before the BIFR, with one unit having stopped manufacturing and the other having gone into winding-up related proceedings. The interest had not been recorded in the relevant years because recovery was uncertain. The governing principle is that income-tax is chargeable on real income and not on hypothetical accrual, even under mercantile accounting. For accrual to be taxed, there must be a real and realistic possibility of realization, assessed in the commercial context of the transaction. Mere continuance of the loan agreement did not by itself establish real accrual where the surrounding facts showed that recovery of the interest was highly doubtful.

Conclusion: The interest did not really accrue to the assessee and could not be assessed as income on accrual basis. The addition was deleted and the assessee succeeded.

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