Mercantile accounting governs tax treatment of credited interest even without actual cash receipt

Interest credited in the assessee's books on advances made to a partnership firm was treated as taxable income because the assessee had voluntarily adopted the mercantile system of accounting. Under that method, credit entries for interest due are treated as receipts irrespective of actual cash movement, and the assessee could not apply a cash basis for this item while retaining mercantile accounting for the rest. On those facts, the interest was treated as income arising under the charging provision, and the reference was answered in the affirmative against the assessee.

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Issues: Whether interest credited in the assessee's books on advances made to a partnership firm outside British India constituted income accruing or arising in British India and, if not, whether it was nevertheless taxable as income received in British India.

Analysis: The assessee had adopted the mercantile basis of accountancy for his business accounts. Under that method, credit entries for interest due to the assessee were treated as receipts, just as debit entries for interest due by him were treated as payments, irrespective of actual cash movement. The interest in dispute was entered in the Rangoon books as profit in the same manner as other interest items, and interest chittas were sent to the Penang business. The accounting method chosen by the assessee governed the assessment, and he could not rely on the cash basis for one item while retaining the mercantile basis for the rest. On those facts, the interest was properly treated as income arising under the relevant charging provision of the Act.

Conclusion: The question was answered in the affirmative and the interest was held taxable under the Indian Income-tax Act on the basis of the mercantile system adopted by the assessee.

Final Conclusion: The reference was decided against the assessee, with costs awarded to the Revenue.

Ratio Decidendi: An assessee who has voluntarily adopted the mercantile system of accounting must be assessed on that basis alone, and interest credited in the accounts as profit is taxable as income even without actual cash receipt.

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