Accrued income, discontinued business losses, and bad debt timing under mercantile accounting in tax law

Under the mercantile system, interest accrued and credited to a suspense account remained taxable income where the accounting treatment was not shown to be a regular practice and was adopted only because recovery was doubtful. Losses from a discontinued business arrangement were not allowable as a revenue deduction, because the business had ceased in the relevant year and the loss was treated as capital in nature. For bad debts, mere expiry of limitation did not prove irrecoverability in the accounting year; the question depended on evidence and was one of fact for the tax authorities. A debt could not be written off piecemeal while a reasonable prospect of recovery remained.

---

---

Issues: (i) Whether interest credited to suspense account could be excluded from taxable income under the assessee's mercantile system of accounting. (ii) Whether losses claimed in respect of a discontinued business or partnership could be allowed as a revenue deduction. (iii) Whether debts said to have become time-barred or bad were proved to have become irrecoverable during the relevant accounting year. (iv) Whether a debt could be treated as bad only when the whole balance had become irrecoverable and not on a piecemeal basis.

Issue (i): Whether interest credited to suspense account could be excluded from taxable income under the assessee's mercantile system of accounting.

Analysis: Under the mercantile method, income is brought into account when it accrues and not only when cash is actually received. The assessee's own admissions showed that the suspense-account treatment was not part of any regular accounting practice and was adopted only because recovery was doubtful. The authorities were entitled to hold that the item had accrued and formed part of income for assessment purposes.

Conclusion: The exclusion was not justified and the finding was against the assessee.

Issue (ii): Whether losses claimed in respect of a discontinued business or partnership could be allowed as a revenue deduction.

Analysis: A business arrangement in which profits were shared and one side financed the venture was treated as a partnership in substance. However, the business had ceased long before the accounting year. Section 10 was applied as dealing with businesses actually carried on in the relevant year, and the loss of a dead business could not be set off against profits of a living business. The claim was also treated as a capital loss rather than a revenue loss.

Conclusion: The deduction was rightly disallowed and the finding was against the assessee.

Issue (iii): Whether debts said to have become time-barred or bad were proved to have become irrecoverable during the relevant accounting year.

Analysis: Whether a debt is bad, and when it became bad, is a question of fact for the income-tax authorities. Mere expiry of limitation does not by itself establish badness in the relevant year. On the material recorded, the assessee produced no sufficient evidence to show that the debts became irrecoverable during the year of account, and the authorities' finding was supported by relevant material.

Conclusion: The claim failed and the finding was against the assessee.

Issue (iv): Whether a debt could be treated as bad only when the whole balance had become irrecoverable and not on a piecemeal basis.

Analysis: So long as a reasonable prospect of recovery remains, even if small, the debt cannot be said to have become irrecoverable. On the facts of the insolvent estate debt, the authorities were entitled to conclude that badness had not arisen during the accounting year. The objection to piecemeal write-off was accepted.

Conclusion: The debt was not shown to have become bad in the accounting year and the finding was against the assessee.

Final Conclusion: The reference was answered on the substantial questions in a manner that sustained the revenue's view on the principal disallowances, while accepting the assessee's contention only on the final question concerning the timing of badness of the insolvent estate debt.

Ratio Decidendi: Under the mercantile system, accrued income is taxable when credited in accordance with the regular method of accounting, a loss from a discontinued business cannot be set off under Section 10, and whether a debt has become bad in a particular year is a question of fact for the income-tax authorities.

---