Bank's memo account interest not taxable under Income-tax Act sections 28 & 145, court approves hybrid accounting

The court held that interest recorded in the memorandum account by the assessee-bank, following a consistent policy for problem loans, was not liable for inclusion in the total income under sections 28 and 145 of the Income-tax Act. The court approved the assessee's hybrid accounting method, distinguishing it from previous cases. The court ruled in favor of the assessee, affirming that the interest in the memorandum account was not assessable income.

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Issues Involved:
1. Applicability of CBDT circulars to the inclusion of interest recorded in the memorandum account in assessable profits.
2. Inclusion of interest recorded in the memorandum account in the assessee's total income under sections 28 and 145 of the Income-tax Act, 1961.

Summary:

Issue 1: Applicability of CBDT Circulars
The court did not address this issue directly as it was contingent on the outcome of Issue 2. The court stated that question No. 2 (originally question No. 1) would be considered only if the answer to the reframed question No. 1 was in favor of the Revenue.

Issue 2: Inclusion of Interest in Total Income
The Tribunal found that the assessee-bank followed a consistent policy of classifying loans into "ordinary loans" and "problem loans," with the latter placed on a non-accrual basis if interest payments were not forthcoming for 180 days or more. The interest on such loans was recorded in a memorandum account and not credited to the profit and loss account until realized. This system was consistently followed and accepted by the Revenue in the past.

The Tribunal held that the assessee's method of accounting, which combined elements of both cash and mercantile systems (a "hybrid system"), was valid. The Tribunal found no fault with the method of accounting and stated that the proviso to section 145(1) could not be invoked by the Department as the income could be properly deduced from the assessee's accounts.

The court agreed with the Tribunal's findings, noting that the assessee's method of accounting for problem loans did not affect the real income since interest was accounted for upon realization. The court distinguished this case from the Supreme Court's decision in State Bank of Travancore v. CIT, where the interest was debited to the accounts and credited to an "Interest suspense account," unlike the present case where no such debits or credits were made.

Conclusion:
The court answered the reframed question No. 1 in the affirmative, holding that the interest recorded in the memorandum account was not liable to inclusion in the assessee's total income under sections 28 and 145 of the Act. Consequently, the court did not address the original question No. 1 (renumbered as question No. 2). The reference was answered in favor of the assessee, with no order as to costs.

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