Taxability of sticky interest: income on advances to a sick company was not treated as accrued where recovery was stalled and accounts omitted it.

Interest on advances to a sick industrial company was treated as not having really accrued where the borrower's reference was pending before BIFR, a rehabilitation scheme had been framed, and recovery was effectively stalled under SICA. On that basis, the commentary states that such sticky interest could not be assessed as taxable income on a merely notional or hypothetical basis under the mercantile system. It also notes that approval of the accounts by the Board of Directors, together with the omission of the amount from the profit and loss account, supported the view that the interest was not being treated as income in the books and therefore was not includible in taxable income.

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Issues: (i) Whether interest on advances made to a sick industrial company, whose reference was pending before BIFR and in respect of which a rehabilitation scheme had been framed, could be treated as accrued income chargeable to tax. (ii) Whether approval of the accounts by the Board of Directors could support exclusion of such interest from taxable income where the amount was not shown in the profit and loss account.

Issue (i): Whether interest on advances made to a sick industrial company, whose reference was pending before BIFR and in respect of which a rehabilitation scheme had been framed, could be treated as accrued income chargeable to tax.

Analysis: The interest related to a loan advanced in the ordinary course of business, but after the borrower was referred to BIFR and a scheme was framed, recovery of the principal and interest was effectively stalled. Section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985 suspended recovery proceedings except with the Board's consent. In that background, the advances became sticky and the interest ceased to represent real income. The Court applied the principle that income-tax is levied only on income that has really accrued or been received, and not on hypothetical entries.

Conclusion: The interest did not accrue as taxable income and was not includible in assessment.

Issue (ii): Whether approval of the accounts by the Board of Directors could support exclusion of such interest from taxable income where the amount was not shown in the profit and loss account.

Analysis: The accounts for the relevant years had been approved by the Board, and the interest was not brought into the profit and loss account. The Court treated this as supporting the conclusion that the amount was not being treated as income in the assessee's books. In the absence of real accrual, the accounting treatment reinforced the conclusion that the amount could not be taxed merely on a notional basis.

Conclusion: The approval of accounts supported the assessee's case and did not justify taxation of the interest.

Final Conclusion: The appeal succeeded and the Assessing Officer was directed to exclude the disputed interest from taxable income for the relevant years.

Ratio Decidendi: Interest on a sticky advance to a sick company, where recovery is stayed by SICA and the amount has not really accrued or been treated as income in the accounts, cannot be taxed on a merely hypothetical basis under the mercantile system.

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