Accrued interest in suspense accounts stays taxable under mercantile accounting absent a genuine switch to cash basis.

Under the mercantile system, interest on sticky loans that has legally accrued remains taxable even if credited to an interest suspense account, because a mere book transfer does not defeat accrual. A change from mercantile to cash accounting must be a genuine abandonment of the former method and adoption of a regular cash basis; a shift in account-head presentation is insufficient. The Reserve Bank of India circular, aimed at preventing inflated profits in financial statements, and the Board's letter did not confer tax exemption or override income-tax liability. Accrued interest therefore remained assessable under the assessee's regular accounting method.

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Issues: (i) whether unrealised interest credited to an interest suspense account under the assessee's mercantile accounting system was chargeable to tax on accrual; (ii) whether the assessee had validly changed over to the cash system of accounting in respect of such interest; and (iii) whether the Reserve Bank of India circular or the Board's letter excluded the interest from tax.

Issue (i): whether unrealised interest credited to an interest suspense account under the assessee's mercantile accounting system was chargeable to tax on accrual.

Analysis: Under the mercantile system, income is taxed when it accrues or arises, whether or not it is actually received. The assessee had debited the borrowers' accounts on the due dates and credited the corresponding amounts to the interest suspense account, which showed that the interest had accrued and become legally due. A mere transfer to a suspense account did not prevent accrual or alter the character of the income. There was no material to show that the interest had become irrecoverable or that the underlying contractual right to receive it had ceased.

Conclusion: The interest was taxable on accrual and was rightly brought to tax.

Issue (ii): whether the assessee had validly changed over to the cash system of accounting in respect of such interest.

Analysis: A change from mercantile to cash accounting requires abandonment of the former regular method and adoption of a genuinely new regular system. The books here still showed debit entries on the due dates and only the head of credit was altered by moving the amount to a suspense account. That was at most a change in book-keeping or account-head presentation, not a change to a cash system. The finding of a cash-based method was unsupported by the facts and could not displace the accrued character of the income.

Conclusion: No valid change to the cash system was established.

Issue (iii): whether the Reserve Bank of India circular or the Board's letter excluded the interest from tax.

Analysis: The Reserve Bank of India circular only advised financial corporations not to credit unrealised sticky-loan interest to the profit and loss account so as to avoid inflated distributable profits. It did not grant tax exemption or alter income-tax liability. The Board's letter was merely a reply to an administrative communication and was not shown to be a binding circular or instruction under section 119. On the facts, neither document displaced the taxability of accrued interest.

Conclusion: Neither the circular nor the letter exempted the interest from assessment.

Final Conclusion: The accrued interest on sticky loans remained taxable under the assessee's regular accounting method, and the reference was answered against the assessee.

Ratio Decidendi: Under the mercantile system, interest that has legally accrued remains taxable notwithstanding its transfer to a suspense account, unless accrual is prevented by contract, statute, or a duly established change to a cash system.

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