Real income principle bars tax on unrealizable accrued interest from a sticky loan settled for less than book value.

Accrued interest on a sticky loan was held not to be taxable where the amount was never actually received, recovery had become doubtful, and the loan was ultimately settled for a lower sum. Although the assessee followed the mercantile system, the real income principle prevailed over a mere book entry because the full interest was not realistically realizable. The fact that substantial interest had already been offered to tax in earlier years also supported the view that taxing the disputed balance would not reflect true income. The operative effect is that notional or unrealizable accrued interest on doubtful recovery does not constitute taxable income.

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Issues: Whether interest shown as accrued on a sticky loan, but not actually received and ultimately settled for a lower amount, constituted taxable income on a real accrual basis.

Analysis: The addition was made because the assessee followed the mercantile system and had not credited the disputed interest for the relevant year. The Tribunal found that the principal and accumulated interest had become doubtful of recovery, that substantial interest had already been offered to tax in earlier years, and that the eventual settlement for a lesser amount showed that the full accrued interest was not realizable. Applying the real income principle, mere book entries could not fasten tax liability on income that had not truly arisen.

Conclusion: The accrued interest did not represent real income and was not taxable in the assessee's hands.

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