Mercantile accounting for bill discounting income taxes advance interest only when it actually accrues, not on receipt.

Interest received in advance on bill discounting under letters of credit was treated as taxable only on accrual under the mercantile system, not merely on receipt. Amounts collected upfront for a later period retained the character of liability until the corresponding income actually accrued, and where realisation or the due date extended beyond the accounting year, only the proportionate income attributable to that year could be taxed. The treatment was supported by the need to refund proportionate interest on early realisation and by regulatory directions on pre-payment and unexpired usance. The issue was decided in favour of the assessee.

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Issues: Whether interest received in advance on discounting of bills against letters of credit was taxable in the year of receipt or only on accrual under the mercantile system of accounting.

Analysis: The assessee bank followed the mercantile system of accounting, under which income is taxable on accrual and not merely on receipt. Amounts received upfront, but relatable to a later period, retain the character of liability until the corresponding income accrues. In bill discounting transactions, the period for which money is actually used is relevant, and where the due date or realization extends beyond the accounting year, the proportionate interest attributable to the later period cannot be brought to tax in the current year. The requirement to refund proportionate interest for early realization, and the regulatory directions dealing with pre-payment and unexpired usance, supported this treatment.

Conclusion: The interest received in advance was not taxable on receipt basis for the relevant year and had to be assessed only to the extent it accrued during that year. The issue was decided in favour of the assessee.

Ratio Decidendi: Under the mercantile system of accounting, income from bill discounting is taxable only to the extent it accrues in the relevant accounting year, and advance receipt for a later period remains a liability until that income accrues.

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