Bona fide change in accounting method permits accrual of statutory bonus and excludes unrealised interest from taxable income.
An assessee may change from one regularly employed accounting method to another recognised method if the shift is bona fide, consistently followed, and needed to compute true income. Where bonus had become a statutory liability and accrued at year-end, adoption of the mercantile basis was permissible and the accrued bonus was allowable. Where recovery of principal was doubtful due to disputes and litigation, adoption of the cash basis for interest receivable was also permissible, and unrealised interest did not constitute taxable income. The governing principle is that income cannot be taxed on a mere notional accrual when it has not truly arisen.
Issues: (i) Whether the assessee could validly change the method of accounting from cash to mercantile in respect of bonus liability and claim the accrued bonus for the year; (ii) Whether the assessee could validly change the method of accounting from mercantile to cash in respect of interest receivable and exclude unrealised interest from taxable income.
Issue (i): Whether the assessee could validly change the method of accounting from cash to mercantile in respect of bonus liability and claim the accrued bonus for the year.
Analysis: The change in treatment of bonus was accepted as a bona fide change from one regular method to another regular method. Bonus had become a statutory liability, and accrual on the last day of the accounting year was consistent with mercantile accounting. The changed method was followed consistently in subsequent years and reflected the correct profits for the year of change.
Conclusion: The change from cash to mercantile basis for bonus was permissible and the accrued bonus was allowable; the finding was in favour of the assessee.
Issue (ii): Whether the assessee could validly change the method of accounting from mercantile to cash in respect of interest receivable and exclude unrealised interest from taxable income.
Analysis: The change in respect of interest receivable was held to be bona fide because recoverability of the principal itself was doubtful in view of disputes and litigation, making the accrual of interest uncertain. The new method was a recognised accounting method, was consistently followed thereafter, and the amounts not actually received did not represent real income for taxation purposes.
Conclusion: The change from mercantile to cash basis for interest receivable was permissible and unrealised interest was not taxable; the finding was in favour of the assessee.
Final Conclusion: The assessee was entitled to adopt different regular accounting methods for bonus and interest where the changes were bona fide, consistently followed, and resulted in computation of true income.
Ratio Decidendi: An assessee may change from one regularly employed method of accounting to another recognised method if the change is bona fide, consistently followed, and necessary to determine true income, and income that has not accrued in reality cannot be taxed on a mere notional basis.