Real income principle bars tax on doubtful interest accrual where recovery of advances is genuinely uncertain.

Under the mercantile system, interest on advances does not accrue for tax purposes where recovery is genuinely doubtful and no real income has arisen. On the facts, the debtor correspondence and dishonoured cheque showed that both principal and interest were uncertain of recovery, so mere book entries could not create taxable income. Applying the real income principle, the addition for accrued interest was not justified and was deleted.

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Issues: Whether interest on advances that had become doubtful of recovery could be brought to tax on accrual basis under the mercantile system of accounting.

Analysis: The assessee had advanced monies to two parties, but the recovery of the principal and the interest had become doubtful on the material on record. The correspondence showed that one debtor had stated that no interest would be recovered and that the principal would be settled only over time, while the other had defaulted and a cheque issued by it had been dishonoured. In such circumstances, mere maintenance of accounts on mercantile basis did not compel recognition of notional interest income. The principle of real income governed the matter, and where recovery of interest itself was doubtful, accrual could not be assumed.

Conclusion: The addition of accrued interest was not justified and was rightly deleted.

Final Conclusion: The Revenue failed to establish taxable accrual of interest on the doubtful advances, and the deletion of the addition was sustained.

Ratio Decidendi: Under the mercantile system, interest on advances does not accrue for tax purposes where recovery is genuinely doubtful and no real income has arisen.

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