IN THE HIGH COURT OF HIMACHAL PRADESH SHIMLA I.T.R. No.23 of 1995. Judgment reserved on: 05.03.2008. Date of Judgment: 9th April, 2008 M/s.H.P. Financial Corporation ….Petitioner -Versus- The Commissioner of Income-tax, Patiala ….Respondent Coram: The Hon’ble Mr.Justice Deepak Gupta, Judge. The Hon’ble Mr.Justice Rajiv Sharma, Judge. Whether approved for reporting? Yes For the Petitioner: Mr.Prakul Khurana, Advocate with Ms.Seema Sood, Advocate For Respondent: Ms. Vandana Kuthiala, Advocate Deepak Gupta, J. The following questions of law have been referred for the opinion of this Court at the instance of the assessee: “1.Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that interest on sticky loans, a part of which was already assessed by the Revenue in subsequent years by accepting the cash system of accounting adopted by the assessee and for which no appeal was pending, as claimed by the assessee, could be assessed on accrual basis in the year relevant to the assessment year 1982-83 and that it was for the assessee to seek whatever remedy was available to it in those years? 2.Whether, on the facts and in the circumstances of the case, the Tribunal is correct in law in holding that in cases where suits had been filed and recovery proceedings initiated in courts of law, interest awarded by the courts shall relate back to the assessment year 1982-83 and not to the year in which the decision of the court is pronounced?” 2 The Assessee is a Financial Corporation set up under the State Financial Corporations Act. Upto the year 1973-74 the assessee was showing interest on sticky loans on accrual basis. Thereafter, from the assessment year 1974-75 onwards the interest on such loans was taken to a suspense account and reflected in the balance-sheet. With effect from the assessment year 1978-79 the Assessee stopped showing the interest in the profit and loss account or in the balance- sheet. Only a note was appended below the balance-sheet in respect of the sticky loan account. For the assessment year 1982-83, with which we are concerned, the assessee was not reflecting the interest on sticky loans even in the suspense account. Only a note was given below the balance-sheet regarding the interest accruing on sticky loans for the year. A track of the interest payable by the defaulting loanees was kept by making relevant entries in the individual loan accounts. The Assessing Officer found that in fact the assessee was making entries regarding the interest on accrual basis but at the end of the year the same were being reversed. The Assessing Officer held that the assessee was following the mercantile system of accounting right from its inception and only from the year 1974-75 the interest accruing on sticky accounts was not being accounted for. He therefore added the amount of Rs.41,98,744/- to the total income of the assessee on account of the amount of interest that had accrued during the relevant year. 3 The assessee filed an appeal who confirmed the addition as ordered by the Assessing Officer. The assessee went before the Appellate Tribunal which also rejected the claim of the assessee. We have heard learned counsel for the parties. Reliance on behalf of the assessee is placed on the judgment of the Apex Court in UCO Bank vs. Commissioner of Income Tax, (1999) 237 ITR 889. In that case a similar question arose and the assessee had credited the interest, recovery whereof was doubtful, to the suspense account and had not included the interest while computing the total income. It is apparent that the assessee Corporation is following a mixed method of accounting which method has been approved by the Apex Court in the aforesaid judgment. The Apex Court held in the following terms: “The assessee’s method of accounting, therefore, transferring the doubtful debt to an interest suspense account and not treating it as profit until actually received, is in accordance with accounting practice.” The Apex Court also held that the circulars issued by the Central Board of Direct Taxes were binding on the Department. Relevant portion of the Circular No.41(V-6)D of 1952 dated October 6, 1952 reads as follows: “Interest accruing to a money-lender on loans entered in the suspense account because of the extreme unlikelihood of their being recovered need not be included in the assessee’s taxable income if the Income-tax Officer is satisfied that there is really little probability of the loans being repaid. It is considered desirable to extend this principle to banks which, instead of transferring the doubtful debts to a suspense account, credit 4 the interest on such debts to that account provided the Income-tax Officer is satisfied that recovery is practically improbable.” This circular was later withdrawn and a fresh circular was issued on June 20, 1978. This circular reads as follows: “The Board has been advised that where accounts are kept on mercantile basis, interest thereon is taxable irrespective of whether the interest is credited to suspense account or to interest account. The Kerala High Court has also expressed the same view in the case of State Bank of Travancore v. CIT (1977) 110 ITR 336. The amount of such interest is, therefore, includible in the taxable income.” Thereafter, on October 9, 1984 the Central Board of Direct Taxes issued another circular which reads as follows: “Interest in respect of doubtful debts credited to suspense account by the banking companies will be subjected to tax but interest charged in an account where there has been no recovery for three consecutive accounting years will not be subjected to tax in the fourth year and onwards.” It is not disputed that the circular dated October 9, 1984 is applicable from the Assessment year 1979-80 and would be applicable to the present case also. The Apex Court has clearly held that these circulars are binding on the authorities. The Apex court considered whether the interest amount on sticky loans could be considered as income if not actually realized and held as follows: “The question whether interest earned, on what have come to be known as “sticky” loans, can be considered as income or not until actual realization, is a question which may arise before several Income-tax Officers exercising jurisdiction in different parts of the country. Under the accounting practice, interest which is transferred to the suspense account and not brought to the profit and loss account of the company is not treated as income. The question whether in a given case such “accrual” of interest is doubtful or not, may also be problematic. If, 5 therefore, the Board has considered it necessary to lay down a general test for deciding what is a doubtful debt, and directed that all Income-tax Officers should treat such amounts as not forming part of the income of the assessee until realized, this direction by way of a circular cannot be considered as travelling beyond the powers of the Board under section 119 of the Income-tax Act. Such a circular is binding under section 119. The circular of October 9, 1984, therefore, provides a test for recognizing whether a claim for interest can be treated as a doubtful claim unlikely to be recovered or not. The test provided by the said circular is to see whether, at the end of three years, the amount of interest has, in fact, been recovered by the bank or not. If it is not recovered for a period of three years, then in the fourth year and onwards the claim for interest has to be treated as a doubtful claim which need not be included in the income of the assessee until it is actually recovered.” It is apparent that none of the authorities in this case have taken into consideration the circular dated October 9, 1984. A bare perusal of this circular clearly shows that the assessee can take benefit only in respect of the interest payable on those loans where no recovery has taken place for three consecutive accounting years and it is only from the 4th year onward that the interest accrued is not to be considered as income. We are, therefore, of the opinion that the Assessing Officer should have taken into consideration the circular dated October 9, 1984 and decided the question whether the interest was in respect of those loans in which no recovery has been made for three consecutive years or not. Accordingly, we answer both the questions by holding that the Revenue is bound by the Circular dated October 9, 1984 and in case no amount has been paid in the loan account(s) for 3 years then the assessee can take benefit of the circular and the interest on such loans cannot be treated as income. 6 In view of the aforesaid discussion, the matter is remanded to the Assessing Officer to frame fresh assessment orders in terms of the circular dated October 9, 1984. The Registrar General of this Court is directed to send a copy of this order to the Income Tax Appellate Tribunal. ( Deepak Gupta ), Judge April 9, 2008. ( Rajiv Sharma ), PV Judge