Judgment:
K. SREEDHARAN J. - At the instance of the assessee and the Department, the Income-tax Appellate Tribunal, Cochin, has referred the following four questions of law for decision by this court. The first three questions are referred at the instance of the assessee and the fourth at the instance of the Department :
'At the instance of the assessee :
(i) Whether, on the facts and in the circumstances of the case the Tribunal was right in holding that the interest amount of Rs. 36,066.70 being the interest payable to the assessee as per the award of the arbitrator on the amount of Rs. 3,00,556 withheld by the public works department is a revenue receipt ?
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was following the cash system of accounting after the termination of its business in 1974 and consequently in holding that the interest amount received by the assessee during the accounting period relevant to assessment year 1979-80 is assessable in the said assessment year ?
(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee is not entitled to claim deduction during the assessment year 1979-80 of the interest paid by the assessee to the Federal Bank during the accounting periods relevant to earlier assessment years ?
At the instance of the Department :
(iv) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee is entitled to claim deduction of the interest paid by the assessee to the Federal Bank during the accounting period relevant to assessment year 1979-80 ?'
The assessee was a contractor under the public works department. He was mainly engaged in the construction of sea wall near Kayamkulam. He stopped his work by April, 1974. At that time, a sum of Rs. 3,00,556 was due to the assessee from the Department and the payment of the same was withheld by the Department. Payment was also due for some work done, for which bills were pending. The matter was referred to arbitration. An award was passed by the arbitrator on July 20, 1977. As per the award, the assessee became entitled to :
(i) Rs. 12,000 for the work done and for which the bill was pending;
(ii) Rs. 36,066.70 by way of interest for the period from June 1, 1974, to May 29, 1976, on the sum of Rs. 3,00,556 withheld by the Department; and
(iii) Future interest at the rate of six per cent. per annum on amounts awarded under items (i) and (ii) above which came to Rs. 790.15 and Rs. 2,076.50.
Amounts by way of interest were received by the assessee during the accounting period relevant to the assessment year with which we are concerned in this proceeding. These amounts were brought to tax by the Income-tax Officer as revenue receipts. The assessee contended that interest payable by the public works department was neither under a statute nor under a contract and so it was only on an ex gratia basis, and cannot be taken as revenue receipt. This contention was negatived by the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal. Yet another contention that was raised by the assessee was that he was following the mercantile system of accounting and so, the amount cannot be brought to tax in the assessment year 1979-80. This contention was also negatived by the Tribunal. The assessee further contended that he had overdraft/loan facilities from the Federal Bank for carrying out the contract work. Even after the termination of the contract work, the assessee was paying on the amounts due to the bank. The interest so paid should be allowed as deduction from the amounts received under the arbitration award. In view of the finding recorded by the Tribunal that the assessee was following the cash system of accounting, the amount paid by the assessee to the bank during the accounting period relevant to the assessment year alone was allowed as a deduction. According to the Tribunal, even under the mercantile method the interest paid by the assessee in earlier years cannot be claimed as deduction against the income relating to the assessment year concerned in this proceedings.
The assessee and the Department got the question quoted above referred to this court under section 256(1) of the Income-tax Act.
The Tribunal took the view that the interest obtained by the assessee is a revenue receipt, on the basis of its decision in the case of Rockwell Engineering Company in Income-tax Appeal No. 715/(Coch.) of 1982. In Rockwell Engineering Companys case, the question whether the interest received by the assessee was a revenue receipt liable to be taxed was referred to this court for its decision. This court in Rockwell Engineering Co. Ltd. v. CIT : [1989]180ITR277(Ker) , took the view that the interest portion of the amount awarded on the basis of the decision rendered by the arbitrator is a revenue receipt. As per the award in the instant case, amounts were payable to the assessee. Since the amounts were not paid at the proper time, interest was awarded for such delay. The interest so paid is only an accretion to the amounts due to the assessee under the contract. It is therefore attributable and incidental to the business carried on by him. Under no circumstance can it be said this interest is de hors the contract business carried on by the assessee. As observed by the Supreme Court in CIT v. Govinda Choudhury and Sons : [1993]203ITR881(SC) , the interest paid to the assessee partook of the same character as the receipts for the payment of which he was otherwise entitled under the contract and which payment was delayed as a result of certain disputes. So, we have no hesitation in holding that the interest amounting to Rs. 36,066.70 is a revenue receipt, liable to be taxed for the assessment year 1979-80. In this view, we answer question No. 1 in the affirmative, against the assessee and in favour of the Revenue.
On the facts, the Income-tax Officer, the Appellate Assistant Commissioner of Income-tax and the Income-tax Appellate Tribunal came to the conclusion, based on the records of the case, that the assessee was following the cash system of accounting after the termination of the business in 1974. In view of this categoric finding arrived at by the authorities below and in the absence of any material warranting a different conclusion, we accept the said finding of fact and answer the second question referred to us at the instance of the assessee in the affirmative, against the assessee and in favour of the Revenue.
The third question referred at the instance of the assessee and the question referred to us at the instance of the Department are inter-related. So, we consider it advantageous to deal with the issues arising out of these questions by a common discussion. It is the case of the assessee that they had overdraft/loan facilities from the Federal Bank for carrying out the contract work. Even after the termination of the contract work, the assessee was paying interest on the amounts due to the bank. The assessee claimed that the interest so paid during the previous accounting years should also be deducted from the amounts received under the arbitration award. This was not allowed by the Tribunal based on its finding that the assessee was following the cash system of accounting after the termination of the business. At the same time, the Tribunal allowed deduction of the amount paid by the assessee to the bank during the accounting period. The stand taken by the Department is that no deduction should have been given of the amount paid by way of interest to the Federal bank during the assessment year.
Section 176(3A) of the Income-tax Act, reads :
'Where any business is discontinued in any year, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on the business had such sum been received before such discontinuance.'
The assessee in the instant case discontinued his business in 1974. He received the amount, with which we are concerned in these references, after the said discontinuance. The amounts so received should be deemed to be the income of the assessee. It is to be charged to tax income in the year of receipt. It is to be so assessed if the sum received by the assessee would have been included in the total income had such sum been received before the discontinuance. Section 176(3A), therefore lays down that where any business is discontinued in any year any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt. Any sum received after the discontinuance of the profession shall be deemed to be the income of the recipient. Will it be the income of the recipient arising out of business The statutory provision in sub-section (3A) is clear that the income so received should be charged to tax accordingly in the year of receipt. The words 'charged to tax accordingly', according to us, are indicative of the head of income under which the receipt is to be charged to tax. In other words, the income should be deemed to be income falling under the head 'Profits and gains of business or profession', i.e., head D coming under section 14 of the Act. When it is specifically provided that the sum received after the discontinuance of the business should be deemed to be the income of the recipient and charged to tax accordingly, it can only mean that the said amount received be treated as income from business and should be taxed accordingly. This is made more clear by the latter half of sub-section (3A). The latter half of sub-section (3A) states that the sum received should be charged to tax, if such sum would have been included in the total income of the person who carried on the business had such sum been received before such discontinuance. It means that the said income shall be charged to tax in the year of receipt if such sum would have been included in the total income of the person had it been received before such discontinuance. 'Total income' has been defined in section 2(45) of the Act as 'the total amount of income referred to in section 5 computed in the manner laid in the Act'. So, as per the fiction incorporated in sub-section (3A), the sum received after the discontinuance of business shall be deemed to be income and charged to tax accordingly if it would been included in the total income of the person during the year of receipt. This means that the entire receipt is not to be taken as the income of the recipient exigible to tax. Only that portion of the receipt which would have been included in the total income of the person during the accounting year as computed in the manner laid down in the Act alone can be charged to tax. Any view contrary to this would be against the very principle of taxation. Kanga and Palkhivala in their Law and Practice of Income Tax, Eighth edition, volume I (at page 484) state :
'Sub-sections (3A) and (4) of section 176 provide the exceptional cases where the income of a business or profession received in an accounting year subsequent to the year of discontinuance of the business or profession is brought to charge. In such cases expenses incurred after the year of discontinuance to earn such income should be allowed as a deduction.'
This also shows that that part of the receipt which would have satisfied the definition of 'total income' alone is to be charged to tax and not the whole of the receipt. In the same book, at page 623, the learned authors further state :
'However, where a receipt from a discontinued business or profession is taxed under section 176(3A) or (4) as the income of a year subsequent to the year of the discontinuance, any expenditure incurred after the year of discontinuance to earn that income should be allowed.'
This makes it clear that the expenditure incurred after the year of discontinuance to earn that income should be deducted. By such deduction only the total income which is chargeable to tax can be found. The opinion expressed by the learned commentators is in tune with the view that for the sum received after discontinuance of the business to be charged to tax under sub-section (3A) of section 176, the same would have been included in the total income of the person. It means that only that portion of the sum received which would be total income of the assessee as found under the Act alone is to be charged to tax. The total income charged to tax under sub-section (3A) of section 176 must be one computed in the manner laid down in the Act.
According to learned counsel representing the Department, the actual expenditure incurred for earning the particular sum alone can be deducted and nothing more. In other words, according to counsel, if the assessee in the instant case shows that any particular amount was spent for getting the interest which is brought to tax, that expenditure alone should be deducted. The assessee has no case that he had spent any amount for getting the interest which is now brought to tax. Therefore, the entire amount received by way of interest should be, according to counsel, charged to tax. If such a procedure is adopted, we feel that we will be doing violence to the provisions contained in the Act and it will go against the very principle of taxation. For adopting this contention, one will have to ignore the latter half of sub-section (3A), which enjoins that the sum received would have been included in the total income of the person in the year of receipt. The provisions of the Act for finding out the total income of the assessee should be applied for charging the sum received to tax.
For carrying on the business prior to its discontinuance, the assessee had availed of loan/overdraft facilities from the Federal Bank. The interest on the outstanding amount was payable to the bank. The interest so paid for the assessment year must be taken as expenditure for deriving the income from the business. The interest received by the assessee on account of delayed payment is nothing but a accretion to the business income. Hence, the interest paid to the bank during the accounting year in which the interest on delayed payment was received must be taken to have been incurred for getting the said interest. That portion of the interest, which was paid during the accounting year, must be deducted from the amount received. This is more so since the assessee was following the cash system of accounting after the termination of the business. Therefore, the assessee is not entitled to claim deduction of the interest paid to the bank during the previous assessment years. In this view of the matter, we answer question No. 3 in the affirmative, against the assessee and in favour of the Revenue. We also answer question No. 4 referred at the instance of the Department in the affirmative, against the Department and in favour of the assessee.
A copy of this judgment under the seal of this court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.