R. Jayasimha Babu, J.
The principal question referred to us at the instance of the revenue in all these tax cases concerns the taxability under the Income Tax Act, 1961, of interest on sticky loans in cases where the assessee is a bank.
2. As long back as on 25-8-1924, the Central Board under the Indian Income Tax Act, 1922, had directed, as a result of the conclusions arrived at in the conference of the Income Tax Commissioners, that the interest accruing to money lenders who entered the same into a suspense account because of the extreme unlikelihood of recovery of the loan, need not be included in the assessee's taxable income. That circular was extended to banks by the circular dated 6-10-1952, which reads as under :
'In its Circular No. 37 of 1924, dated 25-8-1924, the Board held, as a result of the conclusion reached at the conference of the Income Tax Commissioners, that interest accruing to a money lender on loans entered in a 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 possibility 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 the interest on such debts to that account, provided the Income Tax Officer is satisfied that recovery is practically impossible.
In this connection, the Board desires that a record of such loans and interest thereon should be kept in a permanent file to act as an aide memoire both for allowing deductions and for charging tax on recoveries in subsequent assessments. The whole idea underlying the maintenance of this record is to avoid being very meticulous so long as there is no doubt about the bona fides of the write off and also to avoid losing sight of recoveries.'
That Circular of the year 1952 held the field till 1978 until that circular was superseded by a fresh circular.
The circular that was issued by the Board on 20-6-1978, reads. as under :
'Attention is invited to Board's Circular No. 41/V/6/D) of 1952 (No. 27(44)/II of 1952), dated 6-10-1952, wherein it was clarified that interest on doubtful debts credited to a suspense account by banks need not be included in the taxable income provided the Income Tax Officer is satisfied that the recovery of the loan is practically impossible.
(2) The Board vide its Letter F. No. 207/16/71-ITA, II, dated 29-11-1972, informed the Commissioner, Delhi, that interest on doubtful debts credited to suspense account by the Industrial Finance Corporation of India should not be included in the taxable income. This view was reiterated in the cases of various other financial institutions. The revenue audit, however, did not agree with the views expressed by the Board and objected to the exclusion of such interest from the total income.
(3) The Board have recently received a number of representations from other State Financial Corporations/Institutions, seeking exemption of interest on such accounts from inclusion in the total income. The matter has, therefore, been re-examined in consultation with the Ministry of Law. The Board have been advised that where accounts are kept on the mercantile basis, interest thereon is taxable irrespective of whether the interest is credited to suspense account or to the interest account.
The Kerala High Court has also expressed the same view in the case of State Bank of Travancore v. CIT : [1977]110ITR336(Ker) , that the amount of such interest is includible in the taxable income.
(4) In view of this, Circular No. 41/V-6/D of 1952, dated 6-10-1952, and clarifications issued in cases of financial institutions are with drawn with immediate effect.
(5) Immediate review may be undertaken and remedial action by way of initiation of proceedings under section 147(b) or section 263 may be taken in respect of assessments which have been completed in accordance with the Board's instruction and clarification referred to in paragraphs 1 and 2 above.'
3. The circular that was issued in the year 1978 was later modified and the position that prevailed prior to its issue, subject to certain modifications, was restored by another circular of the year 1984. The judgment of the Supreme Court in the case of UCO Bank v. CIT : [1999]237ITR889(SC) mentions the date of that circular as 9-10-1984. That circular reads as under :
'Attention is invited to Board's Instruction No. 1186 (F. No. 201/7/78 ITA II), dated 20-6-1978, wherein it was clarified that interest on doubtful debts credited to a suspense account by the banking companies is includible in the taxable income. It was further stressed that all pending assessments may be completed keeping in view the said instructions and an immediate review be undertaken and remedial action by way of initiation of proceedings under section 147(b) or section 263 be taken in respect of the assessments which have been completed not including such interest in the taxable income in accordance with the Board's earlier instructions.
(2) These instructions have resulted in increased litigation between the Income Tax Department and the banking companies, On a subject like this, it appears futile that two organisations of the government both functioning under the Ministry of Finance, should resort to litigation over extended periods of time. Obviously, this leads to delays and other consequential difficulties. Hence, the matter has been re-examined.
(3) It has been decided that interest in respect of doubtful debts credited to suspense account by the banking companies will be subject 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. However, if there is any recovery in the fourth year or later, the actual amount recovered only will be subjected to tax, in the respective years. This procedure will apply to the assessment year 1979-80 and onwards. The Board's Instruction No. 1186, dated 20-6-1978, is modified to that extent.
(4) Courts of law have held that subsequent withdrawal of beneficial circulars/instructions can be with prospective effect only. As such, the question of taxability of interest of doubtful debts credited by banking companies to suspense account will have to be decided upto the assessment year 1978-79 in the light of the Board's Circular No. 41/V/6/D, dated 6-10-1952, as the said circular was withdrawn only in June, 1978. The new procedure as laid down in paragraph 3 above will be applicable for and from the assessment year 1979-80. All pending disputes on his issue should be settled in the light of these instructions.'
Thus, from 1924 to 1978, interest on loans entered in a suspense account because of the extreme unlikelihood of the recovery of loan amount, was not treated by the Board as part of the assessee's taxable income, if the Income Tax Officer was satisfied that there was really little possibility of the loans being recovered.
It was only in the year 1978 on account of some objections raised by the revenue audit and also by reason of the judgment delivered by the Kerala High Court in the case of State Bank of Travancore v. CIT : [1977]110ITR336(Ker) the circular dated 6-10-1952, was withdrawn. But by the circular of the year 1984, from the assessment year 1979-80 onwards. interest on doubtful debts credited to a suspense account by the banking companies was made subject to tax but interest charged in an account, where there had been no recovery for three consecutive accounting years was not to be subjected' to tax in the fourth year and onwards.
The decision of the Kerala High Court referred to in the Board's circular issued in the year 1978 was upheld by the Supreme Court in the case of State Bank of Travancore v. CIT : [1986]158ITR102(SC) . The circular which the Board had issued in the year 1984, however, was not brought to the notice of the Apex Court. It was held by the Apex Court that where all accounts are maintained in the mercantile system, interest which has accrued but has not been recovered and the recovery of which was also unlikely, but had not been written off, was to be treated as part of the taxable income of the banks.
4. That decision of the Apex Court in the case of State Bank of Traiancore v. CIT : [1986]158ITR102(SC) has now been explained by the Apex Court in the case of UCO Bank v. CIT : [1999]237ITR889(SC) of the report, it was observed by the Apex Court that :
'In the premises the majority decision in State bank of Travancore v. CIT : [1986]158ITR102(SC) , cannot be looked upon as laying down that a circular which is properly issued under section 119 of the Income Tax Act for proper administration of the Act and for relieving the rigour of too literal a construction of the law for the benefit of the assessee in certain situations would not be binding on the departmental authorities. This would be contrary to the ratio laid clown by the Bench of five judges in Navnit Lal C. Javeri v. K. K. Sen, Appellate Assistant Commissioner of IT. : [1965]56ITR198(SC) . In fact State Bank of Tranvancore v. CIT : [1986]158ITR102(SC) , has already been distinguished in the case of Keshavji Ravji and Co. v. CIT : [1990]183ITR1(SC) , by a Bench of three judges in a similar fashion. It is held only as laying down that a circular cannot alter the provisions of the Act. It being in the nature of a concession, could always be prospectively withdrawn.'
As regards the applicability of the circular of 1984, the court observed thus (page 900) :
'In the present case, the circulars which have been in force are meant to ensure that while assessing the income accrued by way of interest on a 'sticky' loan, the notional interest which is transferred to a suspense account pertaining to doubtful loans would not be included in the income of the assessee, if for three years such interest is not actually received. The very fact that the assessee, although generally using a mercantile system of accounting, keeps such interest amounts in a suspense account and does not bring these amounts to the profit and loss account, goes to show that the assessee is following a mixed system of accounting by which such interest is included in its income only when it is actually received. Looking to the method of accounting so adopted by the assessee in such cases, the circulars which have been issued are consistent with the provisions of section 145 and are meant to ensure that assessees of the kind specified who have to account for all such amounts of interest on doubtful loans are uniformly given the benefit under the circular and such interest amounts are not included in the income of the assessee until actually received if the conditions of the circular are satisfied.'
Regarding the nature and extent of the power of the Central Board of Direct Taxes, under section 119 of the Income Tax Act, the court observed :
'The Board has the statutory power under section 119 to tone down the rigour of the law for the benefit of the assessee by issuing circulars to ensure a proper administration of the fiscal statute and such circulars would be binding on the authorities administering the Act. The circulars as contemplated therein cannot be adverse to the assessee. Thus, the authority which wields the power for its own advantage under the Act is given the right to forgo the advantage when required to wield it in a manner it considers just by relaxing the rigour of the law or in other permissible manners as laid down in section 119. The power is given for the purpose of just, proper and efficient management of the work of assessment and in public interest.'
Thus the rigour of the law may be toned down by notifications issued by the Board from time to time and such circulars are binding on the authorities. The assessee, if found eligible for the benefit of the circular in force, must be given the benefit of that circular. Up to the assessment year 1978-79, the interest accruing on 'sticky' loans by banks is not to be treated as taxable income in terms of the circular of the year 1952. Therefore, it is not open to the assessing officer to act contrary to the terms of that circular and proceed to treat the interest accruing on sticky loans as part of the taxable income of the bank. From the assessment year 1978-79, onwards such notional income would be subjected to tax, but the 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 only in the year in which the interest was realised that that amount would be treated as part of the income of the bank for that year.
Having regard to the terms of the circular of the year 1952, extracted above, the assessees in all these cases could not have been assessed to tax on the interest on sticky loans. The fact that there was extreme unlikelihood of recovery of the loans was not disputed before the authorities below. The assessment years with which we are concerned in all these cases are prior to the assessment year 1979-80 and are governed by the circular of the year 1952. The Tribunal has erred in law in holding that the interest accruing on 'sticky' loans should be treated as part of the taxable income of the assessee. The questions referred to us in this regard in all these cases are answered in favour of the assessee and against the revenue .
5. The other question regarding the disallowance of entertainment expenditure under section 37(2B) of the Act is required to be answered against the assessee and in favour of the revenue, in view of the decision of the Apex Court in the case of CIT v. Patel Bros. and Co. Ltd. : [1995]215ITR165(SC) and it is so answered.