Concept of Real Income Section 5
Sometimes we may argue “We are not going to receive this income it
cannot be taxed”.
While it looks correct because of
the perception of the person. He thinks what I may not earn I will not pay
Income Tax on that part.
But in the view and
interpretation of the law something which you might have not received can be
taxed. And here comes the section 5.
Scope of total
income.
5. (1) Subject
to the provisions of this Act,
the total income of any previous year of a person
who is
a resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf
of such person ; or
(b) accrues or arises or is deemed
to accrue or arise to him in India during such year ; or
(c) accrues or arises to him outside India during such year
:
Although the concept of real income is well-accepted yet it
gives rise to some confusion about what is real income & what is
hypothetical income.
The law is very clear about what should be “Income” what we
should understand is the meaning of certain words used in the section 5.
(i)
Accrue
(ii)
Arises
The word “Accrue” means
to come as an accession, increment or produce, to fall to one by way of
advantage, to fall due, to fall as natural growth or increment.
The word “Arise” means
to spring up, to come into existence.
The words “Accrue” or “Arise” have been used in the section
as contradiction to the word “Received”. And so these does not mean actual
receipt of any gain or profit. If an assessee acquires the right to receive the
income though received later on said to accrue to him. Unless and until
there is created a debt due by somebody in favour of the assessee, it can not
be said that he has acquired a right to receive the income or that income has
accrued to him.
“When the right to receive the income becomes vested in the
assessee, it is said to accrue or Arise.”
It can be said the decisive test as to what is real income
one must check thoroughly the contractual obligation of the parties with
respect to each transaction.
To clarify the concept elaborately following judgements
(Source Taxmann website) are worth noting for the concept of real income:
1
Service charges on
delayed payment payable as per contract between parties is liable to tax even
if waived of in following accounting year.
Growth Leasing & Finance Ltd. v.Income-tax Officer [1998] 066 ITD 0067 (AHD.)
Section 5, of the
Income-tax Act, 1961 - Income - Accrual of - Assessment year 1988-89 -
Assessee-company provided a machinery on lease/with and deferred financing
facilities, to Nirlon - Payments were to be made by instalments - As per
agreement assessee was entitled to claim service charges on delayed/non-payment
of instalments - Nirlon could not pay a number of instalments due to its
adverse financial position - Assessee, employing mercantile system of
accounting, accounted for instalments amounts on accrual basis but did not
account for any service charges - Only after expiry of relevant accounting year
assessee-company waived such service charges by entering into another agreement
with Nirlon - Whether income on account of service charges due for
delayed/non-payment of instalments was taxable on accrual basis - Held, yes
2
Interest on loan
along with penal interest on the same are liable to tax even if are due for
payment after accounting period.
Tamil Nadu Small Industries Development Corpn. Ltd. v. Commissioner
of Income-tax [2003] 128 TAXMAN 510
(MAD.)
Section 5 of the
Income-tax Act, 1961 - Income - Accrual of - Assessment year 1978-79 - Whether
in view of clear finding of fact by Tribunal that assessee was following
mercantile system of accounting, accrued interest on hire purchase of machinery
on loans and penal interest were liable to be included in total income of
assessee notwithstanding fact that due dates of payment fell after 31st of
March of relevant previous year - Held, yes
3
Doubtful recovery
will not conclude that in reality income has not accrued.
S.R. Doshi Finance & Investment (P.) Ltd. v. Assistant
Commissioner of Income-tax [2000] 75 ITD
434 (MUM.) (SMC-III
Section 5 of the
Income-tax Act, 1961 - Income - Accrual of - Assessment year 1991-92 - Assessee
did not credit lease rentals accrued to it from a lessee along with interest on
overdue rentals - Assessee had neither surrendered or given up such income -
Whether assessee having accepted that income had accrued but its recovery was
doubtful, mere doubt about recovery would not lead to conclude that in reality
income had not accrued to assessee when assessee was following mercantile
method of accounting - Held, yes - Whether, therefore, addition of lease
rentals and interest was justified - Held, yes
4
Subsequent waiver
does not stop accrual of income.
H.P. Mineral & Ind. Development Corpn. v.Commissioner
of Income-tax [2008] 302 ITR 120 (HP)
Where assessee was
following mercantile system of accounting, interest accrued to it on advance
was chargeable on accrual basis and merely because it was waived by a
resolution of Board passed after close of accounting year, that would not stop
its accrual on basis of real income thereof.
5
Interest on
default of payment of instalment chargeable as per agreement between the
parties not waived off during the accounting period is accrued income to the
assessee and taxable.
Naik Wvg. Mills v. Income-tax Officer [2000] 74 ITD 401 (PUNE)
Section 5 of the
Income-tax Act, 1961 - Income - Accrual of - Assessment year 1990-91 -
Assessee-firm was following mercantile system of accounting - It entered into a
development agreement with a party in respect of a plot - Consideration was to
be paid in instalments and clause 6 of aforesaid agreement provided that in
case of default in payment of instalment, interest was to be paid to assessee -
Other party committed a default in payment of instalment due to be paid during
accounting year relevant to assessment year 1990-91 - Assessee did not include
interest accrued in respect of such instalment in its income shown for
assessment year 1990-91 - Whether as there was neither any request for waiver
of interest from other party nor decision was taken by assessee to waive such
interest income before end of relevant accounting period, it could be said that
interest income accrued to assessee for period of default and same was
assessable in its hands in assessment year 1990-91 - Held, yes
6
Interest on
doubtful advances is realincome as have been accrued to the assessee and liable
to tax.
SUPREME COURT OF INDIA State Bank of Travancore v.Commissioner
of Income-tax [1986] 24 TAXMAN 337 (SC)
Section 5, read
with section 145, of the Income-tax Act, 1961 - Income - Accrual of
-Assessee-bank, following mercantile system of accounting, charged interest on
advances considered doubtful of recovery, called sticky advances by debiting
concerned parties but, instead of carrying it to profit and loss account,
credited it to separate account styled 'Interest suspense account' In its
return assessee disclosed such interest separately and claimed that same was
not taxable in its hands as income of concerned years - Whether in view of
concept of real income, impugned interest, which had accrued to assessee, could
be excluded from assessee's taxable income of concerned years - Held, no
In the above decision of the supreme court the court in
case of SB of Travancore the concept of real income has been thoroughly
elaborated and established following conclusions (extracts of various para of
the decision):
1
The question of how far the concept of real income entered
into the question of taxability in the facts and circumstances of this case and
how far and to what extent the concept of real income should intermingle with
the accrual of income will have to be judged in the light of the provisions of
the Act, the principles of accountancy recognised and followed the feasibility.
The earlier circulars, being executive in character, could not alter the
provisions of the Act. An acceptable formula of correlating the notion of real
income in conjunction with the method of accounting for the purpose of
computation of income for the purpose of taxation is difficult to evolve.
Besides, any strait-jacket formula is bound to create problems in its
application to every situation. It must depend on the facts and circumstances
of each case when and how income accrues and what consequently follow from the
accrual of income. Whether an accrual has taken place or not must, in
appropriate cases, be judged on the principles of real income theory.
2
After accrual, non-charging of tax on the same because of
certain conduct based on the ipse dixit of a particular assessee cannot be accepted.
3
In determining the question whether it is hypothetical
income or whether real income has materialised or not, various factors will
have to be taken into account…, but once the accrual takes place, on the
conduct of the parties subsequent to the year of closing, an income which has
accrued cannot be made 'no income'.
4
It is the income which has really accrued or arisen to the
assessee that is taxable. Whether the income has really accrued or arisen to
the assessee must be judged in the light of the reality of the situation.
5
The concept of real
income would apply where there has been a surrender of income which in theory
may have accrued but in the reality of the situation no income had resulted
because the income did not really accrue.
6
Where a debt has
become bad, deduction in compliance with the provisions of the Act should be
claimed and allowed.
7
Where the Act
applies, the concept of real income should not be so read as to defeat the
provisions of the Act.
8
If there is any
diversion of income at source under any statute or by overriding title, then
there is no income to the assessee.
9
The conduct of the parties in treating the income in a
particular manner is material evidence of the fact whether income has accrued
or not.
10 Mere improbability of recovery, where the
conduct of the assessee is unequivocal, cannot be treated as evidence of the
fact that income has not resulted or accrued to the assessee. After debiting
the debtor's account and not reversing that entry, but taking the interest
merely in suspense account, cannot be such evidence to show that no real income
has accrued to the assessee or has been treated as such by the assessee.
11 The concept of
real income is certainly applicable in judging whether there has been income or
not, but in every case it must be applied with care and within well-recognised
limits, and must not be called in aid to defeat the fundamental principles of
law of income-tax as developed.
The above discussions elaborate a very simple concept of
Real income and how it can affect taxability due to some contractual
obligations.
Hence some contractual obligations yet not meant to earn a
direct income but made for efficient recovery or mode of penal charges for
delay payments or deferment due to uncertainty might trigger the concept of
real income and one might hive to charge the same as income even if it has not
been received by the assessee. ____________________________________________________________________
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