Section 5, read with sections 28(v) and 145, of the Income-tax Act, 1961

Held Admittedly, the firm was following mercantile system of accounting and, accordingly, the interest and remuneration due to the partners in terms of partnership deed was credited to the accounts of partners under section 28(v). Such interest and remuneration from the firm were assessable under the head ‘Profits and gains of business or profession’. As per section 145, the income under the head ‘Profits and gains of business or profession’, is to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Such choice of method is at the discretion of the assessee and not the Assessing Officer. [Para 8] It is now the settled law that the mercantile system of accounting takes note of ‘payment due’, whereas cash system of accounting recognizes only payment received. Under the cash system, only the actual receipts or disbursements are accounted for. The question, therefore, to be decided was whether the amount credited by the firm to the partners in their capital accounts with firm could be said to have been received by the partners or not. It was an agreed fact that in the partnership deed, there was no prohibition for the partner withdrawing the sum lying to the credit of his account with the firm. Thus, the firm had made the amount unconditionally available to the partners. The partners were entitled to withdraw such amount at any point of time just like a deposit in the bank account. The partnership firm credited the interest on the basis of amount standing to the accounts of partners. Such amount also included the share of profit and interest due and payable for earlier years. The interest payable to the partners is an allowable deduction under section 36(1)(iii) subject to the condition prescribed in section 40(b). As per section 36(1)(iii), interest payable in respect of capital borrowed for the purpose of business is admissible deduction. Thus, when the partners claimed the deduction by way of interest in the hands of firm, it was held to be capital borrowed for the purpose of business. That proved that the share of profit and interest credited in earlier year became the capital borrowed in the subsequent year. The amount of interest was paid by the firm to its partners who, in their turn, had lent the amount to the firm in which they were partners. Thus, it could be held that the amount of interest credited to the partners and which was made unconditionally available to the partners was to be treated as amount received by the partners. Hence, even in the case where the partners are following cash system of accounting, such interest would be deemed to have been received by the partners. Scope of total income provided in section 5(1) includes all income received or deemed to be received. The withdrawal by the partners from the firm is their own action. The credit in the account of the partners by the firm implies payment and withdrawal by the partner in no way can be considered as the only amount received by such partner. Thus, the action of withdrawal will not govern the provision of even the cash system of accounting which can be said to have been received by the partners. Mere withdrawal by the partners cannot be considered to be a method of accounting and the amount available to the partners by way of credit to their account can be considered as received by the partners even though such partners are following cash system of accounting. Thus, the amount credited by the firm to the accounts of the partners was to be considered as received by the partners as the same was unconditionally available to the partners and mere withdrawal thereof could not be considered as received based on the cash system of accounting. Accordingly, the finding of the Commissioner (Appeals) was to be reversed and that of the Assessing Officer was to be upheld. [Para 8.1] So far as validity of reopening was concerned, in the instant case, original assessment was completed under section 143(1)(a). While computing the income under section 143(1)(a), the Assessing Officer has no power to vary the income declared in the return. In fact, he formed no opinion on such return. However, when the accounts of the firm and partners were examined subsequently, it came to knowledge of the Assessing Officer that though the firm was claiming deduction by way of interest payable to partners, such sum was not offered for taxation by partners. As per Explanation 1 to section 147, production, before Assessing Officer, of account books or other evidence from which material evidence could, with due diligence, have been discovered by Assessing Officer, will not necessarily amount to discover within meaning of proviso to section 147. However, in the instant case, since the original assessment was not completed under section 143(3), the proviso to section 147 would not apply. Thus, to invoke provision of section 147, the Assessing Officer should merely have reason to believe that any income chargeable to tax has escaped assessment. Since the Assessing Officer had formed an opinion on the basis of facts available to him and in respect of which proper reasons were recorded, the ground raised by the assessees in cross objections was to fail. [Para 11]