Global Tax Alert | 16 October 2013

India's Supreme Court establishes principles on evaluating "real" accrual of income for levy of tax

  • Share

Executive summary

This Tax Alert summarizes a recent ruling of the Supreme Court of India (SC) in the case of Excel Industries Ltd.1 (Taxpayer) addressing whether the benefit of entitlement granted against export obligation to make duty-free imports of raw materials is taxable in the year in which the export is made or in the year in which the duty-free import is made.

While ruling on this aspect, the SC observed that income is taxable under the Indian Tax Laws (ITL) if (a) the income is “due”; (b) there exists a corresponding liability on the other party to pay such sum; (c) there exists a “real,” and not a “hypothetical,” income; and (d) practically, there is a plausibility of realization of benefits by the taxpayer. Real income can be said to have accrued for the purposes of taxation under the ITL once all these tests are satisfied.

As no “real” income but only a “hypothetical” income accrued to the Taxpayer in the tax year of export, the same would not be taxable in the said year but in the year in which the import is made and entitlement is actually exploited.


Under the ITL, the value of any benefit or perquisite, whether convertible into money or not, arising from a business or a profession, is income chargeable to tax as “income from a business or profession.”

Based on certain export performances, the Taxpayer was entitled to certain duty entitlement credits under the Indian Import Export policy which can be set off against import duty liability that it incurs on import of raw material etc. Benefit of entitlement can be availed only on completing import.

As the Taxpayer was following the mercantile system of accounting, for the tax year 2000-01 the Taxpayer accounted the value of entitlement in its books of account in the year of export by way of reduction from value of raw material consumption. However, while offering the income to tax, the Taxpayer excluded a portion of the entitlement by contending that such income accrued in a subsequent tax year, i.e., when the imports are actually effected and the raw material is consumed.

The Tax Authority denied this claim and taxed the benefit of entitlement in the year of export. The Tax Authority understood the scheme to mean that benefit of importing raw material on duty-free basis has come together with an obligation for export commitment of goods by consuming said imported raw material. In as much as the taxpayer has accomplished export during the year, the right to receive benefit is vested and become absolute during the year of export. Accounting entries are also in conformity with this.

The Taxpayer appealed before the First Appellate Authority (FAA) which ruled in favor of the Taxpayer.

The Tax Authority then appealed before the Tribunal. The Tribunal upheld the FAA's order and ruled in favor of the Taxpayer. The Tribunal noted that issue was decided in favor of the Taxpayer consistently for different years and in respect of some of these years appeals of the Tax Authority were rejected also by the High Court.

The Tax Authority appealed before the High Court, which was dismissed. The Tax Authority subsequently filed a special leave petition before the SC.


The SC ruled in favor of the Taxpayer and held that in the year of export the benefit of entitlement was “hypothetical,” which turned “real” in the subsequent year in which import of raw material was affected and entitlement is actually exploited. The SC held:

  • The SC referred to its earlier decisions2 which explained the principles of accrual and concept of real income and laid down the following principles of relevance:
    • Tax can be levied on real income and not on hypothetical income.
    • Real income is said to accrue if
      • the income is “due”;
      • there exists a corresponding liability on the other party to pay such sum and;
    • There is probability of realization of the benefits by the taxpayer in a realistic and practical point of view. In case of hypothetical income, there cannot be a tax, even though in book-keeping, an entry has been made about a hypothetical income.
  • Based on the above principles and the facts of the case, even if it is assumed that the Taxpayer is entitled to the benefits, there is no corresponding liability on the authorities to pass on the benefit of duty- free imports until the goods are actually imported and made available for clearance. The benefits represent, at best, a hypothetical income which may or may not materialize and its money value is, therefore, not the income of the Taxpayer. Further, if the Taxpayer does not import any goods subsequently, there would be no realization of benefits from a realistic and practical point of view. Accordingly, no income should accrue in the year of export, but, the benefit should accrue in the tax year in which the imports are made.
  • In past litigation, a consistent view has been taken in the favor of the Taxpayer for several tax years. Consequently, there is no reason to take a different view unless there are convincing reasons.
  • For some tax years, the Tax Authority had accepted the decision of the Tribunal in the Taxpayer's own case. However, for other tax years, the Tax Authority had litigated the issue. In such circumstances, it is not permissible for the Tax Authority to flip-flop on the issue and the matter should not be pursued for the sake of pursuing.

Further, the Taxpayer had made imports in the subsequent years and paid taxes on the same. The Tax authority is, thus, not deprived of tax. The rate of tax for tax years 2000-01 and 2001-02 are the same. The dispute raised by the Tax Authority is, thus, academic. In such circumstances, there is no reason for the Tax Authority to pursue the matter as it is fruitless and is not going to add much to the public exchequer.


The present ruling lays down the key principles for evaluating when income is said to accrue for the purposes of taxability under the ITL. The ruling reiterates that it is only real income, and not hypothetical income, which can be taxed in India. Further, for real income to accrue under the ITL, the income should be due; there should be a corresponding liability to pay; and practically, there is a plausible realization of such income. In the instant case, these tests are not satisfied. Consequently, there can be no accrual of real income but only hypothetical income and, accordingly, there can be no levy of tax under the ITL.

The decision of the SC, which is the highest judicial forum in India, is binding on the lower Courts/Tribunals.


1. Civil Appeal No. 125 of 2013.

2. Shoorji Vallabhdas [46 ITR 144 (SC)]; Morvi Industries [82 ITR 835 (SC)]; State Bank of Travancore [158 ITR 102 (SC)].

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (India), Mumbai
  • Sudhir Kapadia
    +91 22 6192 0900
Ernst & Young LLP (India), Hyderabad
  • Jayesh Sanghvi
    +91 40 6736 2078
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
  • Nachiket Deo
    +44 20 778 30862
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
  • Gagan Malik
    +65 6309 8524
Ernst & Young LLP, Indian Tax Desk, New York
  • Tejas Mody
    +1 212 773 4496

EYG no. CM3889