Cash system
Also written Cash system of accounting · Receipt basis
One of the two accounting methods Section 145 permits — income, including interest on securities, is taxed only when actually received, not when it accrues, as under the alternative mercantile system.
In plain language
When exactly is interest income "earned" for tax purposes — the day it becomes due, or the day it lands in the bank account? The answer depends on which accounting method the taxpayer follows.
Section 145 of the Income Tax Act allows two methods: the mercantile system and the cash system. Whichever one the assessee regularly employs decides the timing of the tax.
Under the cash system, income — interest on securities, in the workbook's running example — is taxed only on a receipt basis: when the money is actually received, not when it becomes due. The mercantile system is the opposite: income is taxed on an accrual basis, as it becomes due, whether or not it has actually been paid yet.
How it works
The choice of method affects when a rupee of interest is taxed, not whether it is taxed — the same total interest eventually falls into some year's income either way. It can, however, shift income between financial years at the edges of a period.
The workbook's worked example: a bond pays interest half-yearly, on 30 June and 31 December. For the period January to March 2024 — interest actually paid out on 30 June 2024 — a mercantile-system taxpayer includes it in FY 2023-24 income (the year it accrued), while a cash-system taxpayer includes the same rupees in FY 2024-25 income (the year the cash was received).
The method is not something the taxpayer switches on a whim from year to year — Section 145 requires whichever system is regularly employed, so a consistent choice is expected across years.
A worked example
Mr A holds 1,000 bonds of an Indian company, face value Rs 100 each, coupon 7.50% per annum, interest paid half-yearly on 30 June and 31 December.
For the quarter January to March 2024, interest of Rs 1,875 accrues (1,000 × 100 × 7.5% × 3/12), but is actually paid only on 30 June 2024.
| Accounting method followed | Rs 1,875 taxed in which year? |
|---|---|
| Mercantile system | FY 2023-24 — the year it accrued |
| Cash system | FY 2024-25 — the year it was received |
Over the life of the bond the total interest taxed is identical either way; only the year in which each instalment lands differs. A taxpayer who wants to defer a small amount of interest income into the next financial year, for instance to manage which year's slab it falls into, cannot simply pick the cash system for one payment — the same method must be applied consistently to all their interest income.
Why NISM asks about it
Chapter 9 (Income from Other Sources), section 9.3 — Interest on Securities — and Chapter 10 (Taxation of Debt Products), section 10.1.1, both apply Section 145's mercantile-versus-cash choice to interest income, with a worked half-yearly interest example in each chapter. Expect a computation question that gives a half-yearly interest schedule and asks how much is taxable in a given financial year under each method.
Common exam traps
- Cash system taxes on receipt; mercantile system taxes on accrual — reversing the two is the standard trap.
- The choice is Section 145's, and must be "regularly employed" — not selected transaction by transaction.
- Total lifetime interest taxed is the same either way — only the timing, and therefore which year's slab or rate applies, differs.
- The same choice governs all of an assessee's income under this head, not just one security.
Check yourself
1.An assessee who follows the cash system of accounting is taxed on interest on securities on what basis?
- a)On accrual, as the interest becomes due
- b)On receipt, when the money is actually received
- c)On due or receipt, whichever is earlier
- d)Half on accrual and half on receipt
Show the answer
Answer: (b) On receipt, when the money is actually received
Under section 145, interest on securities is computed in accordance with the method of accounting regularly employed by the assessee. Under the mercantile system it is taxable on ACCRUAL basis; under the cash system it is taxable on RECEIPT basis. The "due or receipt, whichever is earlier" rule belongs to salary, not to interest on securities.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Accrued interest in sale considerationInterest that has built up on a bond but not yet been paid out, bundled into its sale price — taxed as interest income and then stripped back out of the price before computing capital gains, so it is not taxed twice.
- Accumulated profitsA company's built-up reserves of profit — the source that, under Section 2(22), turns certain distributions to shareholders (bonus debentures, buy-back proceeds, a shareholder loan) into taxable deemed dividend.
- Attributable expensesThe expenses a taxpayer may deduct while computing income from other sources — collection charges, interest on borrowed funds and similar costs incurred wholly and exclusively to earn that income.
- Mercantile systemThe accounting method under which interest and other income are taxed in the year they accrue, whether or not the money has been received — the alternative the Income-tax Act allows alongside the cash system.