JUDGMENT
M.N. Rao, J.
1. At the instance of the assessee, this reference was brought under section 256(1) of the Income-tax Act, 1961 (Act No 43 of 1961), for short “the Act”. The question referred is :
“Whether, on the facts and in the circumstances of the case, the assessee is entitled to claim as business expenditure for the assessment year 1969-70, the sum of Rs. 1,60,654 towards bonus payable to persons from whom maize was purchased ?”
2. The assessee is a primary co-operative marketing society carrying on the business of marketing at Armoor in Nizamabad District. The apex body at the State level is the Andhra Pradesh State Co-operative Marketing Federation. The assessee adopts mercantile basis of accountancy. In the previous year relevant to the assessment year 1969-70, the co-operative marketing societies were given monopoly to procure maize from cultivators and export the same outside the State. The object of conferring such monopoly on the co-operative marketing societies was to ensure a good price to the farmers by eliminating middlemen and also to encourage production of more maize, especially of the hybrid variety. The policy decision taken by the Government in this regard was embodied in the letter dated August 26, 1967, issued by the Registrar of Co-operative Societies. The letter contemplated that a good proportion of the profits made by the society in maize should go back to the cultivators as bonus to encourage them to grow more maize and the balance be utilised to improve the financial position of the society by crediting it to the reserve fund, building fund, etc. If necessary, the letter advised the societies to amend the bye-laws suitably in pursuance of the above policy, the apex body, the Andhra Pradesh State Co-operative Marketing Federation, requested all the district and primary marketing societies to enter the market immediately and speed up the purchase of maize. By its letter dated September 15, 1967, the apex body appointed all the societies within its jurisdiction to act as its agents for the procurement of maize, green gram and black gram. The letter further stated that 1/4th of the net profit accruing from the marketing of maize shall go to the apex body and the balance of 3/4ths should go to the district or the primary co-operative society. The managing committee and the assessee society in order to implement the aforesaid direction, passed a resolution on September 26, 1967, deciding to give bonus up to 50% of the total net profit on the procurement of maize out of the 3/4ths portion remaining with the society. This resolution was approved unanimously by the general body at its meeting on November 22, 1967, subject to the approval of the Registrar. The general body further resolved that out of the bonus that would be paid to the members, 50% should be adjusted towards the share capital of the concerned members and the balance should be paid to them. By another resolution dated November 20, 1971, the general body unanimously resolved to enrol growers of maize as members of the society by crediting to their accounts bonus payable to them on the maize supplied for the year 1967-68. The Deputy Registrar of Co-operative Societies accorded permission to the assessee by his letter dated September 26, 1972.
3. The society, in its accounts relevant to the previous year, debited a sum of Rs. 1,60,654 as bonus payable to the cultivators from whom it procured the maize. It claimed deduction on the said sum on the ground that it was an allowable business expenditure. The claim was rejected by the Income-tax Officer taking the view that the assessee acted as an agent and that at the relevant period no money was actually paid by it to the growers. He was also of the view that under the bye-laws, viz., bye-law 75(g) of the society, net profits not exceeding 30% alone could be disbursed to the members in proportion to the value of goods sold through the society. On appeal, the Appellate Assistant Commissioner reversed the view taken by the assessing officer. The Appellate Assistant Commissioner was of the view that the letter of the Registrar dated August 26, 1967, authorised the assessee to conduct the business not only for members but for others also who could subsequently become members. The actual bonus to the extent of Rs. 1,57,225.35 was paid to the growers which fact was noticed by the Appellate Assistant Commissioner. He was also of the view that in terms of the bye-laws 38 of the society, the managing committee of the society was competent to frame subsidiary bye-laws for conducting the business. The managing committee accordingly passed a resolution on September 26,1967 and the general body approved the same for payment bonus to the extent of 50% of the profits made in the maize procurement. These resolution were subsequently approved by the Registrar and, therefore, the expenditure incurred was allowable. The Department carried the matter in appeal to the Income-tax Appellate Tribunal which accepted the contentions put forth by the Revenue and reversing the order of the Appellate Assistant Commissioner restored the assessment order of the assessing authority. The Tribunal was of the view that the letter of the Registrar was in the nature of advice given by the head of the co-operative department to all the co-operative marketing societies to suitably amend their respective bye-laws providing for payment of bonus.
4. At the instance of the assessee, the aforesaid question was referred to this court.
5. Sri Y. Ratnakar, learned counsel for the assessee, contends that there was no need for the society to amend any of its bye-laws in order to give effect to the directions contained in the letter of the Registrar of Co-operative Societies dated August 26,1967. The liability had accrued to the society by virtue of the directions contained in the aforesaid letter and in order to give effect to those directions, the general body of the society had passed the resolution. The mere fact that the money was paid by way of bonus to the growers in the year previous to the relevant assessment year would not disentitle the assessee from claiming allowance of the expenditure incurred.
6. On the other hand, Sri M.S.N. Murthy, learned standing counsel for the Revenue, contends that even though the assessee has adopted the mercantile system of accounting since the liability had not accrued in the year previous to the relevant assessment year, the payment incurred was not entitled to be allowed. Till the amendment of the bye-laws, the nonmembers-growers are not entitled to any bonus and correspondingly no liability was imposed on the society to make the payments. The approval of the Registrar being a condition precedent for payment of bonus and as the approval was received only in 1972, any payment made prior to that was not entitled to be deducted in the computation of the net income.
7. The Income-tax Appellate Tribunal, as already noticed, has based its decision on three grounds, namely, (1) the letter of the Registrar dated August 26, 1967, was in the nature of advice given by the head of the co-operative department to all the co-operative marketing societies to suitably amend their respective bye-laws. Even though the societies administratively we bound to give effect to the instructions issued by the Registrar, there was no liability on the part of the societies to pay bonus to the suppliers of the maize and consequently the letter dated August 26, 1967, did not create any legal liability on the assessee; (2) there was no contract between the society and the suppliers of maize stipulating payment of bonus and correspondingly there was no obligation on the assessee to make the payment; and (3) there was no statutory liability or any compulsion by way of an award or a decree by a competent court obligating the society to incur the expenditure in question. In reaching the aforesaid conclusions, the Income-tax Appellate Tribunal relied upon CIT v. Swadeshi Cotton & Flour Mills (P.) Ltd. , CIT v. Somasundaram Mills (P.) Ltd. and Pankaja Mills Ltd. v. CIT [1963] 50 ITR 665 (Mad). In Kedarnath Jute Mfg. Co. Ltd. v. CIT , the Supreme Court has considered the question whether an assessee company which follows mercantile system of accounting is entitled to claim deduction by way of business expenditure when the amount of tax for the assessment year was due although the demand was quantified and paid subsequently. In that case, the assessee contested the proceedings before the appropriate tax authorities. Dealing with this aspect, the Supreme Court held (p. 366) :
“It is not possible to comprehend how the liability would cease to be one because the assessee had taken proceeding before higher authorities for getting it reduced or wiped out so long as the contention of the assessee did not prevail with regard to the quantum of liability, etc. An assessee who follows the mercantile system of accounting is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being computed.”
8. The Supreme Court also observed (p. 367) :
“Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter.”
9. A Division Bench of the Calcutta High Court in CIT v. Orient Supply Syndicate , considered the question whether the assessee which followed the mercantile system of accounting was entitled to claim deduction of Rs. 29,008 paid towards provident fund contribution relating to earlier years in the computation of its income of the previous year relevant to the assessment year. In that case, the demand was raised by the statutory authority for the first time in the relevant previous year. Reiterating the principle that unlike the cash system of accounting, in the mercantile system of accountancy, the assessee is entitled to the deduction in the year, when the liability arises and not in the year when the liability is enforced or discharged, the Calcutta High Court observed (p. 16) :
“…..from a commercial point of view, for a commercial man, in the reality of the situation, to claim deduction in the year under question, was not unjustified.”
10. We must also mention that the Calcutta High Court has not laid down as an inflexible rule that in every case the statutory liability discharged in a particular year becomes eligible for deduction. It expressed the view (p. 16) :
“We would, however, say that it is not in all cases correct to say that a statutory liability discharged in a particular year becomes eligible for deduction in the year in question in the mercantile system of accounting. It depends on the facts and circumstances of the case and on the statutory provisions.”
11. In J. K. Synthetics Ltd. v. Bajpai (O.S.), ITO , the Allahabad High Court dealing with a similar situation in respect of payment of excise duty held that an assessee which follows the mercantile system of accounting can legitimately claim deduction in respect of a business liability even if such liability has not been quantified or paid or even when such liability is being disputed.
12. In Symonds Distributors (P.) Ltd. v. CIT , the board of directors of the company passed a resolution on December 4,1967, declaring bonus for the year 1961 at the rate of one-sixth of the total basic pay drawn by the staff and directing payment to be made after the final accounts for the year have been drawn up. Pursuant to that resolution, a sum of Rs. 6,500 was earmarked for the payment of bonus and the said sum was claimed as deduction for the year 1962-63. The Income-tax Officer disallowed the claim. While considering that question, the Allahabad High Court observed (p. 92) :
“Now, the importance of the accounts being kept on the mercantile system is that in such a case a deduction in respect of bonus can be claimed when the company incurs the liability to pay the bonus and makes appropriate entries in the books of accounts. The date of actual payment of bonus is immaterial. Under the cash system, a deduction can be allowed only when the payment is made. In the instant case, the assessee-company keeps its accounts on mercantile system. It is not disputed that the assessee has incurred a liability when it passed the resolution. The company had made appropriate entries in the books of accounts. In the circumstances, the company was clearly entitled to the deduction claimed by it regardless of the fact that the actual profits had not been worked out, when the declaration for bonus was made.”
13. In Shahzada Nand & Sons v. CIT , the question before the Supreme Court was whether a certain sum of company of money paid by way of commission by the assessee to two of its employees could be allowed as business expenditure. There was no obligation, contractual or otherwise on the part of the assessee in that case to make such payments. The Supreme Court, after considering the justness of the payment, upheld the plea of the assessee. Speaking through the court, Bhagwati J. (as he then was) ruled (p. 366) :
“It is true that there was no obligation on the assessee to make payment of this commission to Saheb Dayal and Gurditta Mal, but it is now well-settled that the mere fact that commission is paid ex gratia would not necessarily mean that it is unreasonable. Commercial expediency does not mean that an employer should not make any payment to an employee unless the employee is entitled to it under a contract. Even where there is no contract, an employer may pay commission to an employee if he thinks that it would be in the interest of his business to do so. It is obvious that no business can prosper unless the employees engaged in it are satisfied and contented and they feel a sense of involvement and identification and this can be best secured by giving them a stake in the business and allowing them to share in the profits. It would indeed be a wise step on the part of an employer to offer incentives to his employees by sharing a part of his profit with them. This would not only be good business but also good ethics. It would be in consonance with Gandhian concept as also modern socialistic thought which, with its deeply rooted faith in social and economic democracy, regards the employees as much as the employer as co-sharers in the business. It an employer earns profits to which the employees have necessarily contributed by putting in their labour, there is no reason why the employer should not share a part of these profits with the employees. That is the demand of social justice today and it is high time that the administration of our tax law recognised it and encouraged sharing of profits by employers with employees by adopting a progressive and liberal of approach in the applicability of section 36, sub-section (1), clause (ii). What is the requirement of commercial expediency must be judged not in the light of the 19th century laissez faire doctrine which regarded man as an economic being concerned only to protect and advance his self-interest but in the context of current socio-economic thinking which places the general interest of the community above the personal interest of the individual and believes that a business or under-taking is the product of the combined efforts of the employer and the employees and where there is sufficiently large profit, after providing for the salary or remuneration of the employer and the employees and other prior charges such as interest on capital, depreciation, reserves etc., a part of it should in all fairness go to the employees.”
14. In the light of the dictum laid down in the aforesaid cases, could it be said that the assessee did not incur the liability to pay bonus in the year previous to the relevant assessment year in question ? The policy of the Government as contained in the letter of the Registrar dated August 26, 1967, clearly aims at eliminating the middlemen to improve the lot of the farmers. The progressive policy of the State in the field of agriculture for the purpose of increasing production by giving necessary incentives to the farmers was embodied in the said letter. Apart from stating the Governmental policy, the letter, in our view, contains a positive direction to the co-operative societies to pay bonus to the growers of maize from whom the society procures the maize. The letter does not expressly state that there should be a modification of bye-laws of the co-operative societies to enable them to make payment of bonus. The Registrar of Societies was not definite whether the bye-laws of the society should be amended in order to give bonus to growers, and that is the reason why the letter says that if it is necessary, the bye-laws may be amended. The letter was addressed to the President the of the apex body, viz., the Andhra Pradesh State Marketing Federation. It contains a positive direction that the Registrar should be intimated :
“…..what amount has been disbursed as bonus to the growers from whom maize was purchased and whether the balance amount has been utilized properly towards reserve fund, building fund, etc.”
15. This letter was communicated to all the co-operative societies including assessee. In order to implement the directions contained in the Registrar’s letter, the apex body issued a circular dated September 15,1967, containing guidelines. Pursuant to the aforesaid guidelines and the letter of the Registrar, the managing committee of the assessee-society passed a resolution on September 26, 1967, deciding to give bonus up to 50% of the total net profit on procurement of the maize, out of the 3/4ths portion remaining with the society. This resolution of the managing committee was unanimously approved by the general body at its meeting held on November 22, 1967. The resolution of the general body was to the following effect :
Agenda : Item No. II Resolution
To ratify the action taken by the The general body unanimously
managing committee to distribute approved the resolution passed
50% bonus out of the net profit of by the managing committee to
maize procurement during the seasons distribute 50% bonus out of
1967-68, to the members who the net profits of maize
transacted maize business with procurement subject to the
with the society. approval of the "Registrar".
The general body further
resolved unanimously that out
of the bonus which was to be
paid to the members, 50% should
be adjusted towards share
capital of the concerned members
and the balance should be
paid to them.
By another resolution passed on November 29, 1971, the general body unanimously resolved to enrol maize suppliers as members of the society. The Registrar (which expression includes Deputy Registrar) accorded permission to the assessee by his letter dated September 26, 1972, under section 45(2)(a) of the Andhra Pradesh Co-operative Societies Act, 1964, for conversion of the bonus granted to the maize suppliers as share capital on their becoming members of the Co-operative Marketing Society, Armoor.
16. Section 45 of the Andhra Pradesh Co-operative Societies Act deals with disposal of net profits. Sub-section (1) thereof speaks of disposal of net profits towards reserve fund, co-operative education fund, etc. The balance amount may be utilised for the purposes specified in clauses (a) to (e) of sub-section(2). The relevant portion of sub-section (2) reads as follows :
“The balance of the net profits may be utilised for all or any of the following purposes namely :
(a) payment of dividend to members on their paid-up share capital at a rate exceeding the prescribed limit;
(b) payment of rebate to members on the amount or volume of business done them with the society, to the extent and in the manner specified in the bye-laws;
(clauses (c) to (e) are not necessary for the purposes of this case and are therefore, omitted)
Provided that such money may be utilised with the permission of the Government for any such purpose outside the area of operation of the society.”
17. The proviso to section 45 of the Andhra Pradesh Co-operative Societies Act says that the society may spend moneys outside the area of operation, provided the Government permits it to do so. Even assuming that the society has no power under the bye-laws to pay bonus to the growers, it is entitled, by virtue of the letter of the Registrar, to make such payment. The Registrar’s letter is a policy direction if the Government and, therefore, by necessary implication, the society had the permission of the Government to pay bonus to the growers in compliance with its directions.
18. There was no need for the society to make disbursement until the permission of the Registrar was accorded. It is true that long after the previous year relevant to the assessment year permission was accorded to the society by the Registrar under section 45(2)(a). Section 45(2)(a) is inapplicable wholly to a situation of this type. It deals with payment of dividend to members on their paid-up share capital. What was paid by the society to the growers was in the nature of additional purchase money which is described customarily as bonus. It was not payment of dividend to its members and, therefore, section 45(2)(a) was not attracted.
19. Sri. M.S.N. Murthy, learned standing counsel for the Revenue, contends that permission was accorded by the Registrar under section 45(2)(b) which relates to payment of rebate to its members on the amount or volume of business done by them with the society. We are unable to accept the contention. The order of the Deputy Registrar according permission does not state that the permission was accorded under section 45(2)(b). The payment made in this case to the members was not a rebate. Section 45(2)(b) has no application to non-members was not a members, learned counsel for the assessee, Sir Y. Ratnakar, says that the bye-laws are silent. Whether the bye-laws are silent or not, we do not want to decide for the obvious reason that the bye-laws were not a considered by the Tribunal. On a true interpretation if section 45(2)(b), we are of the view that the amount a paid by the society to the growers by way of bonus was not a rebate falling within the ambit of section 45(2)(b).
20. The general body of the society passed a resolution approving the resolution of the managing committee to distribution 50% of the bonus out of the net profit to the growers with the qualification “subject to the approval of the Registrar.” In our view, this was done only by way of abundant caution. The policy statement of the Government as contained in the letter of the Registrar did not spell out in what proportion the profits should be shared between the society and the suppliers of the maize. In order to give effect to the directions contained in the letter of the Registrar, the apex body issued a circular dated September 15, 1979, containing the guidelines which, inter alia, stated that 1/4th of the profit earned by the co-operative marketing society should be remitted to the apex body and the remaining 3/4th should be retained by the concerned society. The general body of the assessee society felt that 50 per cent of the society’s 3/4th share of the income should reasonably be diverted as bonus to farmers. Presumably, entertaining the doubt whether the reasonableness of 50 percent of the income being paid as bonus should have the seal of approval of the Registrar, by way of abundant caution it had introduced the qualification in the resolution “subject to the approval of the Registrar”. This cannot in our view, be construed as a condition precedent enabling the society to make payment to the farmers.
21. Does clause (g) of bye-law 75 of the society really require amendment before the bonus was paid ?
22. The Income-tax Appellate Tribunal was of the view that as there was no bye-law authorizing the payment, the amount in question should not be deducted from the computation of net income. Bye-law 75 of the society bears the heading “Net profit distribution”. It says that the net profit of the society shall be disposed of in the manner indicated in clause (g) reads thus :
“Out of the remainder a sum not exceeding 30% of the net profits shall be disbursed as rebate to the members in proportion to the value of goods sold through the society. However 6-1/4th of the rebate payable to each member shall be appropriated towards additional shares.”
23. This clause speaks of disbursement of net profit as rebate to the member. What was done by the society in the present case was not disbursement of net profits to the members. It was only payment of additional purchase money to the growers and the payment as already observed by us, was, for purposes of convenience, terminated as bonus. Therefore, there was no necessity to amend clause (g) of the bye-law 75 of the society in order to enable it to make the payment. The action of the society in making the payment should not, in our considered view, be examined from any abstract legal principal, but the whole matter should be viewed pragmatically. The society is should is bound to carry out the policy directions issued by the Registrar. No society can afford to flout or ignore the directions. It is not as if any palpably illegal direction were issued by the Registrar compelling the society to carry them out. The directions issued by the Registrar only incorporated the policy decisions of the Government. The policy subserves the interests of the farmers by providing incentives to them. It is one of the directives contained in part IV of the Constitution to secure economic justice to the people. Elimination of middlemen and encouraging the farmers directly to market their produce through co-operative societies is one of the recognized method of ensuring economic justice to farmers and thus protecting them from exploitation by middlemen. When the society was asked to carry out such a policy decision, it had incurred the liability when it had adopted the resolution to pay 50 percent of the net profit earned by it. Incurring of the liability was not subject to any necessary preconditions. The accounting year of the assessee ended on June 30, 1968. The general body’s resolution was on November 22, 1967, much earlier to the ending of the accounting year. By passing the resolution, the society had incurred the liability and a corresponding right and accrued to the grower to demand payment in terms of the resolution. In the light of the law down by the Supreme Court in Shahzada Nand and Sons v. CIT , it is not necessary for the assess to incur the liability by virtue of any a contract or statute. As held by the Allahabad High Court in Symonds Distributors (P.) Ltd. v. CIT , the date of the resolution is relevant. The date of actual payment is immaterial in respect of an assessee who adopts the mercantile system of accounting.
24. In the view we have taken the three ruling relied upon by the Income-tax Tribunal do not support the case of the Revenue. Sri M.S.N. Murthy, learned standing counsel for the Revenue, has also placed reliance on three decisions. In Pankaja Mils Limited v. CIT [1963] 50 ITR 665 (Mad), a certain amount of money paid by the assessee on the advice of the Southern Indian Mills Owners’ Association was held to be not deductible. There was no agreement between the assessee and its workmen and, therefore, the Madras High Court disallowed the claim. CIT v. Somasundaram Mills (P.) Ltd. [1974 ITR 365 (Mad) is also a case where there was no claim or agreement or award obligating the assessee their in to make any payment towards bonus to the employees. The obligation arose there only when the matter was adjudicated by the Industrial Court. The Madras High Court therefore negative the claim of the assessee for deduction of the amount is question. CIT v. Swadeshi Cotton and Flour Mills Pvt. Ltd. also relates to payment of bonus and its deduction from the computation of the net income. Because of an industrial dispute, the assessee there in paid the bonus for the year 1947 only in 1949, but claimed deduction for the year 1947. Till the award was passed by the Tribunal, no liability was incurred by the assessee. Under those circumstances, the Supreme Court negatived the assessee’s plea for deduction of the amount.
25. For the foregoing reasons, we answer the question in favour of the assessee and against the Revenue. There shall be no order as to costs.