JUDGMENT
Nazir Ahmad, J.
1. A statement of the case has been submitted by the Income-tax Appellate Tribunal, Bench “A”, Patna (hereinafter referred to as “the Tribunal”, under Section 256(2) of the Income-tax Act, 1961
(hereinafter referred to as “the Act”), referring the following questions of law for the opinion of this court :
“1. Whether, on the facts and in the circumstances of the case, the Tribunal has erred in law in holding that only a part and not the entirety of the outstanding bills, was the income fallen due for the previous year ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in allowing the expenditure relating to extra work, for which claims were made by the assessee, but receipts for which were not accounted for either as work-in-progress or bills receivable ?
3. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the Appellate Assistant Commissioner of Income-tax was justified in allowing the relief, as the bills to that extent had not yet been accepted and hence it could not be said that the right of the assessee had accrued in respect of that amount ?”
The relevant facts of the case may be culled from the statement of the case and the various relevant orders of the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal. The assessee is a private limited company deriving income from contract work for the construction of an earthen dam and a spillway at Getalsud in the District of Ranchi. The assessment year involved is assessment year 1970-71. While making assessment, the Income-tax Officer found that the assessee had shown in the profit and loss account gross receipts for the value of the work done at Rs. 1,10,38,639. The Income-tax Officer found that in fact the total value of the work done was Rs. 1,12,63,067 and thus the assessee had not included Rs. 1,64,428 in the bills shown as receivable. It was explained before the Income-tax Officer that these amounts had been withheld by the Irrigation Department pending verification of the satisfactory conclusion of the work for which the payment related and that Rs. 10,000 was withheld relating to the spillway work and Rs. 1,54,428 was withheld out of the dam and dyke work. The Income-tax Officer also found that these amounts were paid back to the assessee in the subsequent year on satisfactory verification of the work by the Irrigation Department. The Income-tax Officer considering this circumstance held that this amount had to be included in the receipts of the assessee. He, therefore, included Rs. 1,64,428 while computing the income of the assessee.
2. The next amount which the Income-tax Officer added was an amount of Rs. 23,06,079. The assessee was required by the Income-tax Officer to furnish in writing the amount of claim preferred by the assessee
before the Irrigation Department for reimbursement of various expenses incurred by the assessee in this year beyond the provisions of the contract agreement but the assessee-company did not furnish these figures and the assessee in its letter dated March 29, 1973, asserted that the submission of the figures of claims pertaining to this year cannot be easily furnished and it will take time. Under such circumstances, the Income-tax Officer added the amount of Rs. 23,06,079 as he found that the assessee had furnished claims before the Irrigation Department to the extent of a sum of Rs. 1,32,21,569 as per the statements kept in the miscellaneous file of the assessment year 1969-70. Out of this amount, an amount of Rs. 9,21,483 had been considered in the assessment years 1968-69 and 1969-70, and so the balance amount of claim remained at Rs. 1,22,99,086 and this claim related to the assessment years 1970-71 to 1972-73. The Income-tax Officer found from the figures of payment received for the work done in these years that the proportionate receipts pertaining to the assessment year 1970-71 works out to about 75 per cent. of the total receipts relating to the assessment years 1970-71 to 1972-73. In the absence of details of claims pertaining to this year, the Income-tax Officer estimated the claim pertaining to this year at the rate of 75 per cent. of Rs. 1,22,99,086. At this rate, the amount came to Rs. 92,24,315. In the preceding assessment years, the Income-tax Officer had disallowed 75 per cent. of this amount and had treated the balance of 25 per cent. as income of the year under consideration pertaining to the amount of such claims. He, therefore, calculated 25 per cent. of the amount of Rs. 92,24,315 as the income of the assessee which came to Rs. 23,06,079 and this was added back for similar reasons as in the assessment year 1969-70.
3. A copy of the assessment order of the Income-tax Officer for the assessment year 1970-71 has been annexed and marked as annexure A forming part of the statement of the case.
4. When the matter came before the Appellate Assistant Commissioner, it was submitted on behalf of the assessee that the amount of Rs. 1,64,428 was not sanctioned by the authorities and they did not admit the bills as valid though the bills were prepared for the work done in this regard and as the claims were not admitted by the Department, they were not shown on the receipts side or as received or as bills receivable or as work-in-progress. It was also urged that it was not known as to whether the entire amount or any portion of it or none of it could be allowed to the assessee by the Government in respect of the work done in this year. The assessee admitted before the Appellate Assistant Commissioner that a sum of Rs. 80,585 had been received in respect of those bills in the subsequent years and papers were produced in that connection. The Appllate Assistant Commissioner held
that only the sum of Rs. 80,585 had been admitted by the Irrigation Department in the subsequent years and so only the addition to this extent out of Rs. 1,64,428 could be sustained. The Appellate Assistant Commissioner, therefore, allowed a relief of Rs. 84,243 which was deleted out of the total amount of Rs. 1,64,428.
5. The Appellate Assistant Commissioner also considered the addition of Rs. 23,06,079 relating to the addition for the work done by the assessee beyond the provisions of the contract agreement. The Appellate Assistant Commissioner had pointed out that the addition was made on similar grounds on which similar additions were made in the assessment years 1968-69 and 1969-70 and the Appellate Assistant Commissioner for the detailed reasons mentioned in the assessment years 1968-69 and 1969-70 deleted the addition of Rs. 23,06,079.
6. A copy of the order of the Appellate Assistant Commissioner has been annexed and marked as annexure B forming part of the statement of the case,
7. The Department being aggrieved by the order of the Appellate Assistant Commissioner filed an appeal before the Tribunal. The Tribunal disposed of the appeal filed by the Department by order dated October 29, 1975. As regards the relief of Rs. 84,243 allowed by the Appellate Assistant Commissioner relating to the addition of Rs. 1,64,428 made by the Income-tax Officer, it was submitted before the Tribunal by the departmental representative that the order of the Appellate Assistant Commissioner was not clear and it was not known whether the balance of the amount was still a bill receivable or not. It was also submitted that the figures mentioned by the Appellate Assistant Commissioner were not verifiable and the assessee’s assertion was accepted without proper verification. On behalf of the assessee it was submitted that though the assessee had made bills yet in respect of such bills, it was the system of the assessee that he used to show only when the bill was accepted in principle by the Government or the authorities concerned. The attention of the Tribunal was also drawn to the order of the Tribunal for earlier years where the system followed by the assessee was discussed. The Tribunal held that the Appellate Assistant Commissioner was justified in allowing relief as the bills to that extent had not yet been accepted and, therefore, it cannot be said that the right to the assessee had accrued in respect of that amount and merely because there was a claim by the assessse, it could not result in the conclusion that the amount was due to the assessee. The Tribunal, therefore declined to interfere with the order of the Appellate Assistant Commissioner with respect to the relief of Rs, 84,243 allowed by the Appellate Assistant Commissioner. The Tribunal also considered the relief allowed
by the Appellate Assistant Commissioner to the extent of Rs. 23,06,079. The Tribunal found that the Appellate Assistant Commissioner had decided this ground by following his order for the earlier year where similar additions were deleted by him. It was also argued before the Tribunal that in the earlier years, the matter had come to the Tribunal and the matter was considered in detail and the Tribunal held that the addition and its basis were not justified and that the Appellate Assistant Commissioner was justisfied in deleting the addition in that year. The Tribunal found that the facts in the present case were the same and the addition had been made on similar grounds and so the Tribunal, following its earlier order in ITA Nos. 839 and 840 of 1972-73, declined to interfere with the order of the Appellate Assistant Commissioner. This order of the Tribunal has been annexed and marked as annexure C forming part of the statement of the case.
8. The consolidated order dated June 13, 1974, of the Tribunal, in ITA Nos. 839 and 840 of 1972-73, relating to the assessment years 1968-69 and 1969-70, has been annexed and marked as annexure D forming part of the statement of the case, where reasons have been given for deleting the additions which shall be discussed subsequently.
9. On the aforesaid facts, the three questions have been referred by the Tribunal in view of the direction of this court under Section 256(2) of the Act.
10. The questions do not mention specific amounts and so they have to be understood in the light of the questions themselves. Question No 1 is to the effect whether the Tribunal has erred in law in holding that only a part and not the entirety of the outstanding bills was the income fallen due for previous year. This can only relate to the amount of Rs. 1,64,428 out of which the Appellate Assistant Commissioner sustained an addition of Rs. 80,585 and allowed a relief of Rs. 84,243. Before the Tribunal, this relief of Rs. 84,243 allowed by the Appellate Assistant Commissioner was challenged, although it appears that the figures do not exactly tally. If we add Rs. 80,585 to Rs. 84,243, then the total amount will come to Rs. 1,64,828, but the Income-tax Officer has mentioned the figure as Rs. 1,64,428 and the Tribunal has mentioned the figure as Rs. 1,64,825. Whatever be the amount, the fact remains that the Appellate Assistant Commissioner allowed relief of Rs. 84,243 to the assessee out of the total amount of Rs. 1,64,428 and this relief was challenged by the Department before the Tribunal. This clearly goes to show that question No. 1 relates to the amount of Rs. 84,243.
11. The case of the Revenue before us, as pointed out by Mr. B. P. Rajgarhia, is that the moment the bill for Rs. 1,64,428 was presented and
a claim to that amount was made, it became due to the assessee, as the assessee admittedly is following the mercantile system of accounting, and so the amount should be added the moment the bills are presented.
12. It appears from the order of the Income-tax Officer, annexure “A”, that the assessee had shown gross receipts for the value of work done at Rs. 1,10,38,639 but the Income-tax Officer found that the gross receipts for this year amounted to Rs. 1,12,63,067 and thus he found a difference of Rs. 1,64,428. However, he found that gross bills for this year amounted to Rs. 21,28,091 for spillway work and Rs. 90,74,976 for dam and dyke work and the amount not shown by the assessee out of the spillway work was Rs. 10,000 and out of the dam and dyke work was Rs. 1,54,428 and thus the total amount came to Rs. 1,64,428. The figure of gross receipt of Rs. 1,12,63,067 appears to be wrong. If we add Rs. 21,28,091 to Rs. 90,74,976, the total gross receipts will come to Rs. 1,12,63,067 and then the difference of RS. 1,64,428 can be held to be correct. The assessee explained to the the Income-tax Officer that these amounts were withheld by the Irrigation Department pending verification of the satisfactory conclusion of the work pertaining to these amounts and that these amounts, however, were paid back to the assessee in the subsequent years on satisfactory verification of the work by the Irrigation Department. It goes to show that this amount of Rs. 1,64,428 related to the bills presented to the Irrigation Department out of which deductions were made by the Irrigation Department for withholding the amount pending verification of the satisfactory conclusion of the work. The Appellate Assistant Commissioner has pointed out that the amounts were paid in the subsequent years by the Irrigation Department after satisfactory verification of the work done by the assessee. In such circumstances, it is clear that these amounts were also included in the bills presented by the assessee to the Irrigation Department and were to be paid after satisfactory verification of the work done by the assessee.
13. The Income-tax Officer has admitted that these amounts were temporarily withheld by the Irrigation Department and were paid subsequently but he was of the view that they should be assessed in the assessment year 1970-71. Before the Appellate Assistant Commissioner also, the assessee claimed that the bills in respect of Rs. 1,64,428 were not passed by the authorities as the bills had not been sanctioned by the authorities during the assessment year 1970-71. The assessee also pleaded that the authorities did not admit the bills as valid though the bills were prepared for the work done. It was also urged that it was not known to the assessee as to whether the entire amount or any portion of it or none of it could be allowed to the assessee by the Government in respect of the work done in this year. The assessee accepted before the Appellate Assistant Commissioner that the
amount of Rs. 80,585 was received by the assesses out of the aforesaid amount in the subsequent years and papers were produced in that connection. On this basis, the Appellate Assistant Commissioner sustained an addition of Rs. 80,585 and allowed a relief of Rs. 84,243. It appears to me that the Appellate Assistant Commissioner was not justified in making an addition of Rs. 80,585 when the assessee had pleaded that the amount had been withheld by the Department for satisfactory verification of the work done in the assessment year 1970-71 and so the addition could not be justified, but as the assessee had not filed any appeal against the addition of Rs. 80,585 and the Department filed an appeal for deletion of Rs. 84,243, the Tribunal considered only the relief relating to Rs. 84,243. The Tribunal has also clearly pointed out that the assessee submitted that though the assessee had made bills yet in respect of such bills, it was the system of the assessee that the assessee used to show only when the bill was accepted in principle by the Government or the authority concerned and this system had been accepted by the Tribunal in the earlier years also. The Tribunal also clearly pointed out that the claim for Rs. 84,243 of the assessee had not been accepted and, therefore, it cannot be said that the right had accrued to the assessee in respect of that amount and merely because there was a claim by the assessee, it could not result in the conclusion that the amount was due to the assessee.
14. Mr. B. P. Rajgarhia, for the Revenue, has submitted that the assessee follows mercantile system of accounting and so the mere presentation of the bill amounts to a claim by the assessee and it will be deemed that the amount has accrued to the assessee and has become due to him. For this purpose, Mr. B. P. Rajgarhia, for the Revenue, has relied on the case of E. M. Muthappa Chettiar v. ITO [1961] 41 ITR 1 (SC), which is a decision of their Lordships of the Supreme Court. In this case, it was held that the fact that the managed company did not disburse the firm’s remuneration in cash, made no difference to the liability of the firm to tax, since the firm’s accounts were made on the mercantile basis. It appears that the firm was the managing agent of a textile mill company for which the firm was entitled to remuneration. It was also held in this decision that the fact that the managed company raised a dispute that the firm had failed to fulfil certain obligations, claimed damages and withheld from immediate payment a part of the firm’s remuneration and carried it to a suspense account did not affect the firm’s liability to tax on the entire remuneration. It appears that, according to the agreement, the remuneration was payable and so it cannot be doubted that the amount was known and it was to become due at the end of the accounting period. This decision will not be applicable to the case of a contract business which is not
similar to the managing agency business. Thus, this decision is not helpful to the Revenue.
15. The next decision on which Mr. B. P. Rajgarhia has relied is the case of Thiagaraja Chettiar & Co. v. CIT [1964] 51 ITR 393 (Mad), which is a decision of the Madras High Court. In this decision, it has been held that where a managing agent is entitled under the terms of the managing agency agreement to remuneration at a certain percentage on the annual net profits of the company, the remuneration payable to the managing agent accrues when the net profits of the company for the year are ascertained and that the mere fact that owing to the disputes between the company and the managing agent, the company had not credited the managing agent’s account with the remuneration due to the latter in its accounts would not entitle the managing agent to claim that the remuneration due to him has not accrued and should not be assessed to income-tax until the company has credited him in its accounts with the amount of commission due to him. From this decision, it is evident that the remuneration was fixed and so the remuneration was due at the end of the accounting period. The principle relating to the managing agency remuneration cannot be applicable in this case before us.
16. Mr. B. P. Rajgarhia has also relied on the case of Poona Electric Supply Co. Ltd, v. CIT [1965] 57 ITR 521, which is a decision of their Lordships of the Supreme Court. In this case, certain amounts were credited by the appellant during the accounting years to the “Consumers’ Benefit Reserve Account”, being a part of the excess amount paid to it and reserved to be returned to the consumers. In those circumstances, it was held by their Lordships of the Supreme Court that these amounts did not form part of the appellant’s real profits ; and to arrive at the taxable income of the appellant from business under Section 10(1) of the Indian Income-tax Act, 1922, the amounts had to be deducted. In that connection, it was also observed that, as the appellant had adopted the mercantile system of accounting, the amounts so reserved for future payments were deductible in computing the income, profits and gains from the appellant’s business for the relevant years, since the liability had accrued in those years. Thus, it is evident that if an assessee follows the mercantile system of accounting, then he is entitled to deduct expenses made during a particular accounting period.
17. Mr. B. P. Rajgarhia has also relied on the case of CIT v. A. Gajapathy Naidu [1964] 53 ITR 114. In this case, their Lordships of the Supreme Court have held that when an Income-tax Officer proceeds to include a particular income in the assessment, he should ask himself, inter alia, two questions, namely : (i) what is the system of accountancy adopted by the assessee, and (ii) if it is the mercantile system subject to the deeming
provisions, when has the right to receive accrued ? If he comes to the conclusion that such a right accrued or arose to the assessee in a particular accounting year, he should include the said income in the assessment of the succeeding assessment year. It has also been held in this decision that no power is conferred on the Income-tax Officer under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year, on the ground that that income arose out of an earlier transaction, nor is the question of reopening of accounts relevant in the matter of ascertaining when a particulur income accrued or arose. It has also been held in this decision that the meaning of the word “accrue” or “arise” in Section 4(1)(b)(i) of the Indian Income-tax Act, 1922, cannot be extended so as to take in amounts received in a later year though, the receipt was not on the basis of a right accrued in the earlier year and that such amounts are in law received by the assessee only in the year in which they are paid. In this case, the assessee, who supplied bread to a Government hospital under a contract during the period April 1, 1948, to March 31, 1949, made certain representations to the Government after the close of the year that he had incurred loss. The Government directed payment of the sum of Rs. 12,447 to the assessee by way of compensation for the loss sustained in respect of the supply of bread. That amount was received by the assessee in the accounting year 1950-51 and, in those circumstances, their Lordships of the Supreme Court held that the amount ought to be included in the profits of the year 1950-51 relevant to the assessment year 1951-52, and that it could not be related back to the earlier year during which the assessee actually supplied bread to the hospital. The principles laid down by their Lordships of the Supreme Court are very clear that in the mercantile system of accounting, it has to be seen when the right to receive accrued to the assessee.
18. The principles laid down in CIT v. A. Gajapathi Naidu [1964] 53 ITR 114 (SC) are also found in the case of Raja Mohan Raja Bahadur v. CIT, which is also a decision for their Lordships of the Supreme Court reported in [1967] 66 ITR 378, where it has been held that if accounts are maintained according to the mercantile system, whenever the right to receive money in the course of a trading transaction accrues or arises, even though income is not realised, income embedded in the receipt is deemed to accrue or arise. Thus, according to this decision also, the question has to be considered whether the right to receive the amount has accrued or arisen to the assessee who is following the mercantile system of accounting.
19. Mr. B.P. Rajgarhia has also relied on the case of Morvi Industries Ltd. v. CIT [1971] 82 ITR 835. In this case, the assessee, which was the managing agent of its subsidiary company, maintained its accounts on the
mercantile system and it was entitled to receive an office allowance of Rs. 1,000 per month, a commission at 12 1/2 per cent. of the net profits of the managed company and an additional commission of 1 1/2 per cent. on all purchases of cotton and sales of cloth and yarn. In the accounting years ended on December 31, 1954, and December 31, 1955, the managed company suffered losses and the assessee earned only commission on the sale of cloth and yarn for the two years. The total amounts including the office allowance which the assessee was entitled to receive were Rs. 50,719 and Rs. 13,963 for the two years. Under Clause 2(e) of the, managing agency agreement, the commission was due to the assessee on December 31, 1954, and December 31, 1955, respectively, and it was payable immediately after the annual accounts of the managed company had been passed in the general meetings which were held on November 24, 1955, and July 21, 1956, respectively. By resolutions of its board of directors dated, respectively, April 4, 1955, and June 19, 1956 [i.e., after the commission had become due but before it had become payable in terms of Clause 2(e)], the assessee relinquished its commission on sales and office allowance because the managed company had been suffering heavy losses in the past years. The Tribunal held that the relinquishment by the assessee of its remuneration after it had become due was of no effect; and also rejected its claim that the amounts relinquished were allowable under Section 10(2)(xv) of the Indian Income-tax Act, 1922, because, as a result of the relinquishment, the financial position of the managed company did not become stronger while that of the assessee-company became weaker and, therefore, the relinquishment was not for the benefit of the assessee. On these facts, their Lordships of the Supreme Court held that the commission had accrued to the assessee on December 31, 1954, and December 31, 1955, and the fact that the payment was deferred till after the accounts had been passed in the. meetings of the managed company did not affect the accrual of the income and since the amounts of income for the two years were given up unilaterally by the assessee after they had accrued to it, it could not escape the liability to tax on those amounts. In those circumstances, it was held that the income accrues when it becomes due and the postponement of the date of payment does not affect the accrual of income and that the mere fact that the amount of income is not subsequently received by the assessee would not also detract from or efface the accrual of the income, although non-receipt may, in appropriate cases, be a valid ground for claiming deductions. It has also been held in this decision by their Lordships of the Supreme Court that under the mercantile system, credit entries are made in respect of the amounts due immediately they become . legally due and before they are actually received and, similarly, the expenditure items for which a
legal liability has been incurred are immediately debited even before the amounts in question are actually disbursed. It has also been held in this decision that where accounts are kept on the mercantile basis, the profits or gains are credited though they are not actually realised, and the entries thus made really show nothing more than an accrual or arising of the said profits at the material time. It cannot be doubted that on the basis of this decision of their Lordships of the Supreme Court, it has to be seen whether the assessee becomes entitled to the amount immediately after the bills relating to the contract work are presented and claims are made or it will become legally due when the Department admits the claim and passes the bills.
20. Mr. B.P. Rajgarhia has also relied on the case of Vishnu Agencies Private Ltd. v. CIT [1963] 48 ITR 444, which is a decision of the Bombay High Court. In this case, the assessee, which maintained its accounts on the mercantile system, acted as transport contractor to the Government. After transporting sugar from the docks to the godowns for some time, the assessee found that sufficient load for its trucks were not provided. The assessee brought this fact to the notice of the Government, but as no action was taken by the Government, the assessee informed the Government that it would not be possible for it to supply any more trucks until tbe loading conditions were improved. For the work it had done already, a sum of Rs. 1,45,395 was due to the assessee during the relevant previous year. Although it had debited in its accounts the expenses incurred by it in connection with the work, the assessee did not take the sum due to it to the revenue account on the ground that the Government had raised a dispute with regard to the payment of its bills. The bills submitted by the assessee were required to be presented to the Pay and Accounts Officer, but the Government claimed deduction from the amount of the bills, such amounts as would be due towards damages for breach of contract on the part of the assessee. The Tribunal found that the Government had not disputed the amount of the bills but had accepted the liability in full and only claimed to withhold payment on the ground of breach of contract and that, therefore, the sum of Rs. 1,45,395 had accrued to the assessee. In those circumstances, the Bombay High Court held that the sum of Rs. 1,45,395 accrued at the time when the bills were accepted and its accrual had no reference to the time when it would be actually received and that the mere assertion of a claim on the part of the Government for damages for breach of contract was not sufficient to make the claim an enforceable one or to affect the accrual of the income to the assessee. The sum of Rs. 1,45,395 accrued to the assessee during the relevant previous year. In this case, the Tribunal had found that the Government had not disputed the amount of bills but had accepted the liability in full. So it
cannot be doubted that if the liability is accepted relating to the bill of the contractor and the amount is not disputed, then in the mercantile system of accounting, the accrual will take place the moment the bills are accepted and the claim is admitted but where claim is not admitted and accepted by the Government, it cannot be said that the income accrues to a contractor by mere presentation of the bill.
21. Mr. K. N. Jain, on behalf of the assessee, has submitted that presentation of the bill amounts to a mere claim and unless the claim is admitted and accepted by the Government Department, the income will not accrue to the assessee as the assessee will have no legal right to recover money unless the claim is admitted and accepted by the Government Department, and so although the assessee is following the mercantile system of accounting, the amount cannot be legally recovered by the assessee unless the Government Department admits and accepts the claim of the assessee. Learned counsel for the assessee relied, before the Tribunal, on the case of E. D. Sassoon and Company Ltd. v. CIT [1954] 26 ITR 27 (SC). In this case, the S company were the managing agents of the U company. Under the managing agency agreement, the S company were entitled to receive as their remuneration, subject to a minimum, a commission of certain per cent. per annum on the annual net profits of the U company which was due to them on the 31st March every year. On 1st December, 1943, the S company assigned to A their office as managing agents and all their rights and benefits under the managing agency agreement and the consideration received by them was transferred by them to the capital reserve account. The accounts of the managing agency commission payable to the managing agents for the calendar year 1943 were made up in 1944 and paid to A in 1944. The question was whether in the assessment year 1944-45, A was liable to pay tax on the accrual basis on the whole of the commission or whether the tax was payable by A and the S company on proper apportionment being made between them of the amount received by A. It was held by their Lordships of the Supreme Court that, in the circumstances of the case, the managing agency commission was not liable to apportionment between the S company and the A company in the proportion of the services rendered as managing agents by each one of them, but A was liable to pay tax on the whole commission. It was also held by their Lordships of the Supreme Court that the remuneration or commission became due by the U company to the managing agents only on completion of a definite period of service and at stated periods and it was a condition precedent to the recovery of any wages or salary in respect thereof that the service or duty should be completely performed. Such remuneration constituted a debt only at the end of each such period of service and no remuneration or commission was payable to the managing agents for the broken periods. It was also held in this decision that the right to receive the commission would arise and the income, profits or gains would accrue to the managing agents only at the end of the calendar year which was the terminus a quo for the making up of the accounts and ascertaining the net profits earned by the company. This decision clearly shows that unless the claim becomes a debt, the income cannot accrue.
22. Mr. K. N. Jain, for the assessee, has also relied on the case, C1T v. Associated Commercial Corporation [1963] 48 ITR 1, which is a decision of the Bombay High Court. Mr. K. N. Jain has referred to p. 17 of this decision which shows that the transaction of sale in favour of Andrew Gruenberg took place in October, 1946. On the date when the transaction took place, it was a transaction of Amin. It was subsequently claimed by Valia in the suit which he filed that the benefit of this transaction must go not to Amin but to the partnership firm and it was the partnership firm which was truly and legally entitled to the profits. In those circumstances, it was held by the Bombay High Court that until this claim which was set up by the partnership to the profit arising from the said transaction was adjudicated and determined in favour of the partnership and the partnership was declared to be entitled to the said claim, the profit could not be said to have accrued to the partnership and that mere assertion of the claim by Valia on behalf of the partnership to the profit was not such a claim so as to accrue to the partnership firm. On this basis, Mr. K. N. Jain has submitted that the presentation of the bill by the assessee was only a claim by the assessee and unless the claim is admitted and accepted by the Government Department, income will not accrue.
23. Mr K. N. Jain has relied on CIT v. Mehar Singh Sampuran Singh Chawla [1973] 90 ITR 219. It is a decision of the Delhi High Court. The assessee, the managing director of a company, who was entitled to a salary which was made payable at the end of the accounting year though computed on the basis of Rs. 5,000 per month, and also commission and bonus, had forgone all these three items during the relevant accounting year and prior to the year coming to an end. In those circumstances, it was held by the Delhi :High Court that the salary, commission and bonus had not accrued to the assessee during the accounting year and were not taxable income in his hands. The questions for determination in such case were, when did the salary, commission and bonus accrue to the assessee and whether the assessee gave up his right to claim them from the company prior to those amounts crystallising into a debt due from the company to the assessee and becoming recoverable by him as such from the company. Mr. K. N. Jain has referred to page 226 of this decision where it has been held that in order that the income can be said to have accrued
to or earned by the assessee, it is not only necessary that the assessee must have contributed to its accruing or arising by rendering services or otherwise, but he must have created a debt in his favour and that a debt must have come into existence and he must have sacquired a right to receive the payment. On the basis of this decision, Mr. K. N. Jain has submitted that unless the Government Department accepts the claim of the assessee, a debt is not created in favour of the assessee and the right to receive the payment does not arise and so it is not a debt.
24. I find from the case of New Victoria Mills Co. Ltd. v. CIT [1966] 61 ITR 395 (All), that though under the mercantile system of accounting, all items of credit are brought into credit immediately they become legally due and before they are actually received, and all expenditure is debited, for which a legal liability has been incurred before it is actually disbursed, yet before a credit or debit entry can legitimately be made in the accounts, it must be shown that a certain enforceable liability has accrued or arisen and that such liability must be one that has been ascertained and capable of being enforced by the person in whose favour the debit has been raised. It has also been held in this decision by the Allahabad High Court that the mercantile system can never be stretched to embrace all sorts of provisional, notional or contingent payments which the assessee considers that he might ultimately be called upon to pay.
25. In the case of Lakshman Pmkash v. CIT [1973] 92 ITR 492 of the Allahabad High Court, the assessee was a contractor, who followed the mercantile system of accounting and closed his accounts on 31st March each year. During the financial year 1943-44, the assessee entered into a contract for the supply of some materials to the Government of India. On April 10, 1944, the Government suspended the contract. There were meetings between the assessee and military authorities about payment for the materials taken over by the authorities. On February 20, 1945, the basis for the payment was fixed and the amount payable to the assessee was determined at Rs. 1,77,000 and a part payment was made. The balance was not paid and on January 28, 1946, the compensation payable was finally fixed at Rs. 1,73,767. The Income-tax Officer determined the profit of the assessee at Rs. 43,582 which was assessed to tax in the assessment year 1945-46 for the reason that as the basis of compensation was fixed at the meeting on February 20, 1945, the profit accrued to the assessee in the assessment year 1945-46 and not in 1946-47. In those circumstances, the Allahabad High Court held that though the basis for payment of compensation was fixed on February 20, 1945, the authorities at Delhi did not approve the amount of compensation. This led to the meeting on January 28, 1946, at which the amount was finally fixed at Rs. 1,73,767 and, so, the amount became ascertained only on that date and since that
date fell in the accounting year relating to the assessment year 1946-47, the profits of Rs. 43,582 was assessable in the assessment year 1946-47. This decision also shows that unless the claim is finally admitted and accepted by the Government department, the income cannot accrue to the assessee.
26. A similar question arose in the case of Jamatha Contract Co. v. C1T [1976] 105 ITR 627(Ker). In this case, the assessee was a firm of contractors which carried out certain works on contract for the State. Clause 9 of the contract provided : ” …To allow of a guarantee fund being formed on the part of the Government a deduction of 10 per cent. from all payments to contractors is to be made by the Executive Engineer at the time of payments. But the amount so held as retention plus the security deposit of 4 per cent. as per Clause (1) shall not at any time exceed 8 per cent. of the contract amount. This retention amount will not be released before the expiry of three months (6 months in the case of road works) after the issue of certificate or otherwise of completion of work or the final bill has been prepared and passed, whichever is later.” Under the provisions of this clause, a sum of Rs. 1,14,071 had been retained by the Government. The Appellate Tribunal included this in the total assessable income of the assessee. In those circumstances, it was held by the Kerala High Court that if the money had become due during the accounting period, it would be income which would have to be taken into account in determining the total income of the assessee and that the question whether the money had become due or whether income had accrued would depend upon the terms of the contract and that by reading Clause 9 of the contract alone, it was not possible finally to conclude that the money had become due. On the other hand, the provision therein that ” this retention amount will not be released before the expiry of 3 months (6 months in the case of road works) after the issue of certificate or otherwise of completion of work or the final bill has been prepared and passed, whichever is later” seemed to indicate that the money retained had not become due and that when there is a stipulation postponing the time for payment of the whole or part of the balance until after the expiration of a period during which the contractor is liable for defects or for repairs, payment would not have become due to that contractor. The High Court also held that the explanation given by the executive engineer in this case indicated that at least part of the money retained was of that kind.
27. In the present case before us, the assessee clearly asserted before the Income-tax Officer, relating to the amount of Rs. 1,64,428, that this amount was withheld by the Irrigation Department pending verification of satisfactory conclusion of the work pertaining to these amounts. Thus, it
is evident that until verification of the satisfactory conclusion of the work was done, the amount had been withheld by the Irrigation Department. The Income-tax Officer has accepted this position that the amount was withheld by the Irrigation Department for the purpose that it was to be paid after verification of satisfactory conclusion of the work. This clearly goes to show that the amount of Rs. 1,64,428 had not accrued to the assessee and that it could accrue only when, after the verification of satisfactory conclusion of the work, the Department admitted the claim. As the Appellate Assistant Commissioner had allowed relief only to the extent of Rs. 84,243, it has to be held, in view of the various decisions that the claim for this amount was not. admitted by the Department till the verification of satisfactory conclusion of the work was done, that the assessee had no right to claim the amount and the amount had not become a debt in the assessment year 1970-71 and so it has to be held that the Tribunal rightly deleted the amount in question.
28. Questions Nos. 2 and 3 are interconnected. These questions relate to the extra work and it relates to the addition of Rs. 23,06,079. The Income-tax Officer has pointed out that the assessee was required to furnish in writing the amount of claim preferred by the company before the Irrigation Department for reimbursement of various expenses incurred by the assessee-company in this year beyond the provisions of the contract agreement. It appears that the assessee furnished its claim before the Irrigation Department for Rs. 1,32,21,569 relating to the work beyond the provisions of the contract agreement. Out of this amount, the Income-tax Officer considered the amount of Rs. 7,35,043 for the assessment year 1968-69 and an amount of Rs. 1,87,440 for the assessment year 1969-70 and thus he considered the total amount of Rs. 9,22,483 and the balance amount remained at Rs. 1,22,99,086 which related to the assessment years 1970-71 to 1972-73. From the figures of payment received for these works in these three years, the Income-tax Officer found that the proportionate receipt pertaining to the assessment year 1970-71 works outto 75 per cent. of the total receipts relating to the assessment years 1970-71 to 1972-73 and so he estimated 75 per cent. of Rs. 1,22,99,086 which came to Rs. 92,24,315. Out of this, he treated 75 per cent. as expenses in this connection and treated 25% as the income of the assessee which came to Rs. 23,06,079.
29. The Appellate Assistant Commissioner deleted the entire amount of Rs. 23,06,079 for the reasons mentioned in the assessment order for the year 1968-69. The order of the Appellate Assistant Commissioner for the assessment year 1968-69 is not in the paper book.
30. When the matter went before the Tribunal, the Tribunal upheld the deletion by the Appellate Assistant Commissioner in view of the grounds
given in ITA Nos. 839 and 840 of 1972-73. A copy of the order of the Tribunal in ITA Nos. 839 and 840 of 1972-73 relating to the assessment years 1968-69 and 1969-70 has been annexed and marked as annexure D forming part of the statement of the case.
31. It appears from the consolidated order of the Tribunal that the appeal was against the relief of Rs. 5,51,283 granted by the Appellate Assistant Commissioner in the assessment year 1968-69 and a similar relief of Rs. 1,40,500 in the assessment year 1969-70. The Income-tax Officer found that besides the normal bills submitted by the assessee in respect of its work, it had made certain claims against the Executive Engineer and in these claims the assessee had claimed certain payments from the Government (Irrigation Department) on the ground that the assessee had to execute certain works which were required of him by the supervisory authorities but which were not strictly given under the contract agreement. It was found that the claims to the extent of Rs. 1,50,00,000 by the assessee on different accounts had been made. The Income-tax Officer further learnt that in the later years, the assessee received certain payments in respect of these claims and the total payments received were found to be Rs. 7,30,219 received between November, 1968, to October, 1971. After looking into the details of the claims made by the assessee, the Income-tax Officer found that the total claims made in the course of the accounting period relevant to the assessment year 1968-69 came to Rs. 7,35,043. According to the Income-tax Officer, these claims were in respect of extra work done by the assessee under the specific direction of the Irrigation Department. The Income-tax Officer was of the view that the assessee had enforceable rights in respect of such claims as soon as they were lodged with the Department. The Income-tax Officer was, therefore, of the view that these amounts should have been shown in the account books or alternatively the expenses incurred in respect of these works should have been kept in suspense account till the date of receipt of the claim. The Income-tax Officer, instead of adding the total claimed amount of Rs. 7,35,043, estimated that 25 per cent. of these amounts could represent an element of profit, etc., and 75 per cent. of the claim represented the expenses which might have been incurred by the assessee on these works. According to the Income-tax Officer, these expenses cannot be allowed as deduction as the assessee was not showing claims in his return. He, therefore, added Rs. 5,51,283 as the income of the assessee. Under similar circumstances, the Income-tax Officer found the claim of Rs. 1,87,440 in respect of the assessment year 1969-70 and he estimated 3/4ths of this amount to be the expenses relating to these claims. He, therefore, added Rs. 1,40,580 in that assessment year. The gross amount has been mentioned
relating to the assessment years 1968-69 and 1969-70 by the Income-tax Officer in his order relating to the assessment year 1970-71.
32. Annexure D also shows that when the matter went before the Appellate Assistant Commissioner it was urged before him that the claim made by the assessee did not represent its income as the assessee had no right to receive the amount contained in the bills until the same were accepted and admitted by the Irrigation Department of the Bihar Government. It was explained, on behalf of the assessee, that the system of accountancy followed by the assessee was mercantile and it was not cash system and that the claims were only in respect of disputed matters and with regard to such matters the assessee did not have any right to receive the amount and, therefore, the claims themselves could not constitute income in the hands of the assessee. It was also submitted before the Appellate Assistant Commissioner that the contract was for a single piece of work and there could not be any bifurcation of the work in different parts, and all the works done were in respect of one contract and it could not be stated that the assessee was doing some independent work apart from the contract entered into by it. It was also mentioned that as against the total value of contract of Rs. 6 crores, the assessee had claimed to the extent of Rs. 1,50,00,000 in the course of these years but ultimately after prolonged correspondence and dispute, the Government had admitted and paid the claims of the assessee to the extent of Rs. 7,30,219 only. It was explained that this constituted only about 5 per cent. of the total claim and these amounts have been shown in the years when the claim had been admitted by the Government of Bihar. It was also explained that out of the total claims made in the course of this year, the total payments received till the date of hearing by the Appellate Assistant Commissioner was only Rs. 47,211.
33. The Appellate Assistant Commissioner after considering the facts of the case came to the conclusion that the claim could not be treated as income as the right to receive these amounts did not accrue to the assessee as a result of making that claim. The Appellate Assistant Commissioner was also of the view that unless the claims were admitted, the assessee could not show them as bills receivable or work-in-progress, and that the value of the work-in-progress was being shown in this case on the basis of the bills prepared by the Government in respect of the works completed by the assessee till the end of the accounting period. The Appellate Assistant Commissioner was, therefore, of the view that there was no justification for disallowing certain estimated expenses related to these claims made by the assessee in the course of this year. The Appellate Assistant Commissioner, therefore, deleted the additions made by the Income-tax Officer in both the years.
34. Before the Tribunal, the departmental representative submitted that the assessee having made the claims in respect of extra work done, it could not be said that it did not incur expenses in respect of these claims. It was also submitted that the assessee did not show the amount of the claims on the credit side and at the same time was claiming all the expenses in respect of these additional work’s done by him. According to the departmental representative, the assessee should have either separated the expenses relating to the additional work or should have shown the additional works done as work-in-progress. It was also submitted that the Appellate Assistant Commissioner had not separated the expenses relating to the additional claim. According to the departmental representative, the Appellate Assistant Commissioner should have gone through the details of expenses and should have found out which part of the expenses had to be disallowed in the hands of the assessee. According to the departmental representative, the assessee was taking a double advantage by not showing the receipts and at the same time by claiming the expenses relating to these additional works.
35. On behalf of the assessee, it was pointed out that there was certain confusion regarding the system of accountancy followed by the assessee and that the assessee’s system of accountancy with regard to the claims was not cash system but mercantile system, and that the amounts were shown by the assessee only after the acceptance of these claims by the Government and only then it could be stated that the assessee’s right to receive the claim had accrued. It was pointed out on behalf of the assessee that the assessee had followed the same system in the immediately preceding year also when the company was floated. It was also argued before the Tribunal that the bills relating to the contract work are always prepared by the Government and the assessee signs those bills and those bills are shown on the credit side even if the receipt of the amount takes some time. As far as the claims of disputed items were concerned, it was submitted that they stood on a different footing and they could have been shown by the assessee only when the claim was accepted or admitted by the Government. Learned counsel for the assessee referred to the assessee’s letter explaining the position before the Income-tax Officer and submitted that the system of accountancy followed by the assessee was made clear in that letter. It was submitted on behalf of the assessee that though in the assessee’s letter dated December 13, 1971, it had stated that in respect of these claims it was following the cash system of accountancy, in fact, it was not so and even in respect of these claims the assessee continued to follow the mercantile system and used to credit the amount in respect of those claims which were accepted and admitted and the learned counsel for the assessee placed reliance before the Tribunal on the decisions reported in E. D. Sassoon and
Co. v. CIT [1954] 26 ITR 27 (SC), CIT v. Associated Commercial Corporation [1963] 48 ITR 1 (Bom) and CIT v. A. Gajapathy Naidu [1964] 53 ITR 114(SC) which decisions have already been discussed above.
36. It was further submitted before the Tribunal on behalf of the assessee that the assessee had made huge claims and in respect of these claims there was exchange of letters between the assessee and the Government, and most of the claims were disputed and were ultimately rejected and it was only in respect of a few claims that the Government ultimately agreed to pay a part of the claims. It was pointed out that as against the total claim of Rs. 1,50,00,000, the assessee could receive payments to the extent of Rs. 7 lakhs and that would show that the whole of the claim could not be considered to be the income of the assessee at the time when the claims were lodged. The Tribunal has also pointed out that the claims were disputed and even when in respect of the claim of Rs. 3,16,800, the claim was agreed to by the Bihar Government, the payment was immediately stopped as further dispute arose regarding them. It was also submitted before the Tribunal that the disallowance of any part of the expenses by the Income-tax Officer was not justified as all the expenses had been incurred and there was no dispute as the expenses had actually been incurred in the course of the accounting period and the expenses were debited on the mercantile system and the liability in respect of them were admitted liabilities and such expenses were allowable under Section 37 of the Act, and it was not necessary that the expenses should create some income. It was also pointed out that the amounts of the claims were shown by the assessee in the later years as soon as the claims were admitted or payments were received.
37. The Tribunal has given a clear finding in paragraph 8 at page 36 of the paper book. The Tribunal has pointed out that from the details of the claims as described in the orders of the Income-tax Officer as well as the Appellate Assistant Commissioner, it appears that the assessee had made a large number of claims in respect of the contract work and most of these claims were disputed and were not admitted by the Government. The Tribunal also held that the Income-tax Officer took an erroneous view that the claim made by the assessee became income under the mercantile system. The Tribunal held that the claims were not based on a prior agreement or undertaking and they were disputed items as it would be clear from the correspondence which were placed before the Tribunal by the assessee. From the letters, it was evident to th” Tribunal that most of the claims were either withdrawn by the assessee or were rejected by the appellate authorities and some of the claims were partly accepted but that acceptance was after the close of the accounting period relevant
to the assessment years 1968-69 and 1969-70. In respect of these claims, the assessee had to produce certain evidence in order to establish that they were required to be done by the appropriate authorities and they were over and above the contracted work, and if the authorities concerned were satisfied about these aspects, then they could agree to compensate the assessee for the extra expenses incurred by it in respect of the extra work. The Tribunal also pointed out that after certain claims were rejected by the appropriate authority, the assessee again took up the matter and tried to persuade the authority concerned about the correctness of the claim, and thus the Tribunal gave a clear finding that the final decision about these claims had not been made before the close of the accounting period and they remained merely claims in the accounting period and so the Tribunal held that these amounts cannot be considered as income accrued to the assessee. The Tribunal has also pointed out that the Income-tax Officer not only added the amount of the claims but disallowed the expenses relating to the additional work which had been done on an estimated basis. The Tribunal held that the expenses could be disallowed only if they had not been incurred in the course of the year, and no mention was made by the Income-tax Officer disputing the incurring of the expenses. The Tribunal took the view that the contract of the assessee was one whole and no part of the expenses relating to the business could be disallowed unless some specific reason was given for this disallowance. The Tribunal also held that the claims had not become bills receivable and the work done by the assessee could not be treated as work-in-progress unless that was accepted by the appropriate authorities. The Tribunal, therefore, finally held that neither the claims of amounts could be added nor any part of the expenses incurred by the assessee could be disallowed either by way of bills receivable or as representing any work-in-progress. The Tribunal, therefore, upheld the deletion of the additions relating to the extra work by the Appellate Assistant Commissioner in both the assessment years 1968-69 and 1969-70.
38. In the assessment year 1970-71, the Tribunal has relied on its order relating to the assessment years 1968-69 and 1969-70. In view of the order of the Tribunal and in view of the various decisions, it has to be held that the amount relating to the extra work cannot be added till the claim is finally accepted by the Government in the Irrigation Department. Admittedly, the claims were disputed and so the additions could not be made on the basis of the claims made by the assessee through bills. The income will be deemed to accrue to the assessee only when the bills are finally admitted and accepted by the Government in the Irrigation Department. Moreover, when the amounts relating to the assessment years 1968-69 and 1969-70 have already been deleted by the Tribunal, the
addition on the basis of the calculation in the manner done by the Income-tax Officer was not justified and so it has to be held that the Income-tax Officer had made the addition of Rs. 23,06,079 on the basis of the presentation of the bills and so the addition was rightly deleted by the Appellate Assistant Commissioner and the Tribunal. If the assessee failed to produce the materials as to when the claim of the assessee was admitted and accepted by the Department, the Income-tax Officer can find out from the Irrigation Department as to when the claim of a particular amount was admitted and accepted by the Irrigation Department of the Government of Bihar and the entire amount has to be added in the year when the claim is finally admitted and accepted by the Irrigation Department of the Government of Bihar and the addition cannot be made on the basis of the presentation of the bills.
39. It also cannot be doubted that in the mercantile system the expenses are allowable when the expenses are incurred and it cannot be postponed as the contract work is one whole work and so the expenses incurred in a particular year has to be allowed on the mercantile system of accounting.
40. In view of my discussions above, I hold that the Tribunal has not erred in law in holding that only a part and not the entirety of the outstanding bills was income falling due for the previous years. I also hold that the Tribunal was correct in law in allowing the expenditure relating to extra work for which claims were made by the assessee, but receipts for which were not accounted for either as work-in-progress or bills receivable, and I also hold that the Tribunal was justified in holding that the Appellate Assistant Commissioner was justified in allowing the relief, as the bills to that extent had not yet been accepted and hence it cannot be said that the right of the assessee had accrued in respect of that amount.
41. In the result, question No. 1 is answered in the negative and questions Nos. 2 and 3 are answered in the affirmative and all the three questions are answered in favour of the assessee and against the Revenue. However, in view of the peculiar circumstances of the case, the parties will bear their own costs. Let a copy of this judgment be forwarded to the Tribunal in terms of Section 260 of the Act.
Uday Sinha, J.
42. I agree.