PETITIONER: COMISSIONER OF INCOME TAX, AMRITSAR Vs. RESPONDENT: M/S.SHIV PRAKASH JANAK RAJ & CO.PVT. LTD. ETC. DATE OF JUDGMENT: 30/09/1996 BENCH: B.P. JEEVAN REDDY, SUHAS C. SEN ACT: HEADNOTE: JUDGMENT:
J U D G M E N T
B.P.JEEVAN REDDY, J.
These appeals are preferred by the Revenue against the
judgment of the Punjab and Haryana High Court answering the
questions, referred at the instance of the assessee, in
favour of the assessee and against the Revenue. The question
involved in all these appeals are common. It would be
sufficient if we take the case of one of the assessees,
M/s.Shiv Prakash Janak Raj & Co.(P) Ltd. Four assessment
years are relevant in this case, viz., Assessment Years
1968-69, 69-70, 1970-71 and 1971-72. The two questions
referred under Section 256(1) of the Income Tax Act, 1961
are:
“(i) Whether, on the facts and in
the circumstances of the case, the
Tribunal was right in holding that
the interest for the assessment
year 1971-72, had already accrued
to the assessee on October 31,
1970, under the mercantile system
of accountancy?
(ii) Whether, on the facts and in
the circumstances of the case, the
Tribunal was right in holding that
the subsequent relinquishment of
interest by a resolution dated
November 24, 1970, did not affect
the tax liability of the assessee
on accrual basis?”
The partners of a firm, M/s.Shiv Prakash Janak Raj &
Co. [the Firm], are also the shareholders/directors of the
assessee-company. The assessee-company had advanced a loan
to the firm. During the accounting year relevant to the
Assessment Year 1966-67, it charged interest in a sum of
Rs.25,048/- on the loan so advanced. Similarly, for the
Assessment Year 1967-68, it charged interest in a sum of
Rs.25,843/-. For the four assessment years concerning
herein, however, the assessee adopted a different course.
[The accounting year adopted by the assessee was the year
ending on 31st October 31] In respect of the Assessment Year
1968-69 [year ending October 31, 1967], the assessee-company
passed a resolution on October 9, 1967 [i.e., before the end
of the accounting Year] deciding not to charge interest from
the firm in view of the difficult financial position of the
firm. For the next three assessment years, i.e., Assessment
Years 1969-70, 1970-71 and 1971-72, similar resolutions were
passed on February 26, 1969, March 16, 1970 and November 24,
1970 respectively. In other words, in the case of last three
assessment years, the resolution deciding not to charge
interest on the loan advanced to the firm was passed after
the expiry of the relevant accounting year. Indeed, the
resolution says that the firm had approached the assessee-
company to waive the interest on the loan for each of the
said years and that on such representation that the
directors of the assessee-company [who were also partners in
the said firm] decided that no interest shall be charged for
each of the said three assessment years.
In the assessment proceedings relating to the said four
assessment years, the Income Tax Officer took the view that
inasmuch as the loans in question were interest-bearing
loans and because the assessee-company had relinquished the
interest without any commercial considerations and further
because the directors/ shareholders of the assessee-company
were interested in the firm, it was a case of collusion
between them to evade the tax liability. Accordingly, he
added an amount towards interest calculating it at the rate
of fifteen percent per annum. On appeal, the Appellate
Assistant Commissioner found that inasmuch as the resolution
to waive the interest was passed after the expiry of the
accounting year and further because the assessee-company was
following the mercantile system of accounting, the interest
must be held to have already accrued to the assessee before
it was waived. He, however, reduced the rate of interest to
nine percent. With that modification, he dismissed the
appeals. The assessee thereupon filed a further appeal to
the Tribunal but without success. The Tribunal observed
that even though no entries were made in the books of the
assessee-company or of the firm with respect to receipt or
payment of interest, that circumstance is of no relevance in
view of the facts that the resolutions were passed after the
expiry of the accounting year that the assessee was
maintaining its accounts on mercantile business and further
that the relinquishment of interest was not for any
commercial reasons. On reference, however, the High Court
took a contrary view purporting to follow the decision of
this Court in Commissioner of Income Tax West Bengal-II v.
Birla Gwalior (P) Limited [(1973) 89 I.T.R.266]. The High
Court held that in view of the said decision, the principle
of earlier decision of this Court in Morvi Industries
Limited v. Commissioner of Income Tax (Central), Calcutta
[(1971) 82 I.T.R.835] cannot be applied to this case.
In these appeals, it is contended by Sri J.Ramamurthy,
learned senior advocate for the appellant-Revenue, that in
the facts and circumstances of the case, the view taken by
the Tribunal was the correct one being consistent with the
decisions of this Court and that the High Court was in error
in holding to the contrary. Sri G.C.Sharma, learned counsel
for the assessee, however, sought to support the reasoning
and conclusion of the High Court.
Before we refer to the decisions of this Court, it is
necessary to reiterate the basic facts of the case. For the
previous two assessment years, viz., 1966-67 and 1967-68,
the assessee-company did charge interest on the loan
advanced by it to the firm which shows that the loan was an
interest-bearing loan. The second circumstance to be noticed
is that the resolution waiving interest was passed after the
expiry of the relevant accounting year in the case of three
subsequent assessment years, viz., Assessment Years 1969-70,
1970-71 and 1971-72. Only in the case of Assessment Year
1968-69, was the resolution passed before the expiry of the
accounting year. Thirdly, the assessee-company was
maintaining its accounts on mercantile basis. Yet another
circumstance to be noticed is that the Tribunal has found it
as a fact that the waiver was not based upon any commercial
considerations. Of course, no entries were made in the
accounts of the assessee-company, or for that matter in the
accounts of the firm, in respect of four assessment years
concerned herein, that any interest was received or paid. On
these facts, it has to be held that in the case of three
subsequent assessment years, the interest had accrued to the
assessee notwithstanding the fact that no entries may have
been made in the accounts of the assessee to that effect.
The waiver of interest after the expiry of the relevant
accounting year only meant that the assessee was giving up
the money which had accrued to it; It cannot be said, in the
circumstances, that the interest amount had not accrued to
the ascessee. Therefore, the Tribunal was right in taking
the view it did in respect of Assessment Years 1969- 70,
1970-71 and 1971-72. In the case of Assessment Year 1968-69,
however, the resolution was passed before the expiry of the
accounting year and though the finding of the Tribunal is
that the said waiver was not actuated by any commercial
considerations, yet the learned counsel for the Revenue did
not press the Revenue’s case so far as this assessment year
is concerned.
In Morvi Industries Limited, the relevant facts are the
following: the assessee which was the managing agent of its
sursidiary company, maintained its accounts on the
mercantile system. It was entitled to receive an office
allowance of Rupees one thousand 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 cert on all
purchases of cotton and sales of cloth and yarn. In the
accounting year 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
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 general meetings, which were held on
November 24, 1955 and July 21, 1956 respectively. By
resolutions of its board of directors dated April 4, 1955
and June 19, 1956 respectively [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 because the managed 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. It also rejected the
assessee’s claim that amounts relinquished were allowable
under section 10(2)(xv) of the Income Tax Act, 1922. The
High Court agreed with the view taken by the Tribunal. On
appeal, this Court agreed with the view taken by the High
Court and the Tribunal. It 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. It
was held that since the assessee had chosen to give up
unilaterally the amounts accrued to it, it could not escape
the liability to tax on those grounds. Khanna,J., speaking
for the three-Judge Bench made the following observations
which are apposite to the issue concerned herein:
“The appellant-company admittedly
was maintaining its accounts
according to the mercantile system.
lt is well known that the
mercantile system of accounting
differs substantially from the cash
system of book-keeping. Under the
cash systems it is only- actual
cash receipts and actual cash
payments that are recorded as
credits and debits; whereas under
the mercantile system, credit
entries are made in respect of
amounts due immediately they become
legally due and before they are
actually received; similarly, the
expenditure items for which legal
liability has been incurred amounts
in question are actually disbursed.
Where accounts are kept on
mercantile basis, the profits or
gains are credited though trey 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. The same is the
position with regard to debits
made. (See Indermani Jatia y.
Commissioner of Income-tax [1959]
35 I.T.R.298; [1959] Suppl.1
S.C.R.45 (S.C.)…..In the present
case, the amounts of income for the
two years in question were given up
unilaterally after they had accrued
to the appellant-company. As such,
the appellant could not escape the
tax liability for those amounts.”
The learned Judge also quoted with approval certain
observations made by Hidayatullah,J. [as he then was] in
Commissioner of Income Tax v. Shoorji Vallabhdas & Co.
[(1962) 46 I.T.R 144], which we shall refer to presently.
The ratio of this decision clearly support the Revenue’s
case.
In Birla Gwalior (P) Ltd., the facts are the following:
the respondent, which was the managing agent of two
companies, maintained its accounts on the mercantile system.
It was entitled to an agreed managing agency commission and
an office allowance from each of the managed companies. No
date for payment of the commission was stipulated in the
managing agency agreements. The accounting year of the
respondent as well as the managed companies was the
financial year. The respondent gave up the managing agency
commission from both the managed companies for the
Assessment Years 1954-55 to 1956-57, after the end of the
relevant financial Years but before accounts were made up by
the managed companies. It also gave up before the end of the
relevant financial Years its office allowance from one of
the managed companies for the Assessment Years 1955-56 and
1956-57. The Appellate Tribunal held that the commission
given up was not the respondent’s real income and that since
it was given up op grounds of commercial expediency, it was
an allowable deduction under Section 10(2)(xv) of the Indian
Income Tax Act, 1922. In relation to office allowance, the
Tribunal found that the financial position of the managed
company was not sound during the relevant accounting years
that it was necessary for the respondent to give up the
office allowance in order to stabilise the finances of the
managed company and because of the sacrifice made by the
respondent the finances of the managed company improved and
as a result the respondent was able to earn more profits in
later years. On reference made under Section 66(2), the High
Court opined that (1) the commission foregone by the
respondent-assessee was not its real income. [On that basis,
it declined to answer the question whether the amounts of
the commission foregone were allowable as revenue
expenditure under Section 10{2)(xv) of the 1922 Act] and (2)
that the office allowance foregone was deductible as
business expenditure under Section 10(2)(xv). On appeal,
this Court affirmed the view taken by the High Court. We
are, however, concerned only with the first answer given by
the High Court. In our opinion, there is no contradiction or
inconsistency between the holding in this case and the
holding in Morvi Industries Limited. In this case, the
important fact found was that the money became due to the
assessee not at the end of the accounting year, but on the
date the managed company made up its accounts. Indeed, no
date was fixed in the agreement for payment of the
commission and the assessee gave up its commission even
before it accrued to it, i .e., before the managed company
made up its account. It is for this reason, this Court held
that the commission had not accrued to the assessee by or
before the date it gave it up. Indeed, Hegde,J., speaking
for himself and Khanna,J., specifically referred to the
decision in Morvi Industries Limited and distinguished it on
the above basis. We are, therefore, unable to agree with the
High Court that by virtue of the decision of this Court in
Birla Gwalior (P) Ltd., the principle of Morvi Industries
Limited does not apply to the present case. The facts of the
present case [with respect to three assessment years, viz.,
1969-70, 1970-71 and 1971-72] do squarely fall within the
principle of Morvi Industries Limited.
In State Bank of Travancore v. Commissioner of Income
Tax, Kerala [(1986) 158 I.T.R.102], the facts were the
following: the appellant-Bank maintained its accounts on the
basis of mercantile system. It was charging interest on the
loans advanced by it. Some of the loans had become “sticky”,
i.e., their recovery had become extremely doubtful. The
Bank, however, charged interest on these loans also,
debiting the account of the concerned parties. But instead
of carrying the interest amount to the profit and loss
account, the appellant remitted the said interest amount to
a separate account called “the Interest Suspense Account”.
In the course of its assessment, the Bank claimed that
having regard to the poor financial condition of the said
debtors and the poor chances of recovery of interest from
them, the interest amount due from them was taken to the
“Interest Suspense Account” to avoid showing inflated
profits by including hypothetical and unreal income and
further that the interest on such sticky advances was not
its real Income and, hence, not taxable. Both the Tribunal
and the High Court rejected the plea. On appeal, this Court,
by majority, Sabyasachi Mukharji and Ranganath Misra,JJ.,
[Tulzapurkar,J. dissenting] affirmed the decision of the
High Court. This Court held that the interest on sticky
advances did accrue to the appellant-Bank according to the
mercantile system of accounting and that, indeed, the
appellant had debited the respective parties with interest.
The appellant, however, did not chose to treat the debt as
bad debts but carried the interest amount to the ‘Interest
Suspense Account”. Mere crediting of the said interest
amount to, what it called the “Interest Suspense Account”,
without treating it as a bad debt or irrecoverable interests
was repugnant to Section 36 (1)(vii) and Section 32(3) of
the Act and that the concept af real income does not help
the appellant-Bank. It was observed that the concept of real
income cannot he so read as to defeat the object and the
provisions of the Act. Sabyasachi Mukharji,J., in his
opinion, discussed all the relevant cases on the subject
including Morvi Industries Limited and Birla Gwalior (P)
Ltd. as well as the derision of this Court in Shoorji
Vallabhdas & Co. and stated the proposition emerging
therefrom in the following words:
“(1) It is the income which has
really accrued or arisen to the
assessee that is taxable. Whether
the income has really accrued or
arisen to the assessee must be
Judged in the light of the reality
of the situation. 12) The concept
of real income would apply where
there has been a surrender of
income which in theory may have
accrued but in the reality of the
situation, no income had resulted
because the income did not really
accrue. (3) Where a debt has become
bad, deduction in compliance with
the provisions of the Act should
be claimed and allowed. (4) Where
the Act applies, the concept of
real income should not be so read
as to defeat the provisions of the
Act. (5) If there is any diversion
of income at source under any
statute or by overriding title,
then there is no income to the
assessee.
(6) The conduct of the parties in
treating the income in a particular
manner is material evidence of the
fact whether income has accrued or
not. (7) Mere improbability of
recovery, where the conduct of the
assessee is unequivocal, cannot be
treated as evidence of the fact
that income has not resulted or
accrued to the assessee. After
debiting the debtor’s account and
not reversing that entry – but
taking the interest merely in
suspense account cannot be such
evidence to show that no real
income has accrued to the assessee
or been treated as such by the
assessee. (8) The concept of real
income is certainly applicable in
judging whether there has been
income or not but, in every case,
it must be applied with care and
within well-recognised limits.”
To the argument of real income pressed with great
persistence in that case, the learned Judge responded in
the following words:
“We were invited to abandon legal
fundamentalism. With a problem like
the present one, it is better to
adhere to the basic fundamentals of
the law with clarity and
consistency than to be carried away
by common cliches. The concept of
real income certainly is a well-
accepted one and must be applied in
appropriate cases but with
circumspection and must not Be
called in aid to defeat the
fundamental principles of the law
of income-tax as developed.”
We respectfully agree with the propositions as well as
the observations of the learned Judge with respect to the
plea of real income.
We may now deal with the decision in Shoorji Vallabhdas
& Co., relied upon strongly by Sri Sharma, learned counsel
for the respondent-assessee. The assessee-firm was the
managing agent of two shipping companies. Under the managing
agency agreement, the assessee was entitled to receive as
commission ten percent of the freight charged. Between April
1, 1947 and December 31, 1947, a sum of Rs.1,71,885/- from
one company and Rs.2,56,815/- from the other company became
due to the assessee as commission at the aforesaid rate of
ten percent. In the books of account of the assessee, these
amounts were credited to itself and debited to the managing
companies. But what happened even before December 31, 1947
is of relevance. In November 1947, the assessee desired to
have the managing agency transferred to two private limited
companies, Shoorji Vallabhdas Limited and Pratapsinh
Limited, floated by the assessee-firm. Certain shareholders
of the managed companies objected to the rate of commission
and suggested that the commission should be either ten
percent of the profits of the managed companies or 2 1/2
percent of the freight receipt. The board of directors of
the Malabar Steamship Company agreed with the said
suggestion and invited the assessee-firm to reduce its
managing commission to 2 1/2 percent of the freight for that
year as well as for the future years. The assessee accepted
the said offer and agreed to voluntarily reduce its managing
agency commission both in respect of that year as well as
for the future years to 2 1/2 percent of the total freight.
A similar procedure was followed in the case of the other
managed company [New Dholera Steamships Limited]. On this
basis, both the managed companies appointed the two private
limited companies aforesaid as their managing agents at
their extraordinary meeting held on December 30, 1947 – the
appointment was to take effect from January 1, 1948.
Subsequently, at the annual general meetings cf the two man
managed companies held in December, 1948, the commission was
reduced from ten percent of the freight to 2 1/2 percent as
already agreed. The assessee accordingly gave up seventy
five percent of its earnings during the aforesaid year of
account [April 1, 1947 to December 1, 1947] and disclosed
only the remaining twenty five percent amount as its income
in its assessment proceedings. The Income Tax Officer and
the Appellate Assistant Commissioner held that the
commission amount @ ten percent of the freight had already
accrued to the assessee during the previous year ending on
March 31, 1948 and since the assessee had given up seventy
five percent of the said amount after such accrual, the
whole of the commission amount, which was actually credited
in the books of the assessee, is includible in its income.
On appeal, there was a difference of opinion between the two
members of the Tribunal. On reference to the President, he
held that even though the actual reduction took place after
the year of account was over, there was in fact an agreement
to reduce the commission even during the currency of the
accounting year and hence, it cannot be said that the larger
income [@ ten percent] had accrued to the assessee-firm.
Accordingly, the assessee’s appeal was allowed by the
Tribunal. Thereupon, the following two questions were
referred to the High Court under Section 66, viz.:
“(1) Whether the two sums of
Rs.1,36,903 and Rs.2,00,625 are
income of the ‘previous year’ ended
March 31,1948?
(2) If the answer to the first
question is in the affirmative,
whether they represent an item of
expenditure permissible under the
provisions of section 10(2)(xv) of
the Indian Income-tax Act, 1922, in
computing the assessee’s income of
that ‘previous year’ from its
managing agency business?”
The High Court agreed with the view taken by the
President of the Tribunal and answered the first question in
the negative, i.e., in favour of the assessee and against
the Revenue. It declined to express any opinion on the
second question. This Court affirmed the approach adopted by
the President of the Tribunal and the High Court. It pointed
out:
“Here too, the agreements within
the previous year replaced the
earlier agreements, and altered the
rate in such a way as to make the
income different from what had been
entered in the books of account. A
mere book-keeping entry cannot be
income, unless income has actually
resultad, and in the present case,
by the change of the terms the
income which accrued and was
received consisted of the lesser
amounts and not the larger. This
was not a gift by the assessee firm
to the managed companies. The
reduction was a part of the
agreement entered into by the
assessee firm to secure a long-term
managing agency arrangement for the
two companies which it had
floated.”
Hidayatullah,J., speaking for himself and J.C.Shah,J.,
observed that the facts of the case before them was
identical to the facts of the case in Commissioner of Income
Tax v. Chamanlal Mangaldas & Co. [(1960) 39 I.T.R.8] and
that the principle of the said decision squarely applied to
the facts of the case before them. In the course of the
judgment, thy learned Judge observed:
“Income-tax is a levy on income. No
doubt, the Income-tax Act takes
into account two points of time at
which the liability to tax is
attracted, viz., the accrual of the
income or its receipt; but the
substance of the matter is the
income. If income does not result
at all, there cannot be a tax, even
though in book-keeping, an entry is
made about a ‘hypothetical income’,
which does not materialise. Where
income has, in fact, been received
and is subsequently given up in
such circumstances that it remains
the income of the recipient, even
though given up, the tax may be
payable. Where, however, the income
can be said not to have resulted at
all, there is obviously neither
accrual nor receipt of income, even
though an entry to that effect
might, in certain circumstances,
have been made in the books of
account. This is exactly what has
happened in this case, as it
happened in the Bombay case
[Commissioner of Income-tax v.
Chamanlal Mangaldas & Co. (1956) 29
I.T.R.987), which was approved by
this court.”
We may also mention that when this case was cited
before this Court in State Bank of Travancore, it has
been distinguished on the basis of the above fact, viz.,
that the agreement to give up seventy five percent of the
commission was arrived at during the relevant previous year
itself, i.e., before the close of the previous year and,
therefore, what accrued to the assessee at the end of the
relevant previous year was the commission at 2 1/2 percent
of the freight alone and not @ ten percent. It cannot,
therefore, be said that this case lays down any principle
contrary to the one enunciated in Morvi Industries Limited.
Since the facts of the case in Chamanlal Mangaldas & Co. are
identical to the facts in Shoorji Vallabhdas & Co., we do
not think it necessary to refer to the facts of that case
separately.
Sri G.C.Sharma submitted that applying the real income
theory, it must be held that no interest had really accrued
to or received by the assessee for the said three assessment
years [1969-70, 1970-71 and 1971-72] and that indeed, no
such entries were made in the account books of the assessee.
He submitted that, as a fact, no income was received and
that the assessee cannot be asked to pay tax on income which
it had not received. We answer this contention by repeating
the words of Sabyasachi Mukharji, J. in State Bank of
Travancore, which we have extracted hereinabove. The concept
of real income cannot be employed so as to defeat the
provisions of the Act and the Rules. Where the provisions of
the Act and the Rules apply and followed. There is no room-
nor would be permissible for the court – to import the
concept of real income so as to whittle down, qualify or
defeat the provisions of the Act and the Rules.
For the above reasons, the appeals relating to
Assessment Years 1969-70, 1970-71 and 1971-72 [in the case
of Shiv Prakash Janak Raj & Co.] are allowed and the appeal
relating to Assessment Year 1968-69 [in the case of Shiv
Prakash Janak Raj & Co.] is dismissed as not pressed. For
the same reasons, the other appeals are allowed. The
judgment of the High Court in all these matters [except with
respect to the Assessment Year 1968-69 in the case of Shiv
Prakash Janak Raj & Co.] is set aside. The questions
referred to are answered in favour of the Revenue and
against the assessee [except in the appeal relating to
Assessment Year 1968-69 in the case of Shiv Prakash Janak
Raj & Co.].
There shall be no order as to costs.