PETITIONER: NONSUCH ESTATE LTD. Vs. RESPONDENT: THE COMMISSIONER OF INCOME-TAX, MADRAS DATE OF JUDGMENT21/11/1974 BENCH: GUPTA, A.C. BENCH: GUPTA, A.C. KHANNA, HANS RAJ CITATION: 1975 AIR 428 1975 SCR (2) 806 1975 SCC (3) 443 ACT: Income-tax Act. 1922-Assessee followed mercantile system of accounting Debited in books each year managing agency remuneration for three years Claimed deduction in the third year on receipt of approval from Central Government for reappointment of managing agents as required under s. 326 Companies Act-Whether assessee should have claimed deduction in each assessment Year. HEADNOTE: The assessee who followed the mercantile system of accounting debited in its account books certain sums of money as remuneration of the managing agents for the assessment years 1957-58 to 1959-60. For the purpose of income-tax the company added back the sum to its taxable income and claimed the whole sum as a deductible expenditure in the assessment year 1959-60 on the ground that the sum became payable only during that year when the Government accorded its approval to the new managing agency agreement. The income-tax Officer rejected the claim holding that the approval of the Central Government was necessary only for actual payment and the assessee should have ascertained the liability for each year and claimed it since he followed the mercantile system of accounting. This view was upheld by the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal. The High Court held that although at the time the debit entries were made in the account books of the assessee, approval of the Central Government had not been received, when it came later, it gave legal effect to the debit entries with retrospective effect from April 1. 1956 and that the refusal of deduction by the Income-tax Officer was right. Allowing the appeal to this Court, HELD : The High Court was in error in answering the question against the assessee. Even an assessee following the mercantile system of accounting is not entitled to claim a deduction until liability for the sum for which deduction is claimed has accrued. The High Court overlooked the plain terms of s.326 of the Companies Act, 1956 under which it could not be assumed that the Central Government would approve every proposed appointment or re-appointment of managing agent. [809A; D; 810A] In the instant case it is only when the Central Government conveyed its approval to the appointment of managing agents by its letter dated September 2, 1957 that the appointment became effective and the Company's liability to pay the remuneration of the managing agents accrued. The liability became effective from April 1, 1956 because the Central Government chose to give its approval retrospective operation. The liability could not be said to had &risen from any date prior to September 2, 1957 when the approval was given. Section 326 of the Companies Act contains an absolute prohibition against the appointment or re- appointment of a managing agent before the approval of Central Government was obtained. [810B-C] JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1554 of 1970.
Appeal. by Special Leave from the Judgment & Order dated the
19th August, 1968 of the Madras High Court in Tax Case No.
18 of 1 965.
G. B. Pai, A. G. Manessea, D. C. Mathur and K. K. John,
for appellant.
B. B. Ahuja and S. P. Nayar, for the respondent.
807
The Judgment of the Court was delivered by
GUPTA, J. This is an appeal by special leave from a judgment
of the Madras High Court in a reference under section 66(1)
of the Income Tax Act, 1922. The appellant, Nonsuch Estate
Limited, is a public limited company incorporated in the
‘year 1924 under the Companies Act, 1913. The appellant,
referred to hereinafter as the Company, derives its income
from tea grown in its estate for which it is assessed to
income-tax. M/s. Harrisons and Crosfield Limited have been
the managing agents of the Company from the beginning. The
following question relating to the assessment year 1959-60
was referred to the High Court :
“Whether on the facts and in the circumstances
of the case, the sum of Rs. 97,188/-
representing the Managing Agency remuneration
for the period 1-4-1956 to 30-6-1957 was
deductible in the computation of the income of
previous year ending on 30th June 1958,
relevant for the assessment year 1959-60.”
The relevant facts leading to the reference are these. The
managing agents of the Company were entitled to commission
at the rate of 11 per cent on all sales of tea and other
produces of the Company and a further sum of Rs. 12,000/-
per annum for secratarial work. There was, however, no
written. agreement embodying the terms. After the Companies
Act, 1956 came into force on April 1, 1956 it was decided
that there should be a fresh managing agency agreement
between the Company and its managing agents in conformity
with the provisions of the said Act. A fresh agreement
drawn up and submitted by the managing agents was approved
by the Company. The new agreement proposed the
reappointment of M/s. Harrisons & Crosfield Limited as the
managing agents of the Company for a period of 10 years on a
remuneration of 5 per cent commission on the net profits of
the Company computed in the manner laid down in sections 349
to 351 of the Companies Act, 1956 subject to a minimum
remuneration of Rs. 12,000/- per annum. The revised terms
were to take effect from April 1, 1956. As required by sec.
326 of the Companies Act, the new agreement was sent to the
Central Government for approval by a communication dated
august 3, 1957 enclosing a formal application for the
purpose in Form 25, On September 2, 1957 by a letter
addressed to the Company the Government conveyed its
approval to “the appointment of M/s. Harrisons & Crosfields
Ltd. as the Managing agents…….. for a period of 10 years
with effect from 1st April 1956, on a remuneration of 5 per
cent commission on the net profits of the Company computed
in the manner as laid down in Sections 349 to 351 of the
Companies Act, 1956 subject to a minimum remuneration of Rs.
12,000/- (Rupees twelve thousand only) per annum payable to
the Managing Agents, in the event of absence or inadequacy
of profits in any financial year.” On receipt of the
approval, the Company by a resolution adopted at an
extraordinary general meeting of its shareholders held on
October 4, 1957 reappointed M/s. Harrisons & Crosfield
Limited on the terms stated above. In terms of the new
agreement the existing agency agreement between the parties
stood cancelled with the expiry of March 31, 1956.
808
The Company follows the mercantile system of accounting.
For the period April 1, 1956 to June 30, 1956, the Company
credited a sum of Rs. 9320/- to the account of the managing
agents as their remuneration in accordance with the terms of
the proposed new agreement. This was disclosed in the
published accounts of the Company for the year July 1, 1955
to June 30, 1956 relevant to the assessment year 1957-58.
For the purpose of assessment of income-tax, however, the
Company added back the said sum of Rs. 9,320/- to its
taxable income. In the next accounting year ending on June
30, 1957 relevant to the assessment year 1958-59 the same
process was followed with regard to the remuneration payable
to the managing agents. For the assessment year 1959-60 for
which the previous year was July 1, 1957 to June 30, 1958, a
total sum of Rs. 97,188/- was shown as managing agents’
remuneration payable during that year. This amount was made
up as under
Amount
.lm15
” Proportionate remuneration for 3 months at 5 per cent on
the net profits for the period ending on 30-6-1956 paid
during the year ending on 30-6-1958
9,320
Remuneration at 5 per cent on the net profit of the year
ending on 30th June 1957 paid during the year ending on
30-6-1958 71,368
Managing Agents expenses for the year ending 30th June
1957 recouped during the year ending on 30th June
1958.13,200
Proportionate Managing Agent’s expenses for the year
ending on 30th June 1956 recouped during the year ending
on 30-6-19583,300
97,188.
Though this sum did not pertain to the previous year
relevant to the assessment year 1959 60, the Company claimed
it as deductible expenditure for that year on the ground
that the sum became payable only during that year when the
Government accorded its approval to the new ‘agreement. The
Income-tax Officer rejected this claim on the view that the
approval of the Central Government was necessary only for
actual payment and “the assessee should have ascertained the
liability for each year and claimed it on the mercantile
basis which was the system adopted by the assessee company.”
The Appellate Assistant Commissioner and the Tribunal also
took the same view. The High Court answered the question
referred to it against the assessee on the following
reasoning :
“.. … …. There was undoubtedly an
understanding between the managing agency and
the assessee as to the new terms of
remuneration which actually were given effect
to by making debit entries in the remuneration
account then and there. It is true that
at the time the debit entries were made,
approval of the Central Government had not
come. But when it came actually later, it
gave legal effect to the debit
809
entries, not from the date of the approval but
from April 1, 1956. That being the case, the
refusal of the deduction, in our opinion was
right.”
In our judgment the High Court was in error in answering the
question referred to it against the assessee. It appears
that the Income-tax authorities, the Tribunal and the. High
Court all laid special emphasis on the fact that the Company
followed the mercantile system of accounting. The
distinction between the two methods of accounting, one on
the cash basis and the other on the mercantile basis is
well-known. In Commissioner of Income-tax, Madras v. A.
Gajapathy Naidu(1), this Court explained the difference
between the two methods quoting with approval an extract
from a Judgment of the, Allahabad High Court in Commissioner
of Income-tax v. Singari Bai(2). In
Gajapathy Naidu’s(1) case this Court said:
” It is commonplace that there are two
principal methods of accounting for the
income, profits and gains of a business one is
the cash basis and the other, the mercantile
basis. The latter system of accountancy
“brings into credit what is due immediately it
becomes legally due and before it is actually
received; and it brings into debit expenditure
the amount for which a legal liability has
been incurred before it is actually
disbursed”.”
However, even an assessee following the mercantile system of
accounting is not entitled to claim a deduction until
liability for the sum for which deduction is claimed has
accrued. The reasons given by the High Court overlook the
plain terms of sec. 326 of the Companies Act, 1956. Sec.
326 so far it is material for the question involved in this
case, is in these terms :
"Sec. 326.)1) In respect of any company............ (a)..........
(b) unless the approval of the Central
Government has been obtained for such
appointment or re-appointment.
(2) The Central Government shall not accord
its approval under sub-section (1) in any
case, unless it is satisfied-
(a) that it is not against the public
interest to allow the company to have a
managing agent;
(b) that the managing agent proposed is, in
the opinion, a fit and proper person to be appoi
nted or re-appointed as such, and that
the conditions of the managing agency
agreement proposed are fair and reasonable;
and
(c) that the managing agent proposed has
fulfilled any conditions which the Central
Government requires him to fulfil.”
(1) 53 I.T.R. 114.
(2) 13 I.T.R. 224.
810
Section 326 prohibits the appointment or re-appointment of a
managing agent unless the Central Government approved such
appointment or re-appointment. The Central Government would
not accord its approval unless the requirements specified in
clauses (a), (b) and (c) of sub-section (2) of the section
have been fulfilled. Therefore, it cannot be assumed that
the Central Government will approve every proposed
appointment or reappointment of a managing agent. Thus in
the instant case it is only when the Central Government
conveyed its approval to the appointment of M/s. Harrisons
and Crosfield Limited as managing agents by its letter
dated September 2, 1957 that the appointment became
effective and the Company’s liability to pay the
remuneration of the managing agents accrued. The position
here is not that the liability had arisen earlier and its
quantification only depended on the approval of the Central
Government. It is true that the liability became effective
from April 1, 1956, a date anterior to the relevant previous
year, but ‘that is because the Central Government chose to
give its approval retrospective operation. The liability in
these circumstances cannot be said to have arisen from any
date prior to September, 2, 1957 when the approval was given
as sec. 326 contains an absolute prohibition against the
appointment or re-appointment of a managing agent before the
approval of the Central Government was obtained. In our
opinion, the position is quite clear from the terms of sec.
326 and we do not consider it necessary to refer to the
authorities cited by the learned counsel for either side.
The appeal is accordingly allowed, the answer given by the
High Court to the question referred to it is discharged and
the question is answered in the affirmative and in favour of
the assessee. The appellantwill be entitled to its costs
in this Court and in the High Court.
P.E.R.
Appeal allowed.
811