TMI Blog1980 (12) TMI 14X X X X Extracts X X X X X X X X Extracts X X X X ..... or other overseas principals. The Bombay branch acts as agents for Lloyds. Both the branches deal in sundry electrical and other goods. The books of account of both the branches in India are closed on 31st December. The assessment year 1970-71, with which we are concerned, was in respect of the relevant accounting year being the calendar year 1969. In the company's books of account for the year ending on December 31, 1969, the following amounts receivable as interest on advance was found credited in suspense account: ----------------------------------------------------------------------------------------------------------------------------------------------- Name of the Amount credited in suspense Name of the party from whom branch a/c. as interest interest was receivable ----------------------------------------------------------------------------------------------------------------------------------------------- Rs. Calcutta 8,264 M/s. Bags Cartons, New Delhi. Bombay 55,920 Speciality Papers Ltd., Bombay. ------------------------------------------------------------------------------------------------------------------------------------------------ T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en received. After this decision the interest due for the years ended December 31, 1969, was credited to a suspense account. The amount thus credited in the books of account, relevant to the assessment year 1970-71, was Rs. 55,920." As regards the deletion of Rs. 55,920 representing the interest due from M/s. Speciality Papers Ltd., it was urged, on behalf of the Revenue, that the assessee followed the mercantile system of accounting and any income due in a particular accounting year would have to be included in the total income of the relevant assessment year irrespective of whether or not the amount due was credited to the profit loss account or a suspense account. Reliance was placed on several decisions, attention to some of which were drawn before us. On behalf of the assessee, it was urged that the method of accounting followed by the assessee need not be an invariable one. Reliance was placed on certain observations of a decision. It was further urged that the assessee had decided to change w.e.f. January 1, 1968, its method of accounting in respect of the interest, of which recovery was doubtful, and that such interest was being credited since then to a suspense accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... management was requested by the assessee-company to pay interest on loan up to 31-12-1967, because the interest accruing up to this stage had already suffered tax in the assessee's hands. 31-12-1971. The entries in the suspense account relating to interest were reversed. February, 1972. The debtor-company wanted the instalments to be reduced to Rs. 50,000 per month from Rs. 70,000. December, 1972. The debtor-company was asked to liquidate the sum of Rs. 12,47,423 by half-yearly payments from June, 1975, to June, 1976." In the aforesaid view of the matter, it was submitted, on behalf of the assessee, that the Board circular dated October 6, 1952, referred to hereinbefore, were fully applicable and reliance was placed on the decision of the Supreme Court in the case of Ellerman Lines Ltd. v. CIT [1971] 82 ITR 913 (SC), in aid of the proposition that the Board's instructions could not be ignored by the authorities subordinate to it. It was submitted in the alternative that the interest credited to the suspense account could not form part of the assessee's " real income ". In support of this contention, reliance was placed on several decisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al basis. This is important because one of the contentions urged, on behalf of the assessee, before the Tribunal was that there was a change in the method of accounting. The Tribunal had not decided that contention and if there was a change, in fact as was contended, in the method of accounting, then there was no question of considering whether there was any question of applying any theory of real income. It was submitted, on behalf of the assessee, that in respect of a subsequent year, that is, for the assessment year 1972-73, in Appeal No. 3154 of 1976-77 and No. 3170 (Cal-76-77), another Bench of the Tribunal was of the view that the assessee had taken the plea before the Tribunal, in the appeal in respect of which this reference relates, that w.e.f. January 1, 1968, in respect of the interest of the aforesaid loan, it was following the cash system of accounting. The Tribunal had not, according to the subsequent Tribunal, dealt with the plea of the assessee. Therefore, the Tribunal, in the subsequent appeal, was of the view that it was free for determination whether it was a fact and also to determine the question if there was a change in the system of accounting in the years un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m, on behalf of the assessee, that the system of its accounting in respect of its interest income "Was being altered but it was particular kind of interest that was being spoken of, viz., the interest which was of doubtful recovery. Whether such an attempt certain particular types of source or one source could unilaterally be changed from the method of accounting usually followed by the assessee was doubtful proposition. But, it was urged on behalf of the assessee, that in this case, the two amounts, with which we are concerned in the instant reference, were the only interests and thus the method of accounting in respect of the interests was changed. Assuming that is the position, which is not apparent or clear from the submissions urged before the Tribunal, even then the question arises whether there was any decision to change the accounting in respect of a particular source, on the assumption that the entire source of interest income was being sought to be changed from mercantile system to cash system. What was urged was an attempt to change the head of the account to which the interest would be credited ; the assessee decided to change w.e.f. January 1, 1968, the head to which i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... change in the method of accounting, we will refer to the several decisions to which our attention was drawn. We must first refer to the decision of the Supreme Court in the case of Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC). There, at page 529 of the decision, the Supreme Court dealt with the concept of real income and referred to the decision of the Bombay High Court in the case of H. M. Kashiparekh Co. Ltd. v. CIT [1960] 39 ITR 706 (Bom), to which we shall also refer. There the Supreme Court observed that the principle or the concept of real income had been succinctly enunciated by the Division Bench of the Bombay High Court in the aforesaid decision as follows (at p. 529 of 57 ITR): " The principle of real income is not to be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect of managing agency commission is made, accrued to or given up on grounds of commercial expediency, simply because it takes place some time after the close of an accounting year. In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pplication. The principle of real income, it was reiterated by the Division Bench of the Bombay High Court, was not to be so subordinated as to amount virtually to negation of it when a surrender or concession or rebate in respect of the managing agency commission was made, accrued to or given up on grounds of commercial expediency, simply because it took place some time after the close of the accounting year. In examining any transaction and situation of this nature, the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it. It would lay greater emphasis on the business aspect of the matter viewed as a whole when that could be done without disregarding the statutory language. The important point that the Bombay High Court emphasised in this case, in our opinion, was that in considering the concept of real income, the fact that the assessee followed the mercantile system of accounting did not have any bearing. The accrual of the commission, the making of the accounts, the legal obligation to give up a part of the commission and the forgoing of the commission at the time of making up accounts were n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the agreement which made the income accrue or arise, something was there which entitled the recipient or the person in whose hands the income accrued, to receive the income or to claim the income after the end of the relevant accounting period. It will also be applicable in cases where the original agreement is subsequently replaced or exchanged in view of another agreement subsequently entered into. Within these two limits normally unless the germ of subsequent conduct which brings about the income is embedded in the relevant year, the theory of real income cannot be invoked to defeat the consequence of accrual of income. Reliance was placed on another decision of the Supreme Court in the case of CIT v. Birla Gwalior (P.) Ltd. [1973] 89 ITR 266 (SC). There, the assessee, 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 assessee as well as the managed companies was the financial year. The assessee gave ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ired to have the managing agency transferred to two private companies and, in this connection, agreed in December, 1948, to accept 2 1/2 % as commission, and gave up 75 per cent. of its earnings. The Revenue sought to assess the amounts of Rs. 1,36,903 and Rs. 2,00,625, being the 75 per cent., which the assessee had given up, on the ground that commission at IO per cent. had already accrued to the assessee in the year of account, and the agreement in December, 1948, after the close of the previous year, to give up a portion of that income, could not save that portion from liability to income-tax. It was held that the subsequent agreement had already altered the rate of commission in such a way as to make the income which really accrued to the assessee different from what bad been entered in the books of account. This was not a case of a gift by the assessee to the managed companies of a portion of the income which had already accrued, but an agreement to receive a lesser remuneration than what had been agreed upon. The assessee had, in fact, received only the lesser amount in spite of the entries in the books of account, and this lesser amount alone was taxable. The Supreme Court r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sion 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, 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 cl. 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 u/s. 10(2)(xv). of the Indian I.T. 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 had become weaker and, therefore, the relinquishment was not for the benefit of assessee. On a reference, the High Court had agreed with the view taken by the Tribunal. The Supreme Court affirme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TR 835 (SC), and observed that the real question for decision was whether the income had really accrued or not. It was not a hypothetical accrual of the income that had got to be taken into account but the real accrual of the income. If this concept of the real accrual of income in law and the principle on which the theory of accrual is based were to be taken into account, then, in the light of the facts of this case, where we are dealing with the question of interest, which had not to take into account anything to be done or happening subsequent to the closing of the year of account and the accrual was not dependent on any subsequent making up of the accounts or the company's borrowing acts, then the subsequent conduct, subsequent to the year in which income accrued, cannot, in our opinion, be of any help to the assessee. Our attention was drawn to a Bench decision of the Patna High Court in the case of CIT v. S. K. G. Sugar Ltd. [1974] 96 ITR 194 (Pat), where Chief justice Untwalia, speaking for the Patna High Court, has culled out the general principles of the accrual of liability under mercantile system of accounting. There, the assessee-company was manufacturing sugar and dist ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ough the case dealt with the question of interest, in our opinion, the Revenue cannot draw much assistance from the said decision. Reliance was also placed on the decision of the judicial Committee in the case of CIT v. Maharajadhiraja Kameshwar Singh of Darbhanga [1933] 1 ITR 94 (PC). There, at page 100 of the report, the judicial Committee observed as follows : " Now it will be observed at once that the method adopted by the Income-tax Officer has the result of bringing out a sum composed in part of actual interest receipts of the assessee in the year of computation and in part of sums received in previous years and allocated by the assessee to interest in that year. The question is whether this method or combination of methods was legitimate. That it was legitimate to ascertain in the first place the actual receipts of interest in the year of computation is undoubted. Was it legitimate to add the items which the assessee in the year of computation carried to interest account out of sums received in previous years ? Was the officer entitled to treat these allocations as income of the year of computation ? Where an assessee keeps his books on a cash basis disclosed to the Reve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commission of certain percentage per annum on the annual net profits of the U company which was due to them on 31st March of every year. On December 1, 1943, 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 S company on proper apportionment being made between them of the amount received by A. It was held by the majority view that in the facts and circumstances of the case the managing agency commission was not liable to be apportioned between S and A company in proportion to the services rendered as managing agents by each one of them but A was liable to pay tax on the whole agreement. There, at page 34 of the report, the court had referred to the clause, being cl. 2(d), which provided that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on, volume 20. It runs as follows: ' Where accounts may be reopened : Closely allied to the question of the year in which receipts are to be brought in or expenses allowed is the question of reopening trading accounts. It is now established that trading accounts for a year or period may be reopened and amended. For example, where a transaction included in the accounts for any year or period whether as a receipt or an expense is not settled in amount during the said year or period, and is subsequently settled at a figure different from that shown in the accounts, the accounts may be reopened and the figure subsequently ascertained inserted in place of the original figure, and the balance of profit as so revised will form the basis for assessment to income-tax. In certain cases trade receipts have been related back to the period in which goods were delivered or services rendered as a result of which money became payable, or deductions for trade expenses have been subsequently disallowed or reduced in amount. In other instances accounts have not been reopened.' The principle as quoted above does not militate against the legal principles involved in the instant case, although it ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d five companies amounted to Rs. 42,000 and the ITO included the whole amount of Rs. 42,000 in the total income of the assessee on the ground that the sum had already accrued to the assessee and subsequent relinquishment of the income bad no effect so far as the incidence of tax was concerned. The Appellate Tribunal allowed the appeal of the assessee, holding that in respect of the first four companies, the assessee was entitled to deduction of the managing agency commission and rejected the contentions of the assessee in respect of the fifth company. It was held by this court that since the managing agency agreement clearly provided that the agency company would be entitled to receive an office allowance of Rs. 500 per month and a commission of 10% of the net yearly profits and the proviso with regard to minimum applied only to the commission of 10% of the profits, it could not be said that the assessee was entitled to office allowance only at the end of the year. The office allowance payable by the said four companies accrued at the end of every month and, as such, the relinquishment of such allowance on July 5, 1953 could not entitle the assessee to claim deduction of the office ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any decided not to charge interest from the firm for the assessment year 1971-72, relevant to the accounting period ending on October 30, 1970. The ITO held that the loans in question were interest-bearing loans and since the assessee-company had relinquished the interest without any commercial consideration and since the directors and shareholders of the assessee-company were interested in the firm, it was a case of collusion to evade the tax liability and, therefore, added a sum of Rs. 31,565 to the income of the assessee-company under the head " interest " at the rate of 15 per cent. per annum. On appeal, the AAC held that the resolution to waive the interest was passed on November 24, 1970, i.e., after the end of the accounting period, and since the assessee-company followed the mercantile system of accountancy, the interest had already accrued to the assessee-company before it was waived and upheld the addition of Rs. 18,941 to the income of the assessee-company under the head " interest " at 9 per cent. per annum. On second appeal, the I.T. Appellate Tribunal upheld the order of the AAC. On a reference, the assessee-company contended that income-tax could be levied only if th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany carrying on money-lending and banking business. It followed the mercantile system of accounting. For the accounting year ending March 31, 1959, the company stated that no credit was taken in its balance-sheet in respect of interest on several loans advanced by it as the interest payment had remained unpaid from March 31, 1956. For the assessment year 1959-60, interest in respect of amounts due by debtors amounting to Rs. 9,275 was brought to tax and similarly for 1960-61 an amount of Rs. 13,033 was brought to tax. The order of the ITO was reversed by the Appellate Tribunal which took the view that the records showed that there had hardly been any receipts of interest for a number of years past. On a reference, the High Court held that the fact that there were hardly any receipts in respect of items of interest or that the bona fides of the assessee in not charging interest was not disputed, were circumstances which were by themselves insufficient to support the conclusion that there was no real income in respect of items of interest as none of the debts due by the several debtors was written off by the assessee and no evidence was produced to show that interest in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... abandon what up to that time had been his regular method, and start a new regular method and not merely a new method for a casual period. This is precisely what the assessee had sought to urge, that the method of accounting was changed of debt which was considered doubtful of realisation and that also not in the light of the agreement reached with the debtor and that after the interest had accrued in the relevant year and long thereafter. It is true that whether the question of the regular method of accounting has been changed or not is a question of fact. In this case, under the head " Interest " there was no claim, as we have been able to gather from the contentions raised before the Tribunal, that there was change of method of accounting. Reference in this connection was made to the decision in the case of Shiv Parkash Janakraj Co. Pvt. Ltd. v. CIT [1978] 112 ITR 872 (P H). However, we may incidentally refer to the decision of the Punjab Haryana High Court in the case of CIT v. Ferozepur Finance Pvt. Ltd. [1980] 124 ITR 619 (P H), where the court reiterated the principle that in the mercantile system of accounting, an assessee could forgo the whole or part of the debt wh ..... X X X X Extracts X X X X X X X X Extracts X X X X
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