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PETITIONER: COMMISSIONER OF INCOME-TAX, MADRAS

       Vs.

RESPONDENT: K. R. M. T. T. THIAGARAJA CHETTY & CO.

DATE OF JUDGMENT: 14/10/1953

BENCH: HASAN, GHULAM BENCH: HASAN, GHULAM SASTRI, M. PATANJALI (CJ) DAS, SUDHI RANJAN BOSE, VIVIAN BHAGWATI, NATWARLAL H.

CITATION:  1953 AIR  527            1954 SCR  258  CITATOR INFO :  R          1954 SC 470  (40)  F          1957 SC  49  (35)  D          1960 SC 703  (3,4)  RF         1961 SC 204  (10)  RF         1986 SC 757  (6,14,46)  RF         1991 SC 513  (7)

ACT:      Indian  Income-tax  Act (XI of  1922),  ss.  4(1)(b),13-  Commission   agency-Accounts  kept  on  mercantile   system-  Commission  credited  to  agent  and  debited  as   business  expenditure,  but withheld and carried over subsequently  to  suspense   account  pending  disputes-Whether   income   has  accrued-Computation of profits, whether condition  precedent  to accrual.

HEADNOTE:   Where, under the terms of a managing agency agreement the assessee firm who were the managing agents of a company were entitled  to  a certain percentage of the profits  as  their commission and in the books of the company maintained by the firm  a sum of Rs. 2,26,850 odd was shown as commission  due to the firm on the profits for the year 1941-42 and the said sum was also debited as an item of business expenditure  and credited to the managing agents’ commission account, but the aforesaid sum was subsequently carried to a suspense account by a resolution of the company as a result of a request made by  the firm that a debt due by the firm to the company  may be written off :     Held,  that, as the assessee kept the accounts  on  the mercantile  system  the commission accrued to  the  assessee when the commission was credited to it in the accounts,  and the subsequent carrying over of the amount of the commission to a suspense account pending the settlement of the  dispute between  the  company  and the  assessee  could  not  affect assessee’s liability to be taxed on this income.    Held  further,  that the fact that the  profits  of  the business  could  be computed only after the 31st  of  March, 1942, was Immaterial as quantification of the commission  is

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not a condition precedent to its accrual.

JUDGMENT: CiviL APPELLATE JURISDICTION: Civil Appeals Nos. 131,  131-A and 131-B of 1952.     Appeals  from the Judgment and Decree dated the 2nd  day of February, 1950, of the High Court of Judicature at Madras (Satyanarayana  Rao  and  Vishwanath Sastri  JJ.)  in  Cases Referred Nos. 76 and 78 of 1946 and 32 and 56 of 1947. 259      C.K.  Daphtary,  Solicitor-General for  India  (G.   N. Joshi, with him) for the appellant.      B.   Somayya  (Alladi  Kuppuswami, with  him)  for  the respondent.    1953.   October  14.   The  Judgment  of  the  Court  was delivered by     GHULAM  HASAN  J.-These  three appeals  arise  from  the judgment  and  order  of the Madras  High  Court  dated  2nd February,  1950, delivered on a reference by the  Income-tax Appellate   Tribunal  (hereinafter  referred  to   as   ’The Tribunal’),  whereby  the  High  Court  answered  the  first referred  question  in,  the negative, and  as  regards  the second  question,  Satyanarayana Rao J. answered it  in  the affirmative,  while Viswanatha Sastri J. answered it in  the negative, as a result of which the judgment of Satyanarayana Rao J. ultimately prevailed.  They relate to the  assessment for  1942-1943 and are filed by the Commissioner of  Income- tax, while Appeal No. 132     of 1952 which relates to 1943- 1944 is filed by the assessee, and,     is    dealt     with separately.     The  two question which were referred in respect of  the first group of appeals are as follows:-     (1)  Whether  there is any material for  the  Tribunal’s finding that the appellants (respondents in this case)  were being assessed on cash basis in the prior years?     (2) Whether on the facts and in the circumstances of the case  the Appellate Tribunal’s finding that the sum  of  Rs. 2,26,850 could not be assessed for the assessment year 1942- 43 is correct in law?     The assessee is a registered firm (hereinafter  referred to as ’the firm’) consisting of K.R.M.T.T. Thiagaraja Chetty and  his two sons.  The firm is the managing agent  of  Shri Meenakshi Mills, Ltd., (hereinafter referred to as the  Com- pany) owning a, spinning mill at Madura.  The firm also con- ducted insurance business and the business of ginning cotton in a ginning factory at another place.  Under the terms of L/B(D)2SCI-3(a) 260 the  agreement the managing agents were entitled to a  remu- neration  of Rs. 1,000 per mensem and a commission of I  per cent. on all purchases, I per cent. on all sales and 10  per cent.  commission  on the net profits of  the  mills  before allowing for ,depreciation.  The firm had plenary powers  of management of the affairs of the company subject to  general supervision  -of the directors.  It was to have  charge  and custody on behalf of the company of all the property,  books of  accounts, papers and documents and effects belonging  to the company.  It was required to keep at the expense of  the company  proper  and  complete  books  of  account  of   all purchases  and  sales and of all payments  made  and  moneys received on behalf of the company.  It had to defray all the expenses  of  maintaining a suitable office and a  staff  of assistants and clerks sufficient to transact the business of

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the  firm as managing agents of the company.  Clause  16  is most important and lays down that the firm be at liberty  to retain,  reimburse, and pay themselves out of the  funds  of the  company, all charges and expenses, legal  or  otherwise and all the costs and expenses of providing and  maintaining offices  for  the  company  and  the  salaries  of   clerks, servants, agents or workmen and all moneys expended by  them on  behalf of the company and all sums due to the  firm  for commission or otherwise.      The company made considerable profit in the  assessment year 1942-1943 and the firm became entitled to commission to the  tune of Rs. 2,26,850-5-0.  The firm did not  show  this sum in the return on the ground that it was not actually re- ceived  in  the year of account, viz., by  the  31st  March, 1942.  It relied upon a resolution of the Board of Directors of  the company, dated the 30th March, 1942, by  which  they had decided to keep the aforesaid amount in suspense without paying it on the ground that an amount of two lakhs odd  was due to the company from the firm.  It appears that the  firm owed  a debt to the company for a long time past  which  was outstanding.  The firm wrote on the 30th March, 1942, to the company  requesting that the debt be written off.  The  Firm also wrote that on account of the extraordinary increase  in the 261 volume of business. it found it difficult to bestow adequate attention  on  all  the aspects of  the  mill  business  and proposed  that  the  direct  responsibility  for  sales  and purchases  may be transferred to some other agency,  leaving the  general supervision over the entire management  in  the firm’s  hands.  The firm agreed to forego its commission  on purchases  and  sales  and  agreed  to  take  half  of   the commission  on  the  net profits.  The  directors  by  their resolution,  passed on the same date, refused to  write  off the   amount   without  consulting  the  general   body   of shareholders  and  pending  the settlement  of  the  dispute resolved, to keep the amount in suspense.      The Income-tax Officer held that the firm followed  the mercantile  method of accounting and not the cash basis  and that  the  income having accrued become  assessable  whether received or not.  The actual amount payable to the firm  in, accordance  with the terms and conditions of  the  agreement for  the  year 1942-1943 was not  disputed.   The  Appellate Assistant   Commissioner   confirmed  the   assessment   and dismissed  the  appeal of the  assessee.   The  Commissioner upheld  the  view  that the income  was  determined  on  the mercantile  basis and that the income had accrued or  arisen to the assessee within the meaning of section 4(1) (b)(i) of the  Income-tax Act. and the mere fact that the  amount  was put in the suspense account did not alter the fact that  the income had accrued to the firm Upon the matter being carried further  in appeal by the assessee, the Tribunal  held  that the  income had not accrued to the firm and that the  amount should be excluded from taxation as not having been received during    the   accounting   year.    The   two    questions aforementioned  were then referred, at the instance  of  the Commissioner by the Tribunal to the High Court.     As already stated, the opinion on the first question was unanimous, both the learned Judges Satyanarayana Rao J.  and Viswanatha Sastri J. holding against the assessee that there was no material for the Tribunal’s finding that the firm was being  assessed on cash basis in previous years, the  latter observing that finding in respect of 1942-1943 and 1943-1944 262 were  mutually  inconsistent, for in respect of  the  latter

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assessment  year the Tribunal had held that the sum  of  Rs. 2,20,702  was  assessable to income-tax, though  the  amount merely  stood  as a credit to the firm in the books  of  the company and has not been drawn by the firm.     It  is  contended by Mr. Somayya on behalf of  the  firm that  the finding of the Commissioner that the firm was  not paid  in  cash  in  the prior years was  set  aside  by  the Tribunal and being a finding of fact ought not to have  been interfered with by the High Court.  The firm had raised this question  before the Tribunal at the time of  the  reference and  had  contended that no question of law arose  from  its order,  as  it  was  concluded  by  finding  of  fact.   The Tribunal,  however repelled this contention  observing  that the question was one of ,law, as it related to the existence of any material for the finding.  The High Court upon  such- question  being  referred applied its mind  to  the  precise question  and  came  to the conclusion that  there  was  no. material for the finding that the firm was being assessed on cash  basis in the prior year.  The case of Commissinoer  of Income-tax,   Bihar   and  Orissa  v.   Maharaiadhiraja   of Darbhanga(1) does not support the contention of Mr. Somayya. There the Income-tax Officer had computed the profits of the business  for a particular year by taking into account  both actual receipts of interest in that year and sums treated by the  assessee in that year as receipts of interest by  their transference  to  the interest register from what  might  be regarded as a suspense account.  The Privy Council held that there  was nothing illegel or contrary to principle  in  the computation  arrived  by the Income-tax Officer.   The  High Court under section 66(1) had to decide the question of  law raised  by  the first question and decided  it  against  the assessee.   Nor  can  it  be  said  that  in  answering  the question,  the  High Court acted illegally  or  contrary  to principle.   Admittedly, the firm kept no separate books  of accounts other than the (1)  60 I.A, 146.                             263 books of accounts of the company in which there was a ledger containing entries relating to the remuneration and  commis- sion paid in cash to the firm.  The sum of Rs.  2,26,850-5-0 was  debited  as  a revenue expenditure of  the  company  as having been paid to the firm in the books of accounts of the company kept by the firm and was also allowed as a deduction in  computing the profits and gains of the company  for  the purposes of income-tax for 1941-1942.  The fact that certain moneys were drawn in cash by the firm from time to time does not necessarily lead to the inference that the firm kept its accounts  on a cash basis.  Anyone familiar with  commercial transactions   knows  that  even  in  accounts  kept  on   a mercantile  basis there can be entries of cash  credits  and debits.   We  see no flaw in the conclusion reached  by  the High Court on the first question.     The next question that falls to be determined is whether the sum of Rs. 2,26,850-5-0 was part of the profit and gains which  had  accrued to the firm during the  accounting  year 1941-1942.   The  undisputed facts are that  the  amount  in question  was the commission earned by the firm as  managing agents  of the company.  In the books of the  company  main- tained by the firm the aforesaid sum was debited as an  item of  revenue expenditure and the profits were computed  after deducting that sum.  The amount was simultaneously  credited to  the  managing agents’ commission account.   Under  these circumstances, it is idle to contend that the aforesaid  sum had  not accrued.  There can be no doubt under  the  circum- stances that the aforesaid sum was income which had  accrued

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to the firm.  The only question is whether the aforesaid sum ceased to be, income by reason of the fact that on the  30th March the sum was carried to the suspense account by a reso- lution  of the directors as a result of the request made  by the  firm  that  the outstanding debt due  from  it  may  be written off.  It is true that the, sum was not drawn by  the firm  but  that  can  hardly  affect  the  question  of  its liability to tax, once it is established that the income had accrued or- arisen to the firm 264      The mere fact that the company was withholding  payment on account of a pending dispute cannot be held to mean  that the amount did not accrue to the firm.       The  resolution of the directors itself  shows  beyond doubt  that the amount in question was treated as  belonging to the firm though its payment was deferred on account of  a pending  dispute.   As Viswanatha Sastri J. tersely  put  it "The  sum  had  irrevocably entered the debit  side  of  the company’s  account  as  a disbursement  of  managing  agency commission  to  the firm and had been appropriated  to  the, firm’s dues and the same sum could not again be entered in a suspense  account  at  a later date.   The  sum,  therefore, belonged  to  the  firm  and  had  to  be  included  in  the computation of the profits and gains that had accrued to  it unless  the firm had regularly kept its accounts on  a  cash basis, Which is not the case here"’.      A  reference to the ledger -folios in the books of  the company  shows that apart from the managing agents’  monthly remuneration of Rs. 1,00.0 which has duly entered in.  their account  the  amount in question also finds a place  in  the ledger  as  outstanding charges against the company  and  as credits  in favour of the firm, The’ journal entries in  the company’s books are the same.     Section 10 of the Act makes "profits and gains of  busi- ness,  profession  or vocation"’ carried on by  an  assessee liable to tax.  Section 12 makes "income from other  sources in  respect  of  income, profits and gains  of  every  kind" liable  to  tax.  By section 13 income,  profits  and  gains shall be computed for the purposes of both those sections in accordance with the method of accounting regularly  employed by  the assessee, but there is a proviso that, if no  method of accounting has been regularly employed, or if the  method employed  is  such that, in the opinion  of  the  Income-tax Officer,  the income, profits and gains cannot  properly  be deduced therefrom, then the c Computation shall be made upon such basis and in such manner as the Income-tex Officer  may determine. 265 The  Income-tax  Officer  in computing  the  income  of  the assessee  would have followed the mercantile system  or  the cash basis whichever was employed by the assessee.  There is some evidence, though not conclusive, on the record that the assessee  followed  the mercantile  system  of  accountancy. This  appears from the assessment orders field in the  case, but  apart  from  this,’ the  Income-tax  Officer  had  full authority under the proviso to compute the profits upon such basis and in such manner as he thought fit.     The  case of St. Lucia Usines and Estates Company,  Ltd. v.  Colonial  Treasurer  of St.  Lucia(1)  was  relied  upon strongly before us as it was in the High Court in support of the  contention  that  the sum not having been  paid  to  or realized  by the firm no income can be said to have  accrued to the firm.  In that case the assessee company sold all its property in St. Lucia in 1920 and ceased to reside or  carry on business there.  In 1921 interest upon the unpaid part of

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the  purchase  price, was payable to it, but was  not  paid. The  company was liable to pay income-tax for the year  1921 under the Income-tax Ordinance, 1910, of St. Lucia, only  if the  interest  above  mentioned  was  ’income  arising  and, accruing’  to  it  in 1921.  It was  held  that  though  the interest  was  a debt accruing in 1921, it was  not  ’income arising  or accruing’ in 1921, and that the company was  not liable.  The decision was based upon the meaning of the word ’income’ as used in the Ordinance which was said to  connote the  idea  of  something "coming  in".   Lord  Wrenbury  who delivered  the judgment of the Privy Council  construed  the words  "income  arising  or accruing" as  money  arising  or accruing  by  way  of  income  and  not  "debts  arising  or accruing".   The  learned  Law Lord  observed  "A  debt  has accrued to him (taxpayer) but income has not".  It is  clear that the case related to the meaning of the word "Income" as used  in  the  Ordinance  and can be  no  authority  on  the question  of the assessment of profits and gains  under  the Indian Income-tax Act.      The next case relied upon is Dewar v. Commissioners  of Inland Revenue(2).  In that case one of the executors be- (1) [1924] A.C. 508.    (2) [1935] 2 K.B. 351.                             266 came  entitled to a legacy which carried interest  for  such time  as  it  remained unpaid.  The  testator’s  estate  was sufficient  at all material times to enable interest  to  be paid  on the legacy but the legatee acting on the advice  of his  accountant  did  not  demand  the  legacy  or  interest thereon.   It was held that as the legatee had not  received interest,  there was no income in respect of which he  could be  charged  to  sur-tax.   The  decision  turned  upon  the language  of  Schedule D, clause 1, sub-clause  (b)  of  the English Income Tax Act of 1918, as distinguished from clause I  (a).   Clause I (a) deals with annual  profits  or  gains arising or accruing from any kind of property whatever...... but clause (b) imposes a tax in respect of "all interest  of money,  annuities and other annual profits." Lord  Hanworth. M.  R.  drew  the distinction between the  two  clauses  and observed that the case was one of interest of money and fell under  clause  (b)  and not under clause  (a).   Under  that clause the tax was limited.to any interest of money  whether the same is received and payable half-yearly or any  shorter or  more  distant period.  The learned Master of  the  Rolls observed:  "If the interest on the legacy in this  case  has not  arisen  to  the respondent, if he had  not  become  the dominus of this sum, if it does not lie to his order in  the hands  of  his agent, can it be said that it has  arisen  to him?  I think the answer definitely upon the facts must  be: No. it has not."      Lord  Maugham L. J. put the question thus: "I think  in the present case two circumstances may be accurately  stated in regard to the sum of pound 40,000 which it is said can be brought  into  charge.  The first is that the sum  of  pound 40,000  was not during the year of assessment a debt due  by the  executors to Mr. Dewar, and secondly, that the  sum  in question may never be paid or received at all."      The  case  of Commissioner of Taxes  v.  The  Melbourne Trust, Limited(1) turned on the construction of the charging (1)  [1914] A.C. 1001 267 section  in the Income Tax Act 1903 of Victoria,  whereby  a company was liable to pay tax upon the profits earned, in or derived  in or from Victoria...... In this case the  surplus realized  by the assessees over the purchase price  for  the assets  sold after making all just deductions was  taxed  as

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profit  but it was held that they were entitled to  hold  in suspense  part  of  the surplus realised  to  meet  possible losses on other assets and that under the circumstances  the profit  was  earned for the purposes of the  Act  only  when distributed to the share holders.     Having  considered  all these cases, we are  of  opinion that  neither  of them has any bearing upon  the  facts  and circumstances of the present case.    Lastly it was urged that the commission could not be said to  have  accrued, as the profit of the  business  could  be computed  only after the 31st March, and therefore the  com- mission  could  not be subjected to tax when it is  no  more than  a mere right to receive.  This argument  involves  the fallacy that profits do not accrue unless and until they are actually computed.  The computation of the profits  whenever it  may  take place cannot possibly be  allowed  to  suspend their  accrual.   In  the case of income where  there  is  a condition that the commission will not be payable until  the expiry of a definite period or the making up of the account, it  might be said with some justification, though we do  not decide it, that the income has not accrued, but there is  no such  condition in the present case.  Clauses 7 & 8  of  the agreement which relate to the payment of the commission  and the  calculation of the profits mean no more than this  that the  commission  will  be  quantified  only  after   certain deductions  had been made and not that the  commission  will not  accrue  until the profits have been  ascertained.   The quantification   of  the  commission  is  not  a   condition precedent to its accrual.  If the profits of the company are said to have accrued on the 31st of March, upon a parity  of reasoning,  it  must be conceded that  the  commission  also accrued  on the same date.  The date has as much to do  with the  accrual  of  the commission as it has to  do  with  the accrual of the profits.    It  was faintly suggested that the managing.  agency  was not  a  business  but  this  is  immaterial  for  income-tax purposes  because section 13 will apply to cases both  under sections 10 268 and 12, so we refrain from deciding the point.  We may, how- ever,  point  out in passing that in two cases  Tata  Hydro- Electric  Agencies,  Ltd.  v.  Commissioner  of   Income-tax Bombay(1) and Commissioner of Income-tax.  Bombay Presidency v. Tata Sons Ltd.(2) it was assumed that the managing agency is business but the point was directly decided in Inderchand Hari  Ram  v. Commissioner of Income-tax, U.P.  and  C.P.(3) that it is so.       For the foregoing reasons, we accept the view taken by Viswanatha Sastri J. and allow the appeals.  The  respondent shall  pay the costs of the Commissioner both in this  court and before the High Court.                                     Appeals allowed. Agent for the appellant: G. H. Rajaddhyaksha. Agent for the respondent: S. Subramanian.