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PETITIONER: COMMISSIONER OF INCOME TAX, KANPUR

       Vs.

RESPONDENT: U.P. STATE INDUSTRIAL DEVELOPMENT CORPORATION

DATE OF JUDGMENT:       11/04/1997

BENCH: S.C. AGRAWAL, G.T. NANAVATI

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T  S.C. AGRAWAL , J.:-      These appeals, by certificate granted under section 261 of the Income Tax Act, 1961 (hereinafter referred to as ’the Act’), have  been filed  by the Revenue against the judgment of the  Allahabad High  court dated  June 30, 1980 in Income Tax References Nos. 31 and 137 of 1976. By the said judgment the High  Court has  answered the following question against the Revenue  and in  favour of  the  U.P.  state  Industrial Development corporation  (hereinafter referred  to  as  "the assessee"):-      "Whether on  the facts  and in  the      circumstances  of   the  case,  the      Tribunal was  justified in  holding      that under  writing  commission  in      the case  of  shares  held  by  the      assessee itself   and  not actually      subscribed by  others was  reducing      the cost of the shares in the hands      of  the   assessee  and   was   not      separately taxable as the assessee"      income of that year ?"      The references  relate to  the assessment years 1970-71 and 1971-72.      The assessee  is a  state   undertaking. Its shares are wholly subscribed by the state of Uttar Pradesh. It has been incorporated with the object of developing industries in the state of   Uttar  Pradesh and  with  that  end  in  view  it finances industrial  project or  enterprises, whether  owned firm or  individuals etc.  one of  the clauses for financing the companies by the assessee was that on the shared of such companies as well as brokerage on the sale of shares of such companies and  in case the shares of such companies were not subscribed by  the public  in to the assessee was obliged to underwriting commission  and brokerage in the same manner as if the  shares of  such companies  were  subscribed  by  the public. The  method adopted by the assessee was that instead of crediting  the underwriting  commission and  brokerage to its profits  and loss  account in the case of such companies the shares  of which  had to  be subscribed  by the assessee

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itself, it  used to reduce the cost of the shares held by it as stock-in-trade,  During the previous year relevant to the assessment year  1971-71 the  assessee had  earned by way of underwriting  commission   a  sum   of  Rs.  1,01,250/-  and brokerage to  the extent  of Rs.33,719/-  while the assessee offered a  sum of Rs. 12,535/- out of the aforesaid receipts as its  taxable income. In the previous year relevant to the assessment year  1971-72  the  assessee  earned  by  way  of underwriting  commission   and  brokerage   a  sum   of  Rs. 1,15,000/- and  no part  of it  was included  in its taxable income. While  making the  assessment the Income Tax officer added the  entire amount  received by the assessee by way of underwriting commission  and brokerage  as part  of  taxable income  for   both  the   assessment  years.  The  Appellate Assistant  commissioner,  however,  held  that  underwriting commission was  assessable as  assessees" income in the year in which  it  accrues,  i.e.;  in  the  year  in  which  the underwriting agreement was made. But as regards brokerage he held that  brokerage on  the shares  held  by  the  assessee was not  includable in  the income of the assessee and  that it had  to be adjusted against the cost of the shares taken. The  assessee  filed  appeals  against  the  orders  of  the Appellate  Assistant  commissioner  before  the  Income  Tax Appellate  Tribunal   (hereinafter  referred  to  as  "  the Tribunal") .  The Revenue  did not question the order of the Appellate Assistant  commissioner regarding  brokerage.  The Tribunal held that the underwriting commission in respect of the shares  held that the underwriting commission in respect of the shares held by the assessee would reduced the cost of the shares  and would  not be  separately assessable  as the assessees" income. The Tribunal has observed:-      "And  this  difference  by  way  of      commission and brokerage is charged      by  the   underwriter  because   it      agrees to  subscribe  for  a  large      amount  of   the  capital   of  the      company. As  such  whatever  amount      the    underwriter     earns     as      underwriting  commission,  it  does      not   automatically    become   its      income.  is  postponed  unless  the      risk of  taking or  not taking  the      shares is  over. If  the shares are      fully subscribed,  the  institution      gets   commission,    event,    the      commission    earned     by     the      corporation is  loss account of the      assessee.  But,   if  the  assessee      subscribes some  share out  of  the      underwritten shares, the commission      relating  to   those  shared   goes      towards the cost and, therefore, no      income    is    earned    by    the      underwriter."      After  referring   to  various  books  on  accountancy, namely,  Accountancy  by  William  Ribbles,  3rd  Edn.  page 1144(Chapter XXVI);  Booking keeping  and Accounts by Ernest Even Spicer  and Ernest  C. Pagler,  10th  Edn.,  page  650; Dicksee’s Auditing, 17th Edn., page 279; and Auditing Theory and practice  bu R.K.  Montogomri, 2nd  Edn., pages 215-216, the Tribunal  has held  that the  underwriting account  is a part of profit and loss account, which includes not only the income from  underwriting commission  and brokerage  but the same is  debited by  the expenses  and the  cost of  shares, which the  underwriting is  called upon  to take and as much

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underwriting   commission    could   not   be   taken   into consideration leaving aside the other items of this account. Account is  taken into  consideration, the practice followed by  the   assessee  to   first  adjust   the  brokerage  and underwriting commission  towards the  cost  of  the  shares. which  are   underwritten  by  it  but  the  commission  and brokerage earned on shares not subscribed by it are taken to the profit  and loss account, was absolutely correct and was in accordance  with accountancy principles and , since there is no  contrary provision in the Act, the system followed by the assessee  must be  respected. At  the  instance  of  the Revenue   the    Tribunal   has    referred   the   question abovementioned for the opinion  of the High Court.      The references  were considered by the High Court along with Income  Tax Reference  No. 37  to 1976  relating to the assessment years  1966-66, 1966-67,  1967-68,1969-70 wherein also similar  question had  been referred for the opinion of the High  Court. The  High Court agreed with the view of the Tribunal and  has held  that the  commission earned  by  the assessee as  underwriter in respect of the shares offered by the company and purchase by the public, would undoubtedly be the profit and loss account, but so far as the shares agreed bu the  assessee to  be underwritten and purchased by it are concerned, the  transaction  in  substance  results  in  the assessee purchasing  those shares  for a consideration which is equal  to the  face value of the shares as reduced bu the amount of  commission and  brokerage and in such a case, the amount of  commission and  brokerage and in such a case, the amount of  underwriting commission and brokerage merely goes to  reduce  the  value  of  the  shares  and  it  cannot  be considered to be the income of the assessee. The High Court, however, felt  that the  question whether  the  underwriting commission in  relation to  shares which the assessee itself subscribed as  underwriter went  to reduce the cost of those shares or  whether such  underwriting  commission  could  be taxed as  an income  is a  substantial question  of  law  of general importance and, therefore, it granted certificate of fitness for  appeal to  this Court  under section 261 of the Act. Hence these appeals.      In the  case  of  public  companies,  when  shares  are offered to  the public for subscription, it is usual to make certain of  obtaining the  necessary capital  by having  the shares underwritten.  The word  "underwriting " means that a persons  agrees   to  take   up  shares   specified  in  the underwriting agreement  if the  public or other persons fail to subscribe  for them.  The consideration for this contract takes the  form of  commission for  this contract  takes the form of  payment of  commission". Underwriters are thus paid for the  risk they expose themselves to in placing of shares before the  public. Under  section 76  of the companies Act, 1956.      The question  that falls  for consideration  is whether the underwriting commission in respect of shares which could not be  subscribed by  the public and had to be purchased by the assessee  has to  be  regarded  as  the  income  of  the assessee of  it goes towards reducing the cost of the shares so purchased. In the accounts maintained by the assessee the underwriting commission  is first  adjusted towards the cost of the  shares that  are  underwritten  and  thereafter  the commission on shares not subscribed by the assessee is taken to the  profit and loss account. The Tribunal has found that the said practice followed by the assessee was in consonance with  principles   of  accountancy   governing  underwriting account. The  Tribunal,  after  referring  to  authoritative books  on   Accountancy,  has  held  that  the  underwriting

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commission is  a part  of  profit  and  loss  account  which includes not  only the  income from  underwriting commission and brokerage  but the  same is  debited by the expenses and the cost  of shares, which the underwriter is called upon to take and  as such underwriting commission could not be taken into consideration  leaving aside  the other  items of  this account  and,  therefore,  the  underwriting  commission  in respect of  the assessee. The High Court has agreed with the said view of the Tribunal.      The  main  contention  urged  by  the  learned  counsel appearing for the Revenue in support of the appeals was that the entitlement  to reduction  is  to  be  governed  by  the provisions of law and not by the accounting practice adopted by the assessee and in support of his submission the learned counsel has placed reliance on the decision of this Court in Kedar Nath  Jute Manufacturing  Company v.  Commissioner  of Income Tax,  (1971) 82  ITR 363;  Morvi Industries  Ltd.  v. Commissioner of  Income Tax, (1971) 82 ITR 835, and state of Tranvancore v.  Commissioner of  Income Tax,  (1986) 158 ITR 102.      In our opinion, this contention is devoid of force. The accounting practice  followed by the assessee in the instant case  was   in  consonance   with  general   principles   of accountancy governing  underwriting accounts.  It is  a well accepted proposition  that "for the purposes of ascertaining profit and  gains  the  ordinary  principles  of  commercial accounting should  be  applied,  so  long  as  they  do  not conflict  with   any  express   provision  of  the  relevant statute". [See:  Whimster &  co. v.  commissioners of Inland Revenue, 12  T.C. 813;  Commissioner of  Inland  Revenue  v. Cock, Russell  & Co. Ltd. 29 T.C. 387]. This proposition has been affirmed  by this  court in  P.M. Mohammed Meerakhan v. commissioner of  Income Tax,  Kerala, (1969)  73 ITR 735. In the said case it has observed:-      "For that  purpose it  was the duty      of the  income Tax  officer to find      out what  profit the  business  has      made   according    to   the   true      accountancy practice."[P.743]      The decisions  on which reliance has been placed by the learned counsel  for the  Revenue do  not depart  form  this principle.      In   Kedar   Nath   Jute   Manufacturing   Company   v. Commissioner  of   Income  Tax   (supra)  this   court   was considering the  question whether  the amount  of sales  tax paid or payable by the assessee is an expenditure within the meaning of  section 10(2)  (xv) of the Income Tax Act, 1922. The said  claim of the assessee was disallowed by the Income Tax officer  on the  ground that  the assessee was following the  mercantile  systems  of  accounting  and  had  made  no provision in  its books  with  regard  to  payment  of  that amount. Upholding the claim of the assessee for deduction of the said  amount, this  court  has  held  that  whether  the assessee is  entitled to  a particular deduction or not will depend on  the provision  of law relating thereto and not on the view  which the  assessee might  takes of his rights nor can the  existence or  absence of  entries in  the books  of account be  decisive or  conclusive in  the matter.  In this case the  question whether the principles of accounting have to be taken into account for ascertainment of profit did not fall for consideration.      The decision  in Morvi  Industries Ltd. v. commissioner of Income Tax (supra) also does not deal with this question. In that  case this  court has  explained the  meaning of the word" accrued"  used in  section 4(1)  (b) (i) of the Income

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Tax Act,  1922 and  has observed  that income can be said to have accrued when it becomes due and the postponement of the date of  payment has  bearing only so far as time of payment is concerned but it does not affect the accrual of income.      State of  Tranvancore V.  Commissioner  of  Income  Tax (supra) was  a case  where  the  assessee-Bank,  instead  of carrying the  interest on  sticky advances,  i.e.,  advances which had  become extremely  doubtful of  recovery,  to  the profit and  loss account,  had credited  it  to  a  separate account called  the Interest Suspense Account’. The question was whether  the said  interest was taxable. Tulzapurkar J., in his dissenting judgment held that the said income was not an  income  and  was  taxable  and  observed  that  even  in mercantile system  of accounting  it is  only the accrual of real income  which is  chargeable to  tax and  accrual is  a matter of  substance to  be decided on commercial principles having regard  to the  business character of the transaction having regard  to the business character of the transactions and the  realities and  specialities of  the  situation  and cannot be  determined by  adopting a  purely theoretical  or doctrinaire or doctrinaire or legalist approach. The learned Judge has  referred to standard text books on accountancy to show that  in case  of interest on sticky loans the practice of debiting  the accounts  of  the  concerned  debtors  with interest and  carrying the same to Interest suspense Account instead of  the interest  account or profit and loss account is well  recognised  and  accepted  practice  of  commercial accountancy which  is wholly  consistent with the mercantile system of accounting. Sabyasachi Mukharji J. (as the learned chief Justice  then was), however, held that the interest on sticky advances  had accrued  according  to  the  mercantile system of  accounting because  the assessee-Bank had debited the respective  parties with  the interest,  which it  could have, as  a bad  debt, did  not offer  it for  taxation  but carried  it  to  the  Interest  suspense  Account  and  that carrying a  certain amount  which had  accrued  as  interest without treating  it as a bad debt or irrecoverable interest but keeping  it in suspense account was repugnant to section 36(1) (iii)  read with section 36(2) of the Act. The learned Judge,  after   taking  note  of  the  recognised  books  on accountancy to  which reference had been made by Tulzapurkar J., observed:-      "Even if  in a  given circumstance,      the  amounts   may  be  treated  as      interest   suspense   account   for      accountancy purpose, that would not      affect the  question of  taxability      as such. This must be determined by      well-settled legal  principles  and      principles  of   accountancy  which      have     been      referred      to      hereinbefore".      Ranganath Mishra  J.(as the  learned chief Justice then was )  concurred with reasonings and conclusions of Mukharji J.   The aforementioned  observations of  Mukharji  J.  also postulate that  for determining  the question  of taxability well settled  legal principles  as  well  as  principles  of accountancy have  to be taken into account. In that case the learned Judge  held that  without treating  the amount which had accrued  as interest  as a  bad  debt  or  irrecoverable interest but  keeping it in suspense amount was repugnant to section 36(1)(vii)  read with  section 36(2) of the Act and, therefore, even if the amount might be taken to the Interest Suspense Account  for accounting  Purposes, that  would  not affect its taxability as such.

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    In the  present case,  the Tribunal, after referring to authoritative books  on  Accountancy,  has  found  that  the assessee  was   maintaining  the   accounts   correctly   in accordance with  the principles of accountancy applicable to underwriting  accounts   and  keeping   in  view   the  said principles the  underwriting commission  on the shares which were not  subscribed by the public and were purchased by the assessee could  not be  treated  as  profit  earned  by  the assessee in  the transaction  and the  said commission could only  be  treated  as  reducing  the  price  of  the  shares purchased by the assessee. The Tribunal has also stated that there is  no contrary  provision in  the  Act.  The  learned counsel for  the Revenue  has not shown that the accountancy practice followed  by  the  assessee  is  repugnant  to  any provision of  the Act. In the circumstances, it must be held that the  Tribunal has not committed any error in taking the view that the underwriting commission earned by the assessee in respect  of the  shares which  were not subscribed by the public and  were purchased  by the  assessee  could  not  be treated as  a part  of  its  taxable  income.  The  question referred was,  therefore, rightly answered by the High Court against the Revenue and in favour of the assessee.      As a  result, the  appeals  fail  and  are  accordingly dismissed. No order as to costs.