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PETITIONER: MORVI INDUSTRIES LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX (CENTRAL)CALCUTTA

DATE OF JUDGMENT05/10/1971

BENCH: KHANNA, HANS RAJ BENCH: KHANNA, HANS RAJ HEGDE, K.S. GROVER, A.N.

CITATION:  1971 AIR 2396            1972 SCR  (1) 970  1972 SCC  (4) 451

ACT: Income-tax  Act, 1922, ss. 4(1)(b)(i)  and  10(2)(xv)-Income accrues’  when  it  becomes  due-Relinquishment  of   office allowance  and commission by managing agent after  they  had become  due on the ground that managed company had  suffered losses-Relinquishment   made after amounts had  become  due’ under  agreement but before they had become  payable-Amounts rightly  included in total income-Relinquished  amounts  not deductible  as expenses under s. 10(2)(xv) when  the  relin- quishment  is not for purpose of assessee’s business  or  on ground of commercial expediency.

HEADNOTE: The  appellant,  a limited company, was  managing  agent  of another  company.   Under  the terms of  the  agreement  the appellant  company was entitled to receive a  fixed  monthly sum as office allowance and commission at fixed rates on net profits  and  purchases and sales of cotton and  yarn.   The managed company’s accounting year closed on the 30th day  of December every year and that of the appellant company on the 30th day of June every year.  Under cl. 2(e) of the managing agency  agreement the commission was due on the 31st day  of December every year and it was payable immediately after the annual  accounts of the managed company bad been  passed  in the  General  meeting.  The Annual General meetings  of  the managed  company  were held to adopt the- accounts  for  the relevant accounting years on November 24, 1955 and July  21, 1956,  The  amounts of commission in terms of the  cl.  2(e) were thus ’due’ on 31st December 1954 and 31st December 1955 and were ’payable’ immediately after 24th November 1955  and 21st July 1956 respectively.  Since the managed company  had suffered  losses  in  the  preceding  years  the   appellant relinquished the commission as well as the office  allowance by resolutions of the Board of Directors dated April 4, 1955 and June 19. 1956.  On these dates the amounts of commission relinquished  had  become  ’due’  but  not  ’payable’.   The Income-tax Officer in making the assessments for the 1955-56 and  1956-57  did  not make any allowance  for  the  amounts relinquished  and included them in the total income  of  the appellant.   According to the Income-tax Officer the  office allowance-   had   been  relinquished  ex-gratia   and   the

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commission had been relinquished after it had accrued.   The Appellate Assistant Commissioner and the Appellate  Tribunal confirmed   the  order  of  the  Income-tax   Officer.    In ,reference  the  High Court held : (i) that the  accrual  of income  was  complete  within the  accounting  year  of  the managed  company  and  as no relinquishment  had  been  done before the amount became due, the case came within the ambit of s. 4(1)(b)(i) of the Income-tax Act, 1922, (ii) that  the relinquishment had not been made for the purpose of  facili- tating  the legitimate commercial undertaking or by  way  of commercial  expediency  and  the  case  was  not  then--fore covered by s. 10(2)(xv).  In ;appeal to this Court, HELD : (i) According to s, 4(1) (b) (i) of the- Act, subject to  the  provisions  of this Act the  total  income  of  any previous year of any person includes all income profits  and gains from whatever source derived which if such a person is resident in the taxable territories during 971 such  year accrue or arise of the deemed to accrue or  arise to him in the taxable territories that year. The  dictionary meaning  of  the word ’accrue’ is to come as  an  accession, increment,  or produce; to fall to one by way of  advantage; to fall due.’ The income can thus be said to accrue when  it becomes due.  The postponement of the date of payment has  a bearing only in so far as the time of payment is  concerned, but  it does not affect the accrual of income.   The  moment the income accrues, the assessee gets vested with the  right to  claim  that amount, even though it may  not  be  payable immediately.  There also arises a corresponding liability of the other party from whom the income becomes due to pay that amount.  The further facts that the amount of income is  not subsequently received by the assessee would also not detract front or efface the accrual of the income, although the non- receipt  may,  in appropriate cases, be a valid  ground  for claiming deductions.  The accrual of an income is not to be equated  with  the  receipt of the income.   That  the  two, accrual  and receipt of income, have different  connotations is also) clear from the language of s. 4 of the Act.  Clause (a) of sub-s.’(1) of s. 4 of the Act deals with the receipts of  income while the accrual of income is dealt with in  cl. (b) of that sub-section.. [975 B-E] In  the present case the accounts of the  appellant  company were  maintained on a mercantile basis.  Under  this  system the  profits and gains are credited though  not  immediately realised, and the entries thus made really show nothing more than  an  accrual  or arising of the said  profits,  at  the material  time.  Further, 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.  [975 G-H; 976 E] Indermani  Jatia V. C.I.T., U.P., 35 I.T.R. 298 and  C.I.T., Bombay  City I v. M/s.  Shoorji Vallabhdas & Co., 46  I.T.R. 144, applied. (ii) The  appellant  could claim deduction  of  the  amounts under s.  10(2)(xv)   of   the  Act  if  the   amounts   had represented  an expenditure laid out or expended wholly  and exclusively  for the business of the, appellant.  There  was however  nothing to show that the amounts were  relinquished for    the purpose of the appellant’s business or on  grounds of commercial expediency.  The High Court therefore  rightly rejected the claim under s. 10 (2) (xv)[976 F-G]

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JUDGMENT: CIVIL  APPELLATE JURISDICTION: Civil Appeals Nos.  2093  and 2084 of 1970. Appeals from the judgment and order dated January 28, 1964 of  the Calcutta High Court in Income-tax Reference No.  104 of 1960. B.   P. Maheshwari, for the appellant (in both the appeals). S.T.  Desai,  P. L. Juneja and R. N.  Sachthey,  for  the respondent (in both the appeals). The Judgment of the Court was delivered by Khanna,J.  This judgment would dispose of two Civil Appeal.s Nos.  2083  and  2084  of 1970  which  have  been  filed  on certificate 972 granted by the Calcutta High Court and are directed  against the Judgment of that Court whereby it answered the questions referred  to  the Court under Section 66(1) of  the,  Indian Income-tax  Act, 1922 (hereinafter referred to as  the  Act) for two assessment years against the assessee-appellant  and in favour of the respondent. The assessee is a Limited Company and the matter relates  to the assessment years 1956-57 and 1957-58, the  corresponding accounting  years for which ended on June 30, 1955 and  June 30, 1956 respectively. The appellant Company was appointed as the Managing Agent of Shree Ramesh Cotton Mills Ltd., Morvi (hereinafter  referred to  as the managed company), as per agreement  dated  30-12- 1946.   The  managed company was a 100%  subsidiary  of  the appellant  company.  Under the terms of the  agreement,  the appellant  company  was entitled to receive a  fixed  office allowance of Rs. 1,000/- per mensem plus a commission at the rate of 121/2% of the net profits, an additional  commission of 1 % on all purchases of cotton and an equal amount on all sales of cloth and yarn.  In the relevant years, the managed company  suffered  losses  and  congruently  the  commission payable  at  121/2%  of  the net profits  was  nil  but  the commission  on purchase of cotton at the rate of 1 1/2%  and on  sales of cloth and yarn at the same rate, aggregated  to Rs. 38,719/- for the assessment year 1956-57 and Rs. 1,963/- for   the  following  year.   Besides  these  amounts,   the appellant was entitled to Rs. 12,000/- per annum for each of the two years as fixed office allowance.  The total  amounts which the appellant was entitled to receive from the managed company  were  Rs.  50,719/- and Rs. 13,963/-  for  the  two years. The managed company’s accounting year closed on the 30th day of  December and that of the appellant company on  the  30th day of June every year.  Clause 2(e) of the Managing  Agency Agreement dated 30th ember 1946 contained the following term as to when the commission would be due and payable               " (e) The said commission shall be due to  the               Agents  yearly  on  the  thirty-first  day  of               December  or  any  other  date  on  which  the               Company’s  yearly  account close in  each  and               every  year  during the  continuance  of  this               Agreement  and  shall be payable and  be  paid               immediate  after annual accounts of  the  said               Company  has  been  passed  by  the  Board  of               Directors  and Auditors of the Company and  by               the company in, General Meeting". According to the above clause, the commission was due on the 31st  day  of December every year and it was  payable  imme- diately after the annual accounts of the managed company had 973 been  passed  in the General Meeting.   The  Annual  General

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Meetings  of  the  managed company were held  to  adopt  the accounts   on   November,  24,  1955  and  July   21,   1956 respectively   with  regard  to  the  assessment  years   in question.   The amounts of commission in terms of the  above clause were "due" on 31st December, 1954 and 31st  December, 1955  and  were  "payable " immediately after  the  24th  of November, 1955 and 21st of July, 1956 respectively. The  appellant  company  relinquished  the  managing  agency commission for the assessment year 1956-57 as per resolution dated  4th of April, 1955 of the Board of Directors and  for the following year as per resolution dated 19th June,  1956. The  amounts of the commission were thus relinquished  after they  had  become "due" but before they  were  "payable"  in terms  of  clause 2(e) of the agreement.  On behalf  of  the appellant,  it was stated that the managed company had  been suffering heavy losses in the past years and, therefore, the appellant   did  not  consider  it  proper  to  charge   any commission   or   the  fixed  office,  allowance   and   had consequently relinquished the same. The Income-tax Officer included the sums of Rs. 50,719/- and Rs.  13,963/- in the total income of the appellant  for  the two  assessment years in question.  The  Income-Tax  Officer took  the view that in so far as the fixed office  allowance was concerned, it had been given to the appellant to  enable it to recoupe the expenses incurred on behalf of the managed company  and  the  relinquishment was,  therefore  made  ex- gratia.   As regards the commission, the Income-tax  officer held  that it had become due to the appellant at the end  of the  accounting  year  of the managed company,  and  if  the commission had been foregone after it had become due, it was taxable   on   accrual  basis.   The   Appellate   Assistant Commissioner and the Income-tax Appellate Tribunal  affirmed the  order  of  the Income-tax Officer.   According  to  the Tribunal, the commission became due to the appellant  yearly on  the  last  day of the accounting  year  of  the  managed company,  though the actual payment was deferred to a  later date.  Postponement of the actual payment after the  income had  accrued was held to be inconsequential.  Likewise,  the relinquishment of the income after it had become due in  the opinion of the Tribunal, was inconsequential.  Claim was ten made by the appellant that the amount relinquished should be treated  as a permissible expenditure under  section  10(2) (xv)  of the Act.  The above claim was rejected and  it  was observed that the total loss carried over at the end of year 1955  of  the  managed company was Rs.  14,95,221/-.   As  a result  of  foregoing  the amounts of  the  managing  agency commission,   according  to  the  Tribunal,  the   financial position of the managed company did not 974 become  stronger while that of the appellant company  became weaker.  The relinquishment was consequently held to be  not for the benefit of-the appellant. At the instance of the appellant, the Tribunal referred  the following two questions to the High Court :-               "  (1)  Whether  on  the  facts  and  in   the               circumstances  of  the case, the sums  of  Rs.               50,719/-   and  Rs.  13,963/foregone  by   the               assessee by its Directors’ resolution dated 4-               4-1955 and 19-6-1956 respectively, were liable               to  be  included in its total income  for  the               accounting  years ending 30-6-1955  and  30-6-               1956 ?"               "(2) If the answer to question No. 1 be in the               affirmative, whether the assessee is  entitled               to claim an allowance of an equivalent  amount

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             as expenditure under the provisions of Section               10 (2) (xv) of the Indian Income Tax Act ?" The  High Court agreed with the view taken by the  Tribunal. It  was  observed that the accrual of  income  was  complete within the accounting year of the managed company and as  no relinquishment  had been done before the amount became  due, the case strictly came within the ambit of section 4 (1) (b) (i)  of  the  Act.   ’no  relinquishment,  it  was   further observed, was a unilateral act of the appellant.  As regards the   second  question,  the  High  Court  found  that   the relinquishment  had  not  been  made  for  the  purpose   of facilitating the legitimate commercial undertaking or by way of  commercial  expediency.  The appellant’s case  was  thus held to be not covered by section 10(2) (xv) of the Act, Mr. Maheshwari has assailed the findings of the High  Court. Regarding  the first question, the learned counsel  contends that  as the amounts in question were never received by  the appellant   but  were  relinquished,  there  arose  no   tax liability   for  those  amounts.   As  regards  the   second question, Mr. Maheshwari submits that the relinquishment  of the  amounts should be construed as permissible  expenditure under  section  10(2)  (xv) of the Act.  There  is,  in  our opinion, no substance in any of the above contentions. So  far  as the first question is concerned,  we  find  that according  to clause 2(e) of the Managing  Agency  Agreement reproduced  above,  the  commission for  the  two  years  in question  became  due to the appellant on the  31st  day  of December,  1954  and  31st  day  of  December,  1955.    The appellant  also  became  entitled to  receive  fixed  office allowance  of Rs. 12,000/- for each of the two  years.   It, therefore,  can be said that the income of Rs. 50,719/-  had accrued to the appellant on 31st December, 1954 and of 975 Rs. 13,973/- on 31st December, 1955.  The fact that the pay- ment  of  the managing agency commission was  deferred  till after  the accounts had been passed in the meetings of.  the managed company did not affect the accrual of the income  of those  amounts  on December 31, 1954 and December  31,  1955 respectively.   According  to Section 4 (1) (b) (i)  of  the Act, subject to the provisions of this Act, the total income of  any  previous year of any person  includes  all  income, profits and gains from whatever source derived which if such person  is resident in the taxable territories  during  such year accrue or arise or are deemed to accrue or arise to him in the taxable territories during such year.  The dictionary meaning  of the word "accrue" is "to come as  an  accession, increment, or produce : to fall to one by way of advantage : to fall due".  The income can thus be said to accrue when it becomes due.  The postponement of the date of payment has  a bearing only in so far as the time of payment is  concerned, but  it does not affect the accrual of income.   The  moment the income accrues, the assessee gets vested with the  right to  claim  that  amount even though it may  not  be  payable immediately.  There also arises a corresponding liability of the other party from whom the income becomes due to pay that amount.   The further fact that the amount of income is  not subsequently received by the assessee would also not detract from or efface the accrual of the income, although the  non- receipt  may,  in appropriate cases, be a valid  ground  for claiming deductions.  The accrual of an income is not to  be equated  with  the  receipt of the income.   That  the  two, accrual  and receipt of income, have different  connotations is  also  clear from the language of Section 4 of  the  Act. Clause (a) of sub-section (1) of Section 4 of the Act  deals with  the receipt of income while the, accrual of income  is

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dealt with in clause (b) of that sub-section. The appellant-company admittedly was maintaining its account according  to the mercantile system.  It is well known  that the  mercantile system of accounting  differs  substantially from  the  cash  system of book  keeping.   Under  the  cash system,  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 are immediately debited even before the amounts  in question are actually disbursed.  Where accounts are kept on mercantile  basis, the profits or gains are credited  though they  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 976 with regard to debits made. [See Indermani Jatia V.  Commis- sioner of Income-Tax, U.P. (1)] In the case of Commissioner of Income-Tax, Bombay City I  v. Messrs Shoorji Vallabhdas and Co.(2) Hidayatullah, J (as  he then was) speaking for the Court observed,: "Income-tax is a levy on income.  No doubt, the Income-tax 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". The  assessee  firm,  who  was the  managing  agent  of  two shipping companies in that case, gave up 75% of the managing agency  commission  with a view to get the  managing  agency transferred to two private companies.  It was held that this was  not  a case of a gift by the assessee  to  the  managed companies of a portion of income which had already  accrued, but an agreement to receive a lesser remuneration than  what had  been agreed upon.  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. Coming  to  the second question we find that  the  appellant could  claim  deduction of the amounts under  section  10(2) (xv)  of’  the  Act  if  the  amounts  had  represented   an expenditure laid out or expended wholly and exclusively  for the  business of the appellant.  There is, however,  nothing to show that the amounts  were relinquished for the purpose of  the  appellant’s business.  The present is  not  a  case wherein  the  amounts due to the assessee were given  up  on grounds  of  commercial  expediency  or  for  advancing  the business  interest of the assessee.  The conclusion  of  the learned  Judges  of the High Court in this respect,  in  our opinion, is well founded. The  result is that the appeals fail and ire dismissed  but, in the circumstances, without costs.                   Appeals dismissed. G. C.

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(1)  35 I.T.R. 298. (2)  46 I.T.R. 144. 977