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PETITIONER: RAJA MOHAN RAJA BAHADUR

       Vs.

RESPONDENT: THE COMMISSIONER OF INCOME-TAX, U.P.

DATE OF JUDGMENT: 06/04/1967

BENCH: SHAH, J.C. BENCH: SHAH, J.C. SIKRI, S.M. RAMASWAMI, V.

CITATION:  1968 AIR  114            1967 SCR  (3) 482

ACT: Income-tax-Assessee  maintaining  accounts  on  cash  basis- Obtaininig  decree for repayment of loan made to  debtor  to whom  U.P.  Encumbered Estates Act,  1934  applied-Receiving interest in loan in U.P. Encumbered Bonds-Whether  amounting to receipt of income on date when bonds received.

HEADNOTE: The  appellant,  a Hindu undivided family,  carried  on  the business  of. money-lending and maintained its  accounts  on cash  basis.  After the appellant had obtained a decree  for the recovery of a loan made to a debtor, the latter obtained an  order under the U.P. Encumbered Estates Act 25 of  1934, applying  the  provisions of the Act to  him.   The  Special Judge, Sultanpur, thereafter passed an order for payment  of the  principal sum and interest to the appellant.   Pursuant to  this order the appellant received in 1946 an  amount  in cash  from  the  debtor  and  for  the  balance  the   State Government  gave  to the appellant U.P.  Encumbered  Estates Bonds.    While  the  cash  amount  received  in  1946   was appropriated by the appellant towards the principal due,  he split up the amount of the face value of the bonds into  two sums and credited one amount in the books of account towards the balance of principal and the other amount to an  account styled  as "interest accrued".  In submitting the return  of the  taxable  income for the assessment  year  1948-49,  The appellant  did  not  disclose any -receipt  of  income  from interest  due  on the loans advanced to the debtor  and  was duly  assessed  to tax on the income disclosed by  him.   In October  1948 the appellant sold the bonds and disclosed  in the  return  for the assessment year  1949-’50  as  interest received  during the year of account the difference  between the amount realised by sale of the bonds and the amount  due as principal.  The Income-tax Officer issued a notice  under s.  34(1)(a) of the Income-tax Act, 1922 and brought to  tax the  amount disclosed by the appellant as escaped income  of the previous year relevant to the assessment year 1948-49. This   order  was  confirmed  by  the  Appellant   Assistant Commissioner  as well as by the Tribunal.  The  High  Court, upon a reference, also held in favour of the respondent. In  appeal to this Court it was contended on behalf  of  the

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appellant  that  the accounts maintained  by  the  appellant being, on cash basis until the appellant realised the  value of  the bonds, no interest was received by him; that when  a trader  maintains  accounts on cash basis,  the  receipt  of money  alone  can be taken into account in  determining  the taxable  income.  It was contended in the  alternative  that the  bonds  issued by the Government merely  amounted  to  a fresh promise by an agent of the debtor to pay the amount of the  bonds  in  instalments  and  by  receiving  the   bonds incorporating such a promise, no money or money’s worth  was received by the creditor. HELD  : Dismissing the appeal; the Encumbered Estates  Bonds were  by operation of the statute received by the  appellant in  satisfaction pro tanto of the liability of  the  debtor. They  were a fresh security. the liability of  the  original debtor was substituted by an obligation undertaken 483 by the State : the bonds were convertible in terms of  money :  income was therefore received by the appellant  when  the bonds were received. Where  the accounts are maintained on cash basis receipt  of money  or  money’s  worth and not accrual of  the  right  to receive is the determining factor.  Therefore, if commercial assets are received by a trader maintaining accounts on cash basis  in  satisfaction of an obligation,  income  which  is embedded  in  the  value  of the  assets  is  deemed  to  be received;  the  receipt of income is not deferred  till  the asset  is realised in terms of cash or money.  It  makes  no difference whether the receipt of assets is in pursuance  of an  agreement  or  that the trader is compelled  by  law  to accept the assets from the debtor.  Once title of the trader to  an  asset  received is complete  whether  by  consensual arrangement or by operation of law, he receive-, the  income embedded in the value of the asset,.,,. [486D-F] Californian Copper Syndicate (Limited and Reduced) v. Harris (Survevor of Taxes), 5 T.C. 159, referred to. Although the Government had the right to recover the  amount due  tinder the bonds from the land-holder, it did  not,  on that  account,  become  the agent  of  the  land-holder  for payment  of his dues.  Even if the Government was unable  to recover  the  money  from  the  land-holder,  the  liability undertaken by it Linder the bond remained unimpaired. [487C- D] Cross  (H.  M. Inspector of Taxes) v. London and  Provincial Trust Ltd. 21 T.C. 705, distinguished. What was taxable was only that income which represented  the difference  between  the  amount due as  principal  and  the market value of the bonds, it the date of receipt. [488E-F]

JUDGMENT: CIVIL  APPELLATE  JURISDICTION : Civil Appeal  No.  1395  of 1966. Appeal  from the judgment and decree dated July 10, 1962  of the Allahabad High Court in Income-tax Reference No. 445  of 1959. Bishan Narain and Govind Sarall Singh, for the appellant. T. V. Viswanath lyer, R. Ganapathy Iyer, S. P. Nayyar for R.   N. Sachthey, for the respondent. The Judgment of the Court was delivered by Shah, J. The appellant, a Hindu undivided family, carries on the business of money-lending, and maintains its accounts on cash .basis.  The appellant commenced an action in the Civil Court  for  a decree for recovery of Rs. 2,58,000/-  due  by

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Nisar Ahmad Khan, Taluqdar of Mohana Estate.  The action was carried to the  Judicial Committee of the Privy Council  and was  ultimately decreed in favour of the  appellant.   Nisar Ahmad  Khan then obtained under the U.P. Encumbered  Estates Act  25 of 1934 an order applying the provisions of the  Act to  him.  The Special Judge, Sultanpur passed an  order  for payment of Rs. 5,00,992/- to the appellant.  Pursuant to the order  the appellant, received in 1946 Rs.  1,54,692/-  from the debtor and for the balance the Government of the  United Provinces gave to the appealant Encumbered Estates bonds  of the face value of Rs. 3,46,300/-.  The amount 484 received in the year 1946 was appropriated by the  appellant towards  the  principal  due.  The appellant  split  up  the amount  of the face value of the bonds into two sums of  Rs. 2,22,097/9/11  and Rs. 1,24,202/6/1, and credited the  first amount  in  the  books of -account towards  the  balance  of principal  and  the  second  amount  to  an  account  styled "Interest Accrued".  In submitting the return of his taxable income  for the assessment year 1948-49 the  appellant  .did not disclose any receipt of income from interest due on  the loans advanced to Nisar Ahmad Khan.  The appellant was  duly ,assessed to tax on the income disclosed by him.  In October 1948  the  appellant sold the Encumbered Estates  bonds  and realized a total sum of Rs. 3,21,600/-, and disclosed in the return for the ,assessment year 1949-50 as interest received during the year of account the difference between the amount realized  by  sale  of  the bonds  and  the  amount  due  as principal.  The Income-tax Officer issued a notice under  S. 34(1)(a) of the Indian Income-tax Act and brought to tax the difference  between  the face value of the  bonds  :and  the amount  due as principal as escaped income of  the  previous year relevant to the assessment year 1948-49.  The order was confirmed  by the Appellate Assistant Commissioner  and  the Income-tax Appellate Tribunal.  The Tribunal then  submitted three questions to the High Court of Judicature at Allahabad of which the following were canvassed before us               "(2) Whether, the receipt of Encumbered Estate               Bonds   during  the  previous   year   1947-48               amounted  to  receipt  of  cash  during   that               previous year and not during the previous year               1948-49  when the Bonds were in fact  sold  at               less than their face value ?               (3)   Whether  in  the  circumstances  of  the               case,  the  mere  receipt  of  the  Encumbered               Estate  Bonds  was tantamount  to  receipt  of               income assessable in the year 1948-49 ?" The  High Court answered the questions in  the  affirmative. Against   the   order  passed  by  the  High   Court,   with certificate, the appellant has appealed to this Court. The scheme of the U.P. Encumbered Estates Act 25 of 1934 and the  form  of  the  bonds  issued  in  satisfaction  of  the liability  of the debtors may be briefly summarised.   Under the U.P. Act.a "landlord" may apply to the Collector stating the  amount of his debts and requesting that the  provisions of the Act be applied to him.  The Collector entertains  the petition  and  transfers  it  to  the  Special  Judge.   The landlord then submits a written statement giving the list of his  creditors  and  the list of his  assets.   Notices  are published by the Special Judge and the creditors are  called upon  to  submit their written claims.  On  the  claims  for debts secured or unsecured duly proved, simple money decrees are passed in 485 favour of the creditors.  The Special Judge then  determines

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the properties belonging to the landlord and prepares a list of the properties and a list of the debts adjudged to be due by  the landlord ranking the same in order of  priority  and then  sends the decrees to the Collector for execution.   If the  amount  due by the debtor is less than  the  instalment value  of his proprietary rights in land, the  Collector  is enjoined  to  direct the landlord to pay with  land  revenue dues such amount to the Provincial Government in instalments with future interest at a rate determined by the  Provincial Government.   If the Collector has proceeded under s. 27  he has  to  give  to  each creditor a  bond  or  bonds  bearing interest  at the prescribed rate for the amount due  to  him payable  in  instalments within a period  not  exceeding  20 years.  The form of the bond is as follows               "The  Governor of the United Provinces  hereby               promises to pay to or order at any Treasury in               the   United  Provinces  or  at  the   General               Treasury  at Fort William or at Bombay on  the               day  of 1 9 on the application of the  holder,               or  earlier  at  the  entire  option  of   the               Government of the United Provinces, the sum of               and  in  the  meantime  to  pay  at  the  said               Treasury  interest on such sum at the rate  of               three  and  one-quarter per cent,  per  annum,               such  interest to be paid half yearly  on  the               20th  day  of  February and the  20th  day  of               August in every year, commencing from the 20th               day of 19 on which date the whole interest due               from the date hereof shall be paid." On  February  26,  1948 the  appellant  received  Encumbered Estates  Bonds  of the face value of  Rs.  3,46,300/-.   The appellant  appropriated  bonds  of the  face  value  of  Rs. 2,22,097/9/11  towards  the  principal and  costs  due,  and appropriated  the  remaining  bonds  of  the  value  of  Rs. 1,24,202/6/1 towards "interest accrued due" in the  debtor’s account.  The departmental authorities and the Tribunal held that the receipt by the appellant of bonds of the face value exceeding  the principal amount of the debt due  constituted receipt of interest.  The High Court agreed with that view. Counsel  for  the  appellant  submitted  that  the  accounts maintained  by the appellant being on cash basis, until  the appellant  realised. the value of the bonds no interest  was received  by  the appellant.  Counsel asserted that  when  a trader  maintains  account on cash basis  receipt  of  money alone  may be taken into account in determining the  taxable income.   In  the alternative Counsel urged  that  the  bond issued  by the Government under the U.P. Encumbered  Estates Act merely amounted to promise by an agent of the debtor  to pay  the amount of the bond in instalments and by  receiving the  bonds incorporating such a promise no money or  money’s worth is received by the creditor. 486 Under S. 4 of the Income-tax Act, 1922, the total income  of any  previous  year  of a  resident  assessee  includes  all income,  profits  and gains from  whatever  sources  derived which  are  received  or are deemed to be  received  in  the taxable  territories  in such year by or on behalf  of  such person, or accrue or arise or are deemed to accrue or  arise to  him  in  the taxable territories during  such  year,  or accrue  or  arise  to him without  the  taxable  territories during  such  year,  or having, accrued  or  arisen  to  him without the taxable territories before the beginning of such year and after the 1st day of April, 1933, are brought  into or  received in the taxable territories by him  during  such year.  The Act does not contain much guidance as to cases in

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which  tax is to be levied on income received, and cases  in which  tax  is  to be levied on income  accrued  or  arisen. Section  13 however requires that income, profits and  gains for  the  purposes  of ss. 10 and 12 shall  be  computed  in accordance with the method of accounting regularly  employed by  the assessee.  If accounts are maintained  according  to the  mercantile system, whenever the right to receive  money in  the course of a trading transaction accrues  or  arises, even  though income is not realised, income embedded in  the receipt  is deemed to arise or accrue.  Where  the  accounts are  maintained  on cash basis receipt of money  or  money’s worth  and  not the accrual of the right to receive  is  the determining  factor.   Therefore, if commercial  assets  are received  by a trader maintaining accounts on cash basis  in satisfaction  of an obligation, income which is embedded  in the  value  of  the assets is deemed to be  received  :  the receipt of income is not deferred till the asset is realized in  terms of cash or money.  It makes no difference  whether the  receipt  of assets is in pursuance of an  agreement  or that  the  trader is compelled by law to accept  the  assets from  the  debtor.   Once title of the trader  to  an  asset received is complete, whether by a consensual arrangement or by operation of law, he receives the income embedded in  the value  of  the  asset.   In  Californian  Copper   Syndicate (Limited and Reduced) v. Harris (Surveyor of Taxeses(1) Lord Trayner  in dealing with a case of assessment to income  tax of  a  Company  formed  for  the  purpose,  inter  alia,  of acquiring and reselling mining property resold the whole  of its assets to a second Company and received payment in fully paid shares of the purchasing Company, observed               "A profit is realised when the seller gets the               price he has bargained for.  No doubt here the               price  took the form of fully paid  shares  in               another  company,  but,  if there  can  be  no               realised  profit, except when that is paid  in               cash,  the  shares were realisable  and  could               have been turned into cash, if the  Appellants               had been pleased to do so. I cannot think that                             Income Tax is due or not               (1)   5 T.C. 159                487               according  to the manner in which  the  person               making the profit pleases to deal with it." Counsel  for  the appellant contended that  the  bonds  were intended  to renew the promise to pay the amount due by  the debtor through his agent, and by the renewal of the  promise even if the original liability was extinguished and a  fresh liability  was  substituted, no income was received  by  the appellant. We are unable to agree with that contention.  The Government of  the  State undertook to pay the amount of the  bonds  in satisfaction of the liability of the debtor.  The  liability of  the  original  debtor  was  extinguished  and  a   fresh obligation  was  undertaken  by  the  State  Government   in substitution of the original liability.  The Government  had the right to recover the amount due under the bonds from the landholder,  but  on  that account the  Government  did  not become the agent of the landholder for payment of his debts. Even if the Government was unable to recover the money  from the  landholder, the liability undertaken by the  Government under the bond remained unimpaired.  The bond was a security for  payment  of  the debt which  completely  ,replaced  the original liability of the debtor. The  decision in Cross (H.M. Inspector of Taxes)  v.  London and  Provincial  Trust  Ltd.(1) on  which  counsel  for  the

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appellant  relied  has, in our judgment, no  application  to this  case.   In  1932 the  Brazilian  Government  suspended payment  of  interest on Government bonds for  a  period  of three  years  and issued interest bearing funding  bonds  in exchange   for  the  interest  coupons.   The   London   and Provincial  Trust  Ltd.  which held  among  its  investments Brazilian  bonds received funding bonds which it  sold  from time to time, It was held that by issuing the funding  bonds the  Government  of  Brazil did not  pay  interest  and  the assessee  Bank  received no interest when  it  received  the funding bonds.  Sir Wilfrid Greene, M.R. observed :               "It is not open to question that income can be               in the form of money’s worth.  Nor is it  open               to question that if the holder of a  security,               the  contractual income from which  is  money,               receives  from the person liable to  pay  that               money  some  thing  of  money’s  worth  (e.g.,               goods)  instead of the money, such  goods  are               income  arising from the security..... On  the               other hand, where there is a mere substitution               of  a promise to pay at a later date  for  the               obligation   to  make  an   interest   payment               presently due, the owner of security cannot be               said to have received income from it.  In such               a case, the payment               (1)   21 T.C. 705.                                    489               has  been postponed instead of being  made  on               its  due date.  Nor do I see how it  can  make               any difference if upon the true reading of the               transaction   the   original   obligation   is               extinguished and the promise to pay at a later               date is accepted in its place."               MacKinnon, L.J., observed at p. 721               "It is quite true that income may arise by the               receipt  of  money’s worth as well as  by  the               receipt of money.  And it is equally true that               a  debtor  may  pay his  debt  by  giving  the               promise  of a third party to pay : .... But  I               am  satisfied that there can never be  payment               of  his  debt by a debtor by  giving  his  own               promise  to  pay at a future date.  And  I  am               equally  satisfied that, though income  arises               to a creditor from a debtor’s paying his  debt               income   does  not  arise  by   the   debtor’s               promising that he will pay his debt later on." But  the Encumbered Estates Bonds were by operation  of  the statute received by the appellant in satisfaction pro  tanto of the liability of the debtor.  They were a fresh security. The  liability of the original debtor was substituted by  an obligation  undertaken  by  the  State  :  the  bonds   were convertible  in  terms  of  money.   Income  was   therefore received by the appellant when the bonds were received. It  is  necessary to state that the  income-tax  authorities have brought to tax the difference between the face value of the  bonds  and  the principal which  remained  due  in  the relevant previous year.  But what was taxable was only  that income  which represented the difference between the  amount due  as principal and the market value of the  bonds  (which were payable in twenty instalments) at the date of  receipt. It  is  true that before the Income-tax  Appellate  Tribunal this question was not expressly pressed.  The appellant  did however  contend that no part of the difference between  the face  value  of the bonds and the principal amount  due  was taxable and the third question referred by the Tribunal  was

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sufficiently  comprehensive to justify consideration of  the plea that a part of the difference only was taxable.  Having regard to the argument presented before the Tribunal and the amplitude  of the question referred, the High Court  was  in error  in  refusing to consider whether only a part  of  the difference  between  the  face value of the  bonds  and  the principal amount due to the appellant was taxable.   Counsel appearing on behalf of the Department concedes that what was taxable was only the difference between the principal amount due  and the market value of the bonds when received in  the year  of  account,  and he has agreed  that  the  necessary, adjustments will be made by the Department in that behalf. 489 In  that  view, we do not think it necessary to  modify  the answer recorded by the High Court on the third question. It is also necessary to observe that in the year 1949-50 the appellant  had submitted a return disclosing the  difference between  the  amount received by sale of the bonds  and  the principal  amount  due as income received  in  the  previous relevant  year.   Whether  that income was  brought  to  tax pursuant  to  the  return cannot  be  ascertained  from  the record.   Counsel for the Department has stated that  it  is not  the object of the Department to levy tax in respect  of the  same income twice.  He has agreed that if tax has  been levied  in respect of the difference between  the  principal and the realized value of the bonds disclosed in the  return for  -the assessment year 1949-50,  appropriate  adjustments will be made in that behalf.  In view of the statements made at  the  Bar  we  do not think  it  necessary  to  give  any directions in that behalf also. The appeal is dismissed.  There will be no order as to costs in this Court. R.K.P.S.                                              Appeal dismissed.