MORVI INDUSTRIES LTD. v. COMMISSIONER OF INCOME TAX (CENTRAL) CALCUTTA October 5, 1971 [K. S. HEGDE, A. N. GROVER AND H. R. KHANNA, JJ.] 111come-tax · Act, 1922, ss. 4(1) (b) (i) and
10(2) (xv)-Income accrues' when it becomes due-Relinquishment of office allowG.nce and commission by managing agent after they had become due on the ground that managed compan,v had suffered losses-Relinqufshmelll made after amounts had become due und~r agreement but before they hcd be- come payable-Amounts rightly included in total income-Relinquished amounts not deductible as expenses under s. !0(2)(xv) when the rtlin· quishment is not for purpose of assessee's business or on ground of com .. mercial expediency.
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 commis- sion 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 appeiiant company on the 30th .da)' of June every year. Under cl. 2(e) of the managing agency agree-
ment 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 had 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' imme· diately aft~r 24th November 1955 and 21st July 1956 respectively. Since the managed company had suffered losses in the preceding years the appeiiailt relinquished the commission as weii as tho 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 'duo' but not 'payable'.
The Income-tax Officer in making the assess- ments 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.
ACCQrding to the Income-tax Officer the office allowance had Deen relinquished ex-graf1Ja and the commission had been relinquished after it had accrued. Tu~ Appellate Assistant Commissioner and the
Appellate Tribunal confirmed the order of the Income-tax Officer. In reference th~ High Court held: (i) that the accrual of income was com- p1cte within the accounting year of the managed company and as no relinquishment had been done before the amount became due, the ca-;c came within the ambit of s. 4(1)(b)(i) of the Income-tax Act. 1922. (ii) that the mlinquishment had not been made for the purpose of facili- 1.ating the legitimate commercial undertaking or by \\!ay of commercial cxoediency and the case was not thenofore covered bys. 10(2)(xv). In <Jppeal to this Court,
HELD: (i) According to s. 4(1)(b)(i) of the Act. subjoct to the pfovisions of this Act the total income of any previous year of nny person includes all income profits and gains from
whatever source ttlerived which if such a person is re:side~t in the taxable territQries during c II c MORYi INDUSTRIES v. C.I.T. (Khanna, J.) such year accrue or arise of lhe deemed to accrue or arise to him in the taxable territories !hat year. The dictionary meaning of the word 'accrue' is to come as an accession, increment, or produce; to
fall to one by way of advanta!)e; 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 light to claim that amount, even though it may not be payable immediately. There also arises a corres- ponding 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 from or efface the accirual 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 main· tained 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 thc __ appcllant company. As such the appellant could not escape the tax liability for those amounts. [975 G-H; 976 BJ
Indermani Jatia v. C.I.T., U.P., 35 J.T.R. 298 and C.I.T., Bombay City Iv. M/s. Slzoorji Vallabhdas & Co., 46 J.T.R. 144, applied. (ii) The appellant could claim deduction of the amount• under
'· 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. Thete 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. !0(2)(xv). [976 F-G]
CIVIL APPELLATE JURISDICTION : Civil Appeals Nos. 2083 and 2084 of 1970. Appeals from the judgment and order dated January 28, i 964 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. Sac/1they, for the respon- dent (in both the appeals). The Judgment of the Court was delivered by
Khanna, J. This judgment would dispose of two Civil Appeals Nos. 2083 and 2084 of 1970 which }\ave been filed on certificate granted by the Calcutta High Court and are directed against the jµdgment of that Court whereby it answered the questions referred to the Court und·~r Section 66 ( 1) of the Indian Income-tax Act, 1922 (hereinafter reforred to as the Act) for two assessment years again<t the assessee-appellant and in favour of the r~pondent. The assessee is a Limited Company and th~ matter relates to th·~ assessment years 1956-57 and 1957-58, the corresponding accouniing years for which ended on June 30, 1955 and June 30, 1956 iespectively.
The appellant Company was appointed as the Managing Agent of Shree Ramesh Cotton Mills Ltd., Morvi (hereinafter referred 1to as the managed company), as per agreement dat·~d 30-12-1946. The managed company was a 100% subsidiary of
the appellant company. Under the terms of the agre·~ment, the appellant company was entitled to receive a fixed office allowance of Rs. 1,0001- per mensem plus a commission at the rate of 12t% of the net profits, an additional commission of H% on all pur- chases of cotton and an equal amount on all sales of cloth and yarn.
In the relevant years, the managed company suffered losses and conS"..,quently the commission payable at 12t% of the net profits was . nil but the commission on purchase of cotton at the rate of 1 ?;% and on sales of cloth and yarn at 1the same rate, aggregated to Rs. 38,719/- for the assessment year 1956-57 and Rs. 1, 9631- 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 offio~ allowance. The !O'tal amounts which the appellant was entitled to receive from the managed company were Rs. 50,7191- and Rs. 13,9631- for the two years.
The managed company's accounting year closed on the 30th <lay of December and that of the appellant company on the 30th F day of June every year. Clause 2 ( e) of the Managing Agency
Agreement dated 30th Decem!J.~r, 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 annl!al 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 MORVJ JNDUSTR!ES v. C.I.T. (Khanna, J.)
been passed in the General Meeting. The Annual General Meet· ings of the managed company w~re held to adopt tl)e accounts on November, 24, 1955 a~d July ~I, 1956 respectively with rei::anl to the assessment years m quesuon.
The amounts of commission in tenns 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 resol_u1ion .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 agreemen-t. On behalf of the appdlant, 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 consequ·~ntlv relinquished the same.
The Income-tax Officer included the sums of Rs. 50,7191- and Rs. 13,963/ – in the t<Ytal income of tl)e ~ppellant for the two assess- ment years in question. The Income-Tax Officer took the view
that in so far as the fixed office allowance was concerned, rt had been criven to the appellant to enable it to recoupe the expenses incurr~d on behalf of the managed company and the relinquish- ment 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 aft>~r it had become due, it was taxable on accrual basis. The Appellate Assistant Commissioner and the Income-tax Appellate Tribunal affirme(l 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 account- ing year of 1he 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 w;1s then 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 rej>Wted 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 9.7'
(1972) 1 5.C.R. 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 Tribum!l referred the following two questions to ithe High Court :-
" ( 1 ) Whether on the facts and in the circumstances of the case, the sums of Rs. 50,719/- and Rs. 13,9631- 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 affir- mative, whether the assessee is entitled to claim an
allowa~ of an equivalent amount as expenditure under the provisions of Section 10(2) (xv) of the Indian Income Tax Act ?" c The High Court agreed with the view taken by the Tribunal. l>
lt was observed that the accrual of income was complete within the accounting year of the managed company and as no relinquish- ment had been done before the amount became due, the case
strictly came within the ambit of section 4(1)(b}(i) Qf the Act. ·The relinquishment, it was further observed, was a unilateral act of the appellant. As regards the second question, the High Court E
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 Coult. Regarding the first question, the learned counsel contends that as the amounts in question were never received by the appellant but were re!inqJ!ished, there arose no tax liability for those amoUil'ls. AB regards the second question, Mr. Mabeshwari submits that the relinquishm~nt of the amounts should be construed as permi'sible expenditure under section 10(2) (xv) of the Aot.
There is, in our opinion, no substance in any of the above conte11tions. 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. lt, therefore, can be said that the inc<ime of E.s. 50,7191- had accrued to the appellant on 31st December, 1954 and of MORYi INDUSTRIES v. C.I.T. (Khanna, /.)
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 pas5'ed in the meetings o~ the managed com- pany did not affect the accrual of the income of those amounts on December 31, 1954 and December 31, 1955 respectivefy. Accord- ing to Sectigp. 4(1)(b)(i) of the Act, subjeot to the provisions of this Act, the total income of any previous year of any person includes all income, profits and gains from whatever soilrce 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, incre- ment, or produce : to fall to 011e by way of advantage : to fall due''. The income can thus be said to accrue when it becomes
due. The postponement of the dalte 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, al- though 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 rcceipt of income while the accrual of income is 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 ~ystem 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 syste.m, credit en tries are mad.e 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 reali&"…d, 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 [1972) 1 S.C.R. with regard to debits made. [See Indermnni Jati" v. Commi.1·· sioner of Income-Tax, U.P. (')] In the case of Commissioner of lncome~Tax, Bombay City I
v. Messrs Shoorji Yallabhdas-an,d Co.( 2 ) Hidayatullah, J (as he then was) speaking for the Court ot>served .: "Income-tax is, a levy on inq:ime. No doubt, ,the Income-tax iakes into account
two points of tim~ at which the liability' to tax is attrayred, viz. the accrual of ,the incoii1e oi:._ its receipt; ];>ut the substance of the matter is the ·income. If ineome_ does not result at all,
there cannot be a tax, even •though in book-keeping, an entry is mad~ about a ~hypothetical income", wliich dqes not materialise. Where income .has,· in fact, been received and is subsequently gwerr up in such circiunsi_ances that it remains th,e ipctnne of _the recipi~nt even though given up, the ta)( may be payable. ·Where, however, t11e income can be said not' to have resulted at all, ;there is obviou~ry~ nei\her a~crual nor receipt of income, even though, an entry to that. effect .might, in certailf circumstances, have been made in the l:>ooks of account".
The assessee firm, who was the managing agent of two shipping companies in that case, gave up 75% of. the managing agenc) commission with a view to get the -1n'~naging agency tramferrc,r to iwo .privatt! companies. lt was held, that this was not a case of a gift by the_ assessee to the ma:naged companies of a portion of income which.had ·aiready'accrued, but an agreement tO receivG a lesser remuneration t11al). what had been ag!]!ed upon.
In the present case, the' alllomits of income for the two years in questio'' were given up unilaterally .after they had accrued to the appdlant company. As ~uch, the appellant could not escape the.Jax Iiab.· lity for those amounts.
c 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 alllounts 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 re- linquished for the purp6se of the anoellaht's bnsiness. The pre- se,nt is not a case wherein >the amounts due- to- the asse~sec w~1-.: given up on grounds of commercial expediency or for advancing the business interes1 of the assessee.
The oonclusion of the learned Judges of the High Court in this respect, in our opinion. is well founded. The result is that the appeals fa.ii and iµe dismissed but. in the circumstances, without cost~.
G. C. ~— ·—- __ ___,_ __ _ (I) 35 I.T.R. 29R., (2) 46 I.T.R. 144: Appeals dismissed. II