Nonsuch Estate Ltd. Vs. The
Commissioner of Income-Tax, Madras [1974] INSC 249 (21 November 1974)
GUPTA, A.C.
GUPTA, A.C.
KHANNA, HANS RAJ
CITATION: 1975 AIR 428 1975 SCR (2) 806 1975
SCC (3) 443
ACT:
Income-tax Act. 1922-Assessee followed
mercantile system of accounting Debited in books each year managing agency
remuneration for three years Claimed deduction in the third year on receipt of
approval from Central Government for reappointment of managing agents as
required under s. 326 Companies Act-Whether assessee should have claimed
deduction in each assessment Year.
HEADNOTE:
The assessee who followed the mercantile
system of accounting debited in its account books certain sums of money as
remuneration of the managing agents for the assessment years 1957-58 to
1959-60. For the purpose of income-tax the company added back the sum to its
taxable income and claimed the whole sum as a deductible expenditure in the
assessment year 1959-60 on the ground that the sum became payable only during
that year when the Government accorded its approval to the new managing agency
agreement.
The income-tax Officer rejected the claim
holding that the approval of the Central Government was necessary only for
actual payment and the assessee should have ascertained the liability for each
year and claimed it since he followed the mercantile system of accounting. This
view was upheld by the Appellate Assistant Commissioner and the Income-tax
Appellate Tribunal.
The High Court held that although at the time
the debit entries were made in the account books of the assessee, approval of
the Central Government had not been received, when it came later, it gave legal
effect to the debit entries with retrospective effect from April 1. 1956 and
that the refusal of deduction by the Income-tax Officer was right.
Allowing the appeal to this Court,
HELD : The High Court was in error in
answering the question against the assessee. Even an assessee following the
mercantile system of accounting is not entitled to claim a deduction until
liability for the sum for which deduction is claimed has accrued. The High
Court overlooked the plain terms of s.326 of the Companies Act, 1956 under
which it could not be assumed that the Central Government would approve every
proposed appointment or re-appointment of managing agent. [809A; D; 810A] In
the instant case it is only when the Central Government conveyed its approval
to the appointment of managing agents by its letter dated September 2, 1957
that the appointment became effective and the Company's liability to pay the
remuneration of the managing agents accrued. The liability became effective
from April 1, 1956 because the Central Government chose to give its approval
retrospective operation. The liability could not be said to had &risen from
any date prior to September 2, 1957 when the approval was given. Section 326 of
the Companies Act contains an absolute prohibition against the appointment or
re- appointment of a managing agent before the approval of Central Government
was obtained. [810B-C]
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 1554 of 1970.
Appeal. by Special Leave from the Judgment
& Order dated the 19th August, 1968 of the Madras High Court in Tax Case
No. 18 of 1 965.
G. B. Pai, A. G. Manessea, D. C. Mathur and
K. K. John, for appellant.
B. B. Ahuja and S. P. Nayar, for the
respondent.
807 The Judgment of the Court was delivered
by GUPTA, J. This is an appeal by special leave from a judgment of the Madras
High Court in a reference under section 66(1) of the Income Tax Act, 1922. The
appellant, Nonsuch Estate Limited, is a public limited company incorporated in
the 'year 1924 under the Companies Act, 1913. The appellant, referred to
hereinafter as the Company, derives its income from tea grown in its estate for
which it is assessed to income-tax. M/s. Harrisons and Crosfield Limited have
been the managing agents of the Company from the beginning. The following
question relating to the assessment year 1959-60 was referred to the High Court
:
"Whether on the facts and in the
circumstances of the case, the sum of Rs. 97,188/- representing the Managing
Agency remuneration for the period 1-4-1956 to 30-6-1957 was deductible in the
computation of the income of previous year ending on 30th June 1958, relevant
for the assessment year 1959-60." The relevant facts leading to the
reference are these. The managing agents of the Company were entitled to
commission at the rate of 11 per cent on all sales of tea and other producers
of the Company and a further sum of Rs. 12,000/- per annum for secratarial
work. There was, however, no written. agreement embodying the terms. After the Companies
Act, 1956 came into force on April 1, 1956 it was decided that there should be
a fresh managing agency agreement between the Company and its managing agents
in conformity with the provisions of the said Act. A fresh agreement drawn up
and submitted by the managing agents was approved by the Company. The new
agreement proposed the reappointment of M/s. Harrisons & Crosfield Limited
as the managing agents of the Company for a period of 10 years on a
remuneration of 5 per cent commission on the net profits of the Company
computed in the manner laid down in sections 349 to 351 of the Companies Act,
1956 subject to a minimum remuneration of Rs. 12,000/- per annum. The revised
terms were to take effect from April 1, 1956. As required by sec.
326 of the Companies Act, the new agreement
was sent to the Central Government for approval by a communication dated august
3, 1957 enclosing a formal application for the purpose in Form 25, On September
2, 1957 by a letter addressed to the Company the Government conveyed its
approval to "the appointment of M/s. Harrisons & Crosfields Ltd. as
the Managing agents........ for a period of 10 years with effect from 1st April
1956, on a remuneration of 5 per cent commission on the net profits of the
Company computed in the manner as laid down in Sections 349 to 351 of the Companies
Act, 1956 subject to a minimum remuneration of Rs. 12,000/- (Rupees twelve
thousand only) per annum payable to the Managing Agents, in the event of absence
or inadequacy of profits in any financial year." On receipt of the
approval, the Company by a resolution adopted at an extraordinary general
meeting of its shareholders held on October 4, 1957 reappointed M/s. Harrisons
& Crosfield Limited on the terms stated above. In terms of the new
agreement the existing agency agreement between the parties stood cancelled
with the expiry of March 31, 1956.
808 The Company follows the mercantile system
of accounting.
For the period April 1, 1956 to June 30, 1956,
the Company credited a sum of Rs. 9320/- to the account of the managing agents
as their remuneration in accordance with the terms of the proposed new
agreement. This was disclosed in the published accounts of the Company for the
year July 1, 1955 to June 30, 1956 relevant to the assessment year 1957-58.
For the purpose of assessment of income-tax,
however, the Company added back the said sum of Rs. 9,320/- to its taxable
income. In the next accounting year ending on June 30, 1957 relevant to the
assessment year 1958-59 the same process was followed with regard to the
remuneration payable to the managing agents. For the assessment year 1959-60
for which the previous year was July 1, 1957 to June 30, 1958, a total sum of
Rs. 97,188/- was shown as managing agents' remuneration payable during that
year. This amount was made up as under Amount .lm15 " Proportionate
remuneration for 3 months at 5 per cent on the net profits for the period
ending on 30-6-1956 paid during the year ending on 30-6-1958 9,320 Remuneration
at 5 per cent on the net profit of the year ending on 30th June 1957 paid
during the year ending on 30-6-1958 71,368 Managing Agents expenses for the
year ending 30th June 1957 recouped during the year ending on 30th June
1958.13,200 Proportionate Managing Agent's expenses for the year ending on 30th
June 1956 recouped during the year ending on 30-6-19583,300 97,188.
Though this sum did not pertain to the
previous year relevant to the assessment year 1959 60, the Company claimed it
as deductible expenditure for that year on the ground that the sum became
payable only during that year when the Government accorded its approval to the
new 'agreement. The Income-tax Officer rejected this claim on the view that the
approval of the Central Government was necessary only for actual payment and
"the assessee should have ascertained the liability for each year and
claimed it on the mercantile basis which was the system adopted by the assessee
company." The Appellate Assistant Commissioner and the Tribunal also took
the same view. The High Court answered the question referred to it against the
assessee on the following reasoning :
".. ... .... There was undoubtedly an
understanding between the managing agency and the assessee as to the new terms
of remuneration which actually were given effect to by making debit entries in
the remuneration account then and there. It is true that at the time the debit
entries were made, approval of the Central Government had not come. But when it
came actually later, it gave legal effect to the debit 809 entries, not from
the date of the approval but from April 1, 1956. That being the case, the
refusal of the deduction, in our opinion was right." In our judgment the
High Court was in error in answering the question referred to it against the
assessee. It appears that the Income-tax authorities, the Tribunal and the.
High Court all laid special emphasis on the fact that the Company followed the
mercantile system of accounting. The distinction between the two methods of
accounting, one on the cash basis and the other on the mercantile basis is
well-known. In Commissioner of Income-tax, Madras v. A. Gajapathy Naidu(1),
this Court explained the difference between the two methods quoting with
approval an extract from a Judgment of the, Allahabad High Court in
Commissioner of Income-tax v. Singari Bai(2). In Gajapathy Naidu's(1) case this
Court said:
" It is commonplace that there are two
principal methods of accounting for the income, profits and gains of a business
one is the cash basis and the other, the mercantile basis. The latter system of
accountancy "brings into credit what is due immediately it becomes legally
due and before it is actually received; and it brings into debit expenditure
the amount for which a legal liability has been incurred before it is actually
disbursed"." However, even an assessee following the mercantile
system of accounting is not entitled to claim a deduction until liability for
the sum for which deduction is claimed has accrued. The reasons given by the
High Court overlook the plain terms of sec. 326 of the Companies Act, 1956.
Sec.
326 so far it is material for the question
involved in this case, is in these terms :
"Sec. 326.)1) In respect of any
company............
(a)..........
(b) unless the approval of the Central
Government has been obtained for such appointment or re-appointment.
(2) The Central Government shall not accord
its approval under sub-section (1) in any case, unless it is satisfied- (a)
that it is not against the public interest to allow the company to have a
managing agent;
(b) that the managing agent proposed is, in
the opinion, a fit and proper person to be appoi nted or re-appointed as such,
and that the conditions of the managing agency agreement proposed are fair and
reasonable;
and (c) that the managing agent proposed has
fulfilled any conditions which the Central Government requires him to
fulfil." (1) 53 I.T.R. 114.
(2) 13 I.T.R. 224.
810 Section 326 prohibits the appointment or
re-appointment of a managing agent unless the Central Government approved such
appointment or re-appointment. The Central Government would not accord its
approval unless the requirements specified in clauses (a), (b) and (c) of
sub-section (2) of the section have been fulfilled. Therefore, it cannot be
assumed that the Central Government will approve every proposed appointment or
reappointment of a managing agent. Thus in the instant case it is only when the
Central Government conveyed its approval to the appointment of M/s. Harrisons
and Crosfield Limited as managing agents by its letter dated September 2, 1957
that the appointment became effective and the Company's liability to pay the
remuneration of the managing agents accrued. The position here is not that the
liability had arisen earlier and its quantification only depended on the
approval of the Central Government. It is true that the liability became
effective from April 1, 1956, a date anterior to the relevant previous year,
but 'that is because the Central Government chose to give its approval
retrospective operation. The liability in these circumstances cannot be said to
have arisen from any date prior to September, 2, 1957 when the approval was given as sec. 326 contains an absolute prohibition against the appointment or
re-appointment of a managing agent before the approval of the Central
Government was obtained. In our opinion, the position is quite clear from the
terms of sec.
326 and we do not consider it necessary to
refer to the authorities cited by the learned counsel for either side.
The appeal is accordingly allowed, the answer
given by the High Court to the question referred to it is discharged and the
question is answered in the affirmative and in favour of the assessee. The
appellantwill be entitled to its costs in this Court and in the High Court.
P.E.R.
Appeal allowed.
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