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New Victoria Mills Co. Ltd. v. Commissioner Of Income-Tax, U.P
Court Opinion Summary — Manchanda, J.
Factual and Procedural Background
For the assessment year 1949-50 (previous year ending 31 December 1948) the assessee-company made a provision of Rs. 4,50,000 for bonus in its profit and loss account and claimed this provision as a deduction though the actual payment occurred in the following year. In earlier years beginning with the accounting year ending 31 October 1942 and continuing through the years ending 31 October 1943 up to 31 December 1947, the department allowed deductions for bonus only to the extent of actual payments made in those years, disallowing the balance of provisions. The Income-tax Officer (I.T.O.) followed that practice for the relevant assessment year and allowed only Rs. 5,252 actually paid, adding back Rs. 4,44,748 out of the provision of Rs. 4,50,000. On appeal the Appellate Assistant Commissioner confirmed the disallowance on the ground that the assessee could not change from the cash system (as applied by the department for bonus) to the mercantile (accrual) system. The Income-tax Appellate Tribunal held that the assessee, although following the mercantile system generally, had in practice adopted the cash basis for bonus (a hybrid system regularly employed), and it upheld the disallowance. The assessee then caused this reference under section 66(1) of the Income-tax Act, 1922, seeking the opinion of the court on whether the Rs. 4,50,000 provision debited as bonus could be allowed as a deduction in the assessment year.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case stated, the amount of Rs. 4,50,000 provided for in the balance-sheet and debited to the profit and loss account as bonus could be allowed as a deduction in the assessment year under consideration?
Arguments of the Parties
Appellant's Arguments (Assessee)
- The assessee, through counsel Mr. Jagdish Swarup, argued that under the mercantile (accrual) system of accounting a provision made in the accounts must be allowed and the tax department cannot disregard such provision.
- The assessee contended it was entitled to change its system of accounting in respect of bonus from the cash basis previously applied by the department to the accrual (mercantile) basis for the relevant year.
Respondent's Arguments (Revenue / Income-tax Officer)
- The Income-tax Officer and the Appellate Assistant Commissioner took the position that, in practice, allowance for bonus had consistently been on the basis of actual payment (cash basis) and that the assessee had acquiesced in that method over many years; therefore the assessee could not effect a retrospective change to accrual treatment for the year in question.
- The department resisted allowing a provision in the accounts where there was no demonstrable, enforceable liability; it treated bonus claims on a cash basis given the historical practice and the lack of an ascertained liability.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Dhakeshwar Prasad Narain Singh v. Commissioner of Income-tax [1936] 4 I.T.R. 71 (F.B.) | Authority that an assessee may adopt a mixture of cash and mercantile methods of accounting (i.e., a hybrid system) provided it is regularly employed. | The court cited this case to acknowledge that mixed accounting methods are permissible; it used the principle to consider whether the assessee had in fact adopted a cash basis for bonus regularly and thus whether the Tribunal was correct in treating the practice as an acceptable hybrid system. |
| Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Pvt. Ltd. [1964] 53 I.T.R. 134 (S.C.) | Sets out the conditions that must be satisfied before bonus can be allowed under the mercantile system and indicates that reopening accounts to debit bonus retroactively does not fit the Income-tax Act scheme. | The court applied the Swadeshi Cotton conditions (listed in the opinion) and found the assessee had not shown compliance with any of them; accordingly, even if the mercantile system were asserted, the provision for bonus could not be allowed. The court also relied on the Supreme Court's view that liability to pay profit bonus arises only when claims are settled amicably or adjudicated. |
| Commissioner of Income-tax v. Nagri Mills Co. Ltd. (Bombay High Court) | Held that where accounts are on the mercantile basis, a bonus distributed after the year but attributable to that year (pursuant to conciliation/award) could be deducted for that earlier year. | The court noted this Bombay High Court view and stated that, by necessary implication in light of the Supreme Court's later decision in Swadeshi Cotton, that view would stand overruled; the Nagri Mills decision was not followed in the present case. |
Court's Reasoning and Analysis
The court's analysis proceeded in distinct logical steps, grounded on the factual history of how bonus had been treated in prior years and on established legal principles:
- Past practice: The court emphasized that from the year ending 31 October 1942 onward the department had consistently allowed bonus deductions only to the extent of actual payments, notwithstanding that the assessee made provisions in its accounts. The assessee had, in effect, acquiesced in that practice over a number of years.
- Change of accounting method: The court observed that an assessee may adopt a mercantile, cash, or mixed system of accounting (citing Dhakeshwar Prasad Narain Singh), but any change in method must be bona fide and not a casual or opportunistic departure from a regularly accepted method. The court found no bona fide change here—particularly because the alleged change coincided with adverse tax consequences (a loss in a subsequent year) and was not shown to be a legitimate, consistently adopted alteration.
- Legitimacy of provisions under mercantile system: Even assuming the assessee claimed to follow the mercantile system for the bonus item, the court stressed that under mercantile accounting a debit or provision in the books is permissible only where a definite, enforceable liability has accrued. Provisional, notional or contingent liabilities that are unascertained cannot be debited legitimately.
- Application of Swadeshi Cotton conditions: The court relied on the Supreme Court's formulation (Swadeshi Cotton) delineating conditions for allowing bonus under mercantile accounting. Those conditions require, among other things, that workers be entitled to make a claim, that such claim be made, and that it be settled amicably or by industrial adjudication. The court found that the assessee did not demonstrate compliance with any of these conditions—there was no showing that a claim had been made or settled—so the provision represented an unascertained liability incapable of being allowed even on mercantile principles.
- Precedent and account reopening: The court rejected the relevance of the Bombay High Court's Nagri Mills decision (which would have allowed a later-distributed bonus to be charged to the previous year) insofar as it conflicts with the Supreme Court's approach in Swadeshi Cotton, which discourages reopening accounts to debit retrospective bonus provisions outside the specified conditions.
- Conclusion from facts and law: Combining the factual finding of long-standing treatment on a cash basis (and the assessee's acquiescence) with the legal requirement that a provision must reflect an ascertained, enforceable liability under mercantile accounting, the court concluded the provision for Rs. 4,50,000 could not be allowed as a deduction.
Holding and Implications
Holding: The question referred is answered in the negative; the amount of Rs. 4,50,000 provided for as bonus and debited to the profit and loss account could not be allowed as a deduction in the assessment year under consideration. The decision is against the assessee.
Direct consequences and costs: The assessee was ordered to pay the costs of the reference assessed at Rs. 200 and counsel's fee assessed at Rs. 200.
Implications: The direct effect is the disallowance of the provision for bonus for the assessment year in question and the imposition of costs. The court's reasoning affirms that (a) a hybrid accounting method is permissible only if regularly and bona fide employed, and (b) under mercantile accounting a provision is deductible only when it represents a definite, enforceable liability (e.g., claims settled amicably or by adjudication, as per the Swadeshi Cotton criteria). The opinion does not purport to lay down a new general precedent beyond applying and distinguishing existing authorities.
Question answered in the negative. Costs and counsel fee awarded as stated above.
Manchanda, J.:— This is a case stated under section 66(1) of the Income-tax Act of 1922.
2. The question referred is:
“Whether, on the facts and in the circumstances of the case stated above, the amount of Rs. 4,50,000 provided for in the balance-sheet and debited to the profit and loss account as bonus, could be allowed as a deduction in the assessment year under consideration?”
3. The material facts are that for the assessment year 1949-50, the previous year being 31st December, 1948, the assessee-company claimed as a deduction a provision made for bonus amounting to Rs. 4,50,000 provided for in the profit and loss account in the relevant previous year, but actually paid in the following year. For the accounting year ending October 31, 1942, although a provision was made in its accounts for bonus in the sum of Rs. 1,00,000, only Rs. 63,385, the actual payment made, was allowed to be deducted in that year and the balance was disallowed. For the years ending October 31, 1943, up to the year ending December 31, 1947, the position was more or less the same. Allowance for bonus was invariably made on the basis of actual payments and in disregard of the provision that was made in the accounts for bonus. In some years the actual payment was more than the provision that had been made and in others less. Therefore, the allowance for bonus since the year ending October 31, 1942, was always made on the basis of actual payments and this was being acquiesced in by the assessee. In the relevant year of account the assessee while admitting before the Income-tax Officer that the past practice was to claim deduction for bonus on the basis of actual payment contended that it could change the system of accounting hitherto followed by it by insisting on the bonus being allowed on accrual basis and not on the actual receipt or payment basis. The Income-tax Officer did not accept this contention and allowed only the bonus of Rs. 5,252 actually paid during the relevant year of account and added back the balance of Rs. 4,44,748 out of the provision of Rs. 4,50,000 that the assessee had made in its books for bonus. On appeal, the Appellate Assistant Commissioner confirmed the disallowance of bonus on the ground that the assessee could not change over from the cash system of accounting in respect of bonus which it had hitherto followed to the mercantile basis. Still being aggrieved, the matter was taken to the Income-tax Appellate Tribunal. The Tribunal was of the view that though the assessee was following the mercantile system of accounting nevertheless there was nothing to prevent it from following the cash system in respect of bonus payment. It found that the allowance for bonus in the past had never been on the basis of what had been provided by the company in its books of account “during each of the years but it was based entirely on the actual payments made during each such year”. Such disallowance was made year after year out of the provision made by the assessee and it had consistently accepted that position. In these circumstances it was held that the assessee itself had adopted the cash basis in regard to the claim under bonus and as such this was a hybrid system of accounts which, under the proviso to section 13 of the Act, was an acceptable system of accounting provided it was regularly employed by the assessee. The disallowance was accordingly upheld. This reference under section 66(1) has been now made at the instance of the assessee and the question set out hereinabove referred for the opinion of this court.
4. The main attempt of Mr. Jagdish Swarup, the learned counsel for the assessee before us, was to show that under the mercantile system of accounting, whatever provision is made has to be allowed and the department cannot tinker with it. Further, that when the assessee was making a provision for payment of bonus on the mercantile basis but the department was not accepting it, it did not necessarily follow therefrom that the assessee had accepted the cash basis for this item of expenditure or that it was following a hybrid or mixed method of accounting. It is true that the petitioner had continued to make provision in its accounts for bonus since the assessment year 1943-44 but when the department refused to accept that basis and adopted the cash basis it was open to the assessee to take the matter in appeal and have the question determined. The assessee having accepted the cash basis, in respect of bonus, imposed by the department upon it, it is too late in the day now for it to turn round and contend that it was not following a hybrid or mixed method of accounting.
5. It is not incumbent upon an assessee to follow a purely cash method of accounting or a purely mercantile method of accounting. It can be a mixture of both (see Dhakeshwar Prasad Narain Singh v. Commissioner of Income-tax [1936] 4 I.T.R 71 F.B.). It is no doubt open to the assessee to change his method of accounting but the change should be bona fide and not a casual departure from the regular method which has hitherto been accepted by him for a number of years. Merely because in the subsequent assessment year there was a loss and the bonus actually paid in that year could not be effectively set off but had to be carried forward would furnish no justification for permitting a change in the method of accounting. The bona fides, in the instant case, are absent and the Income-tax Officer was justified in resisting the attempt of the assessee to change its method of accounting. Therefore, on the set method of accounting accepted by the assessee for a number of years the allowance of bonus on the cash basis by the Tribunal was right.
6. That apart, even assuming that the assessee's method of accounting in respect of bonus was also on the mercantile basis, then too the assessee cannot succeed. Even under the mercantile system of accounting it is not left to the sweet will of the assessee to debit in its account any amount towards its expenses and claim that the provision so made will have to be allowed by the tax authorities. It is true that under the mercantile system of accounting all items of credit are brought into credit immediately they become legally due and before they are actually received, and all expenditure is debited for which a legal liability has been incurred before it is actually disbursed. But before a credit or debit entry can legitimately be made in the accounts it must be shown that a certain enforceable liability has accrued or arisen. Such liability must be one that has been ascertained and capable of being enforced by the person in whose favour the debit has been raised. The mercantile system can never be “stretched to embrace all sorts of provisional, notional or contingent payments which the assessee considers that he might ultimately be called upon to pay.
7. It is well settled that anticipated losses and contingent liabilities cannot be claimed under the mercantile system of accounting. The liability must be definite and real. The Supreme Court in Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Private Ltd. at page 138, has laid down the conditions which must be satisfied before bonus can be allowed even on the mercantile system of accounting. They are:
“(a) That the workmen are entitled to make a claim to profit bonus because certain conditions stood satisfied;
(b) The workmen have to make a claim from year to year;
(c) That such claim was made and it has either been settled amicably or by industrial adjudication; and
(d) if there is a loss or if no claim is made, no bonus will be permissible.”
8. In the instant case no attempt has been made to show that any of the aforesaid conditions laid down by the Supreme Court were complied with. It has not been shown that the bonus provided for by the assessee in its books of accounts was upon a claim made by the workers nor that it was made as a result of an amicable settlement with the workers or as a result of any industrial adjudication of the liability of the employer to pay to the workers a profit bonus. Therefore, even if it is conceded that the assessee employed the mercantile system of accounting for this particular liability, then too the provision for bonus cannot be allowed. It is only when the claim to profit bonus, if any, is made and the conditions for making such claim are satisfied or the claim is settled amicably or by an industrial adjudication that a liability is incurred by the employer who follows the mercantile system of accounting within the meaning of section 10(2)(x) read with section 10(5) of the Act. The liability in the instant case was an unascertained one and, therefore, even on the mercantile system of accounting it could not have been legitimately debited in the accounts of the assessee.
9. Mr. Jagdish Swarup relied on a decision of the Bombay High Court in Commissioner of Income-tax v. Nagri Mills Co. Ltd., where it was held by the Bombay High Court that even where an assessee maintains its accounts on the mercantile basis but it had not made any entry towards bonus for the calendar year 1951, and upon a dispute regarding bonus payable to the workers having been referred to the conciliation board who by its award in June, 1952, directed the company to pay bonus out of the profits for that year, the company was entitled in making its return to deduct for the year 1951, the bonus which was distributed in December, 1952. This view of the Bombay High Court would necessarily have involved the reopening of the accounts for 1951, if bonus was to be debited against the income for that year. Though this particular case has not been considered by the Supreme Court but by necessary implication it would stand overruled. The Supreme Court in Swadeshi Cotton and Flour Mills case [1964] 53 I.T.R 134 S.C. has pointed out that the reopening of accounts does not fit in with the scheme of the Indian Income-tax Act and that even under the mercantile system of accounting the liability to pay profit bonus is incurred by the employer only in the year when the matter is amicably settled between the workers and the employers or as a result of an award on industrial adjudication. Unless the matter falls within the Full Bench Formula of the Supreme Court and is ascertained on that basis or it is amicably settled or adjudicated upon, no liability arises even under the mercantile system of accounting.
10. In this view of the matter, we would answer the question referred in the negative and against the assessee. The assessee will pay the costs of this reference, which we assess at Rs. 200. Counsel's fee is also assessed at Rs. 200.
11. Question answered in the negative.
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