1. The assessee is a firm dealing in jaggery. During the assessment year 1968-69 it had collected sales-tax amounting to Rs. 17,710 and got refund from the department in a sum of Rs. 8,228. They were not accounted for as trading receipts. When called upon to explain the omission, it stated before the Income-tax Officer that the sales-tax account in its entirety is recorded as liability since it had to be paid. The dispute relating thereto was pending before the Supreme Court and a stay of payment was granted. That was a statutory liability and not a contingent one. The sales-tax authorities had reopened all the assessments consequent on appeal decision and revised orders may be passed by the authorities requiring the firm to repay the refund amount. The assessing authority rejected this contention of the firm and treated the entire amount of Rs. 25,938 as its income. In appeal, the Appellate Assistant Commissioner also held that the assessee colud not claim anything towards sales-tax payment because it had been following cash basis for debiting sales-tax and claiming it as admissible expenditure. In second appeal before the Appellate Tribunal, the finding of the Appellate Assistant Commissioner that the assessee was following cash system of accounting was challenged. Following its earlier decisions raising similar questions, the Tribunal allowed the assessee's appeal and deducted both the amounts from the assessable income of the firm. As it had held in previous cases, the Tribunal concluded that sales-tax was a liability and did not form part of the income. Though the amount had not yet been paid to the Government since it was in dispute, the assessee was holding it only as a trustee. In its statement forwarding two questions to this court at the instance of the revenue, the Tribunal recorded that the assessee's counsel had conceded that in view of the Supreme Court's decision in Chowringhee Sales Bureau P. Ltd. v. Commissioner of Income-tax, the amount of sales-tax received was includible in its income as a revenue receipt, but at the same time maintained that this would not apply to mercantile system of accounting. The two questions referred are :
"1. Whether, on the facts and in the circumstances of the case, the sum of Rs. 17,710 collected as sales-tax which is a revenue receipt was deductible from the assessee's total income as a liability ?
2. Whether, on the facts and in the circumstances of the case, the sales-tax refund of Rs. 8,228 was includible under Section 41(1) in the assessee's total income for the assessment year 1968-69 ?
2. Before us Sri M.J. Swamy for the assessee conceded the claim of the revenue in regard to the amount of refund, i.e., Rs. 8,228, as includible in the assessee's total income for the assessment year 1968-69 under Section 41(1) of the Income-tax Act, 1961. In view of this concession, we answer the second question in the affirmative and in favour of the revenue.
3. On the first question Sri Polavarapu Rama Rao for the revenue contended that the sum of Rs. 17,710 was admittedly collected as sales-tax and so it is includible in the assessee's total income for that year. He relied on Chowringhee Sales Bureau P. Ltd. v. Commissioner of Income-tax, and Sinclair Murray & Co. P. Ltd. v. Commissioner of Income-tax, both of which are decisions of the Supreme Court. In the earlier case the appellant, who was an auctioneer, realised during the relevant period a particular amount as sales-tax and credited it in its accounts under the head "sales tax collection account". It, however, did not pay the amount to the actual owner of the goods, nor did it deposit the amount realised by it by way of sales-tax in the State exchequer, taking up the stand that the statutory provision relating to sales-tax liability was not valid, nor did it refund the amount to persons from whom it had collected. The Supreme Court held that the amount thus realised was in its character a part and parcel of the company's trading or business receipt and that the fact that the amount had been credited towards sales-tax did not make any difference. The Supreme Court observed that it is the true nature and quality of the receipt that is decisive and if a receipt is a trading receipt, the fact that it is not so shown in the account books of the assessee would not prevent the assessing authority from treating it as trading receipt. In the latter case, sales-tax was collected from a purchaser but was not paid to the Government nor returned to the purchaser. It was not also separately earmarked or put into different account. Applying the principle in Chowringhee's case, the Supreme Court held that the amount collected as sales-tax constituted its trading receipt and had to be included in its total income. If and when the amount was paid to the State Government or refunded to the purchaser, the assessee would be entitled to claim deduction of the sum so paid or refunded.
4. So far as the principle goes as stated by the Supreme Court, it is final. But it has to be noted that the Supreme Court was not considering in the above two cases what would be the effect if those sales-tax collections are entered in a separate account maintained under the mercantile system. An income accrues or arises when the assessee acquires a right to receive it. Traders follow two methods of accounting of their receipts, profits and gains. One is cash basis and the other is mercantile basis. The mercantile systsm 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"
. Only the book profits are adopted for the purpose of assessment of tax though the credit amount is not realised or the debit amount is not actually disbursed. If an income accrues within a particular year, it is liable to be assessed in the succeeding year. Whether the right to receive an amount under a contract accrues or arises to the assessee has to be found out upon the terms of a particular contract. If the method of accounting adopted by the assessee is cash system, it would qualify for deduction only in the year in which it was actually paid. If the method is mercantile system, then the deduction will be permissible in the year to which the liability relates irrespective of the point of time when the liability has actually been discharged. (Vide Supreme Court decisions in
Commissioner of Income-tax v. Gajapathy Naidu, and Kedernath Jute Mfg. Co. Ltd. v. Commissioner of Income-tax, . In the latter case the assessee-company, which followed the mercantile system of accounting, incurred a liability of a large sum on account of sales-tax determined to be payable by it. The sales-tax demand was raised pending the income-tax assessment for the same year. The Supreme Court held that the moment a dealer made either purchases or sales, which were subject to sales-tax, the obligation to pay the tax arose. Although that liability could not be enforced till quantification was effected by assessment proceedings, the liability for payment of tax was independent of the assessment. The assessee, which followed the mercantile system of accounting, was entitled to deduct from the profits and gains of its business liability to sales-tax which arose on sales made by it during the relevant previous year. The assessee was entitled to the deduction of the amount of sales-tax which it was liable under the law to pay during the relevant accounting year. That liability did not cease to be a liability because the assessee had taken proceedings before higher authorities for getting it reduced or wiped out so long as the contention of the assessee did not prevail. The fact that the assessee had failed to debit the liability in its books of account did not debar it from claiming the sum as a deduction either under Section 10(1) or under Section 10(2)(xv).
5. The facts and the enunciation of the principle relating to mercantile system of accountancy as stated by the Supreme Court in the above case apply on all fours to the present case. There is no doubt that the assessee in this case followed the mercantile method of accounting. It is so clearly stated in the assessment order of the Income-tax Officer dated January 3, 1969. Therefore, the Appellate Assistant Commissioner went wrong in thinking that it was cash basis that was followed by the assessee. The Tribunal, though it did not clearly say so, was also of the view that the mercantile system was adopted by the assessee. In its order allowing the appeal of the assessee, it followed its own decision in I.T.A. No. 336/Hyd/ 69-70, which decision is also enclosed to the order. In that order it was clearly noticed that since the mercantile system of accountancy was followed, the addition of the amount of sales-tax was deleted. The Tribunal also took a similar view in I.T.A. No. 882/Hyd/69-70, which is also enclosed to the order. Thus, there is no doubt that the assessee was following the mercantile system. It collected Rs. 17,710 during the relevant period as sales-tax and entered the amount in its sales-tax account. Since the matter was still in dispute and stay was granted by the Supreme Court, the amount was not yet paid. Therefore, the decision of the Supreme Court in Kedarnath Jute Mfg. Co. Ltd. v. Commissioner of Income-tax, .
clearly applies to this case.
6. Sri Swamy referred us to a number of other decisions It is not, however, necessary to refer to all those cases in view of the authoritative pronouncement of the Stipreme Court. We will only refer to the decision of the Allahabad High Court in Commissioner of Income-tax v. Poonam Chand Trilok Chand, where also the assessee was following the mercantile system and the court held that the purchase tax collected by him was an allowable deduction.
7. For the foregoing reasons we hold that the amount of Rs. 17,710 is not includible in the total income of the assessee for the assessment year 1968-69. If and when the sales-tax claim was finally disposed of and any deduction was made, the balance will be includible in the income during that year. We, therefore, answer the first question in the negative and against the revenue.
8. Reference is answered as above. Regarding the circumstances of the case, we direct the parties to bear their own costs.