N.K Textile Mills v. Commissioner Of Income-Tax, Delhi

Kapur, J.:— The following question has been referred to us by the Income-tax Appellate Tribunal under s. 256(1) of the I.T Act, 1961, for the assessment year 1967-68:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right that no deduction of Rs. 36,916 was permissible from the total income towards the possible sales tax which might be levied on the assessee subsequently?”

2. It will at once become apparent that the answer to the question has to be in accordance with the facts and circumstances of the case which, in fact, change the meaning of the question. In case, the assessee was keeping accounts on a cash basis and the sales tax had not been quantified, the answer to the question would obviously have been that the Tribunal was right. So, before answering the question, it is necessary to note the actual facts of the case.

3. The sales tax in question was payable under the U.P Sales Tax Act. The assessment year being 1967-68, an amount of Rs. 36,916 had been provided by making entries in the account as sales tax payable for that year. No doubt, this sales tax had not been paid in fact to the authorities during the year but it was payable because the assessee was not contesting the fact that the amount was due.

4. The ITO disallowed the amount on the footing that the amount had not been paid. However, on appeal, the A AC allowed the same in the light of the judgment of the Supreme Court in Kedarnaih Jute Mfg. Co. Ltd. v. CIT, [1971] 82 ITR 363. He also found that in two subsequent years 1968-69 and 1969-70, the ITO had not even added back the amount.

5. When the Department's appeal was heard by the Tribunal, it came to the conclusion that there were observations in the judgments of the Supreme Court, viz., Chowringhee Sales Bureau (P) Ltd. v. Cit, West Bengal, [1973] 87 ITR 542 (SC) and Sinclair Murray and Co. P. Ltd. v. CIT, [1974] 97 ITR 615 (SC), to the effect that sales tax collections were trading receipts in the hands of the trader and could be deducted as and when paid to the Government. From this, the Tribunal deduced that the entry could only be made after a demand had been made by the sales tax authorities and the amount was actually paid to the State Government concerned.

6. The question as to when an entry is to be made under the mercantile system of accounting was not examined in the tw;o judgments of the Supreme Court. Of course, it is observed that the deduction is to be allowed at the time the amount is paid to the State Government. But, when the mercantile system of accounting is followed, an amount which is payable is shown as already paid and an amount which is receivable is shown as already received. This is the feature of the mercantile system of accounting. Hence, the assessee while following the mercantile system would show the amount as already paid though not paid, and in the case of receipts would show the same as having been received though not yet received. This system of accounting has the effect of appropriating the credits and debits to the right year even if the actual receipts and payments may be at a different point of time. There is nothing which the assessee did which appears to be inconsistent with these two judgments of the Supreme Court.

7. It was urged by the learned counsel for the Department that what the Supreme Court meant was actual payment. But, that would mean that the assessee would be forced in this case to maintain the accounts on a cash basis as opposed to mercantile basis, and that would be contrary to the accounting system being used by the assessee. We, therefore, think that there is nothing particularly wrong in the assessee claiming the amount as having been paid though not paid by following the mercantile system of accounting.

8. It may also be observed that Kedarnath Jute Mfg. Co. Ltd.'s case, [1971] 82 ITR 363 (SC), had allowed the deduction to be made even though no entry was made in the accounts by holding that the assessee could not, by making any mistake, change the year for which the liability had arisen. In that case, the assessee did not make an entry regarding the liability, nor was the deduction claimed in the return filed before the income-tax authorities. Before the income-tax case could be decided by the ITO, the sales tax authorities had raised the demand and, therefore, a revised return was filed including the sales tax which had not been included in the return nor in the accounts, as a deduction, and the Supreme Court held that the amount was to be allowed as a deduction because it was appropriated to this particular year, i.e, the accounting year in question. In a similar manner, if the present assessee had not even made an entry but the amount of sales tax had been crystallised, a possible deduction might have been claimed in the return or in a revised return. We do not see any way in which the amount could be appropriated to another year except in a case where the demand was contested and could not be included in this particular year.

9. In Chowringhee Sales Bureau (P) Ltd. v. Cit, West Bengal, [1977] 110 ITR 385, the Calcutta High Court has also had an opportunity to examine the question whether a deduction could be made on the mercantile system before the amount had been paid to the sales tax authorities and it has been held that on the mercantile system, this deduction can be allowed. So, the question whether an entry can be made at a particular time or not depends not only on whether the amount is paid but also on the system of accounting maintained by the assessee.

10. We have recently had an opportunity to examine this matter in another case, Addl. CIT v. Rattan Chand Kapoor, [1984] 149 ITR 1 (Delhi). In that case, the sales tax liability was being contested by the assessee for a number of years. The demand was raised several years later and when raised was claimed as deduction. The case of the Department was that the amount could only be claimed in the appropriate year, i.e, in the year in which the liability to pay tax arose, and not in the year in which the demand was raised or the amount was actually paid. It will be seen that this plea is just the reverse of the present position.

11. We observed in that case that if the demand was treated as payable by the assessee, he could make the entry and claim the deduction in the year in which the liability arose, i.e, during the period when the sales took place. If the liability was contested, but unsuccessfully, the deduction could be claimed by the assessee even by a revised return as held in Kedarnath Jute Manufacturing Co. Ltd.'s case, [1971] 82 ITR 363 (SC). If the liability arose afterwards, and there was no earlier year to which it could be appropriated, because the income-tax cases were closed, then the assessee perforce had to make the entry and claim the deduction at the time the demand was raised, i.e, when the actual accrual had taken place. Another reason supporting this line, as mentioned in that judgment, was that a hybrid system of accounting could be adopted for this situation.

12. From these cases, it would appear that the normal method is to claim the amount in the year in which the liability arises, i.e, the year in which the sales take place. The liability did arise in the year in which the assessee made the entry in this case, though the actual quantification and the final demand for the same might be postponed to another year. If there is a variation in the amount now entered by the assessee, as a result of the actual demand, then an adjustment in the accounts would be made at that time but the primary liability would be appropriated to the present year; the entry was rightly made and, therefore, the deduction has to be allowed.

13. In the circumstances, we would answer the question referred to us in the negative, in favour of the assessee and against the Department. We also note that the question has to be read in the light of the facts particularly the fact that the assessee was using the mercantile system of accounting and in subsequent years this amount was allowed to be deducted without any objection by the Department. The parties are left to beaf their own costs.