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The Commissioner Of Income Tax v. Shri Ram Pistons And Rings Ltd.
Factual and Procedural Background
This reference arose because the question as framed in the Statement of Case (paragraph 15.1) was found to be wrongly framed and was re-formulated by the Court. The re-framed principal question concerns whether the Income Tax Appellate Tribunal (ITAT) was correct in law in disallowing a sales incentive claimed by the Assessee under an incentive scheme which had an initial expiry date of 30th April, 1981 but which continued until 30th June, 1981, and whether that incentive had any relevance for Assessment Year 1983-84.
Material facts stated in the opinion: the Assessee maintains accounts on a mercantile basis and had floated an incentive scheme originally valid to 30th April, 1981, which was continued until 30th June, 1981. Under the extended scheme dealers could obtain additional graded incentives if sales from 1st May, 1981 to 30th June, 1981 were aggregated with earlier sales. The Assessee contends that an additional liability of Rs. 1,40,541/- crystallized on 30th June, 1981 and therefore claimed deduction for Assessment Year 1983-84. The Revenue contends that, because accounts were maintained on a mercantile basis, the liability accrued earlier and only its quantification was postponed.
A further, separate question was referred concerning whether the Tribunal was right in law in allowing, as revenue expenditure, payments of royalty to foreign collaborators. The opinion notes prior consideration of closely related agreements (including ITR No. 70-71/1988 relevant to AY 1981-82 and a decision rendered on 29th April, 2008) and states that the agreement with M/s Karl Smidth (West Germany) is similar to that with M/s Riken (Japan).
Legal Issues Presented
- Whether the Income Tax Appellate Tribunal was correct in law in disallowing sales incentive claimed by the Assessee under the incentive scheme which had expired on 30th April, 1981 but which continued till 30th June, 1981 as having no relevance for the Assessment Year 1983-84?
- Whether on the facts and in the circumstances of the case the Tribunal was right in law in allowing by way of revenue expenditure the payment of royalty to foreign collaborators?
Arguments of the Parties
Assessee's Arguments
- The incentive liability of Rs. 1,40,541/- crystallized only on 30th June, 1981 when the Assessee became aware of the actual sales made by its dealers; consequently the entitlement to deduction relates to the date of crystallization and the deduction claimed for Assessment Year 1983-84 is proper.
- The extended scheme created a graded incentive where the additional entitlement depended on sales during 1st May to 30th June, 1981; therefore the additional liability could not be said to have accrued prior to 30th June, 1981.
Revenue's Arguments
- Because the Assessee maintains accounts on a mercantile basis, the liability had accrued earlier (before 30th June, 1981) and only quantification was postponed; accordingly, the deduction should be allocated to the earlier year.
- The Assessee could and should have made a provision in its books for the additional incentive; failure to do so precludes claiming the benefit in a subsequent assessment year—relying on principles articulated in Rattan Chand Kapoor.
- Reliance was also placed on the Supreme Court's decision in Bharat Earth Movers to the effect that if a business liability has definitely arisen in an accounting year, deduction should be allowed even if quantification/discharge occurs later; the Revenue contended that this principle favored allocation to the earlier year.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Saurashtra Cement and Chemical Industries Ltd. v. Commissioner of Income Tax (Gujarat High Court) | Expense relating to an earlier year is not payable in that earlier year unless the liability was determined and crystallized in that year; when accounts are mercantile, one must find whether liability was crystallized and quantified in the prior year. | The Court relied on this authority to support the view that where liability crystallizes later (30th June, 1981 here), the entitlement to deduction refers to the date of crystallization; applied in favor of the Assessee. |
| Bharat Earth Movers v. Commissioner of Income Tax (Supreme Court) | If a business liability has definitely arisen in the accounting year, deduction should be allowed even though quantification and discharge may occur later; liability must be incurred and capable of reasonable estimation. | The Court distinguished this decision as addressing the opposite situation where liability had accrued earlier; held it was not applicable to the present facts because additional liability here could only be known with certainty on 30th June, 1981. |
| E.D. Sassoon and Company Ltd. and Ors. v. Commissioner of Income Tax, Bombay City (Supreme Court) | Income accrues when the assessee acquires a right to receive it; there must be an acquired right or debt owed to the assessee. | Applied by analogy to dealers' rights: the dealers did not acquire a right to additional incentive until sales were ascertained on 30th June, 1981, so no earlier accrual of entitlement could be said to have occurred. |
| Rattan Chand Kapoor v. Additional Commissioner of Income Tax, Delhi-II | Under mercantile accounting, entries are made when obligation arises; a liability settled before assessment may be appropriated to the relevant year, but a liability raised many years later cannot be appropriated to that year. | The Revenue sought to rely on this principle to argue that the Assessee should have made a provision; the Court held Rattan Chand was not applicable because the Court had found the liability accrued only on 30th June, 1981. |
| Commissioner of Income Tax, Delhi, Ajmer, Rajasthan and Madhya Pradesh v. Nagri Mills Co. Ltd. (Bombay High Court) | Observation that disputes about the particular year for allowing a permissible deduction are often futile, especially where corporate tax rates are uniform; queries as to the year may not affect overall tax collectible. | The Court cited this authority to remark on the limited practical significance of disputes over the year of deduction and to note there was no change in tax rate for Assessment Year 1983-84 in the present reference. |
| ITR No. 70-71/1988 (relevant to AY 1981-82) and the Court's decision dated 29th April, 2008 (involving M/s Riken) | Prior consideration concluded the agreement was merely for the right to use technical knowhow. | The Court relied upon that earlier decision and the Assessing Officer's favourable earlier treatment to hold that the agreement with M/s Karl Smidth was similar and that payment of royalty could be allowed as revenue expenditure; answered the royalty question in favor of the Assessee. |
Court's Reasoning and Analysis
The Court first re-framed the principal question and identified two conceptual situations:
- A liability may arise on one date but crystallize on a later date (the category into which the Court placed the Assessee's case); the Assessee argued that crystallization on the later date governs entitlement to deduction.
- A liability may have actually crystallized earlier but its quantification may be postponed to a later date (the category relied upon by the Revenue and addressed by the Supreme Court in Bharat Earth Movers).
The Court concluded that the facts fall within the first category: the additional graded incentive under the extended scheme depended on sales occurring between 1st May and 30th June, 1981, and the additional liability could only be known with certainty when those sales were ascertained on 30th June, 1981. Thus the liability did not accrue prior to that date.
The Court applied the principle in Saurashtra Cement, which requires a finding that a liability was determined and crystallized in the earlier year before it can be treated as payable in that earlier year under mercantile accounting. That principle supported the Assessee's position that crystallization on 30th June, 1981 governed entitlement to the deduction.
The Court distinguished Bharat Earth Movers because that case concerned a situation where the liability had already accrued in the accounting year; by contrast, here it was possible that a dealer might have no sales in the May–June period and thus acquire no additional entitlement, so accrual could not be said to have occurred earlier.
The Court invoked the accrual concept from E.D. Sassoon (right to receive/income accrues when a right is acquired) and concluded dealers did not acquire a right to additional incentive until the sales were ascertained on 30th June, 1981.
The Court rejected the Revenue's reliance on Rattan Chand Kapoor because that authority presupposes a liability that had accrued earlier and thus could have been provided for; since the Court found accrual occurred only on 30th June, 1981, no provision could have been legitimately made earlier and Rattan Chand did not apply.
Regarding the royalty/foreign-collaborator question, the Court noted that similar agreements had been considered earlier (including in ITR No. 70-71/1988 and the decision of 29th April, 2008) and that the agreement with Karl Smidth was similar to the Riken agreement. Given the Assessing Officer's earlier favourable decision and the Court's prior conclusion that the relevant agreement was for the right to use technical knowhow, the Court followed that reasoning and allowed the royalty as revenue expenditure.
Holding and Implications
Holding (sales incentive question): ANSWERED IN THE NEGATIVE — in favour of the Assessee and against the Revenue. The Court held that the ITAT's disallowance was not correct because the additional graded incentive liability crystallized on 30th June, 1981 and therefore the Assessee's claim was proper.
Holding (royalty/foreign collaborators question): ANSWERED IN THE AFFIRMATIVE — in favour of the Assessee and against the Revenue. The Tribunal was right to allow, as revenue expenditure, the payment of royalty to foreign collaborators insofar as the relevant agreements were for the right to use technical knowhow and were similar to previously considered agreements.
Implications: The direct effect of the Court's rulings is that the Assessee succeeds on both referenced questions — the sales incentive is allowable in the manner claimed (given the crystallization finding), and royalty payments under the cited agreements are allowable as revenue expenditure. The opinion does not purport to lay down a novel legal principle beyond applying and distinguishing existing authorities; no new precedent-making proposition is articulated beyond the application of the cited authorities to these facts. The reference is disposed of.
1. On 30th April, 2008 we had noticed that the question referred for our opinion as formulated in paragraph 15.1 of the Statement of Case has been wrongly framed. There is no dispute about this in so far as both learned Counsel for the parties are concerned. Consequently, on a reading of the facts mentioned in paragraph 15 of the Statement of Case we frame the following question of law:
Whether the Income Tax Appellate Tribunal was correct in law in disallowing sales incentive claimed by the Assessee under the incentive scheme which had expired on 30th April, 1981 but which continued till 30th June, 1981 as having no relevance for the Assessment Year 1983-84?
2. The question arises in the following circumstances: The Assessee maintains its accounts on a mercantile basis. It had floated a scheme, which was valid until 30th April, 1981 and in terms of which the Assessee was liable to pay to its dealers in cash an incentive for the sales made. The scheme was initially up to 30th April, 1981 but it appears to have been continued up to 30th June, 1981.
3. As a result of the extended scheme, not only were the dealers extended the incentives that were available under the earlier scheme but they were entitled to a higher graded incentive if the sales from 1st May, 1981 to 30th June, 1981 were added to the sales already made up to 30th April, 1981. In other words, a graded incentive was stipulated under the scheme as extended up to 30th June, 1981.
4. In terms of the scheme, as extended, the Assessee incurred a liability of Rs. 1,40,541/- and according to the Assessee this amount was liable to be adjusted in the Assessment Year 1983-84. The basis on which the Assessee had claimed this deduction for that year was that the liability had accrued and crystilised only on 30th June, 1981 when the Assessee came to know the actual sales made by its dealers.
5. On the other hand, the view taken by the Revenue was that since the Assessee was maintaining its accounts on a mercantile basis, the liability had accrued earlier and only the quantification of the incentive was postponed.
6. In our opinion, the Assessee has been able to make out a case in its favor particularly in view of the judgment of Gujarat High Court in Saurashtra Cement and Chemical Industries Ltd. v. Commissioner of Income Tax .
7. Before we actually go into the decision, we may note that two situations arise: The first situation is that the liability arises on one date but gets crystallized on a later date (30th June, 1981 in this case). It is submitted by learned Counsel for the Assessee that crystallization of the liability on a future date would necessarily relate back to the earlier period but the entitlement to a deduction would have reference to the date on which the liability gets crystallized. The second situation, which has been canvassed by learned Counsel for the Revenue, is where the liability is actually crystallized on an earlier date but it may be quantified on a future date.
8. In our opinion, the case of the Assessee falls in the first category and not in the second category.
9. In Saurashtra Cement and Chemical Industries Ltd., the Gujarat High Court noted as follows:
...Merely because an expense relates to a transaction of an earlier year it does not become a liability payable in the earlier year unless it can be said that the liability was determined and crystallized in the year in question on the basis of maintaining accounts on the mercantile basis. In each case where the accounts are maintained on the mercantile basis it has to be found in respect of any claim, whether such liability was crystallized and quantified during the previous year so as to be required to be adjusted in the books of account of that previous year. If any liability, though relating to the earlier year, depends upon making a demand and its acceptance by the assessee and such liability has been actually claimed and paid in the later previous years it cannot be disallowed as deduction merely on the basis the accounts are maintained on mercantile basis and that it related to a transaction of the previous year....
10. In so far as the present case is concerned, the liability to pay incentive to the dealers up to 30th April, 1981 cannot be disputed. However, the payment of additional incentive, on a graded scale and relating back to the pre- 30th April, 1981 period would depend upon the sales made by the dealers from 1st May, 1981 to 30th June, 1981. This additional incentive would actually crystallize only on 30th June, 1981 when the Assessee is informed of the actual sales made by the dealers.
11. The decision of the Supreme Court relied upon by learned Counsel for the Revenue in Bharat Earth Movers v. Commissioner of Income Tax relates to a completely opposite situation. In that case the Supreme Court observed as follows:
The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
12. The law laid down by the Supreme Court in Bharat Earth Movers would not applicable to the facts of the present case as in that case the liability had accrued on an earlier date. In the present case it is possible that a dealer may not have any sale at all from 1st May, 1981 to 30th June, 1981 with the result that he would not be entitled to any additional incentive. However, if sales were made, then the additional incentive would be given on a graded scale and therefore the additional liability on the Assessee would only be known with any degree of certainty only on 30th June, 1981 and not earlier.
13. We may also note that in E.D. Sassoon and Company Ltd. and Ors. v. Commissioner of Income Tax, Bombay City the Supreme Court has observed as under:
...Income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody....
14. Applying this principle, in so far as the dealers of the Assessee are concerned, they would not have acquired a right to get additional incentive in the sense that the Assessee would not have known till 30th June, 1981 how much incentive the dealers had earned. On the other hand, in so far as the dealers are concerned, their entitlement would be known only when the sales were actually ascertained and determined and that was possible only on 30th June, 1981 and not on a date prior to that.
15. Learned Counsel for the Revenue sought to place reliance on Rattan Chand Kapoor v. Additional Commissioner of Income Tax, Delhi-II particularly on the follow passage:
We are of the view that a liability which is settled before the assessment is over can be appropriated to the relevant year in accordance with the Supreme Court's judgment, but if the liability is raised, say, ten years later as appears to be the case here, then it cannot be appropriated to that year and has to be claimed at a later date or not at all. The mercantile system of accounting visualizes entries being made in the account books and claims being made in respect thereof when the income has either accrued or is receivable and similarly an expense has to be entered when the obligation arises or the liability to pay arises. The entries are made in anticipation of actual payments.
16. The contention of learned Counsel for the Revenue is that the Assessee could have made a provision in its account books for the additional incentive and having failed to do so, it cannot claim the benefit in the subsequent assessment year. The argument of learned Counsel naturally proceeds on the basis that the liability had accrued on an earlier date which, as we have held, is not so. The liability had accrued on 30th June, 1981 and therefore no provision could have been made for the liability on an earlier date. Therefore, we are unable to apply the principle laid down in Rattan Chand.
17. Finally, we may only mention what has been articulated by the Bombay High Court in Commissioner of Income Tax, Delhi, Ajmer, Rajasthan and Madhya Pradesh v. Nagri Mills Co. Ltd. as follows:
We have often wondered why the Income tax authorities, in a matter such as this where the deduction is obviously a permissible deduction under the Income tax Act, raise disputes as to the year in which the deduction should be allowed. The question as to the year in which a deduction is allowable may be material when the rate of tax chargeable on the assessee in two different years is different; but in the case of income of a company, tax is attracted at a uniform rate, and whether the deduction in respect of bonus was granted in the assessment year 1952-53 or in the assessment year corresponding to the accounting year 1952, that is in the assessment year 1953-54, should be a matter of no consequence to the Department; and one should have thought that the Department would not fritter away its energies in fighting matters of this kind. But, obviously, judging from the references that come up to us every now and then, the Department appears to delight in raising points of this character which do not affect the taxability of the assessee or the tax that the Department is likely to collect from him whether in one year or the other.
18. In the reference that is before us there is no doubt that the Assessee had incurred an expenditure. The only dispute is regarding the date on which the liability had crystallized. It appears that there was no change in the rate of tax for the Assessment Year 1983-84 with which we are concerned. The question, therefore, is only with regard to the year of deduction and it is a pity that all of us have to expend so much time and energy only to determine the year of taxability of the amount.
19. Be that as it may, we answer the question in the negative, in favor of the Assessee and against the Revenue.
20. The remaining question that requires to be considered, though on a different topic, is as follows:
Whether on the facts and in the circumstances of the case the Tribunal was right in law in allowing by way of revenue expenditure the payment of royalty to foreign collaborators....
21. A similar issue had arisen in ITR No. 70-71/1988 relevant to the Assessment Year 1981-82 in respect of an agreement entered into between the Assessee and M/s Riken Piston Ring Ind. Co. Ltd. of Japan (for short Riken). In so far the present question is concerned, the agreement between the Assessee and Riken is the same. In addition, we are also required to consider the terms of an agreement entered into between the Assessee and M/s Karl Smidth of West Germany.
22. It has been submitted by learned Counsel for the parties that the Assessing Officer had decided in favor of the Assessee in respect of a similar agreement entered into by the Assessee with Riken and M/s Karl Smidth of West Germany. We may also add that the same agreement in respect of Riken was considered by us in ITR No. 70-71/1988 relevant to the Assessment Year 1981-82 and in that decision which we rendered on 29th April, 2008 we had came to the conclusion that the agreement was merely an agreement for the right to use the technical knowhow.
23. In the present case, the agreement between the Assessee and M/s Karl Smidth of West Germany is similar to the agreement between the Assessee and Riken. Following the decision rendered in ITR Nos. 70-71/1988 and taking note of the fact that the Assessing Officer has already decided in favor of Assessee on the same agreement and the same issue, we answer the question referred to us in the affirmative and in favor of the Assesse and against the Revenue.
24. The reference is disposed of.
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