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Commissioner Of Income-Tax v. Super Scientific Clock Co.
Factual and Procedural Background
The question referred to this Court arises from a statement of case submitted by the Tribunal under s. 256(1) of the Income-tax Act. The issue concerns whether Rs. 89,722 paid by the assessee to a foreign collaborator as technical know-how fees was an allowable deduction for the assessment year in question (asst. yr. 1977-78).
The factual matrix as presented is: the payment was made during the previous year relevant to asst. yr. 1976-77. The Assessing Officer (AO) disallowed the deduction on the ground that the liability to pay had accrued in the previous year relevant to asst. yr. 1975-76, and the assessee maintained accounts on the mercantile system, so the assessee could not claim the deduction on a payment (cash) basis. The assessee contended that, for this payment and year, it followed a cash system of accounting, but the AO and the Commissioner of Income Tax (Appeals) [CIT(A)] rejected that contention.
On further appeal the Tribunal allowed the deduction, holding that the liability had not accrued earlier because, under s. 9 of the Foreign Exchange Regulation Act (FERA), 1973, payments to persons outside India required permission or exemption from the Reserve Bank of India (RBI); until that permission was granted payment could not be made, and the liability was therefore contingent and only became payable in the later year.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in concluding that the sum of Rs. 89,722 paid as know-how fees to the foreign collaborator by the assessee was an allowable expenditure for the assessment year in question (i.e., whether the liability to pay was contingent such that the deduction could be claimed in the later year).
Arguments of the Parties
Assessee's Arguments
- The assessee asserted that, for the specific transaction and year in question, it followed the cash system of accounting and therefore was entitled to claim deduction on payment in the year the payment was made.
- Implicit in the Tribunal's acceptance was the contention that, because FERA required RBI permission for payments to non-residents, the liability to pay was not enforceable (i.e., was contingent) until such permission or exemption was granted.
Revenue / AO / CIT(A) Arguments
- The AO denied the deduction on the ground that the liability to pay had accrued in the previous year relevant to asst. yr. 1975-76 and the assessee maintained accounts on the mercantile basis, so it could not claim the deduction on a cash basis in a later year.
- The CIT(A) agreed with the AO that the assessee had not properly followed a cash system for the year in question and that the assessee had not provided for the liability in the year it accrued; therefore the deduction could not be claimed in the subsequent year.
- The Revenue (by way of reference) challenged the Tribunal's conclusion that the liability was contingent by reason of FERA s.9 and sought the Court's determination under s. 256(1) IT Act.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Mrs. Chandnee Widya Vati Maddan vs. Dr. Col. Katial & Ors, AIR 1964 SC 978 | Distinction between a contingent contract and a completed contract; authority held that where parties have agreed to bind themselves, the obligation is not contingent merely because a statutory permission is required, and a court can enforce terms and require the party to apply for necessary permission. | The Court relied on this precedent to show that the requirement of governmental or regulatory permission (here, RBI permission under FERA) for making payment does not convert an accrued contractual liability into a contingent liability; the precedent supports the conclusion that the assessee's liability under the collaboration agreement had crystallised and was enforceable notwithstanding the procedural requirement to obtain RBI permission for payment. |
Court's Reasoning and Analysis
The Court's analysis proceeded in the following steps, rooted in the facts and statutory framework presented in the statement of case:
- Clarification of CIT(A)'s finding: The Court observed that the Tribunal incorrectly interpreted the CIT(A) as having found that the assessee "though following cash system of accounting" had not made provision. On close reading, the CIT(A) had in fact found that it could not be said the assessee maintained accounts on a cash system for that year; the assessee had pleaded that only for this particular entry and year it followed cash accounting, which was rejected by the AO and the CIT(A). Thus, the Tribunal erred in construing the CIT(A)'s finding.
- Application of s. 145 IT Act (as in force at the relevant time): The Court noted that income from business or profession must be computed according to the method of accounting regularly employed (cash, mercantile, or hybrid). While an assessee could adopt different systems for different sources, a single source of income could not be accounted for by employing different systems for parts of transactions relating to that same source. The Court held that the assessee's attempt to apply a cash system only to this transaction (while otherwise following mercantile accounts) ran counter to this principle.
- Distinction between accrual of liability and the procedure for payment: The Court emphasized that the Tribunal failed to distinguish between (a) when a liability accrues under the contract and becomes enforceable, and (b) the statutory or procedural mechanism required to make actual payment (here, the RBI permission under FERA). The Court held that FERA's requirement of RBI permission pertains to the procedure for making payment in foreign exchange and does not affect whether a contractual liability has accrued.
- Effect of FERA s.9: The Court stated that the provisions of FERA do not govern the consideration underlying contractual obligations or the accrual of liability; they only regulate unauthorized payments to and from non-residents. The requirement of RBI permission for making the foreign remittance does not render the existing contractual liability contingent or unenforceable. In fact, the need to obtain permission prima facie supports the existence of a valid liability.
- Reliance on authority: The Court cited the decision in Mrs. Chandnee Widya Vati Maddan v. Dr. Col. Katial to illustrate that the requirement of a statutory permission does not convert a completed contractual obligation into a contingent one, and that the court can enforce the contract and require application for permission.
- Conclusion from facts: The Court found no doubt, and no contrary finding was recorded, that the liability under the collaboration agreement became due in the previous year relevant to asst. yr. 1975-76 (i.e., the liability had accrued earlier and was not a contingency arising only in the later year). The only issue relevant to computing profits and gains for the year was the regular method of accounting followed; the assessee could not legitimately treat that single liability as cash-accounted when the business accounts were mercantile.
Holding and Implications
Holding: The Court answered the referred question in the negative — in favour of the Revenue and against the assessee. In other words, the Tribunal erred in holding that the liability was contingent and that the deduction was allowable for the assessment year in question.
Implications:
- The direct effect is that the sum of Rs. 89,722 paid as know-how fees was not an allowable expenditure for the assessment year in question under the reasoning adopted by the Tribunal; the liability had accrued earlier and could not be shifted to the later year by treating the obligation as contingent due to the requirement of RBI permission.
- The Court's decision rests on treating the accrual of contractual liability as independent of statutory procedural requirements for making foreign payments and on the requirement that an assessee cannot apply different accounting systems to parts of transactions arising from the same source. The opinion does not state that a new legal precedent is being laid down beyond applying these principles to the facts before the Court.
- No order as to costs was made. The assessee did not appear despite service.
BY THE COURT
1. The following question has been referred at the instance of Revenue and statement of case has been submitted by the Tribunal to this Court on an application made under s. 256(1) of the IT Act by the CIT in respect of assessment for the asst. yr. 1977-78 in the case of respondent assessee :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in coming to the conclusion that the sum of Rs. 89,722 paid as know-how fees to the foreign collaborator by the assessee was an allowable expenditure for the assessment year in question ?"
2. The facts and circumstances in which the aforesaid question has been referred to this Court are that a sum of Rs. 89,722 paid by the assessee to its foreign collaborator as technical know-how fees during the previous year relevant to asst. yr. 1976-77 was not allowed as deduction by the AO on the ground that the liability to pay had arisen during the previous year relevant to asst. yr. 1975-76 and assessee is not entitled to claim the same on the payment basis for the asst. yr. 1976-77 as he is maintaining his accounts on mercantile basis. The assessee's plea that in respect of this payment, he has followed cash system of accounting though otherwise he has followed the mercantile system of account has not been accepted by the AO. The plea did not find favour with the CIT(A) either, and he observed that; As the assessee has not provided for tax liability in the year in which it has accrued and claimed deduction thereon, it cannot claim deduction for the subsequent year of actual payment. The Tribunal on further appeal held, the liability did not accrue. because of the provisions of s. 9 of the Foreign Exchange Regulation Act (FERA), 1973 that no payment could be made to any person outside India except with the and in accordance with the exemption from the provisions of the Act being granted by the Reserve Bank of India (RBI) until such permission was granted by RBI. Until then the liability was not enforceable and was, therefore, contingent. The Tribunal also observed that CIT(A) in para 7 of his order has held that payment was due in the asst. yr. 1976-77 and as the appellant though following cash system of accounting did not make any provision, the appellant is not entitled to any reduction in respect of amount of Rs. 89,722.
3. At the outset we may say there is no foundation for noticing about CIT(A) finding "though following cash system of accounting". On the close reading of the order of the CIT(A). We do not find any such finding reached by the CIT(A). We find from the order that the assessee has raised this contention that the appellant was maintaining the accounts on cash system basis which was contested by the ITO and the finding was that "it could not be said that the appellant maintained the accounts on cash system basis so far as this year". It was the case of the assessee that only for the purpose of entry in question and for the year in question, he has followed the cash accounting system, otherwise he is following mercantile system. This plea did not find favour with the AO nor with the CIT(A). Therefore, Tribunal in our opinion has erroneously assumed that CIT(A) has found that the appellant though following the cash system of account, the deduction was not allowed because he did not make any provision.
Under s. 145 of the IT Act, as it was in force during the relevant period, income under the head 'profits and gains' of business or profession, where the assessee maintains books of account, has to be in accordance with method of accounts regularly employed by the assessee, which could be either cash mercantile or hybrid system. The assessee for any particular source of income could adopt different system of accounting, but in no case, he could employ for part of the transactions or events relating to one source of income employed different system of accounting. The very foundation of assessee's plea is against this basic principle.
4. In concluding that because of the provisions of s. 9 of the FERA, the liability to pay did not become due and enforceable, in our opinion, the Tribunal has failed to perceive distinction between accrual of liability to pay on the one hand and procedure required for making such payment which has become due on accrual of such liability on the other hand. Provisions of the FERA has nothing to do with the accrual of liability which arises under terms of contract independent of the provisions of the FERA. The liability of the assessee to pay 'know-how fee' to the technical collaborator arises under the collaboration agreements. The consideration for which such agreement was entered is not governed by FERA. The liability to pay, and right of recipient of consideration to receive the same, and on failure of promisor to pay right to enforce does not depend on the permission or grant of exemption of RBI under FERA. The fact that before actual payment is made permission of RBI is to be obtained, does not make the account and enforceability of liability subject to it. On the contrary it prima facie supports that there exist a valid liability to pay to grant such permission. The object of FERA Act is not to control or regulate the obligation to pay any sum due to a non-resident arising under a valid contract, but is to keep a check on unauthorised payment to and from non-residents and regulate payments in foreign exchange. If payment under any provision of law is to be made only by way of a demand draft, it cannot be said that liability to pay accrued only when money is paid into the bank and demand draft is delivered by the bank. The liability to pay accrue independent of required procedure for payment, if any, prescribed under law is put in action. There is no doubt in the present case, nor any finding to the contrary, that so far as the liability of the assessee to pay the amount to its non-resident technical collaborator under the contract became due in the previous year relevant to asst. yr. 1975-76 and not in the previous year relevant to assessment year in question. The only question that could have been germane for purpose of compounding profits and gains under the head 'business and profession' of the year would be the method of accounting followed by the assessee regularly in respect of his business for which the technical know-how was obtained. There cannot be a piecemeal method of accounting in respect of the same business or the same source of income or expenditure. It cannot be said that for a source of income one system is followed, but for some of expenses required to be incurred for earning income from that source, a different method of accounting can be employed. Agreement to acquire technical know-how for its business is not by itself a source of income for which different system of accounting could be maintained. It was very curious that the assessee had urged maintenance of cash system of accounting only for the transaction in question for the year in question and that too by pleading difficulty in making payment in the earlier year. The difficulty or time taken in following the procedure prescribed for making actual payment is hardly relevant for the purpose of maintenance of account on mercantile system. It often happens that there is gap between accrual of liability and its payment. The liability does not cease to be enforceable because of some procedure is required to be fulfilled on the part of the promisor under the agreement, for making such payment under any law. The fact that permission of RBI is required to be obtained is there in all cases payment is to be made or received from non-residents. It is for the person liable to remit or receive payment to apply for the same. The fact that a person may apply for such permission in advance or one awaits until after it becomes due and payable, does not stop accrual of liability or make it contingent on happening of any event. Else the result will be that notwithstanding liability to pay has arisen under the terms of agreement, the party under obligation to make payment, can postpone its accrual or enforceability at his free will, by choosing his own time to move the Appropriate Authority for such permission.
5. We may usefully refer to ratio in case of Mrs. Chandnee Widya Vati Maddan vs. Dr. Col. Katial & Ors. AIR 1964 SC 978 which draws distinction between a contingent contract and a completed contract in order to appreciate distinction between a contingent liability and the liability which is crystalised. It was a case in which parties have entered into agreement to sell certain property. The law required the vendor to seek necessary permission to such transfer. The suit for specific performance of such agreement was sought to be the defended on the ground that the contract was contingent as its performance was dependent on permission to be granted by Collector. As to the obligation of the parties to the contract, the Court said :
"That the contract was not a contingent contract and that the parties had agreed to bind themselves by the terms of the document executed between them. The Court had got to enforce the terms of the contract and to enjoin upon the vendor to make the necessary application for permission."
6. In our opinion, the principle fully applies. Parties have entered into agreement on transfer of technical know-how with the permission of the Government of India. Under it liability of the assessee to pay fee for technical know-how accrued. The fact that actual payment could be made only with the permission of RBI, only put him under obligation to apply to the RBI for grant of necessary permission for releasing payment of amount to a non-resident. But its enforceability is not contingent one.
7. In view of aforesaid discussion, we are of the opinion that the Tribunal has erred in allowing the sum in question as deduction for the assessment year in question by holding liability in the preceding year was contingent and became due and payable in the year in question only.
8. Accordingly, we answer question referred to us in negative, that is to say, in favour of Revenue and against assessee.
9. Assessee has not appeared in spite of service.
10. No order as to costs.
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