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Kashmir Agencies Pvt. Ltd. v. Income-Tax Officer, Central Circle-V, And Others
Case Summary — Judgment of Sabyasachi Mukharji, J.
Factual and Procedural Background
The opinion concerns an application under article 226 of the Constitution challenging a notice dated 29 July 1970 issued under section 148 of the Income-tax Act, 1961, which sought to reopen assessments for the assessment years 1964-65 (and references are made to later years as well). The petitioner is a company that acted as managing agent of Kashmir Ceramics Ltd. under a managing agency agreement said to be dated 24 February 1962 (the reopening reasons refer to an agreement dated 19 March 1962 and appointment from 1 February 1962). Under the agreement the petitioner was entitled to 10% of net profits and, where profits were absent or inadequate, a minimum remuneration of Rs. 50,000 per year.
The petitioner contended that it did not earn or receive any remuneration because the managed company largely ceased working from 1962-63 and most expenses were capitalised, and that the petitioner had surrendered the provisions of the agreement ab initio in 1968. At the original assessment (for 1964-65 completed on 13 March 1969) the petitioner had placed the agreement and relevant materials before the assessing officer and disclosed that the managed company did not earn profit due to cessation of production.
The Revenue produced reasons for reopening, alleging that the managing agents had in fact become entitled to the minimum remuneration of Rs. 50,000 for a series of years, that the managing agents later agreed in August 1968 to forgo such minimum remuneration retroactively (by a supplemental agreement dated 22 August 1968), and that the managing agents had nonetheless not shown the minimum remuneration in their earlier returns—constituting a failure to furnish all material facts—so that income had escaped assessment and section 147(a) proceedings were justified.
Legal Issues Presented
- Whether there were "materials" for believing that income of the assessee had escaped assessment such that a notice under section 148 (proceeding under section 147(a)) was properly issued.
- Whether the alleged failure to disclose (i.e., not showing the minimum remuneration in earlier returns) amounted to an omission or failure to furnish fully and truly all material facts required to justify reopening.
- Whether the primary facts relevant to accrual of income (the terms of the managing-agency agreement and whether the managed company had carried on business/earned profits) had been disclosed to the assessing officer at the original assessment.
Arguments of the Parties
Petitioner's Arguments
- The petitioner did not, in fact, earn or receive managing-agent remuneration for the years in question because the managed company had ceased production and most expenses were capitalised.
- All relevant documents and material facts (including the managing-agency agreement and the fact that the managed company did not earn profits) were produced at the time of the original assessment, so there was no omission or failure to disclose.
- The managing agency provisions were surrendered ab initio in 1968, which the petitioner relied upon to show that no chargeable income remained.
Respondents' (Revenue's) Arguments
- Clause 4 of the managing-agency agreement entitled the managing agents to a minimum remuneration of Rs. 50,000 in the absence or inadequacy of profits; thus the managing agents had accrued minimum remuneration for the years in question despite non-payment.
- Although a supplemental agreement of 22 August 1968 purported to forgo minimum remuneration retrospectively, the managing agents had, in earlier returns for 1964-65 to 1967-68, not shown the minimum remuneration and had thereby misrepresented material facts to the Income-tax Officer at Jullundur.
- Because the managing agents failed to disclose that the minimum remuneration had accrued (it was shown in the managed company's accounts as a liability), income escaped assessment and reopening under section 147(a) was justified. The Revenue relied on precedents to support taxing accrued remuneration notwithstanding a subsequent retrospective surrender.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Rungta Sons Ltd., [1964] 54 ITR 447 (Calcutta High Court) | Principle that income which has already accrued under an agreement may be taxable notwithstanding a subsequent retrospective surrender. | The Revenue relied on this decision to argue that the minimum remuneration once accrued should be taxed even though a supplemental agreement later purported to forgo it. The Court noted the reliance but proceeded to examine whether there was any nondisclosure of primary facts that would justify reopening. |
| Kothari Mehta and Co. Pvt. Ltd., [1963] 50 ITR 753 (Madras High Court) | Similar principle to Rungta Sons regarding taxation of income that has accrued despite later retrospective adjustments. | The decision was cited by the Revenue as supporting the view that accrued minimum remuneration remained taxable; the Court acknowledged the citation in assessing whether materials existed to reopen assessments. |
| Commissioner of Income-tax v. Jai Parkash Om Parkash Co. Ltd., [1964] 52 ITR 23 (Supreme Court) | Observation that under the mercantile system of accounting the question whether income has accrued is a question of law to be inferred from relevant facts. | The Court relied on this authority to frame the legal status of "accrual" under mercantile accounting—i.e., accrual is a question of law drawn from primary facts—when determining whether the reopening was supported by materials. |
| Commissioner of Income-tax v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266 (Supreme Court) | Observations on whether a subsequent year's surrender of income may be relevant in determining tax liability arising from an earlier accrual. | The Court noted that whether a subsequent year's surrender is relevant depends on circumstances; however, the Court confined its inquiry to whether there was a failure to disclose primary facts at the time of the original assessment. |
Court's Reasoning and Analysis
The court approached the challenge to the section 148 notice by asking the specific and narrow question required by section 147(a): whether there were "materials" from which the Income-tax Officer could form a belief that income had escaped assessment due to failure or omission by the assessee to furnish fully and truly all material facts.
The court identified the "primary and relevant facts" necessary to determine whether minimum remuneration had accrued: (1) the terms and conditions of the managing-agency agreement; and (2) whether the managed company had in fact done business or earned profits. The court found that these two primary facts had been disclosed to the assessing officer at the time of the original assessment.
The court accepted the legal propositions cited by the parties: under mercantile accounting the question whether income has accrued is a question of law to be derived from primary facts (citing Jai Parkash Om Parkash Co. Ltd.), and that in some circumstances a subsequent surrender could be relevant (citing Birla Gwalior). It also acknowledged the Revenue's reliance on the Calcutta and Madras High Court decisions (Rungta Sons and Kothari Mehta) for the proposition that accrued minimum remuneration may be taxable notwithstanding a later retrospective surrender.
However, the court emphasized the distinction between (a) nondisclosure of primary facts and (b) a difference of opinion or a failure to draw a particular inference from facts that were disclosed. The court held that if the primary facts were disclosed, the Revenue's failure to draw the same inference at the time of the original assessment does not amount to a failure on the part of the assessee to furnish fully and truly all material facts. Because the managing-agency agreement and the fact of the managed company's lack of profitability were brought to the assessing officer's attention, there was no omission of primary facts justifying reopening under section 147(a).
Concluding from this analysis, the court found that the statutory conditions precedent for issuance of the notice under clause (a) of section 147 were not satisfied in the instant case.
Holding and Implications
The impugned notice dated 29 July 1970 issued under section 148 (proceeding under section 147(a)) was set aside and quashed; the rule was made absolute.
Direct effect on the parties:
- The respondents were restrained from giving effect to the impugned notice dated 29 July 1970.
- Any assessment made pursuant to that notice was also quashed and set aside.
- The operation of the order was stayed for six weeks from the date of the judgment.
- In the related Civil Revision Case No. 426(W) of 1971 the application was allowed for the same reasons and the rule nisi was made absolute.
- There was no order as to costs in the principal matter (and the court expressly repeated that there would be no order as to costs).
Broader implications: The opinion focuses on whether there was an omission to disclose primary facts at the time of the original assessment and does not announce a novel legal doctrine. It analyzes existing authorities on accrual and the relevance of subsequent surrender, but the decision is driven by the factual finding that the primary facts had been disclosed and therefore the statutory preconditions for reopening were not met.
Sabyasachi Mukharji, J.:— The assessments for the assessment years 1964-65 and 1965-66, made under the provisions of the Income-tax Act, 1961, were sought to be reopened by the notice dated the 29th of July, 1970, issued under section 148 of the Income-tax Act, 1961. The said notice is the subject-matter of challenge in this application under article 226 of the Constitution. The petitioner is a company. During the material times, the petitioner was acting as the managing agent of Messrs. Kashmir Ceramics Ltd. The petitioner had entered into an agreement with the said Messrs. Kashmir Ceramics Ltd., dated the 24th of February, 1962. According to the agreement the petitioner was entitled to a remuneration of 10 per cent, of the net profit of the said Messrs. Kashmir Ceramics Ltd. It further appears that the said Messrs. Kashmir Ceramics Ltd. could not work from 1962-63 and mostly all the expenses incurred in construction were capitalised. The petitioner's case is that the petitioner did not earn or receive any remuneration from Messrs. Kashmir Ceramics Ltd. and finally the provisions of the agreement were surrendered by the petitioner ab initio in 1968. The petitioner states that at the time of the original assessment which was made on the 13th of March, 1969, for the assessment year 1964-65, the petitioner had produced all the relevant documents and disclosed all the material facts. A reference to the original assessment order makes it clear that the fact that the petitioner had been appointed as the managing agent of Messrs. Kashmir Ceramics Ltd. by an agreement dated the 24th of February, 1962, was brought to the notice of assessing officer. Indeed, the said agreement was placed before the assessing officer and the clauses of the said agreement were scrutinised. The fact that for the relevant assessment year Messrs. Kashmir Ceramics Ltd. did not earn any profit because it had ceased production due to dispute with the Jammu and Kashmir Government was also brought to the notice of the assessing officer. The company had claimed deduction on account of certain expenses for management of the managed company. Those deductions were disallowed and the reasons for disallowance were stated, inter alia, as follows:
“As per the agreement the company was appointed managing agents of Kashmir Ceramics Ltd., Kathua. The agreement gives the details of the duties to be performed by the managing agents. A scrutiny of this deed of agreement reveals that the duties assigned to the managing agents could be performed only if the factory continued the manufacturing process. There is nothing in the agreement which makes it obligatory on the part of the managing agents to manage the affairs of the company if it ceases to manufacture. In fact this was the plea taken by the Kashmir Agencies Pvt. Ltd. while refusing any commission to the managing agents during the period April 1, 1963, to March 31, 1968. Therefore, in my opinion, there was no operation of the mananing agency during the accounting year 1963-64. Consequently, the expenses claimed by the company cannot be allowed.”
2. The reasons for reopening for the relevant assessment year were produced before me and the said reasons read as follows:
“This company was appointed as the managing agent of Kashmir Ceramics Ltd., Jammu, for a period of 20 years with effect from February 1, 1962, on the strength of an agreement dated March 19, 1962.
3. As per clause 4 of the managing agency agreement the managing agents were entitled to remuneration for their services commission at 10% of the net profits of the managed company. It was further provided in the agreement that in the case of absence or inadequacy of profits in any year the managing agent would be entitled to a minimum remuneration of Rs. 50,000. It was also provided that the said commission would be due to the managing agency yearly and every year during the continuance of the agreement and would be payable immediately after the accounts of the managed company were approved at the annual general meeting.
4. For the assessment years 1964-65 to 1968-69, the managed company did not earn any profit in any of the years concerned and accordingly the managing agents became entitled to the minimum remuneration of Rs. 50,000 in each of the years. The managed company, in their accounts, debited the managing agency remuneration of Rs. 50,000 in each of the assessment years, i.e, 1964-65 to 1967-68, but actually nothing was paid to the managing agents in lieu of remuneration due and the amounts were carried forward and shown as outstanding liability in the balance-sheet of the managed company in all these years.
5. In August, 1968, the managing agents voluntarily offered to forgo the minimum remuneration referred to above with effect from the assessment year 1964-65 and for further years to come. This offer was immediately accepted by the managed company and a supplemental agreement dated August 22, 1968, was entered into between the managed company and the managing agent whereby the clause regarding minimum remuneration in the original managing agency agreement was deleted with retrospective effect from January 1, 1963 (the managed company followed the calendar year as their previous year). On the strength of this supplemental agreement the managed company did not charge minimum remuneration payable to the managing agents in their accounts for the year ending on December 31, 1967 (relevant for the assessment year 1968-69), and it had also written off the accumulated liability to the managing agents of Rs. 2 lakhs which represented minimum remuneration for 4 years, viz., for the assessment years 1964-65 to 1967-68.
6. However, in their returns for the years 1964-65 to 1967-68, the managing agents did not show the minimum remuneration of Rs. 50,000 before the Income-tax Officer; Jullundur, who had jurisdiction over the file then by misrepresenting the facts to the effect that no managing agency remuneration had fallen due because the managed company did not work to its full capacity and did not earn any profit in any year. On this misrepresented fact the Income-tax Officer, Jullundur, who completed the assessments, accepted the contention and did not tax the minimum remuneration which the company had already earned.
7. In the course of the company's assessment for the year 1968-69, the jurisdiction has since been transferred to this circle. It was found out on scrutiny that the assessee must suffer tax on minimum remuneration which it had already earned up to 1968-69 assessment year because the income which had already accrued to the assessee on the strength of the original agreement dated March 19, 1962, was taxable notwithstanding the fact that the incomes for these years were surrendered retrospectively through supplemental agreement dated August 22, 1968. This is in line with the decision of the Calcutta High Court in the case of Rungta Sons Ltd., [1964] 54 ITR 447 as well as of the Madras High Court decision in the case of Kothari Mehta and Co. Pvt. Ltd., [1963] 50 ITR 753. The assessment for the year 1968-69 has accordingly been completed on Rs. 50,000 being the minimum remuneration earned by the company though not shown in the return.
8. Accordingly, the minimum managing agency remuneration of Rs. 50,000 has escaped assessment for each of the years 1964-65 to 1967-68 due to failure on the part of the assessee to furnish fully and truly all material facts relating to its income. Hence this proposal under section 147(a).”
9. Statement to the same effect were reiterated in the affidavit-in-opposition filed in answer to the rule nisi in this case. Therefore, it appears that the Income-tax Officer concerned now is of the opinion that minimum commission of Rs. 50,000 had accrued to the assessee for the relevant year which had escaped assessment. For coming to the aforesaid conclusion the material and relevant facts are the terms and conditions of the agreement and, secondly, whether the managed company had in fact done any business or earned any profit. If these two material and relevant facts are there, then it will be a matter of inference to be drawn from those facts whether any income had in fact accrued to the petitioner for the relevant assessment year. It is not in dispute in the instant case that the petitioner follows the mercantile system of accounting. In such a system of accounting whether the income had accrued or not is a question of law to be inferred from the two relevant factors mentioned hereinbefore. The question of accrual in such a circumstance is a question of law. For this reliance may be placed on the observations of the Supreme Court in the case of Commissioner of Income-tax v. Jai Parkash Om Parkash Co. Ltd., [1964] 52 ITR 23 at page 27. The fact whether the assessee in the subsequent year, that is to say, 1968-69, gave up the remuneration earned or the fact whether the managed company had shown in its accounts the remuneration earned by the managing agent are not factors, in my opinion, relevant for determination whether for the relevant assessment year minimum remuneration under the agreement had accrued to the petitioner. On the question whether, even if there was accrual of income on mercantile basis under the provisions of the Income-tax Act for computing the real income, the fact that in the subsequent year the assessee had given up the income in certain circumstances would be relevant factors or not in determining the question of liability of the assessee to tax, reliance may be placed on the observations of the Supreme Court in the case of Commissioner of Income-tax v. Birla Gwalior (P.) Ltd., [1973] 89 ITR 266. But I am concerned at this stage to find out whether there were materials for the Income-tax Officer for thinking that the income of the assessee had escaped assessment or had been under assessed due to any failure or omission on the part of the assessee to disclose fully or truly all relevant and material facts. It appears that it can be said that there were some materials for believing that the income of the assessee had escaped assessment or had been under-assessed for the relevant assessment year. The question is whether there was any omission or failure on the part of the assessee to disclose fully or truly all materials or relevant facts. If primary facts were disclosed the failure to draw proper inference from those primary facts is not a failure on the part of the assessee. In this case, the primary and relevant facts for determining whether the income had accrued or the minimum remuneration had accrued to the assessee were the terms and conditions of the agreement and whether the managed company had done any business or had earned any profit. These factors indisputably were disclosed. Therefore, it cannot be said that there was any failure or omission on the part of the assessee to disclose the basic or primary facts. In the aforesaid view of the matter and in view of the reasons that have been disclosed now for initiating the proceeding under clause (a) of section 147 of the Income-tax Act, 1961, it must be held that the conditions precedent for issuance of the notice were not fulfilled in the instant case. The impugned notice dated the 29th of July, 1970, is, therefore, set aside or quashed. The rule is made absolute. The respondents are restrained from giving effect to the same. If any assessment had been made pursuant to the impugned notice the same is also quashed and set aside. There will be no order as to costs. Let the operation of this order remain stayed for six weeks from date.
10. Civil Revision Case No. 426(W) of 1971:
For the same reasons as mentioned in Civil Revision Case No. 425(W) of 1971, this application is allowed and the rule nisi is made absolute.
11. There will be no order as to costs.
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