Untwalia, C.J:— This is a reference made under section 66(1) of the Indian Income-tax Act, 1922 (hereinafter called “the Act”), by the Income-tax Appellate Tribunal for determination by this court of the following question of law:

“Whether, on the facts and in the circumstances of the case, the amount of Rs. 2,04,947 was allowable as deduction of selling commission in the assessment for the assessment year 1955–56?”

2. Most of the facts may be taken from the statement of the case prepared by the Tribunal. The assessee is a limited company, named Messrs. Shree Krishna Gyanoday Sugar Ltd., Dalmianagar. The assessment year in question is 1955–56, the corresponding previous year of the assessee being from August 1, 1953, to July 31, 1954. The company carries on manufacturing business of sugar and distillery products. On February 25, 1949, an agreement was entered into between the assessee and another company called the Ashoka Marketing Ltd., appointing the latter as the selling agents for the sale of the products of the former as per terms incorporated in the agreement, a copy of which is annexure “A” to the statement of the case. The agent-company was entitled to a commission of 1 per cent. on the sales of sugar and 2 ¼ per cent. on the sales of distillery products. The commission was to be calculated on the gross invoice value of the products. The assessee had to consign, transmit and deliver to the selling agents or at their request to other parties such quantities of the products manufactured by it for which the agent-company might place orders from time to time. The accounts contained details of the commission credited to the selling agents month by month. In the previous year in question the commission payable on sales of sugar came to Rs. 1,82,690 and Rs. 22,257 on sales of distillery products. On August 2, 1954, just two days after the closing of the previous year, the assessee-company wrote a letter to the agent-company, a copy of which is annexure “B” to the statement of the case, stating therein that in view of the poor working results of the company found during the year it was difficult to make payments of commission at the rates stipulated under the agreement dated February 25, 1949. Ashoka Marketing Ltd. was, therefore, requested to charge only such commission, brokerage, etc., as had been actually incurred by them. It may be stated here that the said company was incurring some small expenditure on that account by payment to other parties.

3. The board of directors of Ashoka Marketing Ltd. considered the letter of the assessee-company dated August 2, 1954, and passed a resolution on August 11, 1954, stating that the agent-company would charge for the period commencing on September 1, 1953, only such commission, brokerage, etc., as was payable by it in respect of sugar and distillery products sold. The negotiation for revision of the agreement was also referred to in the resolution and a fresh agreement was authorised to be entered into. A copy of the resolution dated August 11, 1954, is annexure “C”. In the books of the assessee-company original entries were made crediting the agent-company with the commission as calculated under the agreement. The books were kept open for making adjustment entries in August, 1954, and when the agent-company passed the resolution in August, 1954, the asseseee-company made the necessary journal entries reversing the original entries crediting the commission. The result was that there was ultimately no commission charged in the assessee's profit and loss account as none finally stood credited to the agent-company. Copies of entries and balance-sheets are annexures “D” and “E”.

4. Return was filed without claiming the two amounts, viz., the sums of Rs. 1,82,690 and Rs. 22,257, total Rs. 2,04,947, as business expenditure of the assessee-company. The assessment order in this case is dated March 30, 1960. Just five days before, probably when the assessment proceedings were going on, the assessee-company claimed deduction of the amounts aforesaid by its letter dated March 25, 1960, a copy of which is annexure “F”. The Income-tax Officer held that on the facts and in the circumstances of the case the deduction could not be claimed or allowed. The Appellate Assistant Commissioner, on appeal, affirmed the view of the Income-tax Officer. When the matter was, in second appeal, before the Appellate Tribunal, reference was made to the assessment of the two amounts in the hands of Ashoka Marketing Ltd. on behalf of the assessee-appellant, and it was contended that the amounts, therefore, ought to have been allowed as deductions in the assessment of the assessee-company. I may state here that the Tribunal attached no importance to this aspect of the matter and rightly so. We were further informed at the Bar that the addition of the two amounts in the assessment of Ashoka Marketing Ltd. is sub judice and is under challenge in further proceedings. Be that as it may, the question for consideration in this case is whether the assessee could claim a deduction of the amounts in question as selling commission for the assessment year 1955–56.

5. The principles of law which are deducible from the decided cases, many of which will be noticed in this judgment hereinafter, are these:

(1) In a mercantile system of accounting actual cash receipt of income is not necessary for the purpose of taxing a particular item as income; it is sufficient if the income has accrued during the period in question. Similarly, if the liability to a particular sum has been incurred during the accounting year and if otherwise the sum is allowable as a revenue expense, then whether the sum has been actually paid or not is immaterial; the liability so incurred has got to be allowed as a revenue expense.

(2) If after the accrual of the income or incurring of the liability any party forgoes the sum by way of gift, charity or the like and voluntarily, which cannot be characterised as a remission on grounds of commercial expediency, then such forgoing cannot affect either accrual of the income for the purpose of assessing tax on it or the liability incurred for the purpose of carrying on the business, and the liability so incurred cannot be obliterated by such forgoing.

(3) Mere book entries are not decisive of the matter. What has to be seen and found out is the effect of the forgoing in law on the accrual of the income or the incurring of the liability for expenditure. If the two transactions can be called to be part and parcel of the same transaction so as to wipe off the accrual or the liability, then, on remission by one party, neither the income is available for taxation nor the expenses are fit to be allowed as business expenses. If, however, the two can be viewed as separate transactions and the subsequent remission has not the effect of wiping off the accrual of the income or the liability of the expenses, but is either a unilateral act or some act which has not got that effect, then the accrual of the income or the incurring of the liability of the business expenses remains.

6. In the background of the above principles of law, first, I proceed to examine the facts of this case before I come to discuss the authorities on the point. It was expressly provided in clause 17 of the agreement that by mutual consent it could be determined at any time. It goes without saying that in the realm of contract law it was open to the parties to vary any term of the agreement by mutual consent. As mentioned in the letter dated August 2, 1954 (annexure “B”), the assessee-company was noticing its bad position, and, therefore, about the beginning of the preceding sugar season, which was in the midst of the accounting year, mutual negotiations had started in terms of the agreement dated February 25, 1949, subject to the ratification by the boards of both companies, in respect of the difficulties of the assessee-company in paying commission on sales stipulated under the agreement. It is further stated in this letter that the matter was not finalised during the accounting year, but it was mutually agreed that the position might be reviewed at the end of the year. The agreement was also sought to be amended as per draft enclosed with the letter. It is not quite correct to say that the amendment of the agreement was de hors the remission of the commission amount for the year in question: it was a part and parcel of the same negotiations and the variation of the agreement. The suggestion in the letter, therefore, was that the agent-company might charge from the assessee-company for the year ending July 31, 1954, the actual expenses or commission, brokerage, etc., expended by the former. This proposal was accepted by the board of directors of Ashoka Marketing Ltd. by their resolution dated August 11, 1954 (annexure “C”). This also talks about the revision of the agreement dated February 25, 1949, and I have no doubt in my mind that it also relates to the variation for the year in question. Of course, the proposal for the month of Augut, 1953, does not seem to have been accepted, as the acceptance was for the period of one year commencing from September 1, 1953, only. But that is of no consequence, because the whole of the amount is covered by the period commencing from September 1, 1953, and ending on July 31, 1954. The reversal entry in annexure “D” shows that it was reversed as per statement attached and not because the agent-company remitted it on account of considerations other than commercial expediency. I would better quote the letter written by the assessee-company to the Income-tax Officer on March 25, 1960 (annexure “F”):

“We understand that in the case of our selling agents, Messrs. Ashoka Marketing Ltd., you have questioned why the selling commission forgone by them relating to 1953–54 (accounting year), should not be taxed in their hands. In this connection it has already been explained to you that the said commission was remitted by them on grounds of commercial expediency and in view of our working results being much below those of the earlier years. It is well established by legal decisions that the commission is not taxable in their hands. It is submitted without prejudice that in case the said commission is taxed in their hands the same should be allowed as a legitimate deduction in our assessment.”

7. It would thus be clear that the assessee-company first pleaded that the amount should not be taxed in the hands of Ashoka Marketing Ltd. as they had remitted the amount of commission on the ground of commercial expediency. If, however, it was taxed in their hands, then it should be allowed as a legitimate deduction in the assessment of the assessee-company. It would thus be seen that in the instant case the liability which was incurred as per the agreement dated February 25, 1949, was obliterated and given a go-by by novation of the agreement between the parties. It was open to them to do so. It mattered little whether novation of the term of the agreement came before the close of the accounting year or after: the two were part and parcel of the same transaction. It was not a case where the agent-company had forgone its claim on commission leaving intact the liability of the assessee-company. In the eye of law, the liability incurred earlier was obliterated later by mutual consent of the parties. That being so, the liability to pay the commission was no longer there, and, therefore, the assessee-company could not claim it as a business expense under section 10(2)(xv) of the Act. I am not concerned in this case whether the sums in question could be taxed in the hands of Ashoka Marketing Ltd. It will be beyond the scope of this reference to express any opinion in that regard.

8. The Tribunal has relied upon a decision of the Bombay High Court in Commissioner of Income-tax v. New Jehangir Vakil Mills Co. Ltd. [1959] 37 I.T.R 136 Bom.. and referred to two decisions of the Supreme Court in Commissioner of Income-tax v. Chamanlal Mangaldas & Co. [1960] 39 I.T.R 8 and Commissioner of Income-tax v. Shoorji Vallabhdas and Co. [1962] 46 I.T.R 144 S.C. I shall presently deal with them as also with a few more. However, I want to emphasise at this stage that the Tribunal does not seem to have expressed its view on the footing that the remission by the agent-company was not on the ground of commercial expediency. As I read the order of the Tribunal, it seems to have accepted the stand taken on behalf of the assessee. The facts of the case of New Jehangir Vakil Mills Co. Ltd. were that a total liability to the tune of Rs. 4,00,000 and odd payable as agent's commission was incurred by the assessee-company. The managing agents agreed to forgo a sum of Rs. 1,00,000 and odd out of that amount of remuneration. Ultimately, the net amount received by them was Rs. 4,00,000 and odd. In the balance-sheet of the company one-third of the total commission was shown as “voluntarily given up”. The whole sum had been taxed at the hands of the managing agents. But that apart, S.T Desai J. (as he then was), stated at page 139:

“The question really lies in a very narrow compass. What we have to consider is what was the legal obligation or the liability that was incurred by the company, We are not dealing here with any cash payment or cash receipt and in our judgment the only possible view is that the liability incurred by the company was not the lesser amount but the whole amount of Rs. 4,58,388 and if that be the position, then we do not see how the department was justified in withholding full deduction of Rs. 4,58,388.”

9. When the departmental counsel argued that the amount was given up by the managing agents as a matter of business expediency and not ex gratia as stated by the Tribunal, and, therefore, it was a receipt and income in the hands of the company, the argument was repelled by stating;

“The finding of this court in the earlier reference relating to the assessment of the managing agents was that the managing agents were not compelled under the provisions of any agreement to give up the amount but it was voluntarily given up by them. That being the position, it is extremely difficult for us to see how this amount which was voluntarily given up by the managing agents and received as such by the company can be treated as receipt or income in the hands of the company.”

10. It would thus be seen that on the facts of this case it was found that the amount was voluntarily given up by the managing agents and not in accordance with the provisions of any agreement. In the instant case, the amounts were given up as a result of the variation of the terms of the agreement between the parties by mutal consent and also for commercial expediency.

11. In my opinion, the Tribunal has not correctly appreciated the facts and ratio of the decision of the Supreme Court in the case of Chamanlal Mangaldas & Co. The income-tax authorities in that case had held that the entire sum of Rs. 2,00,000 was taxable income, having accrued as commission during the previous year and out of it a sum of Rs. 1,00,000 was a mere voluntary surrender which could not affect the taxability of the whole amount of commission accruing to the managing agents. The Tribunal, however, held that as a result of the agreement between the managing agents and the managed-company the right of the managing agents to claim full remuneration had been taken away as from January 1, 1950, and it was not a voluntary relinquishment on the part of the managing agents. Therefore, what was taxable was the amount of Rs. 1,00,000 and odd and not the other lakh. The facts of the other civil appeal which was before the Supreme Court were similar. The discussion at page 13 would show that the amounts payable under the agreement could be determined at the end of the year. An entry to that effect had been made on December 31, 1950, but the directors decided that they should be paid a lakh less, and the balance only was credited to their account. In such a situation it was inferred that the right of the managing agents to receive the commission on its accrual was at the end of the accounting year when all the sales were and could be added up and the accounts were made up. It has, therefore, been said:

“Thus, the amount which accrued or which they were entitled to receive was the latter sum, i.e, Rs. 1,05,575, and not what would have been payable had there been no variation in, and modification of, the agreement.”

12. Dr. Pal, appearing for the assessee-company, submitted that in the instant case the amounts became payable every month; they were accordingly credited to the account of Ashoka Marketing Ltd. every month and not at the end of the year. In my opinion, that makes no difference. By mutual consent the liability incurred earlier could be wiped off even though the consensus ad idem was arrived at later. Law did not prevent the parties, by mutual consent, from giving effect to the variation of the agreement from a back date. In the realm of contract law, by retroactive operation of the contract new facts may not be permissible to be brought into existence, but facts or liabilities already created can be obliterated by retroactive operation of the subsequent agreement. Law does not prevent it. In my opinion, the Tribunal has committed an error of law in placing reliance upon the decision of the Supreme Court in the case of Shoorji Vallabhdas and Co., and using this decision in favour of the assessee. In that case, the question was whether the two sums under consideration were income of the previous year; if so, whether they represented an item of expenditure permissible under the provisions of section 10(2)(xv) in computing the assessee's income of that previous year from its managing agency business. The departmental authorities came to the conclusion that the amount of larger commission had already accrued during the previous year and was thus assessable. The amount given up could not be allowed as an expenditure under section 10(2)(xv). In the Appellate Tribunal there was a difference of opinion between the Accountant Member and the Judicial Member, the latter taking the view that the appeal should be allowed. The President agreed with the Judicial Member and opined that, even though the actual reduction took place after the year of account was over, there was, in fact, an agreement to reduce the commission even during the currency of the account year, and the larger income neither accrued nor was received by the assessee-firm. The assessment was, therefore, reduced by deleting the extra commission from computation. The High Court agreed with the view of the President and answered the first question in the negative and, therefore, declined to answer the second question as to the deductibility of the amounts under section 10(2)(xv) of the Act. Hidayatullah J. (as he then was) approved the decision of the Bombay High Court which, in its turn, had relied upon its earlier decision in the case of Commissioner of Income-tax v. Chamanlal Mangaldas & Co. This decision of the Bombay High Court was approved by the Supreme Court in the case of Chamanlal Mangaldas & Co. The learned judge said at page 148 :

“Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account. This is exactly what has happened in this case, at it happened in the Bombay case Commissioner of Income-tax v. Chamanlal Mangaldas & Co., which was approved by this court. Here too, the agreements within the previous year replaced the earlier agreements, and altered the rate in such a way as to make the income different from what had been entered in the books of account. A mere book-keeping entry cannot be income, unless income has actually resulted, and in the present case, by the change of the terms the income which accrued and was received consisted of the lesser amounts and not the larger. This was not a gift by the assessee-firm to the managed companies. The reduction was a part of the agreement entered into by the assessee-firm to secure a long-term managing agency arrangement for the two companies which it had floated.”

13. In the instant case, as I have said above, negotiations for remission of the commission amounts had started during the previous year. Immediately on close of the year a letter was written by the assessee-company to the agent-company. Books of account were kept open for the purpose. The agent-company agreed to remit the amount of commission, except a portion which was in the nature of actual amounts expended by it. That being so, even though the variation of the agreement was effected subsequently, on the facts of this case, I am definitely of the opinion that it will not detract from the position that the liability incurred was made non-existent by the subsequent agreement given effect to by the parties concerned.

14. Dr. Pal also placed reliance upon the decision of the Bombay High Court in H.M Kashiparekh & Co. Ltd. v. Commissioner of Income-tax [1960] 39 I.T.R 706 Bom... S.T Desai J., the same learned judge who had decided the case of New Jehangir Vakil Mills Co. Ltd., when the question arose whether the amount was taxable or not, stated at page 722 :

“In the present case surrender of commission has been made bona fide and as a matter of commercial expediency and at an early point of time when accounts were made up. We need not recapitulate what we have already stated. The accrual of the commission, the making of the accounts, the legal obligation to give up a part of the commission and the forgoing of the commission at the time of the making of the accounts are not disjointed facts. There is a dovetailing about them which cannot be ignored.”

15. I, respectfully, adopt the reasoning of the learned judge and apply them mutatis mutandis to the facts of the instant case.

16. Mr. B.P Rajgarhia, learned counsel for the revenue, cited before us the decision of the Supreme Court in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax. The ratio of this case and passages from it have been quoted with approval in a later decision of the Supreme Court in Commissioner of Income-tax v. Birla Gwalior (P.) Ltd. In the case of Morvi Industries Ltd. v. Commissioner Of Income Tax (Central) Calcutta [1971] 82 I.T.R 835, 840, 841 S.C., it is no doubt true that by resolution of the board of directors of the managing agency company, the assessee relinquished its commission on sales and office allowance, because the managed company had been suffering heavy losses in the past years. This was done after the commission had become due but before it had become payable in terms of clause 2(e) of the agreement. The Tribunal held that the relinquishment by the assessee of its remuneration after it had become due had no effect and also rejected its claim that the amounts relinquished were allowable under section 10(2)(xv) of the Act. The Supreme Court affirmed the view of the High Court and held that the commission had accrued to the assessee at the end of the previous years and the fact that the payment had been deferred till after the accounts had been passed in the meetings of the managed-company did not affect the accrual of the income. The amounts of income for the two years were given up unilaterally by the assessee after it had accrued to it; therefore, it could not escape liability to tax on those amounts. Moreover, the amounts were not relinquished for the purpose of the assessee's business and hence the assessee was not entitled to claim deduction of the amounts as business expenditure under section 10(2)(xv) of the Act. Khanna J., delivering the judgment on behalf of the court, said:

“The accrual of an income is not to be equated with the receipt of the income……

The appellant-company admittedly was maintaining its accounts, according to the mercantile system. It is well-known that the mercantile system of accounting differs substantially from the cash system of bookkeeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits, whereas under the mercantile system, credit entries are made in respect of amounts due immediately they become legally due and before they are actually received; similarly, the expenditure items for which legal liability had been incurred are immediately debited even before the amounts in question are actually disbursed. Where accounts are kept on mercantile basis, the profits or gains are credited though they are not actually realised, and the entries thus made really show nothing more than an accurual or arising of the said profits at the material time. The same is the position with regard to debits made.”

17. The decision of the Supreme Court in the case of Shoorji Vallabhdas and Co. was distinguished on the ground:

“It was held that this was not a case of a gift by the assessee to the managed companies of a portion of income which had already accrued, but an agreement to receive a lesser remuneration than what had been agreed upon. In the present case, the amounts of income for the two years in question were given up unilaterally after they had accrued to the appellant-company. As such, the appellant could not escape the tax liability for those amounts.”

18. On a review of several authorities, Hegde J. has said in the case of Birla Gwalior (P.) Ltd. after laying stress on some lines which Khanna J. has quoted in the judgment in the case of Morvi Industries Ltd. from the decision of the Supreme Court in Shoorji Vallabhdas and Co.:

“Hence it is clear that this court in Morvi Industries' case did emphasise the fact that the real question for decision was whether the income had really accrued or not. It is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income.”

19. On a parity of reasoning, I have no doubt in my mind that what has to be allowed as a business expense is either the actual amount expended or the real liability incurred. But a liability incurred which in law justifiably could be and was given a go-by was not a real liability of the expenditure; it was a hypothetical liability and became non-exi???tent on variation of the terms of the agreement by mutual consent of the parties for the purpose of commercial expediency. That being so, I have no doubt in my mind that the amount was wrongly allowed by the Tribunal under section 10(2)(xv) of the Act.

20. Learned counsel for the assessee submitted that sub-section (2A) was introduced in section 10 with effect from April 1, 1955. Therefore, the subsequent remission brought about in the accounting year commencing from August 1, 1954, which would correspond to the assessment year 1956–57, could be taxed in the hands of the assessee-company under section 10(2A) of the Act. I am not called upon to decide this question in this case as it does not arise out of the Tribunal's order. I may, however, add that sub-section (2A) seems to be attracted to a case where after allowance or deduction had been made in the assessment for any year and subsequently during any other previous year, the assessee had received, whether in cash or in any other manner, any amount in respect of such allowance or deduction. In the instant case, the amount was not allowed or claimed as a deduction in the assessment year 1955–56, because by mutual consent the agent-company had agreed not to charge commission from the assessee-company. The claim made in the letter dated March 25, 1960, was a conditional one that if the amount is taxed in the hands of Ashoka Marketing Ltd. then deduction should be allowed. Such a contingent liability claim, it is undisputed, could not be made and allowed. For the reasons stated above, I answer the question referred to this court in the negative, against the assessee and in favour of the revenue. I hold that, on the facts and in the circumstances of this case, the amount of Rs. 2,04,947 was not allowable as deduction of selling commission in the assessment for the assessment year 1955–56. The assessee must pay the costs of this reference. Hearing fee is assessed at Rs. 250 only.

Nagendra Prasad Singh, J.:— I agree.