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Commissioner Of Excess Profits Tax, Hyderabad v. M/S S.R.V.G Press Company, Kurnool
Factual and Procedural Background
The assessee–a partnership firm engaged in the manufacture of ground-nut oil and cake at Kurnool— maintained mixed mercantile/cash accounts on a Samvat (Diwali) year basis. Under the Madras General Sales Tax Act, 1939 they were permitted to pay sales tax provisionally each year on the turnover of the immediately preceding year, with final adjustment after the close of the current accounting year. For several years this produced either refunds or additional demands once the final assessment was made.
During the Samvat year 18-10-1944 to 4-11-1945 (assessment year 1946-47 for income-tax purposes) the firm provisionally paid Rs 49,633 in sales tax (inclusive of adjustments and after crediting rebates). The Income-tax authorities had consistently allowed the whole of such provisional payments as deductions. However, for the same period the Excess Profits Tax (EPT) Officer allowed only Rs 17,055 and disallowed Rs 30,221, treating the latter as expenditure “in excess of what was reasonable and necessary” under Rule 12 of Schedule I to the Excess Profits Tax Act, 1940. The Appellate Tribunal upheld the disallowance.
At the assessee’s instance the Tribunal referred the following question to the High Court of Andhra Pradesh: “Whether there are materials for the Tribunal to hold that the aforesaid sales-tax payments of Rs 30,221 were unreasonable and unnecessary having due regard to the requirements of the business and not consequently deductible under Rule 12 of Schedule 1 of the Excess Profits Tax Act?” The High Court answered the question in the negative (i.e., in favour of the assessee). The Commissioner appealed to the Supreme Court under Section 66-A of the Income-tax Act read with Section 21 of the EPT Act.
Legal Issues Presented
- Whether the excess provisional sales-tax payment of Rs 30,221 could be treated as “unreasonable and unnecessary” expenditure under Rule 12, Schedule I of the Excess Profits Tax Act, and therefore disallowed in computing excess profits.
Arguments of the Parties
Assessee's Arguments
- The firm had consistently followed the provisional-payment system permitted by the Madras General Sales Tax Act; its method of accounting had never been changed or questioned.
- The payments were compulsory, arising from lawful assessments, and failure to pay would attract statutory recovery and penalties; hence they were commercially necessary.
- Rule 12 requires assessment of reasonableness in the light of commercial expediency, not hindsight or tax-saving motives.
Revenue's Arguments
- Only the portion of sales tax attributable to the actual turnover of the chargeable accounting period (Rs 17,055) should be allowed; the balance was excessive under Rule 12.
- The assessee could have challenged the validity of the provisional-assessment scheme (later declared ultra vires by the Madras High Court in In re M.P. Kumaraswami Raja), and its failure to do so rendered the excess payment unnecessary.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| In re M.P. Kumaraswami Raja (1955) VI STC 113 (Madras HC) | Held the provisional assessment scheme under the Madras General Sales Tax Act, 1939 ultra vires. | The Supreme Court noted the decision but held that commercial reasonableness must be judged at the time of payment; businessmen cannot be expected to litigate every potential illegality. Moreover, the Madras legislature retrospectively validated the scheme. |
Court's Reasoning and Analysis
1. The Court found that the assessee’s accounting method—paying provisional sales tax on prior-year turnover with later adjustment—had been followed consistently and accepted by tax authorities over several years. There was no evidence of manipulation or delay designed to avoid tax.
2. Under clause (12) of Schedule I to the EPT Act, deductibility hinges on whether the expenditure is “reasonable and necessary having regard to the requirements of the business”. Reasonableness must be gauged by ordinary commercial standards, not by retrospective tax calculations.
3. Payment of sales tax was a statutory obligation under Sections 10 and 15 of the Madras General Sales Tax Act; non-payment invited recovery as arrears of land revenue and penalties. Such payments, therefore, were inherently necessary for carrying on the business.
4. The Excess Profits Tax Officer erred in treating the excess provisional payment as unreasonable; the Tribunal likewise erred in assuming that allowing only Rs 17,055 did not disturb the accepted method of accounting.
5. The Commissioner’s argument that the assessee should have contested the validity of the provisional-assessment rules was rejected. Commercial expediency does not require a trader to initiate constitutional litigation before complying with a tax demand. Additionally, subsequent state legislation (Madras Act 8 of 1955) retroactively validated the levy.
6. Consequently, the High Court’s negative answer to the reference question was upheld.
Holding and Implications
Appeal dismissed with costs.
Direct Effect: The assessee is entitled to deduct the full provisional sales-tax payment of Rs 49,633 (including the disputed Rs 30,221) when computing excess profits for the chargeable accounting period. The Revenue must accept the assessee’s established accounting method for such payments. No broader precedent was explicitly set beyond reaffirming that commercial expediency, rather than hindsight or potential legal challenges, governs the assessment of “reasonable and necessary” expenditure under Rule 12.
Shah, J.— The assessees are a firm carrying on business at Kurnool, of manufacturing groundnut oil and cake. Under the Madras General Sales Tax Act 9 of 1939, the assessees were entitled to a rebate of sales tax paid on goods purchased by them and used in the manufacturing process. The assessees maintained their books of account according to the Samvat Year ending with Diwali. The system of accounting was a mixture of mercantile and cash. Purchases and sales of goods on credit were duly entered in the books of account. The sales tax actually recovered by the tax authorities was debited when paid and amounts if any refunded were credited when received. The assessees had adopted the system which was permitted by the Act of paying tax calculated on the turnover of the previous year of account. Under this system, tax was provisionally assessed by the Sales Tax Officer on the basis of the turnover of the previous year, and thereafter the liability was adjusted at the end of the year of account in the light of the actual turnover of that year, and of rebate allowed in respect of groundnuts pressed into oil. As a result of the final adjustment made by the Sales Tax Authorities, in some years the assessees were assessed to pay tax in excess of the amount provisionally assessed and in others they obtained refund of the excess tax paid under the provisional assessment. The following tabular statement shows the official years for sales tax, provisional demands made by the Sales Tax Authorities, the final demands and the adjustments made in that behalf:
Official Yearended Provisionaldemand Finaldemand Adjustment Refund/Additionallevy Rs Rs Rs Rs 31-03-1942 2679 1872 807 31-03-1943 3046 2863 183 31-03-1944 14,509 18,402 3893 31-03-1945 47,276 20,037 27,239 31-03-1946 45,315 13,379 31,936
2. For Assessment Year 1946-47 (corresponding to the year of account 18-10-1944 to 4-11-1945), the assessees claimed in their assessment to income tax, to deduct Rs 49,633 being the amount of sales tax paid under a provisional assessment. In the year ending 31-3-1945, the assessees had paid Rs 47,276 as sales tax provisionally assessed. They also had paid in that year Rs 3894 in adjustment of the liability for the previous year towards sales tax due. After giving credit for Rs 1537 received as rebate, the total sales tax liability under the provisional assessment was Rs 49,633. The Income Tax Officer accepted this claim, and debited it from the income in Assessment Year 1946-47 in assessing the taxable income of the assessees. Deduction of sales tax actually paid under provisional assessment less rebates was permitted by the Income Tax Officer not only in Assessment Year 1946-47 but also in the earlier years. The Excess Profits Tax Officer had also adopted for the chargeable accounting period prior to 18-10-1944, the same method of computation, but for the chargeable accounting period 18-10-1944 to 4-11-1945, the Excess Profits Tax Officer allowed out of the amount of Rs 47,276 debited to sales tax only Rs 17,055 as properly attributable to that period in computing the Excess Profits Tax liability. According to the Excess Profits Tax Officer, the excess amount paid under the provisional assessment i.e Rs 30,221 could not be taken into account, because under Rule 12 of Schedule 1 of the Excess Profits Tax Act, expenditure in excess of the amount reasonable and necessary for the business was not a permissible deduction. In appeal against the order of the Excess Profits Tax Officer, the Tribunal affirmed the order. Against the order passed by the Tribunal confirming the order of the Excess Profits Tax Officer, the assessees applied for and obtained an order referring the following question to the High Court of Judicature of Andhra Pradesh.
“Whether there are materials for the Tribunal to hold that the aforesaid sales tax payments of Rs 30,221 were unreasonable and unnecessary having due regard to the requirements of the business and not consequently deductible under Rule 12 of Schedule 1 of the Excess Profits Tax Act?”
3. The High Court answered the question in the negative and against the order of the High Court, this appeal is preferred with leave under Section 66-A(2) and (3) of the Income Tax Act read with Section 21 of the Excess Profits Tax Act.
4. It is manifest that the assessees had not altered the method according to which their accounts were maintained. Year after year, they were paying tax provisionally assessed by the Sales Tax Officer on the turnover of the previous year subject to adjustment at the close of the year of account. This system of payment of tax under provisional assessments was not adopted with a view to evade tax liability. Nor was recovery of the amounts ordered to be refunded to the assessees delayed because of any deliberate inaction on the part of the assessees. It is not found that excess tax on inflated returns was paid in anticipation of the repeal of the Excess Profits Tax Act. The assessees for reasons of convenience adopted, as they were entitled under the Madras General Sales Tax Act, a system of payment of tax on provisional assessment based on the turnover of the previous year subject to final adjustment to be made at the end of the year. The assessees could opt for the system of paying sales tax on provisional assessment, but the liability to pay tax imposed was on that account not voluntarily incurred. This system produced no direct benefit to the business and adjudged in retrospect, it undoubtedly reduced the taxable income; but if otherwise the payment was reasonable and necessary having regard to the requirements of the business, it was not liable to be ignored in assessing the Excess Profits Tax liability of the assessees. By clause (12) of Schedule 1 of the Excess Profits Tax Act, it is provided that “in computing the profits of any chargeable accounting period, no deduction shall be allowed in respect of expenses in excess of the amount which the Excess Profits Tax Officer considers reasonable and necessary having regard to the requirements of the business;….”
5. It is for the Excess Profits Tax Officer to decide whether the deductions claimed are reasonable and necessary having regard to the requirements of the business. But the reasonableness and necessity of the expenditure sought to be deducted in assessing Excess Profits Tax liability must be adjudged in the light of commercial expediency. The payments made by the assessees were in discharge of obligations imposed lawfully and were necessary for the proper conduct of the business. By Section 10 of the Madras General Sales Tax Act, the assessees were obliged within 15 days from the date of service of the notice of assessment to pay tax and in default, the amount was liable to be recovered as if it were an arrear of land revenue. Again, by Section 15, if the assessees failed to submit the return as required by the provisions of the Act or the rules made thereunder or failed to pay the tax within the time prescribed, they were liable to be penalised. Payments made in satisfaction of liability which arises by virtue of the assessment made by the Sales Tax Officer cannot be called unreasonable. Payment of sales tax as assessed being obligatory and necessary for the purpose of carrying on the business, it must in our opinion be deemed to .satisfy the requirements of clause (12) of Schedule 1 of the Excess Profits Tax Act.
6. The Excess Profits Tax Officer was, in our opinion, in error in thinking that the tax paid was in excess of the requirements of the business. We are also of the view that the Tribunal was in error in holding that by seeking to deduct only the tax properly attributable to the actual turnover during the chargeable accounting period, the Excess Profits Tax Officer was not seeking to disturb the method of accounting which was followed by the assessees and was accepted by the taxing authorities for many years.
7. Counsel for the Commissioner submitted that the rules relating to advance provisional assessment and levy of tax framed under the Madras General Sales Tax Act, 1939, were inconsistent with the provisions of the Act and the assessees should have raised this contention and have obtained a decision from the court before paying tax on provisional assessment and not having done so, payments made cannot be regarded as either reasonable or necessary. Counsel says that in In re M.P Kumaraswami Raja case (1955) VI Sales Tax Cases 113, the Madras High Court has declared this scheme of taxation on provisional assessment ultra vires. But the reasonableness or the necessity of payments under Rule 12, Schedule 1 of the Excess Profits Tax Act must be ascertained in the light of what may be regarded as commercially expedient and not on any legalistic considerations. It would not be expected of a businessman to start a litigation in respect of a tax which the legislature of the State was competent to levy on the ground that the method devised for computing the tax liability was ultra vires. The tax was duly assessed and paid and the reasonableness and necessity must be adjudged in the light of the circumstances then prevailing and not in the light of subsequent developments. It may also be noticed that since the Madras High Court's decision in In re Kumaraswami Raja case (1955) VI Sales Tax Cases 113 the Madras Legislature by the Madras General Sales Tax Amendment Act 8 of 1955 retrospectively validated the levy. By virtue of this Act, assessments made provisionally and the levy of the tax were to be regarded as valid notwithstanding any initial inconsistency between the provisions of the Act and the Rules framed thereunder. It may also be pointed out that no such question was referred to the High Court and not even an argument appears to have been raised in the High Court on this question. We are of the view that the High Court was right in answering the question in the negative.
8. The appeal therefore fails and is dismissed with costs.
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