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Case Number

Tax Case No. 86 of 1960 (Reference No. 15 of 1960)

Judges

Jagadisan
Srinivasan, JJ.

Acts

INDIAN INCOME TAX ACT

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Smart Summary

Summary of the Opinion of Srinivasan, J.

Factual and Procedural Background

The assessee was a registered partnership firm engaged as managing agents of Sree Meenakshi Mills Limited under a managing agency agreement dated 14 March 1945. Under that agreement the firm was entitled to a fixed monthly allowance of Rs. 1,000 and 5% of the annual net profits of the company (clause 7). The mills had branches at Usilampatti and Pudukottah. The present reference concerns the 5% commission due to the assessee in respect of those two branches for the assessment years 1946–47 to 1950–51.

For those years the mills credited the monthly allowance and the 5% profits relating to the head office at Madurai, but did not credit the profits relating to the Usilampatti and Pudukottah branches in their accounts. The Income-tax Officer made assessments in respect of the ascertained but uncredited profits of the two branches. On appeal the Appellate Assistant Commissioner rejected the assessee's contention that assessment could only be made on income actually received, holding instead that the commission had accrued to the assessee. The Appellate Assistant Commissioner found the non-adjustment in the mills' books to be a device to reduce the assessee's tax liability, noting that two partners of the firm held a majority of shares in the mills' directorate.

The Tribunal, relying on the Supreme Court decision in Thiagaraja Chetti & Co., also held that the income had accrued to the assessee. On the assessee's application under section 66(1) of the Income-tax Act the Tribunal referred the following question to this Court:

“Whether the commission of 5% on the profits of Usilampatti and Pudukottah branches of Sree Meenakshi Mills Limited has accrued due to the assessee on the agreement dated 14th March, 1945, notwithstanding the failure of the mills to adjust it in their books so as to be assessable in the hands of the assessee for the assessment years 1946-47 to 1950-51?”

Legal Issues Presented

Whether the 5% commission on the profits of the Usilampatti and Pudukottah branches "has accrued due to the assessee on the agreement dated 14th March, 1945, notwithstanding the failure of the mills to adjust it in their books" so as to be assessable in the hands of the assessee for the assessment years 1946–47 to 1950–51?

Arguments of the Parties

Assessee's Arguments (as represented by Sri Padmanabhan)

The assessee should be assessed only on income actually received; since the mills did not credit the commissions in their books in the relevant years, the amounts neither accrued to nor were received by the assessee and therefore are not taxable.
Although it was conceded that profits became ascertained on 31 March of each accounting year, the assessee argued that taxation could not follow unless the mills made the necessary accounting entries crediting the amount to the assessee.
The assessee also argued that by writing to the mills (letters dated 16 March 1945 and 20 February 1946) requesting higher remuneration (claiming 25% for the Pudukottah branch), the firm had waived its right to the stipulated 5%, i.e., that the claim for additional remuneration constituted abandonment of the 5% entitlement.

Revenue / Department / Lower Authorities' Position

The Appellate Assistant Commissioner and the Tribunal both held that the 5% commission had accrued to the assessee when profits were ascertained at the end of the accounting year, despite the mills' failure to credit the amounts in their books.
The Appellate Assistant Commissioner concluded that non-adjustment in the mills' accounts was primarily a device to reduce the assessee's tax liability, noting the connection between two partners of the firm and the mills' directorate.
The Tribunal relied on the Supreme Court decision in Thiagaraja Chetti & Co. as authority for holding that the income had accrued to the managing agents.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Thiagaraja Chetti & Co. v. Commissioner of Income-tax [1953] 24 I.T.R. 535 S.C.	Decision concerning assessment of a managing agency business (under an earlier agreement) establishing that income of that managing agency accrued.	The Tribunal relied upon this Supreme Court decision; the Court treated it as supporting the view that commission income accrues to managing agents when profits are ascertained, even if not entered in the managed company's books.
Bhogilal Laherchand v. Commissioner of Income-tax	Headnote excerpt: income cannot accrue until the assessee acquires a right to receive it; income may accrue before actual receipt but accrual depends on creation of a debt/right to receive.	The Court considered the decision's facts and held it did not support the assessee's submission that book entries alone create the right; the Court distinguished the case because there profits were ascertainable only on a fixed accounting date and the headnote must be read in that factual context.
Dewar v. Commissioners of Inland Revenue	Relied on by parties as to whether unpaid interest on a legacy could be included in surtax assessment; King's Bench held interest not includible where not received and statutory language differed.	The Court found this case of limited assistance because its decision turned on specific statutory wording and the absence of the phrase “profits or gains arising or accruing”.
Commissioner of Income-tax v. Thiagaraja Chetty & Co. [1951] 19 I.T.R. 261 (High Court) and appeal to Supreme Court [1953] 24 I.T.R. 525	High Court: one judge held commission carried to suspense account was not income; other judge disagreed. Supreme Court preferred the view that the commission was income even though carried to a suspense account.	The Court relied on the Supreme Court's view that commission income did not cease to be income merely because it was carried to a suspense account; this supported the conclusion that non-credit in the managed company's books did not prevent accrual of income to the managing agents.

Court's Reasoning and Analysis

The Court's analysis proceeded from the terms of the managing agency agreement (which the Court obtained from the record). Clause 7 provided for payment of Rs. 1,000 per mensem and 5% of the annual net profits "after making all proper allowances." Clause 8 governed the calculation of net profits and entitlement to additional remuneration.

The Court accepted the assessee's concession that the net profits were ascertained as at 31 March of each accounting year. Given that clause 7 placed a liability on the company to pay 5% of the annual net profits "after it is ascertained", the Court reasoned that the ascertainment of net profits created a corresponding right in the assessee to receive the commission at the same time as the liability to pay arose on the company. Thus, accrual for income-tax purposes occurred on ascertainment.

Addressing the assessee's primary contention — that accrual depended on the mills' making accounting entries crediting the sums to the assessee — the Court distinguished the authorities relied upon by the assessee. In particular, Bhogilal Laherchand was examined: the Court emphasized that in that case profits were ascertainable only on a specific date (Deewali) and the headnote must be read in the light of those facts; thus the case did not support the proposition that book entries alone are determinative of accrual.

The Court also reviewed Dewar and found it of limited relevance because its result depended on specific statutory language (and therefore did not aid the present question). The Court referred to the High Court and Supreme Court decisions in the Thiagaraja Chetty litigation. While a High Court judge had held that commission carried to a suspense account was not income, the Supreme Court preferred the contrary view: the commission was income even though carried to suspense. The Court relied on the Supreme Court view to reinforce that non-crediting in the managed company's books did not prevent accrual of the commission to the managing agents.

Finally, the Court rejected the assessee's separate submission that its letters requesting enhanced remuneration amounted to a waiver or abandonment of the pre-existing contractual right to 5%: clause 8, which provided for additional remuneration as may be sanctioned by the directors, did not extinguish the contractual entitlement under clause 7. The Court found no basis for concluding that a request for additional remuneration could be treated as relinquishment of the guaranteed 5%.

Holding and Implications

Question answered in the affirmative.

Holding (direct effect): The Court held that the 5% commission on the profits of the Usilampatti and Pudukottah branches had accrued to the assessee under the agreement dated 14 March 1945 when the net profits were ascertained at the end of each accounting year, notwithstanding the failure of the mills to credit those amounts in their books. The decision of the department and the Tribunal was affirmed.

Consequences imposed by the Court: The decision is against the assessee, who was ordered to pay the costs of the department; counsel's fee was fixed at Rs. 250.

Broader implications: The opinion applies existing authorities to hold that a contractual right to remuneration arising on ascertainment of profits gives rise to accrual for income-tax purposes even if the payor does not make corresponding book entries. The Court did not state that it was establishing any new legal principle beyond its application of the cited authorities.

End of summary — based exclusively on the provided opinion.

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Thiagaraja Chettiar & Co. v. Commissioner Of Income-Tax, Madras.

Srinivasan, J.:— The assessee is a registered partnership firm which under a managing agency agreement dated 14th March, 1945, carried on a business as the managing agents of Sri Meenakshi Mills Limited. Under this agreement, the assessee was entitled to an allowance of Rs. 1,000 per mensem and 5% of the annual profits of the company. The mills had branches at Usilampatti and Pudukottah. The present reference is confined to the percentage of profits which the assessee became entitled to in respect of these two branches only.

2. For the assessment years 1946-47 to 1950-51, the mills credited in its accounts the monthly allowance stipulated as well as the 5% profits relating to the head office at Madurai. The profits relating to the Usilampatti and Pudukottah branches were not so credited by the mills in its accounts. In respect of the ascertained but uncredited profits of the two branches, assessments were made by the Income-tax Officer. In the appeals to the Appellate Assistant Commissioner, the assessee contended that it must be assessed only on the income actually received. It was urged that the percentage due on the profits of the two branches was in dispute, as the assessee had been demanding a higher share of the percentage than what was allowed in the agreement. The further contention was that since this quantum of profits had not been credited to the assessee's account by the mills no assessment could be made. These contentions were rejected by the Appellate Assistant Commissioner who took the view that the percentage of commission in question had accrued due to the assessee. The officer was further of the opinion that the omission to make the necessary adjustments in the books of the mills despite the matter being brought to the notice of the mills by its auditors was principally due to the fact that two of the partners of the assessee firm held the majority of shares in the directorate of the mills and that the non-adjustment was only a device to obtain a reduction in the assessee's tax liability, while at the same time the managed company of the mills did not stand to lose by this non-adjustment. For these reasons, the appeals were dismissed. In the further appeals to the Tribunal, principally the same ground, viz., that the sums could not be said to be the income of the appellant as there was neither accrual nor receipt thereof, was advanced. On this question the Tribunal relied upon the decision of the Supreme Court in Thiagaraja Chetti & Co. v. Commissioner of Income-tax [1953] 24 I.T.R 535 S.C., in which the assessment of this very managing agency business was under consideration, though on the basis of an earlier agreement. Relying upon this decision, the Tribunal held that the income did accrue to the assessee.

3. On the application of the assessee under section 66(1) of the Act, the Tribunal referred the following question for the decision of this court:

4. Sri Padmanabhan, learned counsel for the assessee, has rested his arguments on practically a solitary ground, viz.; that since the mills did not credit the amounts to the accounts of the assessee in the relevant years, the amounts cannot be deemed to have either accrued to the assessee or to have been received by the assessee, and on this short ground he presses for our acceptance the conclusion that the income not having reached the hands of the assessee, the assessee is not liable to be taxed. It is not however denied by the learned counsel that on the last day of each of the accounting years, the 31st March, the profits became ascertained; but, nevertheless, his contention is that so long as the mills did not make the necessary entries in its books, the amount did not become taxable income.

5. Though the managing agency agreement has not been printed as part of the reference, we called for it from the records of this court. The relevant clauses of the managing agency agreement are these:

Clause 7.— The company shall during the continuance of this agreement pay the firm by way of remuneration for their services as managing agents an allowance of Rs. 1,000 per mensem and 5% on the annual net profits of the company after making all proper allowances.

Clause 8.— In calculating the net profits of the company for the purpose of the last preceding clause, no deduction shall be made from profits for depreciation. The firm shall be entitled to such additional remuneration as the directors may sanction in case of an increase of capital or business with the approval of the company in general meeting.”

6. The short question that arises therefore is whether under the terms of this agreement the assessee did not become entitled to the amounts in question. Clause 7 places a liability on the company to pay five per cent. of the annual net profits of the company, obviously after it is ascertained., But the ascertainment of these net profits, as we have pointed out, is admitted by the learned counsel for the assessee to have been made immediately at the close of the relevant accounting year. Undoubtedly, therefore. the clauses create a corresponding right in the assessee to receive the amount when once the profits have been ascertained. The question then is whether by reason of the failure of the mills to make the necessary credit entries in its accounts in favour of the assessee of the profits payable to the assessee firm under clause 7 of this agreement, the amount neither accrued nor arose within the meaning of the Indian Income-tax Act so as to be taxable in the hands of the assessee.

7. The learned counsel for the assessee placed reliance upon Bhogilal Laherchand v. Commissioner of Income-tax. Part of the headnote, upon which considerable reliance was placed, reads thus:

“Though income may accrue or arise to an assessee before he actually receives it, income cannot accrue or arise to him until he acquires a right to receive the same; and unless and until there is created in favour of the assessee a debt due by somebody, it cannot be said that he has acquired a right to receive the income.”

8. According to the learned counsel such creation of a right in his favour could only take place when the mills credited the amount to his account. Looking at the facts of the case decided by the Bombay High Court in the above decision, we find that it hardly gives any support to the contention of the learned counsel. In that case, the father carried on a business in partnership with his sons, some of whom were minors, who were admitted to the benefits of the partnership. One of the minors attained majority on the 22nd August, 1950, and a fresh partnership deed was executed on the 20th August, 1950, the ex-minor becoming a full-fledged partner. Under both partnership deeds, the accounts were to be taken and the profit and loss ascertained on the Deewali day of each year. The minor son who had become a partner died on 31st August, 1950, and his share in the profits was, ascertained as on that day. The department calculated the proportionate profits up to the 20th August, 1950, and sought to include that amount in the assessment of the father under section 16(3) of the Act. The decision was that since the profits were ascertained only on the Deewali day of each year, it was impossible to predicate whether the partnership had made any profit or loss on any day prior to the Deewali date and that the deceased son had not acquired any right to receive any amount from the partnership as profits at any time during the accounting year. It was held therefore that the amount computed by the department could not be treated as income which arose to him directly or indirectly, from his admission to the benefits of the partnership. It is in the light of these facts that the headnote which we have extracted above has to be understood. If the profits were not payable till a particular date, till that date is reached and the profits are ascertained, no member of the partnership can become entitled to the profits. The accrual could therefore be only in accordance with the terms of the agreement which specified a particular contingency. The construction placed upon the headnote by the learned counsel that until the entries in the accounts of the mills create in favour of the assessee a debt, the assessee cannot be said to have acquired a right to receive the income misses the importance of the earlier part of the headnote which clearly indicates that income may arise or accrue to an assessee before he actually receives it, that is, it can accrue when he has acquired a right to receive, and the accrual of a right to receive that amount does not in all cases depend only upon an entry in the accounts made by the person liable to pay it.

9. Reliance was also placed upon Dewar v. Commissioners of Inland Revenue. That was a case where a legatee under a will was entitled to a pecuniary legacy and also to a share of the residuary estate. Under the law, the pecuniary legacy carried interest at a specified rate on such part of it as remained unpaid. There were several payments of the legacy, but he had received no interest and had made no election as to whether or not he would claim interest from the estate. In an appeal against the inclusion in an assessment for sur-tax made on him on a sum receivable as interest on the legacy, the Special Commissioners decided that the voluntary forgoing by the appellant of the interest which he had a right to receive should be regarded as an application of the interest and was therefore correctly included in the assessment. On appeal, the King's Bench Division held that as the assessee had not received any interest in respect of the legacy, no amount could be included as such interest in computing the total income. An examination of this decision clearly indicates that the claim to sur-tax by the revenue was repelled on the specific provisions of the statute for the reason that the relevant paragraph which was applicable to the interest income in question did not contain in it the expression “profits or gains arising or accruing”. This decision is not of much assistance in the matter. Commissioner of Income-tax v. Thiagaraja Chetty & Co. [1951] 19 I.T.R 261. which went in appeal to the Supreme Court in Commissioner of Income-tax v. Thiagaraja Chetty & Co. [1953] 24 I.T.R 525. was also relied upon. In the High Court decision, Satyanarayana Rao J. held that a sum of Rs. 2,26,850, which was the commission earned by the assessee, was not income of the assessee for the reason that the directors of the managed mills resolved to keep the amount in the suspense account till the question of writing off a debt owed by the assessee to the mills was decided. The other learned judge, Viswanatha Sastry J., took the opposite view and that view was preferred by the Supreme Court in appeal, their Lorships specifically holding that this sum was income which had accrued to the assessee and it did not cease to be income by reason of the fact that it was carried to the suspense account. It is unnecessary to refer to any observations of either decision.

10. Where the clauses of the agreement lay down that the assessee is entitled to a certain amount by way of remuneration for services performed and the clause also stipulated that this amount was payable to the managing agents on the ascertainment of the net profits at the close of the year, a right to receive that amount is created in favour of the managing agent at the same time as liability to pay fastens upon the managed company. If that is so, we are-unable to see how it can be said that there has been no accrual of income till the managed mills chooses to enter in its accounts the amount by way of credit in favour of the managing agents. Even on general considerations, it seems to us that there is hardly any room for doubt that the commission which became ascertained on the 31st March of each of these years was income which accrued to the assessee.

11. Mr. Padmanabhan, learned counsel, advances another argument. It is this. On the 16th of March, 1945, the assessee company wrote to the managed mills a letter in which they drew the attention of the directors to clause 8 of the agreement. They pointed out that the managing agents would be entitled to “such additional remuneration as the directors may sanction” in the case of an increase of business and that in fact there had been considerable increase of business. They claimed that it was fit and proper that they should be paid 25% of the profits in respect of the Pudukottah branch and requested the board of directors to grant such additional remuneration. A second letter was also written by the assessee on February 20, 1946, drawing attention to the earlier letter and requesting that some decision might be taken upon that question. Based upon these letters, learned counsel argues that by making this claim for enhanced remuneration, the assessee company had waived its rights to the stipulated remuneration of 5% of the annual net profits. We are frankly at a loss to understand how such an argument can hold the ground. What the assessee was entitled to on the basis of the agreement was 5% of the profits. Clause 8 provides for “such additional remuneration as the directors may sanction”, in the event of an increase of business. The invoking of this clause does not and cannot take away the pre-existing right of the assessee company to the 5% share of the profits guaranteed to it under clause 7. The argument that by reason of the demand for additional remuneration, the 5% stipulated in clause 7 was given up cannot for a moment be accepted as sound.

12. We are accordingly of the view that the decision of the department and the Tribunal on this question is correct. The question referred to us is therefore answered in the affirmative and against the assessee, who will pay the costs of the department. Counsel's fee Rs. 250.

13. Question answered in the affirmative.

Thiagaraja Chettiar & Co. v. Commissioner Of Income-Tax, Madras.

Summary of the Opinion of Srinivasan, J.

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Arguments (as represented by Sri Padmanabhan)

Revenue / Department / Lower Authorities' Position

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Thiagaraja Chettiar & Co. v. Commissioner Of Income-Tax, Madras.

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