Nonsuch Estate Ltd. v. Commissioner of Income-Tax, Madras

806 NONSUCH ESTATE **LTD.** _v._ THE COMMISSIONER OF INCOME-TAX, MADRAS _November_ 21. 1974 [H. R. KHANNA AND A. C. GUPTA, JJ.) _lncome-taJ: Act,_ 1922-ASJfe.rsee _followed mercantile system_ _of acco11nti111-_ _Debited in_ _boob_ _each year managing_ ~·ency _remuneration_ _for_ _three_ _year-_ _Claimed dedui:tion_ _in_ _the third year on receipt_ _of approval from Central_ Go~·enc­ _ment for reappointment_ _of managing agents as tequired under_ _s._ 326 _CompG!nieB_ _Act-Whether assessee should have claimed deduct/on in each assessment_ ye~:r. The assessee who followed the mercantile system of accounting debited i:a ill account books certain sums of money as remuneration of the managing agenta for the assessment years 1957-58 to 1959·60. For the purpose of incomt:-tu the company added back the sum to its taxable income and claimed the wholo cum as a deductible expenditure in the as:sessment year 1959·60 on the grnund that the sum became payable only during that year when the Government accorded 'its approval to the new managing agency agreement. The Incomc-~ax Officer rejected the claim holding that the approval of the Central Government was necessary only for actual pavment and the assessee should have ascertainod the liability for each year and claimed it since he followed the mercantile sys· tem ·Of accounting. 'This view was upheid by the Appellate Assistant Commilaioner and, the Income-tax Appellate Tribunal. The High Court held that although at the time the debit entries· were mado in the account books of the assessee, approval of the Central Government had not been recelved, when it came later, it gave legal effect to the debit enlriet with retrospective effect from April 1, 1956 and that the refusal of deductioa by the Income-tax Officer was right. Allowing the appeal to this Court, HELD : The High Court was in error in answering the question against the assessee. Even an assessee following the mercantile system of accounting is not entitlea to claim a deduction until liability for the sum for which deduction is claimed has accrued. The High Court overlooked the plain terms of s.326 of the Companies Act, 1956 under which it could not be assumed that the Central Government would approve every proposed appointment or re-appoint· ment of managing agent. [809A; .D; S!OA] I. . I In the instant case it is only when the Central- Government conveyed its approval to the appoi~tment of managing agents by its letter dated September 2, 1957 that the appomtment became effective and the Company's liability to pay t.he remurlerat.ion of the managing agents accrued. The liability becamo effective from Apn,11, 1956. because th~ C::c:ntral Government chose to give ita approval retroi.J>e<;hve operation. The bab11hty could not be said to had arisen fyom any date pnor to ~ptember 2, 1957 when the approval was given. Section _326 of the Compa.mes Act contain~ an absolute prohibition against the appom•ment or re·appomtment of a manaJ?ing agent before the ·approval of Central Government was obtained. [810B-C] CML APPELLATE JURISDICTION : Civil Appeal No. 1554 of 1970. Appeal by Special Leave from the Judgment & Order dated the l<lth Augut, 1968 of the Madras High Court in Tax Case No. 18 of 1965. _G._ _B._ _Pai,_ _A. G._ _Manessea,_ _D._ C. _Mathur_ and _K. K._ _John_ for i:ho appellant. ' _B._ _B._ _Ah11ja_ and _S._ _P._ _Nayar,_ for the respondent. **A** **D** ## c **D** **E** F **G** **H** A B # c D GUPTA, J. This is an appeal by special 1eave from a judgment of the Mauras High Court m a re1erence unaer secuun oo l 1 J uf the Income Tax Aat,, 1922. The appellant, Nonsuch Estate Limited, is a puoilc Lmi1ecl company mcorpuraLecl in the year 1 Y24 wJUer the lnwan Companies Act, 1913. The appellant, referred to hereinafter as Lie Company, derives its. income from tea grown in its estate for which it is assessed to income-tax. M/ s. Harrisons and Crosfield LlIDlted have been the managmg agents of the Company from the h<:gmning. The fo1lowing question relating to the assessment year 19:>9-60 was referred to the High Court: "Whether on the facts and in the circumstances of the case, the sum of Rs. 97,188/- representing the Managing Agency remuneration for the period 1-4-1956 to 30-6-1957 was deductible in the computation of the income of previous year endmg on 30th June 1958, relevant for tbe assessment year 19 5 9-60." The relevant facts leading to the reference are these. The managing agents of the Company were entitled . to commission at the rate of l i per cent on all sales of tea and other produces of the Company and a further sum of Rs. 12,000/- per annum for secratarial work. There was, however, no written agreement embodying the terms. After the Companies Act, 1956 came into force on April l, 1956 it was decided that there should be a fresh managing agency agreement between the Company and its managing agents in conformity with the provisions of the said Act. A fresh agreement drawn up and submitted by the managinig agents. was approved by the Company. The new agreement proposed the reappointment of M/s. Harrisons & Crosfield Limited as the managing agents of the Company for a period of 10 ### NONSUCH ESTATE v. c.u. (Gupta, /,) 8 07 The Judgment of the Court was delivered by yea.ts on a remuneration of _5_ per cent commission on the net profits of the Company computed in the manner laid down in sections 349 to 351 of the Companies Act, 1956 subject to a minimum remuneration of Rs. 12,000/~ per annum. The revised terms were to· take effect from April 1, 1956. As required by sec. 326 of the Companies i' Act, the new agreement was sent to the Central Government for appro val by a communication dated August 3, 1957 enclosing a formal application for the purpose in Form 25, On September 2, 1957 by· a letter addressed to the Company the Govcri;ment conveyed·· its approval to "the appointment of ~/s. H~rris~ns & Crosfi~lds Ltd. as the Managing agents ........ for a period of 10 years with effect from 1st April 1956, on a remuneration of _5_ per cent commission on G the net profits of the Company comouted in the manner as laid down in Sections 349 to 351 of the Comoanies Act, 1956 subject to a minimum remuneration of Rs. 12,000/- (Rupees twelve thousand only) per annum paiyable to fhe Managing Agents, in the event of absence or inadequacy of profits in anv financial year." On rPceiot of the aporoval, the Comoany by a resolution adopted at an extraordinarv ·general meeting of its shareho [1] ders held on October 4. 1957 reappointed M/s. Harrisons & Crosfield Limited on the terms stated above. In terms of the new a1?Teement the exi~ting a!!encv a!!l'CemP.nt between th parties stood cancelled with the expiry of March 31, 1956. 808 - SUPJ\l!ME COURT REPORTS [1975] 2 ~.c.n. The Company follows the mercantile system of accounting. JFor the penod April 1, 1\1:>6 to June jU, 1\156, me Company crt:U1ted a sum ot Rs. 'JJ20/- to the account of the nLmagmg agents as ttteir remunerauon m accordance with the terms of tne prvposeo new agrCC"" ment. TlllS was disclosed in the published accounts of the Compimy for the year July 1, 1955 to June 30, 1956 relevant to the assessmi~nt year 1957-58. For the purpose of assessment of income-tax, howeYer, - & the Company added bacK me said sum or Rs. 9,320/- to its taxable incom.:. In the next accounting year ending on June 30, 1957 relevant to the assessment year l\l:>~-59 the same prncess was followed with regard to the remuneration payable to the managlllg agents. For the assessment year 19:i9-60 for wruch the previous year was July 1, 1957 to June: 30, 1958, a total sum of Rs. 97,188/- was shown as managing agents' remuneration payable during that year. This amo1mt was made up as under : "Proportionate remuneration for 3 months at _5_ per cent: on the net profits for the period ending on 30-6·1956 paid during the year ending on Amount 30-6-1958 9,320 Remuneration at 5 per cent on the net profit of the year ending on 30th Jun€: 1957 paid during the year entling on 30-6-1958 71,3,6S Managing Agents expenses for the year ending 30th June 1957 recouped during the year ending on 30th June 1958 . . - .13,200 Proportionate Managing Agent's expenses for the year ending on 30th June 1956 recouped during the year ending on 30-6-1958 3,300 97,188 Though this sum did not pertain to the previous year relevant to the assessment year 1959 60, the Company claimed it as deductible F expenditure for that year on the ground that the sum became payable only during that year when the Government accorded its approval 1to the new agreement. The Income-tax Officer rejected this claim on the view that the approval of the Central Government was necessa11 only for actual payment and "the assessee should have ascertained the liability for each year and claimed it on the mercantile basis # which was the system adopted by the assessce company." The Appel- a late Assistant Commissioner and the Tribunal also took the same view. The High Court answered the question referred to it ag'<linst the asse:1see on the following reasoning : " . . . . . ... There was undoubtedly an understanding between the managing agency and the assessee as to the new terms of remuneration which actually were given effect to by making debit entries in the remuneration account then and H there. It is true that at the time the: debit entries were made, approval of the Central Government had not come. But when it ciune actually later, it gave legal effect to the debit A B ## c NONSUCH ESTATE _v._ c.r.T. _(Gupta,_ /,) 809 entries, not from the date of the approval but from April l, 1956. That being the case, the refusal of the deductioDJ, in our opinion was right." In our judgment the High Court was .in error in answering the q\)estion referred to it against the assessee. It appears that the In· come-tax authorities, the Tribunal and the High Court all laid special emphasis O!l the fact that the Company followed the mercantile system of accounting. The distinction between the two methods of account· ing, one on the cash basis and the other on the mercantile basis is well-known. In _Commissioner of Income-tax,_ _Madras_ v. _A. Gajapathy_ _Naidu_ ( [1] ), this Court explained the difference between the two methods quoting with approval an extract from a Judgment of the Allahabad High Court in _Commissioner_ _of_ - _Income-tax_ v. _Singari_ Bai(2). In _Gajapathy_ _Naid.u's(_ _[1]_ _)_ case this Co~rt said: "It is commonplace that there are two principal methods of accounting for the inc,ome, profits and gains of a business one is the cash basis and the other, the mercantile basis. The latter system of accountancy "brings into credit what is due immediately it becomes legally due and before it is actuD ally received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed"." ' However, even an as~essee following the mercantile system of accounting is not entitled to claim a deduction until liability for the sum for which deduction is claimed has accrued. The reasons given by E · the High Court overlook the plain terms of sec. 326 of the Companies Act, 1956. Sec. 326 so far· it is material for the question involved in this case, is in these terms : "Sec. 32~. (1) In respect .of any company ........... . (a) ......... . (b) unless the approval of the Central Government has F been obtained for such appointment or re-appointment. G H ( 2) The Central Government shall not accord its approval under sub-section ( 1) in any case, unless it is satisfied( a) that it is not against the public interest to allow the company to have a managing agent; (b) that the managing agent proposed is, in the opinion, a fit and proper person to be appointed or re-appointed as such, and that the conditions of the managing agency agreement proposed are fair and reasonable; and ( c) that the managing agent proposed has fulfilled any conditions which the Central Governmerti requires him to fulfil." (1) 53 I.T.R. 114. 5-L34SSupCI/75 (2) 13 I.T.R. 224. ' 810 SUPREME COURT REPORTS [1975] 2 s.c.R. Section 326 prohibits the appointment or re-appointment of a managing agent unless the Central Government approved such appointment or re-appointment. The Central Government would not accord its approV'al unless the requirements specified in clawses (a), (b) a.nd (c) of sub-section (2) of the section have been fulfilled. Therefore, it can.not be· assumed that the Central Government will approve· every proposed appointment or re-appointment of a managing agent. Thus in the instant case it is only when ~he Central Government conveyed its approval to the appointment of M/s. Harrisons and Crosfield Limi1ted as managing agents by its letter dated September 2, 1957 that the appointment became effective and the Company's liability to pay the remuneration of the managing agents accrued. The position here is not that the liability had arisen earlier and its quantification only depended on the approval of the Central Government. It is true that the liability became effective from April 1, °1956, a date anterior to the relevant previous year, . but that is b1:c11use the Central Governm1!nt chose to giv(: its approval retrospective operation. The Hability in these circumstances cannot be said to have· arisen from any date priior to September, 2, 1957 when the approval was given as sec. 326 contains un absolute prohibition against the appointmevt or re-appointment of a managing agent before the approval of the Central Government was .obtained. In our opinion, the position is quite clear fwm the terms of sec. 326 and we do not 1:onsider it necessary to refer to the authorities cited by the learned counsel for either side. The appeal is accordingly allowed, the answer given by tfle High Court to the question referred to it is discharged and tlie question is answered in the affirmative and in favour of the asseS1H:e. The appellant will be entitled to its costs in this Court and in the High Court. P.E.R. _Appeal_ _allow£!d,_ A B ## c D