Court rules on accrual of dividend income in tax dispute, favoring non-resident assessee

The court ruled in favor of the non-resident assessee in a tax dispute regarding the accrual of dividend income and the system of accounting. It held that dividend income accrued when the Reserve Bank of India granted approval for remittance, not when the dividend was declared. The court also determined that the assessee could choose between cash or mercantile accounting systems, as long as the real income could be deduced. The decision favored the assessee on both issues, concluding that the dividend income accrued in the year of RBI approval and allowing flexibility in the accounting method.

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Issues Involved:
1. Accrual of Dividend Income
2. System of Accounting for Non-Resident Assessee

Detailed Analysis:

(A) Accrual of Dividend Income:

The central issue in this case is the determination of the year in which the dividend income accrued to the non-resident assessee. The Department argued that the income accrued on the date when Pfizer Limited declared the dividend. In contrast, the assessee contended that the income accrued only when the Reserve Bank of India (RBI) granted approval for the remittance under the Foreign Exchange Regulation Act (FERA).

The court examined sections 5(2)(b), 8, and 9(1)(iv) of the Income-tax Act, 1961. Section 5(2)(b) states that the total income of a non-resident includes income that accrues or is deemed to accrue in India. Section 9(1)(iv) extends section 5(2)(b) by deeming that a dividend paid by an Indian company outside India constitutes income accruing in India. The court concluded that section 9(1)(iv) stipulates that dividend income paid to a non-resident is deemed to accrue in India only upon payment, not upon declaration.

Additionally, the court noted that section 8, which deals with dividend income, is part of the computation machinery and not a charging section. Therefore, the declaration of a dividend must be effective, which in this case required RBI approval under FERA. The debt or right to receive the dividend crystallized only upon such approval.

The court held that the final dividend of Rs. 25.20 lakhs became taxable in the assessment year 1977-78 when the RBI granted approval, not in the assessment year 1976-77 when the dividend was declared. Similarly, the final dividend of Rs. 29.40 lakhs became taxable in the assessment year 1978-79 when the RBI granted approval, not in the assessment year 1977-78 when the dividend was declared.

(B) System of Accounting for Non-Resident Assessee:

The second issue concerned whether the non-resident assessee could be assessed based on the cash system of accounting. Historically, up to the assessment year 1975-76, the Department accepted the assessee's cash basis accounting. However, from the assessment year 1976-77 onwards, the Department directed the assessee to adopt the mercantile system of accounting.

The court referred to the judgment in CIT v. Standard Triumph Motor Co. Ltd., where it was held that non-residents receiving income outside India could be assessed on an accrual basis under section 5(2)(b) and not on a cash basis under section 5(2)(a). However, the court found that this judgment did not apply to the present case as the assessee had consistently followed the cash system of accounting, which was accepted by the Department until the assessment year 1975-76.

The court emphasized that section 145(1) of the Income-tax Act, which deals with the method of accounting, is part of the computation machinery and not a charging section. Therefore, non-resident assessees are free to adopt either the cash or mercantile system of accounting, provided the real income can be deduced. The court also cited the case of CIT v. Citibank N.A., where the hybrid system of accounting was approved.

The court concluded that the assessee was entitled to follow either the cash or mercantile system of accounting, subject to the proviso to section 145(1) as it stood before April 1, 1997, which allows the Assessing Officer to determine the computation basis if the income cannot be properly deduced.

Conclusion:

1. The court answered question No. 1 in the negative, in favor of the assessee, holding that the dividend income accrued in the year the RBI granted approval, not in the year the dividend was declared.
2. On question No. 2, the court held that the assessee was free to follow either the cash or mercantile system of accounting, subject to the proviso to section 145(1) as it stood before April 1, 1997.

The reference was disposed of with no order as to costs.

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