1971 (8) TMI 10 - SC - Income Tax

Assessee entitled to claim sales tax deduction under mercantile system despite pending appeals for reduction

Kedarnath Jute Manufacturing Company Limited Versus Commissioner of Income-Tax (Central), Calcutta

The SC ruled in favor of the assessee who maintained accounts under the mercantile system. The court held that the assessee was entitled to claim ... Assessee maintaining his accounts in mercantile system - Assessee was entitled to claim the deduction towards the sales tax liability which it was liable under law to pay during the relevant accounting year - That liability did not cease to be a liability because the assessee had taken proceedings before higher authorities for getting it reduced so long as the assessee's completion did not prevail - assessee's appeal is allowed 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in the judgment are:- Whether the amount of Rs. 1,49,776 claimed by the assessee as a deduction on account of sales tax was deductible as a business expense for the purposes of income-tax assessment under the Income-tax Act, 1922.- Whether unpaid and disputed sales tax liability, which had been quantified by a demand notice but contested by the assessee, could be allowed as a deduction under section 10(2)(xv) or section 10(1) of the Income-tax Act.- Whether the absence of a provision or debit entry in the books of account by the assessee, which followed the mercantile system of accounting, precluded the deduction of the sales tax liability.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Deductibility of sales tax liability under the Income-tax ActRelevant legal framework and precedents: The provisions primarily considered were section 10(2)(xv) and section 10(1) of the Income-tax Act, 1922. Section 10(2)(xv) allows deduction for taxes paid or payable in respect of income from business or profession. Section 10(1) relates to the computation of profits and gains of business on commercial accounting principles. Section 10(5) clarifies that 'paid' means actually paid or incurred according to the method of accounting used.The precedent of Commissioner of Income-tax v. Royal Boot House was central, where it was held that an assessee following the mercantile system who made a provision for sales tax, even if not actually paid, was entitled to deduction under section 10(2)(xv). The liability to pay sales tax was held to arise independently of assessment or demand.Court's interpretation and reasoning: The Court emphasized that the liability to pay sales tax arises immediately upon the taxable event (sales or purchases) and is not contingent upon assessment or demand. The demand notice quantifying the liability during the pendency of income-tax assessment confirmed the liability. The Court held that the liability was enforceable and accrued during the relevant accounting year, making it deductible under the mercantile system.Key evidence and findings: The assessee filed income-tax returns under the mercantile system for the year ending 31st December 1954, claimed the deduction for sales tax payable, but the sales tax demand notice was issued later on 21st November 1957. The assessee contested the demand but had not paid the amount by the time of income-tax assessment. The Income-tax Officer disallowed the deduction on the ground that the liability was disputed and not provided for in the books.Application of law to facts: The Court applied the principle that under the mercantile system, expenses or liabilities which have accrued during the accounting period are deductible, irrespective of payment timing. The liability to pay sales tax had accrued in the relevant year, and the demand notice confirmed the quantum of liability. The fact that the assessee disputed the liability or had not made a provision in the books did not negate the existence of the liability under law.Treatment of competing arguments: The revenue argued that the liability was disputed and not provided for in the accounts, thus not deductible. The Court rejected this, holding that the existence of legal liability is determinative, not the assessee's accounting treatment or dispute. The Court further distinguished the Royal Boot House case, stating that the distinction based on dispute or provision was without substance.Conclusions: The amount of Rs. 1,49,776 on account of sales tax was deductible as a business expense under section 10(2)(xv) and section 10(1) of the Income-tax Act, despite being unpaid and disputed, as the liability had accrued and was quantifiable within the relevant accounting period under the mercantile system.Issue 2: Effect of absence of debit entry or provision in the books of account on deductibilityRelevant legal framework and precedents: Section 10(5) of the Income-tax Act and principles of mercantile accounting were considered. The Court also referred to the principle that the right to deduction depends on law and not on the assessee's accounting entries.Court's interpretation and reasoning: The Court held that failure to debit the liability in the books of account, whether due to misapprehension or mistake, does not deprive the assessee of the right to claim deduction if the law otherwise entitles it. The Court emphasized that the existence or absence of accounting entries is neither decisive nor conclusive on the question of deductibility.Key evidence and findings: The assessee did not make a provision for the disputed sales tax liability in its accounts, leading the Income-tax Officer to disallow the deduction.Application of law to facts: Since the liability was legally enforceable and had accrued during the accounting year, the absence of a debit entry was irrelevant to the entitlement of deduction. The Court underscored that the law governs deductibility, not the accounting treatment adopted by the assessee.Treatment of competing arguments: The revenue's contention that the deduction should be disallowed due to absence of accounting provision was rejected. The Court found no legal basis to deny deduction on this ground.Conclusions: The assessee was entitled to claim deduction for the sales tax liability despite not having made a provision or debit entry in its books of account.Issue 3: Deductibility of disputed sales tax liability pending final decisionRelevant legal framework and precedents: The Court relied on principles established in Pope The King Match Factory v. Commissioner of Income-tax, where it was held that a legally enforceable liability, even if disputed and subject to appeal, is deductible under mercantile accounting principles once it has accrued.Court's interpretation and reasoning: The Court reasoned that the liability to pay sales tax arises independently of assessment proceedings and remains enforceable even if contested. The mere fact that the assessee sought to reduce or eliminate the liability through appeals does not extinguish the liability for the purpose of income-tax deduction.Key evidence and findings: The demand notice quantifying the sales tax liability was issued during the pendency of the income-tax assessment, and the assessee's appeals against the demand did not succeed.Application of law to facts: The Court applied the principle that the liability, once accrued and quantified, is deductible even if disputed, as long as it is enforceable and relates to the accounting year in question.Treatment of competing arguments: The revenue argued that disputed liability cannot be deducted. The Court rejected this, confirming that the liability's enforceability and accrual are determinative.Conclusions: Disputed sales tax liability, once quantified and enforceable, is deductible under mercantile system accounting principles despite pending appeals.3. SIGNIFICANT HOLDINGS- 'For the purpose of claiming a deduction under section 10(2)(xv) of the Income-tax Act, mere legal liability was not enough. There had to be an expenditure in the first place and it must be laid out or expended wholly and exclusively for the purpose of such business.' (As considered by the High Court but ultimately refined by the Supreme Court)- 'The liability to pay the tax was not dependent upon assessment or demand but was an obligation to pay the tax either annually, quarterly or monthly, as the case may be.' (Affirming that liability accrues independently of assessment)- 'An assessee who follows the mercantile system of accounting is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being computed.' (Core principle on mercantile accounting and deductibility)- 'Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter.' (Clarifying that accounting entries are not determinative of deductibility)- 'The liability remained intact even after the assessee had taken appeals to higher authorities or courts which failed.' (Confirming that pending appeals do not negate the liability for deduction purposes)The Court allowed the appeal, set aside the High Court judgment, and answered the referred question in favor of the assessee, holding that the sales tax liability of Rs. 1,49,776 was deductible as a business expense under the Income-tax Act despite being unpaid and disputed at the time of assessment.