TaxTMI 
TaxTMI 
1980 (10) TMI 13
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....shown at the market rate and 80% thereof was shown as the share payable to the Government as entered in the books of account of the assessee Mandli on the basis of the estimated value, and by the time the ITO completed assessment the said stock-in trade was sold and the actual figure of the sale price was available, yet 80% share payable to the Government should not be computed on the basis of the actual figure and should be confined to the figure shown in the accounts of the assessee ? " The facts leading to this reference, shortly stated, are as under The assessee is a co-operative society. It takes jungles on royalty from the State Govt. for exploitation. According to agreement with the forest department and the State Govt., the assessee had to make payment of 80% of sale price to the Government as its share. During the relevant assessment year 1970-71, accounting period being year ending September 30, 1969, the assessee took two coupes bearing No. 9/60 and 4/65 for exploitation. They were situated in the forest comprised in Nesu Range of Vyara Division of Surat District. The assessee had executed two agreements in favour of the Government with respect to the contract pert....
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.... shown at Rs. 5,07,204 and it disclosed a profit of Rs. 9,33,979 which included the royalty of Rs. 7,47,183 payable to the Government. That the assessee had thereafter filed a certificate dated March 22, 1971, from the District Forest Officer, Vyara, according to which, royalty actually payable in respect of the coupes undertaken in. 1968-69 amounted in fact to Rs. 10,21,849. In the view of the ITO, the difference between the estimated figure of 80% share which was debited by the assessee in the profit and loss account, viz., Rs. 7,47,183, and the actual amount of 80% royalty which the assessee paid to the Government amounting to Rs. 10,21,849, the difference being Rs. 2,74,667 could not be permitted to be debited to the trading account for the relevant assessment year by substituting the estimated figure of 80%, being Rs. 7,47,183, by the actual figure of Rs. 10,21,849 as claimed by the assessee. In the view of the ITO, the sale of timber, etc., took place in the subsequent year and the final account was settled with the forest department on the sale of all the goods. Thus, the liability was determined in the subsequent year and, in these circumstances, the assessee's claim for al....
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....r the figure of 80% share of Government as shown by the assessee earlier on the debit side of its trading account for the relevant accounting year. It was further submitted that if, in the past, there was a mistake pertaining to the correct accounting method, the said mistake could be corrected to frame a correct assessment in the subsequent year. The Tribunal took the view that the question involved before it did not pertain to reopening of the assessment which had become final but the question was whether in the subsequent year, a view different from one taken in earlier years could be taken if the earlier view was found to be incorrect. The Tribunal held that the method adopted by the assessee in the past did not bring to tax the correct profit or loss of the year. In the view of the Tribunal, the payment of 80% share which the assessee had to make to the Government by way of government share could be determined after the close of the year as a result of the actual sale price received when the goods were sold in the market and, consequently, additional amount actually paid by way of 80% to the Government cannot be substituted for the earlier figure of estimated 80% share of t....
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....upe No. 4/65. Thus, in all, Rs. 7,92,811.06 was the value of the total stock which remained unsold by the end of the accounting year. On the debit side of the trading account was shown 80% share of the Government at Rs. 7,47,183.30 and on that basis, trading profit of Rs. 1,86,795.84 was calculated. In the profit and loss account for the relevant accounting year ending on September 30, 1969, the aforesaid trading profit of Rs. 1,86,795.84 was shown on the credit side. Certain other interest, commission and stray matters were shown on the credit side while on the debit side, various other expenses were mentioned and ultimately on that basis, cutcha profit of Rs. 1,71,199.50 was estimated for the accounting year in question. It is pertinent to note that the assessee had in terms shown this profit as cutcha profit or provisional profit. The ITO has treated this figure of provisional profit as net profit as per the profit and loss account. The assessee's contention is that the figure of provisional profit was merely an estimate and was not the final net profit as per the profit and loss account as the actual figure of 80% share of Government was not available by the time the account....
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....n support of the aforesaid contention. We may only refer to a few of them. For example, for assessment year 1964-65, the assessment order shows that initially net profit as per the statement submitted by the assessee was shown at Rs. 3,662 and to this net profit was added the share of profit payable to the State Government as debited in the trading account at Rs. 29,393. Thus, the net profit was worked at Rs. 33,055. This shows that the earlier estimated figure of 80% share of the Government was added back by the ITO as, by the time he could finalise the assessment, actual figure of 80% share payable to Government was available. After adding the aforesaid share of Rs. 29,393 to the net profit figure of Rs. 3,662, the total income came to Rs. 33,055 and from this amount of income was deducted the actual share of profit payable to the Government as per the certificate filed. This of course referred to actual 80% share of the Government paid by the assessee concerning the timber exploited by the assessee during the relevant year as per the concerned contract with the Government. This share of actual profit which was deducted was Rs. 17,916 and that is how the net figure of Rs. 15,139 ....
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....t as per the certificate, viz., Rs. 89,026 is deducted. It, therefore, appears clear that the assessee has been following a uniform accounting practice of initially estimating the 80% share of the Government royalty on the basis of the available market value of the closing stock, while closing the account for any accounting year and thereafter if available, producing before the ITO a certificate showing the actual Government share of 80% if such a certificate was available before the assessment proceedings for the relevant assessment year were completed and all throughout the concerned ITOs have accepted the said method of account kept by the assessee and have invariably permitted the actual figures of 80% share as reflected by the concerned certificates to be substituted for earlier estimated figures. It is only during the present relevant assessment year 1970-71 that the ITO who had to deal with the aforesaid assessment proceedings seems to have taken a different view and that is how the present controversy has arisen between the parties. In the light of the aforesaid factual position which is well established on the record of this case, and about which in fact there is no dis....
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.... other hand, contended that the assessee may follow any permissible method of accounting and may value his closing stock accordingly on the basis of cost price or any other market price available to him. But so far as the 80% share of the Government which was payable by way of royalty by the assessee to the Government for exploiting trees in the forests under the contract was concerned, the liability to pay 80% share actually accrued only on an ascertainment of the net realisation of the sale proceeds of the concerned goods and so long as the concerned unsold stock was not actually sold in the market, and so long as the net realisations thereof after deducting permissible expenses were not ascertained, the liability for payment of 80% share to the Government on the net realisations, in fact, did not fasten on the assessee and, hence, till this eventuality actually happened, the liability remained a contingent liability which crystallised only on the sale and ascertainment of the net realisation therefrom. Mr. Raval, therefore, submitted that as the sale of the unsold stock took place during the subsequent assessment year, the 80% share of the Government on net realisation became as....
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....t the assessee's method of accounting, being correct and complete, cannot be effective in properly deducing the income therefrom. Mr. Shah also drew our attention to the Supreme Court judgment in Chainrup Sampatram v. CIT [1953] 24 ITR 481. The Supreme Court in the aforesaid decision had to consider the question of valuation of stock as per the mercantile system and the principles underlying valuation. It was observed (headnote): " It is a misconception to think that any profit 'arises out of the valuation of the closing stock' and the situs of its arising or accrual is where the valuation is made. Valuation of unsold stock at the close of an accounting period is a necessary part of the process of determining the trading results of that period, and can in no sense be regarded as the source of such profits." The Supreme Court agreed with the conclusion arrived at by the I.T. authorities that no part of the profit could be said to have accrued or arisen at Bikaner. But the reasoning of the learned judges of the High Court for arriving at the said conclusion was not approved. In that context, the Supreme Court made the following pertinent observations (p. 485): " It is wrong ....
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....a period. The accepted basis of valuation of stock is cost or market value, whichever is lower, at the date up to which the accounts for a period are made up. The Madras High Court had to consider the question regarding the method of accounting as followed by the assessee in the light of s. 13 of the Indian I.T. Act, 1922, as it stood on the statute book then. We have already referred to the analogous provision in s. 145 of the I.T. Act, 1961. The Madras High Court, with reference to s. 13 of the earlier Act, observed (headnote): " Under section 13 of the Indian Income-tax Act, an assessee is entitled to compute the income, profits and gains in accordance with the method of accounting regularly employed by him, and ordinarily this method must be accepted by the department in the absence of anything to suggest that it is improper or patently false." Mr. Shah, in support of his aforesaid submission, also relied upon the judgment of the Bombay High Court in CIT v. Tata Iron & Steel Co. Ltd. [1977] 106 ITR 363. In that case, the High Court was concerned with the provisions of ss. 10(1), 10(2)(vii) and 13 of the Indian I.T. Act, 1922. With reference to s. 13 of the earlier Act, it....
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....n transactions could object to it in other transactions of similar nature. In that connection, it was observed (headnote): " There was no question of the doctrine of estoppel, as a mere rule of evidence, applying; the doctrine of equitable estoppel necessarily arises." Mr. Shah then drew our attention to two Supreme Court judgments, one of these being CIT v. A. Gajapathy Naidu [1964] 53 ITR 114. The question before the Supreme Court in the aforesaid case was as to whether in a mercantile system of accounting followed by the assessee, the income that accrued in a subsequent year could be related back to any previous year by the ITO. The Supreme Court considered the connotation of the words " accrue " or " arise as defined in s. 4(1)(b)(i) of the Indian Act, 1922. It was observed by the Supreme Court (headnote): When an Income-tax Officer proceeds to include a particular income in the assessment, he should ask himself, inter alia, two questions, namely, (i) what is the system of accountancy adopted by the assessee, and (ii) if it is the mercantile system, subject to the deeming provisions, when has the right to receive accrued ? If he comes to the conclusion that such a righ....
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.... was not open to the ITO to challenge the said system only during the assessment proceedings pertaining to the relevant assessment year. Mr. Shah submitted that even though it was open to the assessee to value the closing stock for the relevant accounting year at cost price, it valued it at a higher market price and that valuation cannot be challenged by the department. In all fairness, it must be stated that Mr. Raval did not contest this legal position. In that view of the matter, it must be held that the first contention raised by Mr. Shah is well made out, viz., that so far as valuation of the closing stock of unsold timber as effected by the assessee in its trading account for the relevant assessment year is concerned, no grievance can be voiced by the revenue against the said valuation. It may also be recalled at this stage that the reframed question of law for our consideration as mentioned by us in the earlier part of this judgment also centres round the controversy which is reflected by the second submission of Mr. Shah and not by his first submission. That takes us to the main grievance of Mr. Shah for the assessee, which is covered by his second submission, which we h....
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....this error which has resulted in the ultimate conclusion at which the ITO arrived, viz., estimated figure of the 80% share as shown in the trading account of the assessee for the accounting year in question cannot be substituted by the actual figure of 80% share as reflected by the certificate dated 22nd March, 1971, as issued to the assessee by the Divisional Forest Officer. It also appears clear to us that the ITO seems to have bypassed the consistent accounting practice which the assessee had adopted over the years and which a number of predecessors-in-office of the concerned ITO had accepted and acted upon. It must be stated that the main and the substantial grievance against the contention of the assessee, raised by Mr. Raval for the revenue in this regard, is that the certificate in question was issued in March, 1971, by the Divisional Forest Officer to the assessee. Thus, the actual figure of 80% share of the Government in the net realisation on the sale of cut material could be ascertained only during the years subsequent to the assessment year in question. Thus, during the assessment year in question, in fact, no liability had been incurred by the assessee to pay 80% share....
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.... these agreements were entered into by the assessee with the State of Gujarat on 5th November, 1968. The agreement in question was entered into by the assessee as the contractor on the one side and the Governor of Gujarat on the other. The assessee had to pay a sum of Rs. 3,00,000 being the provisional price of the contract sum to the State as a consideration for being permitted under the contract to fell and remove timber, firewood and other material as mentioned in cl. (a) of the schedule to the agreement. Clause (a) of the schedule to the agreement refers to the privilege which is conferred on the contractor to remove material from the coupe in question and the said material includes all the timber, marked for felling firewood, bark and charcoal obtained from any unreserved trees, standing or fallen within the limit of the coupe as per the plan attached. In consideration of the aforesaid privilege, the assessee-contractor had to pay Rs. 3,00,000 to the Government for the contract in question. Liberty was also reserved to the assessee to prepare charcoal in the coupe. Out of Rs.3,00,000, being the contractor's sum, one-fourth was to be paid to the Government on or before the time....
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....visional Forest Officer to be necessary and should, if so, required by the Divisional Forest Officer, stack and arrange them there for that purpose in the manner prescribed by him. In condition 1 (i), it was provided that the contractor should on or before 11th March, 1969, or such later date as the Divisional Forest Officer might by order in writing at his absolute discretion fix in this behalf, remove from the depot or if no depot was fixed under clause I(h), remove from the coupe within the period specified in clause I(g) all his timber, firewood and other things under passes duly filled in all quantities and sums therein specified being stated in words as in figures and in accordance with the schedule of standard classification to be obtained from the Divisional Forest Officer. In para. II of the agreement, it was provided that the contractor, his servants and agents were to abstain from the following acts and cl. (b) thereof prohibits from commencing any felling operations before cl. I(c) had been complied with and from continuing the same after the day of 15th March, 1969. We have already referred to cl. I(c) earlier which gave 15 days time for demarcation, that is, by 20th N....
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....is purpose after fixing the up set price for the same. The sold material, however, shall not be removed unless about 60% of the sale price of the material to be removed is paid into the Government treasury. (2) As per the formula fixed by the Government after deduction of permissible expenditure from the total realisation of the coupe allotted to the society, the 80% of the net realisation shall have to be paid as Government share. As shown in cl. C(1) above, if 80% of Government share falls short on finalisation of accounts, the society shall have to pay the same within 30 days. If the society fails to do so, compound interest at the rate of 6 1/4% shall be recovered from the society. The Conservator of Forests may, if he thinks necessary, increase this rate of interest. On failure to pay this amount with interest it shall be recoverable as per r. 83 or 82 and r. 85 as an arrear of land revenue. On finalisation of accounts if more amount is found to be deposited by the society, it shall be refunded to the society. Addition or omission, if any, in the how formula on which coupes are allotted to the society are applicable to the society as per this agreement. The society shall....
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....cer, Vyara." The aforesaid recitals in slip No. 12 show that the contractor had to perform the act of cutting and fastening the material in all the three sub-coups at a time in rehabilitation coupes. The said slip will have to be read along with slip No. 2 which provides that the coupe in question has to be divided into three sub-coupes. Permission will only be granted to the society for felling in sub-coupe if work in sub-coupe No. 1 will suffice for one week only. In the same way, the society will have to obtain the written permission of the Range Forest Officer before starting felling in sub-coupe No. 3. Similarly, the removal of the material from the coupe will have to be done sub-coupe-wise, i. e., permission for removal of the material from sub-coupes 1, 2 and 3 shall have to be obtained. The aforesaid provisions of slip No. 2 when read with slip No., 12 and in the context of other relevant terms of the agreement and the slips, leave no room for doubt that the assessee had to enter upon the concerned coupes by 20th November, 1968, and to finish the entire work of cutting wood from all the three sub-coupes latest by 15th March, 1969, and if the contractor made any default i....
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....the Government had entered into with the assessee, which was a cooperative society of labourers. In consideration for permitting the co-operative society of labourers to exploit these coupes, the contractor, that is, the assessee-society had to pay Rs. 3,00,000 and in addition thereto, 80% of the net realisation of the sale proceeds had to be parted with in favour of the Government. Towards the share of the society, only 20% of the net realisations were earmarked. That represented their labour charges. Thus, under the scheme of this agreement, liability of the society which was of the contractor to pay 80% of the net realisation to the Government arose the moment the contract was acted upon and the coupe was exploited, and the material was cut and removed to the sale depot. Actual sale may take place later on. The liability to pay 80% of the net realisations of sale price to the Government fastened on the assessee the moment the trees were cut and removed from the coupes and materials were stacked in the depot. Out of 80% also 60% on account were to be paid to the Government before removal of the goods. The rest was to be paid after the accounts were finalised. Thereafter, exact fi....
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....ligation which the assessee had incurred during the relevant assessment year. It is not as if that liability to pay 80% share was contingent upon the happening of an uncertain event of the sale of cut material. Computation of 80% of net realisation was deferred but the liability to pay the same was not deferred by the terms of para. 2 of slip No. 1. On the contrary, the last three sentences of para. 2 of slip No 1 show that on finalisation of accounts, it may be possible to find out in a given case that more amount may have been paid by the assessee on account and then, the assessee would be entitled to a refund from the Government. Thus, computation of 80% of net realisation of sale proceeds is in the realm of ascertainment of actual share payable to Government. But it is not in the realm of the creation of a liability of the assessee to pay the same. Liability is incurred by the very act of exploitation pursuant to the terms of the agreement and not on account of actual calculation which may take place at a convenient time later on. Under these circumstances, it must be held that during the relevant assessment year, the assessee had become liable to pay 80% of net realisation of ....
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...., liability for income-tax, wealth-tax or gift-tax for that assessment year or any earlier assessment years is undoubtedly to be deducted as a debt owed by the assessee on the relevant valuation date, even though it is not assessed until after the relevant valuation date, but how is it to be computed ? Is it to be taken at the figure computed on the basis of the return submitted by the assessee or is it to be taken at the figure determined on assessment, where the assessment has taken place after the relevant valuation date but before the computation of net wealth in the wealth-tax assessment ?" Answering this question in favour of the assessee, Bhagwati C.J. (as he then was), on behalf of the Division Bench, held (headnote): " The liability to pay income-tax, gift-tax or wealth-tax is a debt owed by the assessee on the relevant valuation date within the meaning of section 2(m) of the Wealth-tax Act, 1957. The liability which exists in praesenti on the relevant valuation date is the liability to pay tax on total income as determined in accordance with the provisions of the Income-tax Act or tax on gift in accordance with the provisions of the Gift-tax Act or tax on net wea....
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....ion of sale proceeds and the ITO was required to take into consideration the said actual figure of the Government share of 80% instead of insisting on the unreal figure of earlier estimate which, in the light of the actual figure, had no independent existence and was ipso facto substituted by the actual figure of 80% Government share. Mr. Shah also invited our attention to the later judgment of this court in CIT v. Sayaji Mills Ltd. [1974] 94 ITR 26. The question before this court in the aforesaid decision was whether the assessee's claim for development rebate was rightly disallowed by the ITO. The facts in the said case were that in the assessment of the assessee-company for the assessment years 1959-60 and 1960-61, the ITO found that the assessee would be entitled to the development rebate of certain amount in respect of certain machinery, but in the assessment order the ITO did not allow deduction of those amounts for the reason that the machinery was sold in 1961, before the end of ten years from the end of the year in which it was acquired or installed and consequently, the assessee was not entitled to the deduction by virtue of prov. (b) to s. 10(2)(vib) of the Indian I.T....
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.... is substituted for the estimate for the assessment year in question, profit for that year would come down to that extent and for the succeeding year, wherein in fact the material was sold, profit to that extent would mount up. Thus, in the view of the Tribunal, it would result in artificially reducing the profit for the year in question and inflating profit for the succeeding year. Mr. Shah submitted that thus there would be no question of the assessee escaping the provisions of tax for the amount of profit for all time to come. It was merely a result of adopting and following given system of account that necessity arose to substitute the actual figure if available for the prior estimate with the result that over the years, the net effect would not at all be adverse to the revenue. It is in this context and especially in the light of the observations of the Tribunal in paras. 7 and 8 of the judgment that Mr. Shah submitted that this was really an academic fight or a storm in a tea cup. The Tribunal in para. 7 of its judgment has noted this submission of Mr. Shah for the assessee and has observed: " Again Shri Shah stated that there was no harm to the revenue if the system was n....
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....rred in discharging the same could be deducted from the profits and gains of the business, and the amount to be expended could be debited in accounts maintained in the mercantile system of accounting before it was actually disbursed. The difficulty in the estimation thereof did not convert the accrued liability into a conditional one, because it was always open to the income-tax authorities concerned to arrive at a proper estimate thereof having regard to all the circumstances of the case. " In the present case also, we have already found that the liability had already accrued to the assessee to pay 80% of the net profits on sale to the Government pursuant to the contract entered into by the assessee with the Government and the liability accrued during the assessment year in question when the contract was fully acted upon and the coupes were fully exploited pursuant to the contract. It was not a contingent liability as Mr. Raval submitted for the revenue. Thus, the aforesaid decision of the Supreme Court is really of no assistance to the revenue in the present case. On the contrary it supports the case of the assessee. Mr. Raval then invited our attention to another judgment ....
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....um of Rs. 2,341, being the rent for the previous year, and the question was whether the balance of Rs. 40,132 was deductible as business expenditure in computing the respondent's profit. The Tribunal held that after the expiry of the lease on April 1, 1943, and the refusal of the lessor to renew it the respondent was in the position of a trespasser particularly after the dismissal of the suit for specific performance by the trial court, and until the suit was compromised in the High Court in 1953, it could not be said that the respondent's liability had become ascertained. Under these circumstances, it was held that the payment of the entire sum of Rs. 42,473 represented revenue expenditure. The Tribunal and the High Court rejected the application of the Commissioner for a reference. The Supreme Court thereafter in the aforesaid decision, agreeing with the conclusions which the High Court and the Tribunal had reached, held that it was only as a result of the compromise that the respondent became entitled to remain in possession of the demised land. Its liability also became ascertained only at that point of time, and, consequently, it was rightly held as entitled to the deduction o....
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.... year. The ITO rejected the assessee's claim for deduction of that amount on the ground (i) that the assessee had contested the sales tax liability in appeals, and (ii) that it had made no provision in its books with regard to the payment of that amount. The appeals to higher authorities or courts taken by the assessee contesting its liability to pay the sale tax ultimately failed. Thereafter, the assessee approached the Supreme Court and the Supreme Court allowed the appeal and held (headnote) : " The moment a dealer made either purchases or sales which were subject to sales tax, the obligation to pay the tax arose. Although that liability could not be enforced till quantification was effected by assessment proceedings, the liability for payment of tax was independent of the assessment. The assessee which followed the mercantile system of accounting was entitled to deduct from the profits and gains of its business liability to sales tax which arose on sales made by it during the relevant previous year." Thus, even on the basis of the aforesaid decision, it appears clear that computation of liability is entirely different from the question of incurring the liability. In the p....