Commissioner of Income-Tax, Madras vs K. R. M. T. T. Thiagaraja Chetty and Co

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 14 October 1953

Coram: Ghulam Hasan, M. Patanjali Sastri, Vivian Bose, Natwarlal H. Bhagwati

In the matter titled Commissioner of Income-Tax, Madras versus K. R. M. T. T. Thiagaraja Chetty and Co, the Supreme Court of India delivered its judgment on 14 October 1953. The opinion was authored by Justice Ghulam Hasan, with Justices M. Patanjali Sastri, Vivian Bose and Natwarlal H. Bhagwati forming the bench. The petitioner was the Commissioner of Income-Tax for Madras, while the respondent was the firm K. R. M. T. T. Thiagaraja Chetty and Co. The case was reported in the 1953 volume of the All India Reporter at page 527 and also appears in the 1954 Supreme Court Reports at page 258, among other citations.

The central issue concerned the treatment of a commission earned by the respondent under a managing-agency agreement. The agreement provided that the firm, acting as managing agents of a company, would receive a specified percentage of the company’s profits as commission. In the company’s books, which were maintained by the firm on a mercantile accounting system, an amount of Rs 2,26,850 and a fraction was shown as commission due to the firm for the financial year 1941-42. That same amount was simultaneously entered as a business expenditure and credited to the firm’s commission account. Subsequently, a resolution of the company transferred the amount to a suspense account after the firm requested that a debt it owed to the company be written off.

The Court held that because the respondent kept its accounts on the mercantile system, the commission was deemed to have accrued at the moment it was credited in the books. The later movement of the sum to a suspense account, pending resolution of the dispute between the company and the respondent, did not negate the respondent’s liability to tax that income. The Court further observed that the fact that the business profits could be computed only after 31 March 1942 was irrelevant; the quantification of the commission was not a condition precedent to its accrual.

The case originated as civil appeals numbered 131, 131-A and 131-B of 1952, arising from the judgment and decree of the Madras High Court dated 2 February 1950. The High Court decision had been rendered by Justices Satyanarayana Rao and Vishwanath Sastri on references made by the Income-Tax Appellate Tribunal. For the appellant, the Solicitor-General for India appeared, and counsel for the respondent was also present. The judgment of the Supreme Court was pronounced by Justice Ghulam Hasan on 14 October 1953.

These three appeals originated from the judgment and order of the Madras High Court dated 2 February 1950, which had been issued on a reference made by the Income-Tax Appellate Tribunal, hereinafter called “the Tribunal.” The High Court addressed two questions that had been referred to it. On the first question it answered in the negative. On the second question the two judges differed: Justice Satyanarayana Rao answered affirmatively, whereas Justice Viswanatha Sastri answered negatively, and consequently the opinion of Justice Satyanarayana Rao ultimately prevailed. All three appeals concern the assessment for the financial year 1942-1943 and were instituted by the Commissioner of Income-Tax. A separate appeal, numbered 132 of 1952 and dealing with the assessment year 1943-1944, was filed by the assessee and is dealt with in a different proceeding. The two questions that were referred to the High Court in respect of the first group of appeals were as follows: (1) whether any material existed to support the Tribunal’s finding that the appellants, who are respondents in this case, had been assessed on a cash basis in the preceding years; and (2) whether, based on the facts and circumstances of the case, the Tribunal’s conclusion that the sum of Rs 2,26,850 could not be taxed for the assessment year 1942-1943 was correct according to law. The assessee is a registered firm, hereafter referred to as “the firm,” composed of K R M T T Thiagaraja Chetty and his two sons. The firm acted as the managing agent of Shri Meenakshi Mills Ltd., hereafter called “the Company,” which owned a spinning mill at Madura. In addition to its agency work, the firm also carried on an insurance business and operated a cotton-ginning factory at another location. Under the terms of agreement L / B (D) 2 S C I-3(a), the managing agents were entitled to a monthly remuneration of Rs 1,000 and to commissions calculated as one per cent on all purchases, one per cent on all sales, and ten per cent on the net profits of the mills before depreciation was allowed. The firm possessed plenary powers to manage the affairs of the Company, subject only to the general supervision of the Company’s directors. It was required to assume charge and custody, on behalf of the Company, of all property, books of account, papers, documents and other effects belonging to the Company. The firm was also obligated, at the Company’s expense, to maintain proper and complete books recording every purchase, sale, payment made and money received on the Company’s behalf. Furthermore, the firm had to defray all expenses necessary to maintain a suitable office and to employ assistants and clerks sufficient to transacts its duties as managing agent. Clause 16 of the agreement was particularly significant because it permitted the firm to retain, reimburse and pay itself out of the Company’s funds all charges and expenses, whether legal or otherwise, as well as all costs incurred in providing and maintaining offices for the Company, the salaries of clerks, servants, agents or workmen, and any monies expended by them on the Company’s behalf.

In the assessment year 1942-1943 the company earned a substantial profit and, under the terms of its agreement with the managing firm, the firm became entitled to a commission of Rs 2,26,850-5-0. The firm chose not to disclose this amount in its income-tax return, contending that the sum had not actually been received by the close of the accounting year, that is, by 31 March 1942. To support this position, the firm relied on a resolution passed by the company’s Board of Directors on 30 March 1942, which directed that the commission be kept in a suspense account rather than paid, on the ground that the firm then owed the company a debt of a little over two lakh rupees. The firm’s indebtedness to the company had been outstanding for a considerable period.

On 30 March 1942 the firm wrote to the company requesting that the outstanding debt be written off. In the same communication the firm explained that, because of an extraordinary increase in the volume of business, it found it increasingly difficult to give adequate attention to all aspects of the mill’s operations. Accordingly, the firm proposed that direct responsibility for sales and purchases be transferred to another agency, while the firm would retain general supervisory control over the entire management. The firm further agreed to forgo its commission on purchases and sales and to accept only half of the commission on the net profits. The directors, by a resolution on the same day, refused to write off the amount without first consulting the general body of shareholders and, pending settlement of the dispute, ordered that the amount be retained in suspense.

The Income-Tax Officer held that the firm was applying mercantile accounting rather than a cash basis and that, under that method, the commission had accrued and therefore became assessable even though it had not been received. The actual amount payable to the firm under the agreement for the year 1942-1943 was not contested. The Appellate Assistant Commissioner affirmed the assessment and dismissed the firm’s appeal. The Commissioner upheld the view that the income was determined on a mercantile basis, that it had accrued or arisen to the assessee within the meaning of section 4(1)(b)(i) of the Income-Tax Act, and that the mere fact that the amount was placed in a suspense account did not alter the accrual of income to the firm.

When the matter was taken to the Tribunal on further appeal, the Tribunal concluded that the income had not accrued to the firm and that the commission should be excluded from taxation because it had not been received during the accounting year. The Commissioner, dissatisfied with that finding, referred two questions to the High Court. Both learned judges, Satyanarayana Rao J. and Viswanatha Sastri J., unanimously held against the assessee, finding that there was no material to support the Tribunal’s conclusion.

The Court observed that the assessment of the firm for earlier years had been conducted on a cash basis, and it noted that the findings for the years 1942-1943 and 1943-1944 were logically inconsistent. Specifically, for the assessment year 1943-1944 the Tribunal had held that the sum of Rs 2,20,702 was assessable to income-tax even though that amount was recorded merely as a credit in the company’s books and had never been drawn by the firm. Counsel for the firm, Mr Somayya, argued that the Commissioner’s earlier finding that the firm had not been paid in cash in the preceding years had been overturned by the Tribunal, and that, being a factual finding, it should not have been disturbed by the High Court. The firm had raised this issue before the Tribunal at the time of the reference, contending that the order did not involve any question of law because it was based on a finding of fact. The Tribunal rejected this contention, observing that the matter was indeed a question of law since it concerned whether any material existed to support the factual finding. When the High Court considered the referred question, it examined the precise issue and concluded that there was no material to sustain the view that the firm had been assessed on a cash basis in the earlier year. The Court further held that the citation of Commissioner of Income-tax, Bihar and Orissa v. Maharaiadhiraja of Darbhanga (1) did not bolster Mr Somayya’s argument. In that precedent, the Income-tax Officer had computed the profits for a particular year by taking into account both actual interest receipts and sums that the assessee had treated as interest receipts by transferring them to an interest register from a suspense-like account. The Privy Council had ruled that the Officer’s computation was neither illegal nor contrary to principle. Under section 66(1), the High Court had to decide the legal question raised by the first issue and had decided against the assessee, and it was not unlawful or improper for the High Court to reach that conclusion. The Court also noted that the firm maintained no separate set of accounts apart from the company’s books, which contained a ledger showing entries for remuneration and commission paid in cash to the firm. In those books, the sum of Rs 2,26,850-5-0 was debited as a revenue expenditure of the company, recorded as having been paid to the firm, and was allowed as a deduction when computing the company’s profits and gains for income-tax purposes for the year 1941-1942. The Court emphasized that the occasional drawing of cash by the firm did not, by itself, imply that the firm kept its accounts on a cash basis.

In this case, the Court observed that familiarity with commercial transactions indicated that even under a mercantile system of accounting, entries involving cash receipts and payments could appear. Accordingly, the Court found no error in the High Court’s finding on the first issue. The Court then turned to the second issue, namely whether the amount of Rs 2,26,850-5-0 formed part of the profit and gains that had accrued to the firm for the accounting year 1941-1942. The Court noted that the undisputed facts demonstrated that the sum represented commission earned by the firm in its capacity as managing agent of the company. In the company’s books, which were maintained by the firm, the amount was entered as a debit under revenue expenditure and the profit figure was computed after deducting that amount. Simultaneously, the same sum was credited to the managing-agents’ commission account. In view of these entries, the Court held that it was untenable to argue that the sum had not accrued to the firm, and it was clear beyond doubt that the amount constituted income which had accrued to the firm. The Court identified only one remaining question: whether the amount ceased to be income because, on 30 March, the directors resolved to transfer the sum to a suspense account in response to the firm’s request that the outstanding debt be written off. The Court acknowledged that the firm had not actually drawn the cash, but held that this fact did not affect the tax liability once the income was established as having accrued. The Court further stated that the mere withholding of payment by the company due to a pending dispute could not be construed to mean that the income had not accrued. The directors’ resolution itself demonstrated that the amount was regarded as belonging to the firm, although its payment was postponed because of the dispute. Referring to the judgment of Viswanatha Sastri J., the Court quoted that “The sum had irrevocably entered the debit side of the company’s account as a disbursement of managing agency commission to the firm and had been appropriated to the firm’s dues and the same sum could not again be entered in a suspense account at a later date. The sum, therefore, belonged to the firm and had to be included in the computation of the profits and gains that had accrued to it unless the firm had regularly kept its accounts on a cash basis, which is not the case here.” The Court also pointed to the ledger folios in the company’s books, which showed that, in addition to the regular monthly remuneration of Rs 1,00,0 credited to the managing agents, the disputed amount appeared as an outstanding charge against the company and as a credit in favor of the firm. The journal entries in the company’s books reflected the same treatment. Finally, the Court noted that Section 10 of the Act makes

In this case, the Court described the operative provisions of the Income-Tax Act, noting that Section 10 defined “profits and gains of business, profession or vocation” as taxable when they were carried on by a person liable to tax. Section 12, by contrast, brought “income from other sources in respect of income, profits and gains of every kind” within the charge of tax. Section 13 prescribed that income, profits and gains should be computed for the purposes of both Sections 10 and 12 according to the method of accounting regularly employed by the assessee; however, the provision contained a proviso stating that if no regular method of accounting had been used, or if the method employed was, in the opinion of the Income-tax Officer, incapable of yielding a proper determination of income, profits and gains, then the computation could be made on such basis and in such manner as the Officer deemed appropriate. The Court explained that, in computing the assessee’s income, the Officer would normally apply either the mercantile system or the cash basis, depending on which system the assessee actually used. The record contained some, though not conclusive, evidence that the assessee had followed the mercantile system of accountancy, as suggested by the assessment orders filed in the matter; nevertheless, the Income-tax Officer possessed full authority under the proviso to compute the profits in whatever manner he thought fit. The Court then turned to the authorities cited by the parties. It observed that the decision of the Privy Council in St. Lucia Usines and Estates Company, Ltd. v. Colonial Treasurer of St. Lucia (1924) AC 508 had been heavily relied upon, both by the High Court and by counsel, to support the contention that a sum which had not been paid to or realised by the firm could not be said to have accrued as income. In that case the company had sold all of its property in St. Lucia in 1920, ceased to carry on business there, and in 1921 was entitled to interest on an unpaid purchase price, which remained unpaid. The Privy Council held that although the interest constituted a debt accruing in 1921, it was not “income arising or accruing” in that year, and therefore the company was not liable to tax under the St. Lucia ordinance. The judgment, delivered by Lord Wrenbury, interpreted the words “income arising or accruing” as referring to money that actually arose or accrued as income, not to debts, and observed that “a debt has accrued to him (the taxpayer) but income has not.” The Court pointed out that this decision concerned the meaning of the term “income” in the St. Lucia ordinance and could not be regarded as authority on the assessment of profits and gains under the Indian Income-Tax Act. The Court also noted the reliance on Dewar v. Commissioners of Inland Revenue (1935) 2 KB 351, which was mentioned by counsel but not examined in detail in the present reasoning.

In the case that was discussed, one of the executors of a deceased person’s estate became entitled to receive a legacy that carried an interest as long as the amount remained unpaid. The estate of the testator was, at all relevant times, sufficient to enable the payment of interest on that legacy. Nevertheless, the legatee, following the advice of his accountant, chose neither to demand the legacy nor to demand the interest that was due. The court held that because the legatee had not actually received any interest, there was no income on which a surcharge could be imposed. This conclusion depended upon the wording of Schedule D, clause 1, sub-clause (b) of the English Income-Tax Act of 1918, and it was distinguished from clause I (a). Clause I (a) concerns annual profits or gains that arise or accrue from any kind of property whatsoever, whereas sub-clause (b) imposes tax on “all interest of money, annuities and other annual profits.” Lord Hanworth, Master of the Rolls, drew the distinction between the two clauses and observed that the matter involved interest of money, which therefore fell under sub-clause (b) rather than under clause (a). Under sub-clause (b) the tax is limited to any interest of money, whether that interest is received and payable half-yearly or at any shorter or longer interval. The learned Master of the Rolls further remarked, “If the interest on the legacy in this case has not arisen to the respondent, if he had not become the dominus of this sum, if it does not lie to his order in the hands of his agent, can it be said that it has arisen to him? I think the answer, on the facts, must be: No, it has not.” Lord Maugham, L.J., formulated the issue by stating two facts concerning the sum of £40,000 that was alleged to be chargeable: first, that the sum was not, during the year of assessment, a debt due by the executors to Mr Dewar; and second, that the sum might never be paid or received at all. The case of Commissioner of Taxes v. The Melbourne Trust, Limited dealt with the construction of a charging provision in the Victorian Income-Tax Act of 1903, which made a company liable to tax on profits earned, derived in, or from Victoria. In that case the surplus realised over the purchase price of assets, after allowable deductions, was initially taxed as profit, but the court held that the company could retain part of that surplus in suspense to meet potential losses on other assets, and that, for the purposes of the Act, the profit was deemed earned only when it was distributed to the shareholders. After reviewing all these authorities, the court expressed the view that none of them bore upon the facts and circumstances of the present matter.

The Court observed that the arguments raised regarding the present facts and circumstances did not alter the legal position. It was contended that the commission could not be said to have accrued because the profit of the business could be computed only after 31 March, and therefore the commission was merely a right to receive and could not be taxed. The Court rejected this contention as founded on the mistaken view that profits do not accrue until they are actually computed. The Court explained that the timing of the computation of profits cannot suspend the moment at which the profit, and consequently the commission, legally accrues. The Court noted that where a contract provides that a commission will not become payable until a definite period expires or until an account is made up, it may be reasonably argued, though not decided here, that the income has not yet accrued. However, the present agreement contains no such condition. Clauses seven and eight of the agreement, which deal with the payment of the commission and the calculation of profits, merely require that the commission be quantified after certain deductions are made; they do not make the quantification a condition precedent to accrual. Consequently, if the company’s profits are deemed to have accrued on 31 March, the same reasoning compels the conclusion that the commission also accrued on that date. The date is therefore as relevant to the accrual of the commission as it is to the accrual of the profits. The Court also addressed a suggestion that the managing agency was not a business, but held that this point was irrelevant for income-tax purposes because section 13 applies to cases falling under both sections ten and twelve. In passing, the Court referred to two earlier decisions—Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-Tax Bombay and Commissioner of Income-Tax Bombay Presidency v. Tata Sons Ltd.—in which the managing agency was assumed to be a business, and to the decision in Inderchand Hari Ram v. Commissioner of Income-Tax, U.P. and C.P., which directly affirmed that view. For these reasons, the Court adopted the view expressed by Justice Viswanatha Sastri and allowed the appeals. The respondent was ordered to pay the costs of the Commissioner both in this Court and in the High Court. Appeals were allowed. Agent for the appellant was identified as G. H. Rajaddhyaksha, and the respondent’s agent as S. Subramanian.