Keshav Mills Ltd vs Commissioner Of Income-Tax, Bombay

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 151 of 1951

Decision Date: 30 January, 1953

Coram: Natwarlal H. Bhagwati, Mehr Chand Mahajan, S. B. Das, Vivian Bose

In the matter of Keshav Mills Ltd versus the Commissioner of Income-Tax, Bombay, a judgment was delivered on the thirtieth day of January, 1953 by the Supreme Court of India. The opinion was written by Justice Natwarlal H. Bhagwati and the bench was composed of Justice Natwarlal H. Bhagwati, Justice Mehr Chand Mahajan and Justice Vivian Bose. The petitioner in the suit was Keshav Mills Ltd. and the respondent was the Commissioner of Income-Tax for Bombay. The case citation appears as 1953 AIR 187 and 1953 SCR 950, and it is reported in several subsequent law reports including E&D 1959 SC 82, F 1959 SC 1165, D 1961 SC 921, R 1964 SC 1766, R 1965 SC 1636, R 1965 SC 1862, RF 1966 SC 870 and RF 1977 SC 1802. The statutes discussed in the judgment were sections 4(1)(a) and 4(1)(c) together with section 13 of the Indian Income-Tax Act of 1922 (Eleventh Year). The issues identified by the Court involved the accounting method used by a non-resident company that employed the mercantile system, the sale of goods in British India through agents, the assessability of the profit arising from such sales, the applicability of the statutory provisions to the case, and whether the income-tax authorities were required to compute income according to the mercantile system for a non-resident.

The Court’s factual narrative described a non-resident corporation that manufactured textile products outside British India and sold those products directly from its mills. A trading firm identified as R & Co. guaranteed the price at which the goods were sold to purchasers located in Ahmedabad, which lay within British India. Because the corporation kept its books under the mercantile system, it recorded a debit to R & Co. for the price of the goods sold and a corresponding credit to its sales account for the amount of the bills of exchange. R & Co. then collected the amounts due from the purchasers on behalf of the corporation, deposited the sums in the corporation’s bank account at Ahmedabad, and subsequently disbursed the funds to the corporation’s creditors in British India. The corporation itself recorded the payments it received from R & Co. as credits. During the accounting year in question, the corporation recorded receipts amounting to Rs 12,68,480 from the sales facilitated by R & Co., and it also received a further amount of Rs 4,40,878 from direct sales to purchasers inside British India. For those sales, the corporation debited the accounts of the respective merchants for the value of the sales bills that had hundis drawn on the purchasers in favour of banks, and it credited its sales account with the same amounts. When the banks obtained the funds from the purchasers against the delivery of railway receipts, the corporation credited the accounts of the respective purchasers. The Court observed that, in either set of transactions, the entries in the corporation’s books did not alter the legal relationship between the vendor and the purchaser. The High Court had previously reframed the principal question as whether the two sums—Rs 12,68,480 and Rs 4,40,878—constituted sale proceeds from goods sold to merchants in British India, whether those proceeds were received in British India, and consequently whether they should be included in the corporation’s assessable income in British India. The Supreme Court, by a majority of Justices Mehr Chand Mahajan, S. B. Das and Natwarlal H. Bhagwati, held that the two amounts were indeed the sale proceeds of the goods that had been sold and delivered by the corporation to merchants in British India, and therefore were liable to tax under the relevant provisions of the Indian Income-Tax Act. Justice Vivian Bose dissented from this conclusion.

In the present matter, the Court observed that the sums in question were not actually received by the company and could not be regarded as received by it at the moment the corresponding entries were recorded in the books of account at P. Rather, those sums had merely accrued or arisen to the company in British India. The Court further noted that the first receipt of the amounts occurred in the hands of R & Co. and the banks that negotiated the railway receipts on the company’s behalf in British India. Consequently, the Court held that the amounts were liable to tax under section 4(l)(a) of the Indian Income-tax Act as having been received in British India on the company’s behalf. The Court then turned to the distinction between residents and non-residents in respect of the mercantile system of accounting. It acknowledged that, for a resident assessee who regularly employs the mercantile system, the income-tax authorities are bound to compute income according to that system. However, the Court expressed doubt that the same position could be extended to a non-resident who maintains his books of account outside British India while also using the mercantile system. Section 13 was said to be relevant only where the total profits of the assessee must be computed, in which case the assessee could claim that the computation should follow his own system of accounts; the section would not apply when isolated items of income are being assessed as received in the taxable territory by a non-resident. In a separate judgment, Justice Bose explained that, where accounts are kept on the mercantile basis, profit or loss at the close of the accounting year is determined not by the actual cash received and paid but by the difference between the right to receive and the liability to pay. Accordingly, taxation in such cases is levied not on income, profits or gains that were physically received, but on profits that “accrued or arose” to the assessee during the accounting year. This interpretation excludes the application of section 4(l)(a) and means that a resident is taxed under section 4(l)(b) whereas a non-resident is taxed under section 4(l)(c). Applying section 4(l)(c) to the present facts, the Court held that, for the sum of a little over Rs 4 lakhs, the profit accrued in British India where the right to take delivery of the goods arose and the price was actually paid; nevertheless, the amount liable to tax under section 4(1)(c) is not the Rs 4 lakhs itself but the figure recorded in the accounting year as the price of the transactions represented by that sum. In the same way, for the sum of a little over Rs 12 lakhs, the taxable amount is the figure entered in the books for the relevant transactions during the accounting year. The Full Court then clarified that the expression “deemed to be received” in section 4(1)(a) means deemed by the provisions of the Act to be received, and cited authorities such as Subramaniyan (Chettiar v. Commissioner of Income-tax (2 I.T.C. 365)), Ahmed Din Alladitta v. Commissioner of Income-tax, Punjab (2 I.T.R. 369), and Kanwal Yayan Hanir Singh v. Commissioner of Income-tax, Ajmer-Merwara (6 I.T.R. 675), among others, to support its interpretation.

The Court recorded that several earlier rulings were cited in support of the issues before it. It mentioned the decisions of the Income-tax Authority in Ajmer-Merwara (6 I.T.R. 675), the case of Commissioner of Income-tax v. Singari Bai (13 I.T.R. 224) which was distinguished, and the judgment in B.M. Kamdar, In re (1946 I.T.R. 14). Further authorities referred to included Pondicherry Railway Co. v. Commissioner of Income-tax (58 I.A. 239), Commissioner of Income-tax v. Mathias (66 I.A. 23), Commissioner of Income-tax v. Kameswar Singh (1933 I.T.R. 94) and Commissioner of Income-tax v. Chunilal Mehta (1938 I.T.R. 521). These citations were noted as part of the Court’s analysis of the legal principles applicable to the matter.

The judgment concerned a civil appeal numbered 151 of 1951, which was filed against a judgment and order dated the 14th and 15th of September, 1949, rendered by the High Court of Judicature at Bombay. The High Court, consisting of Chief Justice Chagla and Justice Tendolkar, had decided an income-tax reference identified as No. 2 of 1949. Counsel for the appellant were R. J. Kolah and N. A. Palkiwalla, while the respondent was represented by C. K. Daphtary, Solicitor-General for India, assisted by P. A. Mehta. The appellate decision was delivered on 30 January 1953. The bench comprised Justice Mehr Chand Mahajan, Justice Das and Justice Bhagwati, with Justice Bhagwati authoring the principal opinion. Justice Bose also delivered a separate judgment.

Justice Bhagwati explained that the present appeal arose from the Bombay High Court’s affirmation of an order of the Income-tax Appellate Tribunal, issued under Section 66(1) of the Indian Income-tax Act, 1922. The Tribunal had concluded that two amounts – Rs 12,68,480 and Rs 4,40,878 – represented sale proceeds from goods sold by the appellant to merchants located in British India. The Tribunal held that these proceeds were received in British India and therefore fell within the income-tax jurisdiction of British India. The appellant was identified as a company that had been incorporated in the Baroda State before that State’s merger with the Indian Union. The company’s manufacturing operations were situated at Petlad in Baroda, where it produced textile articles. After production, the company sold the goods directly from its mills, a practice known as “ex-mills” sales.

The appellant employed a firm named Messrs Jagmohandas Ramanlal & Co. as guaranteed brokers. Under this arrangement, the broker guaranteed the sale price of the ex-mills goods to purchasers in Ahmedabad and received a commission for providing the guarantee and performing related services. The appellant was classified as a non-resident for tax purposes and maintained its accounts on the mercantile system. In the assessment year 1942-43 – the preceding calendar year being 1941 – the company reported total sales amounting to Rs 29,68,808. For the purpose of determining liability to British Indian tax, the assessment considered three specific streams of revenue. The first stream, identified as item (a), comprised sale proceeds recovered through Messrs Jagmohandas Ramanlal & Co., amounting to Rs 12,68,480. The second stream, item (b), consisted of sale proceeds received via British Indian banks and shroffs through drafts or hundies drawn by the company; this totalled Rs 4,40,878, corresponding to railway receipts that the banks handed over to British Indian merchants upon payment. The third stream, item (c), involved sale proceeds received by cheques on British Indian banks and hundies on British Indian shroffs and merchants, which were collected by the banks and shroffs; this amounted to Rs 6,71,97,35. The aggregate of these three items was Rs 23,81,093. Regarding item (a), the company had debited the account of Messrs Jagmohandas Ramanlal & Co. with Rs 13,41,744, a figure that represented the total sales made through the broker. This detailed accounting formed the factual basis for the tax dispute before the Court.

The company sold goods to merchants in Ahmedabad and the payments for those sales were guaranteed by the firm Messrs. Jagmohandas Ramanlal & Co. The company recorded a debit in the account of that firm for Rs 13,41,744, representing the value of the sales made to the Ahmedabad merchants, and it credited the sales account with the amounts of the corresponding bills. Messrs. Jagmohandas Ramanlal & Co. then collected the bills from the Ahmedabad merchants and entered the sums recovered in the company’s accounts that were held with banks and/or shroffs in Ahmedabad. The firm also disbursed money on the company’s instructions to the company’s creditors in British India. All of these receipts were credited by the company to the account of Messrs. Jagmohandas Ramanlal & Co. During the accounting year concerned the company received Rs 12,68,480 against the total debits of Rs 13,41,744 recorded for item (a). Regarding item (b), the company drew hundies or drafts on its sales bills – which included forwarding charges and the cost of transporting the goods from the mill premises to the railway station – in favour of recognised banks and shroffs in British India. The company sent these drafts to the banks or shroffs together with railway receipts that were duly endorsed in favour of the merchants and instructed the banks or shroffs to recover the amounts, including the costs of transmission. The company debited the accounts of the respective merchants for the value of the sales bills and credited its sales account; when the banks or shroffs recovered the amounts from the merchants in British India against delivery of the railway receipts, the company, on receipt of those amounts, credited the merchants’ accounts in its books. For item (c), the company received Rs 6,71,735 from the merchants by means of cheques and hundies drawn on banks and shroffs in British India in favour of the company. These instruments were negotiated by the company in Petlad and then sent back for credit to its accounts with those banks and shroffs. The cheques and hundies were cashed in British India and the proceeds were remitted by the banks and shroffs to the company. The company debited the merchants’ accounts in its books when the goods were invoiced and subsequently credited those accounts with the monies received from the merchants. The Income-Tax Officer included the profits represented by the three items in the assessment year, arguing that because the sale proceeds had been received in British India, the profits were deemed to have arisen in British India. The Appellate Assistant Commissioner, on appeal, held that the profits from items (a) and (c) were exempt from British Indian tax, while the profits represented by item (b) were correctly taxed. The Department appealed to the Appellate Tribunal against the Assistant Commissioner’s decision concerning items (a) and (c), and the company appealed against the taxation of item (b). The Appellate Tribunal held in

In its analysis of item (a), the Tribunal observed that the merchants operating in British India remained responsible, both legally and factually, for paying the amounts owed to the company, as shown by the debit entries recorded in the account of Messrs Jagmohandas Rainanlal & Co. Regarding item (b), the Tribunal held that the payment of the dues owed by the merchants was a condition precedent to the delivery of the goods, and that this payment was effected by banks in British India acting on behalf of the company. Consequently, the Tribunal concluded that the profits arising from both items (a) and (b) were correctly subject to tax. Concerning item (c), the Tribunal found that the sum of Rs 6,71,735 had been received by the assessee directly from the merchants in British India through cheques and hundies drawn on banks and shroffs in British India in favour of the company, but that these instruments were negotiated in Petlad and then credited to the company's account. Because the amounts were actually received at Petlad, the Tribunal held that they could no longer be regarded as having been received in British India. The Department then requested that the Tribunal refer to the High Court the question of law arising from item (c), while the company asked that the matter concerning items (a) and (b) be referred. The Tribunal therefore framed a single question of law for the High Court: whether, on the facts and circumstances of the case, the sums of Rs 12,68,480, Rs 4,40,878 and Rs 6,71,735, or any part thereof, representing receipts by the assessee of its sale proceeds in British India, included any portion of its income earned in British India. The High Court ruled that the amount of Rs 12,68,480 had indeed been received in British India and therefore formed part of the assessee’s profits and gains. It likewise held that Rs 4,40,878 was received in British India and that the company was liable to tax on that amount. For the sum of Rs 6,71,735, the High Court found the material on record insufficient to reach a decision and directed the Tribunal to submit a supplementary statement of case setting out the various aspects mentioned in the judgment. In addition, the High Court reframed the issue concerning the two larger sums as follows: (1) whether Rs 12,68,480 and Rs 4,40,878 represented sale proceeds of goods sold to merchants in British India or merely debts due from those merchants; (2) if they were sale proceeds, whether they had been received in British India. The Court answered both sub-questions affirmatively, holding that the amounts were indeed sale proceeds and were received in British India. A third question, also arising from the reference, asked whether the profits of the assessee’s business were included in the sums of Rs 12,68,480 and Rs 4,40,878. The High Court answered that the profits were indeed part of those two sums.

In this case the Court noted that the profits of the assessee’s business were held to be included in the two sums of Rs 12,68,480 and Rs 4,40,878, and that the company obtained leave from the High Court to challenge the assessment of those sums. The Court observed that it was undisputed that the company was a non-resident and that its books of account were maintained according to the mercantile system, with balance sheets prepared on that same basis. Accordingly the assessment in British India was based on the proposition that the two sums had been received in British India by or on behalf of the company. Regarding the sum of Rs 12,68,480, the Court explained that although the sales bills were initially debited to the account of Messrs Jagmohandas Ramanlal & Co., the sale proceeds under the terms of those bills were actually paid by the merchants to Messrs Jagmohandas Ramanlal & Co. in British India and were then either credited in the company’s accounts with banks or shroffs situated in British India or disbursed by those agents in accordance with the company’s instructions, also in British India. Concerning the sum of Rs 4,40,878, the Court observed that the sales bills were first debited by the company to the merchants’ accounts in the books kept at Petlad, but the corresponding railway receipts were forwarded by the company to banks or shroffs in British India together with drafts or hundies and with explicit instructions that the receipts should be delivered to the merchants against payment; consequently the merchants paid the amounts of the sales bills to the banks or shroffs in British India, and those agents transmitted the funds, under the company’s directions, to the company’s office at Petlad. On a preliminary examination, therefore, the amounts represented by both sales bills, whether paid to Messrs Jagmohandas Ramanlal & Co. or to the banks or shroffs who negotiated the railway receipts, were paid by the merchants in British India and were received by those agents on behalf of the company in British India. The Court held that such receipt fell within section 4(1)(a) of the Act, meaning that the profits or gains of the business were deemed to have been received in British India by or on behalf of the company. The company, however, sought exemption from tax liability on three grounds: first, that its accounts were kept on the mercantile or book-profit basis, which made the accrual of profit shown in the books the criterion for taxability, thereby rendering section 4(1)(a) inapplicable; second, that under section 13 of the Act the assessing authorities were bound to accept that system of accounting except in the limited circumstances provided by the proviso, and that this method of computation formed the very basis of chargeability, with section 10 read with section 13 serving to save the amounts from tax; and third, that because the amounts had been treated as received when credit entries were entered in the books, the liability for tax had crystallised at that moment, and any subsequent actual receipt of the sums in British India should not give rise to an additional charge, rendering the later handling of the money irrelevant.

The Court observed that the law required the method of accounting prescribed by the statute, except where the proviso to that section applied, to be the foundation of tax liability, and that the provisions of section ten read together with section thirteen operated to exempt those amounts from liability; furthermore, the Court held that once amounts had been treated as received at the time credit entries were recorded in the books of account and tax liability had crystallised on the date when the income was deemed to have accrued or been received, no additional tax could arise when the amounts were later actually collected, and the later handling of those sums by the company and their receipt in British India were irrelevant to the assessment.

The Court explained that the mercantile system of accounting, also known as the double-entry system, stands in contrast to the cash system of bookkeeping, which records only actual cash receipts and cash payments and makes entries only when money is physically collected or disbursed. Under the mercantile system, an amount becomes a credit the moment it is legally due, even before the money is actually received, and an expense becomes a debit as soon as a legal liability is incurred, regardless of when the cash outflow occurs.

The Court noted that profits or gains of a business that are therefore credited in the books are not yet realised; they are merely earned and are treated as received although, in reality, they represent only an accrual or arising of profit at that stage. Such profits are described as “book profits.” Because receipt is not the sole test of taxability, profits and gains that have accrued, arisen, or are deemed to have accrued or arisen are also subject to income-tax. Consequently, the assessability of the profits that are credited in the accounts arises not from actual receipt but from the fact that they have accrued or arisen.

Mr Kolah, appearing for the company, referred the Court to several earlier decisions, namely Subramaniyan Chettiar v. Commissioner of Income-Tax (1927) 2 I.T.C. 365, Ahmed Din Alladitta v. Commissioner of Income-Tax, Punjab (1934) 2 I.T.R. 369, Kanwal Nayan Hamir Singh v. Commissioner of Income-Tax, Ajmer-Merwara (1938) 6 I.T.R. 675, and Commissioner of Income-Tax v. Shrimati Singari Bai. The Court observed that in each of those cases the assessors were residents of British India who maintained their books of account according to the mercantile system. Except for the Singari Bai case, where the assessment concerned the total income or profits, the assessments involved stray items of income that had been treated as received in British India; those items were taxed not on the basis of actual receipt in British India but on the basis that they had accrued or arisen there.

Finally, the Court noted that those earlier cases were decided on the law as it stood before the 1939 amendment. At that time, section 4(l) of the Act made liable to tax all income, profits or gains from any source that were accruing, arising, received in British India, or deemed to have accrued, arisen, or been received under the provisions of the Act.

The Act contained provisions that made any income, profit or gain that accrued, arose or was received in British India liable to tax. The courts were asked to decide whether, under the mercantile system of accounting, profits that were entered in the books could be taxed even though the profits had not actually been received. The courts held that such profits, once credited in the books of account, were deemed to be earned and therefore could be charged as having accrued or arisen within British India, despite the fact that the cash had not been received. In none of the authorities cited did the courts consider a non-resident who claimed that profits earned outside British India, recorded under the mercantile system, should be exempt from tax under section 4(1)(a) on the ground that the profits were actually received in British India.

From these decisions it follows that the mercantile system treats profits or gains as accruing on the date of the underlying transaction, irrespective of the moment of receipt or of any deeming provision. Consequently, book profits are assessed as taxable income. If a taxpayer regularly follows the mercantile system, he becomes liable to tax on the profits that are entered in his books, subject only to the deductions for bad debts that are permitted under section 10(2)(xi). The rule in section 4(1)(a) does not affect this basis of taxation. Section 13, which is an essential part of the computation of total income and which the income-tax authorities must apply when they calculate total income (see section 2(15)), does not create any exemption from liability. Rather, it prescribes a method of computing income that must be accepted by the tax authorities, except where the proviso to that section applies.

Because the profits recorded in the books form the basis of the income computation, the mercantile system assumes that corresponding debts exist – the amounts remain due and payable by the parties to whom they were debited. When it becomes clear that some of those debts are irrecoverable, the taxpayer is allowed a deduction for the bad debts under section 10(2)(xi). This allowance, however, does not alter the nature of the original transaction as recorded under the mercantile or double-entry system, nor does it change the relationship between the parties. A transaction that began as a sale and purchase does not transform into a creditor-debtor relationship. The vendor-purchaser relationship continues to exist, and no new creditor-debtor relationship is created by the accounting entries.

The Court observed that the transaction as entered in the vendor’s books of account must be examined to its fullest extent and that the mere entry of a sale and the debiting of the purchase price to the purchaser does not, in any manner, alter the rights and obligations existing between the vendor and the purchaser. The vendor remains bound to perform all contractual obligations and continues to be liable for any consequences of his default, including the possibility that the purchaser may reject the goods or may claim damages for breach of warranty. Likewise, the purchaser retains the full right to reject the goods or to seek damages for any breach of warranty by the vendor, and these rights and obligations must be assessed notwithstanding that the entries were recorded by the vendor in accordance with the mercantile system of accounting that he follows. The vendor cannot contend that his obligations to the purchaser cease and that the purchaser is merely required to pay the price that has been debited as a debt arising from a book entry. If the vendor institutes proceedings against the purchaser, such a suit would be framed as a claim for the price of the goods that have been sold and delivered, not as an assumpsit for recovery of a debt owed by the purchaser. The Court further held that, in these circumstances, there is no receipt of money at all—neither actual nor constructive—whether in cash or in kind, by actual payment, adjustment, or settlement of accounts. Moreover, there is no basis for the argument that, although the sums may not be said to be actually or constructively received, they should be “deemed to be received.” The expression “deemed to be received” is limited to what the provisions of the Act itself deem to be received. The phrase “statutory receipt” may be conveniently used to describe income that is “deemed to be received” under specific provisions of the Act, such as section 18(4), section 58(E), section 58(J)(3), section 7(2), section 16(1)(c), and sections 19(2)(vii) and 16(2). The Court referred to the observations of Beaumont C.J. in Commissionei of Income-Tax, Bombay v. New India Assurance Co. Ltd. (1938) 6 I.T.R. 603 at p. 614, emphasizing that an amount cannot be “deemed to be received” merely by the volition or will of an individual. In all the authorities cited, the profits that were credited in the books of account under the mercantile system of accounting were at most “treated as having been received,” which is neither “received” nor “deemed to be received,” and therefore they fall outside the scope of section 4(1)(a).

The Court observed that amounts which had merely been credited in the books of account could not be described as received or as deemed to have been received at the time those entries were made. Consequently, the argument advanced by counsel Kolah that a second receipt of the same sum could not occur in British India was rejected as untenable. The Court noted that the language of section 4(1)(a) specifically concerned the first receipt of income after it had accrued. It held that once the entitled party actually receives the income, any later transaction involving the same amount cannot be characterised as a fresh receipt of income. This principle was affirmed by Justice Kania in B. M. Kamdar, where the term ‘receipt’ was explained as referring to the initial occasion on which the recipient obtains control over the money. The Court further observed that once an amount has been received as income, its subsequent remittance or transmission to another location does not constitute receipt within the meaning of the statutory provision. That rule was expressly confirmed by the Privy Council in Pondicherry Railway Co. v. Commissioner of Income-Tax and by the Court of Appeal in Commissioner of Income-Tax v. Mathias. Accordingly, even if the assessee had initially received income, profits or gains outside British India, those sums did not become taxable merely because they were later brought into British India, since tax liability arose on the first receipt, not on any subsequent handling. In such a situation, the amounts would be considered as the assessee’s own money already in his possession, and they would cease to possess the character of income, profit or gain. However, the Court held that this legal ratio did not apply to the facts of the present case. The Court found that the company had neither actually received the monies nor could it be said to have deemed receipt at the time the entries were recorded in the books of account at Petlad. Instead, the monies had merely accrued to the company and, with respect to receipt, were first actually received in British India when they were taken in by Messrs. Jagmohandas Ramanlal, by the various banks or shroffs, or by other agents through whom the railway receipts were negotiated. Thus, the initial receipt occurred when merchants paid the sums to Messrs. Jagmohandas Ramanlal & Co., or to the banks or shroffs mentioned above. Those payments represented the sale proceeds of goods that the company had sold and delivered, and the parties receiving the money did so on behalf of the company within British India, thereby satisfying the definition of receipt under section 4(1)(a) at the moment the merchants made the payments. Counsel Kolah subsequently invoked the foregoing authorities and principles in support of his argument concerning the timing of receipt.

The Court examined the argument that section 13 of the Act required the income-tax authorities to use the mercantile system of accounting, which the assessee regularly applied, for computing his income. While the Court agreed in principle that such a requirement might exist for resident taxpayers, it expressed doubt that the same position could be extended to a non-resident who kept his books outside British India using the mercantile system. The Court explained that section 13 would become relevant only when the total profits of the assessee had to be computed, in which circumstance the assessee could contend that the computation should follow the accounting system he maintained. However, the Court noted that the provision would be of little relevance where isolated items of income were identified in taxable territories because they were received in those territories by a non-resident. In the present matter, the entries recorded by the assessee were intended merely to demonstrate that the sale proceeds originated outside British India at the location where the entries were made. The Court rejected this contention, holding that section 4(1)(a) dealt with actual receipt of income, not with paper receipts. After considering these observations, the Court affirmed the High Court’s findings that the two sums of Rs 12,68,480 and Rs 4,40,878 represented sale proceeds of goods sold and delivered by the appellant to merchants in British India, that these amounts were received by Messrs Jagmohandas Ramanlal & Co. and by the banks and shroffs who negotiated the railway receipts on behalf of the appellant in British India, and that they were therefore taxable under section 4(1)(a) of the Act as received in British India. The Court found no factual or legal basis for exempting these amounts from tax, confirmed that the answers to the questions considered by the High Court were correct, and held that the appellant was liable for tax on the two amounts after allowing all proper deductions and allowances. Consequently, the appeal failed, was dismissed, and costs were awarded.

A dissenting judge expressed disagreement with the majority view. He observed that section 3 of the Indian Income-tax Act stipulated that “total income” should be charged in accordance with the provisions of the Act, and therefore it was necessary to determine the meaning of “total income.” The judge cited the definition of “total income” in section 2(15), which stated that the term meant, not merely included, the total amount of income, profits and gains referred to in sub-section (1) of section 4, computed in the manner laid down in the Act. Accordingly, the computation of all income referred to in section 4(1) had to follow the method prescribed by the Act. The judge noted that section 4, apart from its provisos and explanations, comprised three clauses: (a), (b) and (c). Clause (b) dealt with residents, clause (c) with non-residents, and clause (a) was general, thus applying to both categories. He argued that the words “received” and “deemed to be received” should be construed in the same sense in both resident and non-resident contexts, except where the Act expressly provided otherwise, because sub-section (1) was subject to the Act’s provisions. The judge further contended that “deemed to be received” could be excluded from consideration because it was confined to the deeming sections of the Act, leaving the term “received” as the focal point for analysis under section 4(1)(a), which concerned actual receipts rather than accruals or deemed earnings. This reasoning was presented to contrast the interpretation of “received” with the terms “accrue” and “arise” used in clauses (b) and (c).

In this passage, the Court held that it was legitimate to infer that the term applied to both categories. Consequently, the expressions “received” and “deemed to be received” had to be interpreted in the same manner in each context, except where the Act expressly provided otherwise, because sub-section (1) was subject to the provisions of the Act. The Court then excluded the phrase “deemed to be received” from further consideration, agreeing that it was confined to the so-called deeming sections of the Act, meaning only those situations where deeming was required by explicit statutory provisions. This left the term “received” for analysis; the Court specified that it was dealing solely with section 4(l)(a), which governs “receipts,” and not with section 4(l)(c), which deals with “accruals,” “arisals,” and matters deemed to “accrue” or “arise.” In the Court’s view, the word “received” must be contrasted with the words “accrue” and “arise” that appear in clauses (b) and (c). Although the Court acknowledged that some overlap might exist in particular cases, it expressed the opinion that the three terms were not intended to be synonymous. The Privy Council, in Commissioner of Income-tax v. Mathias (1), observed a variation in meaning among these terms, and in Commissioner of Income-tax v. Chunilal B. Mehta (2) highlighted the antithesis between “accruing and arising” and “received,” while also noting that the earlier decision recognized that the terms were not entirely disjoint and could overlap in certain situations (page 56). The Court then turned to section 6, which classifies the various sources of income under different heads for the purpose of computation and chargeability, and provides that each head shall be “chargeable” in the manner that follows. The Court stressed that the use of “shall” rather than “may” indicated that there was no discretionary choice. Regarding business income, the relevant head is No. (iv) “Profits and gains of business etc.” This leads to sections 10 and 13, which prescribe the method of computation. The language in these sections is also imperative, requiring that a business compute its income in accordance with the accounting method regularly employed by the assessee, as explained in Commissioner of Income-tax v. Kameshwar Singh (3). In the present case, the assessee used the mercantile system of accounting. The Court explained that the essential difference between the mercantile system and the cash-basis system, as noted in earlier authorities (1) [1939] 7 I.T.R. 48 at 56; (2) [1938] P.I.T.R. 521 at 527; (3) [1933] 1 I.T.R. 94 at 100-101, is that the cash-basis method records actual receipts and payments, whereas the mercantile method records sums that are legally due as credits immediately, even before actual receipt. The former records sums that are due to the business on the credit side immediately when they become legally due, and before actual receipt.

In the mercantile system of accounting, expenditures are recorded at the moment a legal liability to pay arises, even before any actual disbursement is made. Consequently, the profit or loss for the accounting year is determined not by the difference between cash actually received and cash actually paid, but by the difference between the right to receive money and the liability to pay it. The Court found it impossible to characterize taxation in such a circumstance as being on income or on profits and gains that were “received”. Rather, the tax must be on profits that “accrued” or “arose” to the assessee during the accounting year, as indicated by the Privy Council decision in Feroz Shah v. Commissioner of Income-tax (‘). In the Court’s view, this interpretation excludes the application of section 4(l)(a). The exclusion, in turn, means that a resident assessee would be taxed under section 4(l)(b), while a non-resident would fall under section 4(l)(c). The Court emphasized that the primary purpose of the Income-tax Act is to levy tax, not merely to ascertain income. The calculation of income is therefore subsidiary and serves only to determine the quantum of tax, a principle reaffirmed in Commissioner of Income-tax v. Kameshwar Singh (2). Accordingly, when the legislature prescribes distinct methods of computation and stipulates that tax shall be levied on the amount so computed, those prescribed methods must be strictly followed. Whether adherence to the prescribed method benefits or disadvantages the assessee is irrelevant; the essential point is that the prescribed method must be applied.

The Court further explained that only those profits and gains that are received or that arise or accrue in the “previous year” can be taxed in a given year. When the Act directs that profits be computed on the basis of “accruals” or “arisals” rather than on actual receipts, the computation must be carried out accordingly, as required by the authorities cited at (1) [1933] 1 I.T.R. 219 at 224-225 and (2) [1933] 1 I.T.R. 94 at 100. From this requirement follows that tax in such cases can only be imposed on the accruals or arisals and not on the actual receipts, because the tax cannot be levied on an amount that the statute forbids the assessor from computing. The Court stressed the necessity of maintaining this distinction, noting that tax rates vary from year to year. For example, if the book profits that are prescribed for taxation in a particular year amount to Rs 10,000 while the actual cash receipts are only Rs 100, the choice of which figure to tax makes a substantial difference. Moreover, the disparity does not necessarily balance out over time; if in the following year the tax rate rises and the business’s situation reverses—book profits falling to Rs 100 while actual receipts rise to Rs 10,000—the aggregate tax liability over the two years will be markedly affected depending on whether tax is based on book profits or on actual receipts.

The Court observed that if the previous year’s transactions amount to Rs 10,000, the choice between taxing on the basis of book profits or on the basis of actual receipts can create a considerable difference in the total tax that the assessee must pay over several years. The Court could not find any justification for treating a resident and a non-resident differently on this point. It saw no basis for holding that a resident must necessarily use the mercantile system of accounting for profit computation merely because that system is regularly employed, while a non-resident could be exempt from that requirement. The Court noted that, had the assessee been a resident company, the tax would, in its view, fall under section 4(l)(b), which taxes profits and gains that have accrued or arisen, rather than under section 4(1)(a), which taxes profits that have been received. The same reasoning, the Court held, should apply to a non-resident; consequently, section 4(1)(c) would be triggered, provided that the profits and gains have actually accrued or arisen in the taxable territories or can, by operation of section 42, be deemed to have accrued or arisen there. If section 4(1)(c) does not apply, the Court explained that tax cannot be imposed. Turning to the question of where profits and gains arise or accrue in the present case, the Court acknowledged that the issue is not free from difficulty and that various views are possible. Since the expressions “arise” and “accrue” have not been defined as technical terms of art, the Court decided they should be interpreted in their ordinary meaning, the meaning that businessmen would naturally understand in a commercial transaction. It reasoned that when goods are sold, the profit or loss on that transaction clearly arises from the sale, because without a sale there can be no profit. Although the profit may not be wholly attributable to the sale, it is unquestionably at least partly derived from it. Therefore, if the goods are sold within the taxable territories, the Court concluded that the profits, or at least a portion of them, arise in those territories. Citing the Privy Council’s observation in Commissioner of Income-Tax v Chunilal B Mehta, the Court stated that determining where profits arise does not depend solely on the place where the contract was formed; other factors, such as acts performed under the contract, are also relevant. The Court clarified that it was not seeking to overturn the Supreme Court’s earlier decision that the place of sale is not necessarily the place where profits are received. Rather, it was interpreting the word “arise” and not the word “receive.” This led the Court to the next issue: the factual and legal question of where the goods in the present case were sold.

In this matter, the Court explained that the question of where profit arises must be answered on a case-by-case basis, using common sense rather than the strict artificial rule prescribed by the Sale of Goods Act for determining the moment and place at which property passes. The Court then turned to the facts. In the transaction involving a little more than four lakh rupees, the assessee retained control over the bulk of the goods until the instant when the price was actually paid. The payment was not made outside British India; instead it was made to the assessee’s nominees within the country, specifically to the assessee’s banks located in British India. Those banks kept the title documents and possessed the legal right to refuse delivery of the goods until the money was physically handed over to them. Consequently, the Court held that the right to take possession of the goods and to receive delivery arose in British India, the place where the money was actually paid. In the Court’s view, that place must be regarded as the location where the profits for income-tax purposes accrued and arose. The Court clarified that the reason for this conclusion was not that the money was physically received there, because the assessment did not depend on actual receipt of cash, but because the right that vested at the date of the transaction was the right to receive the money in British India and to hand over the goods there upon receipt of the money. The Court emphasized that the substance of the transaction had to be examined, and that such substance could not be made to depend on the method of bookkeeping. Even if no books were kept, the profits from such a transaction would still accrue in the place where the money was to be paid and the goods were to be delivered. The Court expressed that it could not see how a change in the accounting method could alter this result.

The Court further stated that it agreed that the particular method of accounting adopted by the assessee could not change the substantive character of the transaction between the parties or affect the nature of their rights and obligations. The rights and liabilities of the parties could not be made to hinge on the manner in which one of them chose to keep its books. However, the Court observed that the situation was different when the question concerned income-tax liability. For tax purposes, the method of accounting was a material factor, yet even in that context the Court insisted that the underlying substance of the transaction must still be examined, because substance could not be transformed merely by a different accounting technique. The Court illustrated that, had the assessee been a resident of British India and had deliberately omitted these transactions from its books, the amounts that ought to have been entered would have been taxable as items that escaped assessment, even in the absence of actual cash receipts in that year or any subsequent year. Accordingly, the Court concluded that tax liability did not arise from the entry in the books but from the profits generated by the transaction itself. When the mercantile system of accounting was applied, the profits arose at the moment the right to receive them accrued, not when the entry was recorded. The Court added that, if the system were applied correctly, the entry would be made as soon as the right to receive the price arose.

The right to receive the price arises at a specific moment, and for practical purposes that moment is the date normally referred to for tax purposes. However, a taxpayer cannot alter his tax liability by choosing whether or not to record items that should be entered on a particular date at his discretion.

The amount of Rs 4 lakhs and some change represents actual cash receipts, but under the mercantile system of accounting that figure is not the taxable amount. What must be taken into account for tax computation are the figures recorded in the accounting year as the sale price of the transactions that produced the Rs 4 lakhs. In my view the profits arising from those transactions do not escape tax because the profits accrue or arise in the taxable territories. Nevertheless, the tax base is not the Rs 4 lakhs of receipts; it is another figure, which unfortunately has not been supplied. I am assuming that the amounts were properly entered in the books at the correct time in accordance with the mercantile system. If the entries were not made, the income-tax authorities possess the power to tax income that has, for any reason, escaped assessment.

Turning to the transactions involving approximately Rs 12 lakhs, the books show an entry of Rs 13,41,744. I am not certain whether that entry was made in the accounting year presently before the Court, although I have gathered that it was. The actual cash receipts that followed amounted to Rs 12,68,480. In my opinion, for tax purposes the computable figure, assuming the entries belong to the relevant accounting year, is the former amount of Rs 13,41,744, not the latter receipt figure. To decide whether the profits on these transactions are taxable, the underlying transactions must be examined.

The sales in question were to merchants residing in Ahmedabad. According to the assessee’s affidavit, “In respect of buyers from Ahmedabad, the applicant Mills have no account of such buyers. The price is debited to the account of the said Jagmohandas Ramlal and Company and credited to the sales account in the books of the applicant.” The affidavit further states that Jagmohandas “discharges its debts by making payments to the applicants from time to time towards the balance in their said account in the books of the applicant Mills. The said amounts are paid by the said firm by paying the same to the credit of the applicant Mills with British Indian banks or shroffs.” From this description it is evident that Jagmohandas & Company do not merely guarantee payment by the Ahmedabad buyers; they actually make the payments, or the equivalent thereof, to the assessee company. Consequently, the actual buyers are of little significance, as their transactions are not reflected in the accounts; the only recorded party is Jagmohandas.

In the present case the Court observed that it was irrelevant whether the ultimate buyers remained primarily and legally liable to the assessee. The essential fact was that, in practice, Jagmohandas & Company had actually fulfilled the obligations of those buyers and had discharged the buyers’ liabilities to the assessee. It was also evident that Jagmohandas & Company must have recovered the amounts it paid in some manner from the buyers, although the exact mechanism was not disclosed. The Court then examined two alternative scenarios. Firstly, if the entire transaction had taken place outside British India, with the buyers or their agents travelling to Petlad, receiving the goods there and making payment to Jagmohandas & Company beyond the limits of British India, the Court was of the view that the profits and gains could not be said to have accrued or arisen in British India, simply because the goods were ultimately delivered there. Secondly, if Jagmohandas & Company or its agents had been paid within British India, the Court held that the profits and gains would have arisen in British India in the same manner as in the earlier “four-lakhs” case. The Court further explained that, where Jagmohandas & Company acted as the actual agents of the assessee, analogous to the banks in the other case, and the payments were made in the taxable territories, the accrual of income was direct. Conversely, if Jagmohandas & Company were not agents in the strict sense, the Court expressed the opinion that Section 42 would become applicable because, at a minimum, a “business connection” would exist, provided the payments were made in the taxable territories. The Court stressed that it was necessary to look at the actual conduct of the parties in order to determine the rights that were created, noting that the conduct was governed by some express or implied agreement between the parties. Those contractual rights, the Court said, determined the place where profits were deemed to have accrued or arisen, either directly or by operation of Section 42. Regarding the reference made by the Income-Tax Appellate Tribunal, the Court found that the Tribunal’s focus on the actual receipts did not reflect the true position, as it ignored the underlying agreement and the method of accounting. The Court observed that, had a cash-basis system of accounting been relevant, the amount of Rs 4,40,878 would constitute part of the assessee’s income in British India, as would have been the case in the other matter, assuming the payments were made in British India. However, the Court warned that it would be misleading to speculate on hypothetical circumstances that were not material, given that the parties employed a mercantile system of accounting. Turning to the High Court’s handling of the matter, the Court noted that the learned judges had refrained from a full answer and had decided the case without referring it back to the Income-Tax Appellate Tribunal for a further statement of facts. The Court regarded that approach as not strictly proper and held that the refrained questions suffered from the same defect. Accordingly, the Court directed that the case be remitted to the Income-Tax Appellate Tribunal for a reconsideration of the questions in line with the observations made, and for a further statement of the case. The appeal was dismissed. Counsel for the appellants.

In the proceedings before the Court, the party identified as the respondent was recorded solely as G. H. Rajadhyaksha. Throughout the judgment the Court refers to the respondent by this name and does not list any additional respondents or co-respondents. The official caption of the case therefore designates G. H. Rajadhyaksha as the lone respondent against whom the petition was filed. No other individuals or entities appear in the record as respondents, and no alternative titles, capacities, or descriptions are supplied. All observations, orders, and findings that concern the respondent are directed to G. H. Rajadhyaksha, and the Court’s discussion of arguments and evidence presented by the respondent is anchored in that identification. The judgment does not disclose the name of any counsel who may have appeared on behalf of the respondent, nor does it indicate any change of counsel during the course of the litigation. The lack of further detail about the respondent’s role or relationship to the matters under dispute suggests that the identity of G. H. Rajadhyaksha was uncontested and required no additional clarification. Consequently, the entire reference to the respondent in this decision is confined to the name G. H. Rajadhyaksha, and every procedural and substantive consideration relates to that individual.