Commissioner Of Income-Tax, Bombay vs Shoorji Vallabhdas 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: 27 March, 1962

Coram: J.C. Shah, M. Hidayatullah

In this matter the Commissioner of Income‑Tax for Bombay filed an appeal against a certificate of fitness that had been issued under section 66A(2) of the Indian Income‑Tax Act by the High Court of Bombay in a judgment dated 1 October 1958. The appellant was the Commissioner of Income‑Tax, Bombay and the respondent was the partnership known as Shoorji Vallabhdas and Co., hereafter referred to as the assessee firm. The dispute concerned the assessment year 1948‑49, which corresponded to the financial year ending on 31 March 1948. The assessee firm was composed of three partners – Shoorji Vallabhdas and his two sons, Pratapsinh and Vikramsinh – and acted as managing agent for several shipping enterprises, notably the Malabar Steamship Co. Ltd. and the New Dholera Steamships Ltd. The firm entered into a managing‑agency agreement with Malabar Steamship Co. Ltd. on 16 September 1938, later modified on 7 December 1943, and a separate agreement with New Dholera Steamships Ltd. on 8 June 1946. Both agreements stipulated that the firm was entitled to a commission equal to ten per cent of the freight charges collected by the shipping companies. During the period from 1 April 1947 to 31 December 1947 the firm earned commissions of Rs 1,71,885 from Malabar Steamship Co. Ltd. and Rs 2,56,815 from New Dholera Steamships Ltd., and these sums were recorded as credits to the firm’s accounts with corresponding debits against the respective shipping companies.

In 1947 the partners of the firm incorporated two private limited companies, namely Shoorji Vallabhdas Ltd. and Pratapsingh Ltd., with the intention of having these entities replace the partnership as managing agents of the two shipping companies, each company taking over one of the agencies. On 20 November 1947 the partnership wrote to the two shipping companies stating its wish to resign as managing agent and to have the newly formed private limited companies appointed on the same terms. Two shareholders of Malabar Steamship Co. Ltd. objected to the ten‑per‑cent commission and, on 27 November 1947, sent a letter protesting the rate. The letter proposed that the commission be either ten per cent of the profits of the managed company or two and a half per cent of the freight received. The board of directors of Malabar Steamship Co. Ltd. considered the protest and invited the partnership to submit an offer to reduce the commission to two and a half per cent of freight for the current year as well as for future years. The partnership responded with an offer stating that, although it would continue to assert its right to the full managing commission, it was prepared to voluntarily agree to a reduction in the managing‑agency commission to two and a half per cent of the total freight in order to place the company on a firm financial footing and because it was interested both as a shareholder and as a managing agent in the company’s prosperity. A similar sequence of events occurred with New Dholera Steamships Ltd., although the documentary record for that company was incomplete. On 30 December 1947 extraordinary general meetings of both shipping companies were held, and the two private limited companies were appointed as managing agents effective 1 January 1948, indicating that the partnership’s offer had been accepted. At the annual general meetings of the two shipping companies held in December 1948, the commission was formally reduced from ten per cent of freight to two and a half per cent, as previously agreed. Consequently, the original partnership surrendered approximately seventy‑five per cent of its earnings for the relevant accounting years, amounting to Rs 1,36,903 from Malabar Steamship Co. Ltd. and Rs 2,00,625 from New Dholera Steamships Ltd.

The assessee firm proposed that its managing‑agency commission be reduced to two and one‑half per cent of the total freight for both the current year and any future years, provided that the reduction was mutually agreed between the board of the managed company and the firm. A similar procedure was followed with the New Dholera Steamships Ltd., although the complete documentary record for that case is not present. On 30 December 1947 extraordinary general meetings of the two managed companies were held, and the two private limited companies were appointed as managing agents effective 1 January 1948. This sequence of events indicates that the offer contained in the firm’s letter was accepted. Subsequently, at the annual general meetings of the two managed companies held in December 1948, the commission was formally reduced from ten per cent of the freight to two and one‑half per cent as previously agreed. As a result of that reduction the assessee firm surrendered seventy‑five per cent of its earnings for the relevant accounting periods, amounting to Rs 1,36,903 for Malabar Steamship Co. Ltd. and Rs 2,00,625 for New Dholera Steamships Ltd.

In the assessment that followed, the Income‑Tax Officer and the Appellate Assistant Commissioner concluded that the larger commission had already accrued during the previous year ending 31 March 1948 and was therefore assessable. The assessee firm claimed the amount given up as an expenditure under section 10(2)(xv) of the Indian Income‑Tax Act, but the claim was disallowed. On appeal to the Appellate Tribunal, the Accountant Member advised that the appeal should be dismissed, whereas the Judicial Member took the opposite view. The President of the Tribunal agreed with the Judicial Member, holding that although the actual reduction occurred after the close of the accounting year, an agreement to reduce the commission had existed during that year, and consequently the larger income had neither accrued to nor been received by the assessee firm. Following the President’s opinion, the assessment was reduced by deleting the extra commission from the computation. The Commissioner of Income‑Tax then referred two questions to the High Court: (1) whether the two sums of Rs 1,36,903 and Rs 2,00,625 constitute income of the “previous year” ended 31 March 1948; and (2) if the answer to the first question is affirmative, whether those sums represent an item of expenditure permissible under section 10(2)(xv) in computing the assessee’s income for that year. The High Court agreed with the President’s view, answered the first question in the negative, and declined to answer the second. The case was certified as fit for appeal under section 66A(2), and the present appeal was subsequently filed.

The assessee firm argued that the commission income had already accrued to it during the relevant account year and therefore was taxable. It further maintained that the arrangement with the shipping companies was not a charitable contribution but a commercial transaction, and that the firm’s mercantile‑based accounts recorded the commission each time a freight charge was entered. The firm also contended that the companies it managed settled their accounts only in December 1948, which was well after the close of the previous year, and that any events occurring in the subsequent year could not alter the tax position for the earlier year. The Bombay High Court, relying on its earlier decision in Commissioner of Income‑Tax v. Chamanlal Mangaldas & Co., held that the facts of the account year themselves showed that neither the accrual nor the receipt of the commission had taken place in a manner that would render the income assessable. The High Court’s decision was subsequently affirmed by this Court in the same case, Commissioner of Income‑Tax v. Chamanlal Mangaldas & Co.

In the earlier case, the assessee was also a managing agent entitled under a contract to receive commission at a specified rate. During the previous year another agreement reduced the commission for the calendar year 1950 by Rs 1 lakh, and the board of directors of the managed company passed a resolution to that effect within the same year, although the formal meeting finalising the resolution occurred on 8 April 1951, after the previous year had ended. The Bombay High Court held that because of the resolution passed during the previous year, the assessee’s right to commission ceased to exist under the original contract and depended solely on the board’s decision to lower the commission. Consequently, the assessee was not liable for the larger, previously anticipated commission, which the Court described as a “hypothetical income” that would have arisen only if the old agreement had continued. The present case bears almost the same facts, and the principle applied by the Bombay High Court therefore governs it. The Court explained that income tax is levied on actual income, and while the Act mentions two moments—accrual and receipt—tax liability cannot arise if no income actually materialises, even though a bookkeeping entry might record a hypothetical amount. Where income is truly received and later relinquished but remains the recipient’s income, tax may be due; however, where the income never materialises, there is no accrual, no receipt, and consequently no tax liability.

In this case, the Court observed that the income in question could not be said to have arisen at all, and therefore there was neither an accrual nor a receipt of income. The Court noted that even though an entry might have been recorded in the books of account under circumstances that could be described as an incineration of the effect, such a bookkeeping entry could not be treated as income unless the income had actually materialised. This situation was identical to the one that occurred in the earlier Bombay case, which this Court had approved. In the present matter, the agreements executed during the previous year replaced the earlier agreements and altered the rate in such a way that the income reflected in the books differed from the income that actually resulted. The Court emphasized that a mere bookkeeping entry could not constitute income unless the income truly resulted, and in the present facts the change in terms meant that the income which had accrued and been received consisted of the lower amounts, not the larger sums that had been entered. The Court held that this was not a gift by the assessee firm to the manager companies; rather, the reduction formed part of the agreement that the assessee firm entered into in order to secure a long‑term managing agency arrangement for the two companies it had established. Consequently, the Court agreed with the High Court that, based on the facts, the larger sum neither accrued nor was received by the assessee firm. As a result, the appeal was dismissed with costs, and the order of dismissal was confirmed.