The Commissioner of Income‑Tax, Madhya Pradesh, Nagpur vs Swadeshi Cotton and Flour Mills

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 587 of 1963

Decision Date: 17 April 1964

Coram: S. M. Sikri, Subbarao K. Shah, J. C. Shah

In this case the Supreme Court recorded that the judgment was delivered on 17 April 1964 by a bench consisting of Justice S M Sikri, Justice J C Shah and Justice K N Subbarao. The petitioner was the Commissioner of Income‑Tax for Madhya Pradesh, Nagpur, and the respondent was Swadeshi Cotton and Flour Mills. The citation of the decision was reported in 1964 AIR 1766 and in the Supreme Court Reporter as 1964 SCR (7) 810, and it was later referenced in the 1992 SC 718 (7) report. The matter concerned the application of the Income‑Tax Act of 1922, specifically sections 10(2)(x) and 10(5), relating to the deduction of bonus paid by an assessee.

The factual matrix disclosed that the respondent company, a limited corporation operating a textile mill in Indore, had paid a sum of Rs 1,08,325 as a profit bonus to its employees for the year 1947. The payment was made in the calendar year 1949 pursuant to an award of the Industrial Tribunal dated 13 January 1949. The company entered the amount as a debit in its profit and loss account for the year 1948 and credited the same to the bonus‑payable account. It was further noted that the books for the year 1948 had not been closed at the time the Industrial Tribunal rendered its award.

For the assessment year 1950‑51, which corresponded to the calendar year 1949, the assessee claimed that, under section 10(2)(x) of the 1922 Act, it was entitled to an allowance for the bonus amount paid. The Income‑Tax authorities rejected the claim on the ground that, according to the mercantile system of accounting followed by the company, the liability for the bonus should be attributed to the year 1947, the year in which the liability arose, rather than to the year 1949 in which the payment was actually made. The tax authorities argued that the liability was a legal one that arose in 1947, and therefore it ought to have been estimated and recorded in the accounts for 1947, with the possibility of reopening the accounts for that year if required. The parties admitted that the bonus in question was a profit bonus.

The Court held that a liability under section 10(2)(x), read with section 10(5), arose only when the claim to a profit bonus was settled either amicably or through industrial adjudication. Because the claim was settled by the Industrial Tribunal award in 1949, the liability could properly be attributed only to the year 1949. The Court further observed that the mechanism of reopening accounts was not applicable under the scheme of the Income‑Tax Act. Finally, the Court interpreted the expression “year in question” in proviso (b) to section 10(2)(x) as referring to the year in which the bonus was actually paid.

The procedural posture was that the matter was appealed to the Supreme Court under civil appellate jurisdiction as Civil Appeal No 587 of 1963. The appeal was taken by special leave from a judgment and order dated 30 November 1960 of the Madhya Pradesh High Court in Miscellaneous Civil Case No 73 of 1960. The judgment therefore set out the Court’s analysis of the applicable statutory provisions, the accounting principles involved, and the correct year to which the bonus liability should be attributed for the purpose of a tax deduction.

Rajagopal Sastri and R. N. Sachthev appeared for the appellant, while S. K. Kapoor, S. Murty and K. K. Fain represented the respondent. The judgment was delivered on April 17, 1964 by Justice Sikri. The respondent, Swadeshi Cotton & Flour Mills, hereinafter called the assessee, is a limited company that owns and operates a textile mill situated in Indore. For the assessment year 1950‑51, which corresponds to the calendar year 1949, the assessee claimed a deduction under section 10(2)(x) of the Indian Income‑Tax Act, 1922. The amount claimed for deduction was Rs 1,08,325, which the assessee had paid as bonus for the calendar year 1947 but actually disbursed in the calendar year 1949 following an award of the Industrial Tribunal dated 13 January 1949.

The claim for deduction was rejected by the income‑tax authorities. The Appellate Tribunal held that the liability related to a year earlier than 1949 and therefore could not be allowed in the assessment year 1950‑51. The assessee subsequently filed an application in which it stated a case and raised two questions. The present Court considered only the first of those questions, namely whether, on the facts and circumstances of the case, the assessee was entitled to claim a deduction of the bonus of Rs 1,08,325 relating to the calendar year 1947 in the assessment year 1950‑51. The High Court of Madhya Pradesh had answered this question affirmatively. Because the appellant had failed to obtain a certificate under section 66A(2) of the Act, it sought special leave to appeal to this Court, and the appeal now stands before the Court.

The statement of the case set out the facts on which the question is based. Although the factual material is sparse, the appellant relies solely on those few facts, and the Court finds it unnecessary to request a further statement of the case. In brief, the assessee paid a bonus of Rs 1,08,325 to its employees for the calendar year 1947 pursuant to an award made on 13 January 1949 under the Industrial Disputes Act. The amount was debited to the profit‑and‑loss account for the year 1948, and a corresponding credit was entered in the bonus‑payable account. The books for the year 1948 had not been closed at the time of the Industrial Tribunal’s order on 13 January 1949. The actual payment of the bonus to the employees occurred in the calendar year 1949, which falls within the assessment year 1950‑51. The Appellate Assistant Commissioner observed that up to the year 1946, when the order for payment of bonus was received before the company’s accounts for that year were finalized, the bonus amount was debited to the profit‑and‑loss account of the respective year. This observation was reiterated by the Appellate Tribunal in its appellate order.

In this case, counsel for the appellant argued that, because the assessee follows the mercantile system of accounting, the profit for the accounting calendar year 1949 was computed on that basis and therefore the liability for the bonus should be assigned to the calendar year 1947 rather than 1949. He contended that a legal obligation to pay the bonus arose in 1947 and that the amount should have been estimated and recorded in the accounts for that year. As an alternative, he invited the Court to reopen the accounts for 1947, relying on a practice that, according to him, is followed in England. The Court observed that the answer to this question must be derived from a proper construction of section 10(2)(x) read together with section 10(5) of the Act. The relevant statutory language states: “section 10(2)(x) – Any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission; Provided that the amount of the bonus or commission is of a reasonable amount with reference to – (a) the pay of the employee and the conditions of his service, – (b) the profits of the business, profession or vocation for the year in question, and – (c) the general practice in similar businesses, professions or vocations.” Section 10(5) adds: “In sub‑section (2), ‘paid’ means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under this section.” By inserting the definition of “paid” from section 10(5) into sub‑clause (x), the provision can be read as: any sum actually paid or incurred according to the method of accounting on which the profits or gains are computed, to an employee as bonus. Since the assessee’s profits and gains have been calculated according to the mercantile system, the question, using the language of the clauses, becomes whether the sum of Rs 1,08,325 has been incurred by the assessee under the mercantile system in the calendar year 1947 or in 1949.

The Court noted that although the wording may appear awkward, the term “incur” includes the notion of becoming liable to an amount. Consequently, the issue reduces to determining in which year the liability for Rs 1,08,325 arose according to the mercantile system of accounting. The Court referred to its earlier decision in Keshav Mills Ltd. v. Commissioner of Income Tax, Bombay, which explained that the mercantile system brings into credit an amount as soon as it becomes legally due, even before actual receipt, and brings into debit an expenditure as soon as a legal liability has been incurred, even before actual payment. This principle was later affirmed in Calcutta Co. Ltd. v. Commissioner of Income Tax, West Bengal. Applying these observations to the present facts, the Court indicated that the determination of the year in which the legal liability for the bonus arose must be based on the mercantile accounting principles explained in those precedents.

Whether a bonus is due depended on the particular facts of the case and on the character of the bonus that had been awarded. The Court noted that it had examined the nature of a profit bonus in several earlier decisions and that, in the present matter, the bonus in question was a profit bonus. In Muir Mills v. Suti Mills Mazdoor Union (3) the Court explained that a demand for bonus could be justified only when two conditions were satisfied: first, when the wages of the workmen fell short of the prevailing living standard; and second, when the industry earned substantial profits, part of which resulted from the contribution of the workmen to increased production. The Court added that the demand for bonus became an industrial claim whenever either or both of those conditions were met.

The Court revisited the issue in Associated Cement Co. v. Their Workmen (4) and observed that a bonus was neither a gratuitous payment nor a deferred wage. The Court held that when wages were below the living standard and the industry realized profit owing in part to labour’s contribution, a legitimate claim for bonus could arise. Subsequent authority in 1961 affirmed that the right to claim a bonus had become a legal right recognised by industrial adjudication, and that a bonus could be claimed as a matter of right provided that, applying the Full Bench formula, the employer possessed sufficient surplus for the relevant year. The Indian Tea Association v. Workmen further held that a profit bonus could be awarded only with reference to a specific year, that a claim therefore had to be made annually, and that each claim must be settled either amicably between the parties or, if referred, by industrial adjudication. A general claim for the introduction of profit bonus could not be entertained in the manner presented in the present proceedings. From these decisions the Court distilled the following principles: (a) workmen may claim a profit bonus if the stipulated conditions are satisfied; (b) such a claim must be made each year; (c) the claim must be resolved either amicably or through industrial adjudication; and (d) if the company incurs a loss or no claim is lodged, no bonus is payable. The Court expressed the view that liability would arise only when a profit‑bonus claim, once made, was settled according to those procedures.

In this case, the Court observed that when a claim for profit bonus was settled either amicably or through industrial adjudication, a liability arose for the employer who employed the mercantile system of accounting, and that liability fell within the scope of section 10(2)(x) read with section 10(5) of the Income Tax Act. The Court noted that, based on the facts before it, the claim for profit bonus had been finally resolved only in the year 1940 by an award of the Industrial Tribunal. Consequently, the Court held that the liability could be properly attributed solely to the year 1949 and therefore affirmed that the High Court had correctly answered the question in favour of the assessee. The Court then turned to the second contention advanced by counsel and expressed that it found no merit in that argument. It further stated that the practice of reopening accounts did not correspond with the design of the Indian Income Tax Act. The Court recalled its earlier decision in Commissioner of Income Tax, Madras v. A. Gajapathy Naidu, where it had held that, with respect to receipts, the law did not permit any reopening of accounts, as reported in the 1961 volume 2 of the Supreme Court Reporter at page 995, the 1962 supplementary volume 1 at page 557, and the 1964 volume 1653 of the All India Reporter. The Court explained that the same principle would apply to expenses as well. It further observed that, even under English law, accounts were not reopened in every circumstance, citing the authority of Halsbury’s Laws of England, footnote (m) on page 148 of volume 20, which enumerates various instances where accounts remain closed. The Court noted that counsel had relied upon several English cases, but it considered it unnecessary to revisit those authorities because Lord Radcliffe had already explained the English position in Southern Railway of Peru Ltd. v. Owen. Lord Radcliffe’s remark was quoted in full, stating that courts had never found it impossible to make substantial adjustments in the timing of receipts or payments to obtain a more accurate statement of profit for successive years, that income‑and‑expenditure accounting was preferred to cash accounting for that purpose, and that the principle allowing a receipt received in one year to be attributed to an earlier year rested on the fact that the payment had been earned by services rendered in the earlier year, so that a true profit figure required the year bearing the cost to also receive the benefit of the receipt. The Court then explained that this principle did not extend to a profit bonus, because a profit bonus was not, for income‑tax purposes, treated as wages or as an ordinary expense incurred to generate profit; rather, it represented a distribution of already earned profit calculated on a specific formula. Finally, the Court addressed another argument raised by counsel, namely that the expression “for the year in question” in the proviso to subsection 10(2)(x) should be interpreted to mean “for the year in which the allowance is claimed.”

The Court examined the argument put forward that the expression “for the year in question” in the proviso to sub‑section 10(2)(x) should be interpreted to mean “in which allowance is claimed.” The Court found this construction unsatisfactory and concluded that the words “for the year in question” must be understood to refer to the year to which the bonus payment actually pertains. Accordingly, the Court held that the appellant’s interpretation was incorrect. As a result of this interpretation, the Court determined that the appeal could not succeed. The Court therefore dismissed the appeal and ordered that costs be awarded against the appellant. The order was rendered in accordance with the precedent cited as (1), [1957] A.C. 334, and the judgment concluded with the formal statement “Appeal dismissed.”