KESHAV MILLS LTD v. COMMISSIONER OF INCOME-TAX, BOMBAY

Citation: [1953] 1 S.C.R. 950; 1953 INSC 10

Court: Supreme Court of India

Bench: MEHR CHAND MAHAJAN , SUDHI RANJAN DAS, VIVIAN BOSE, NATWARLAL HARILAL BHAGWATI

Judgment date: 1953-01-30

Case summary

1953 INSC 10. Supreme Court of India judgment dated 1953-01-30. KESHAV MILLS LTD v. COMMISSIONER OF INCOME-TAX, BOMBAY. Read the judgment and case details...

Judgment text

950 SUPREME COURT REPORTS [1953] KESHAV MILLS LTD. ' v. COMMISSIONER OF INCOME-TAX, BOMBAY [Mmm CHAND MAHA. JAN, S. R. DA~, VrnAN BosE and BHAGWATI JJ. ) Indian Income-ta. •r Act (XI o/1922), ss. 4 (1) (a) and (c), 18- J\-ron-resident-Accoz~nts in 11icrcantile systern-Sale of goods in British Inrli ORTS ll953] him in his books of account subject to all deductions for bad debts as provided in section 10' (2) (xi). Section 4 (1) (a) has nothing to do with this basis of tax-l j ation. Section 13 which is an integra part oft te com-ofputation of the total income of the assessee and is compulsory on the income-tax authorities as well when computing the total income (vide section 2 (15) ) does not lay down ri,ny exemption from liability.

It only sets up a mode of computation of the income which is liable to assessment and imposes upon the income-tax authorities an obligation to accept the mode of accounting regularly adopted by the assessee except in the cases where the proviso to that section comes into operation. The profits earned and credited in the books of account being thus taken tts the basis of computation, the system of accounting postulates the existence of debts in so far as moneys remain due and payable by the parties to whom they have been debited and when it is realised that these debts are not re-coverable the assessee gets a deduction fdr the bad debts under section 10 (2) (xi). This however does not mean that the transaction ltS it has been recorded in the books of account under the mercantile system of accounting or the double entry system is metamor-phosed or the relationship between the parties assumes a different character.

What was in its inception a transaction of sale and purchase is not converted into another transaction as between creditor and debtor. The relationship as between vendor and purchaser still subsists and there dues not come into existence a new relationship as between creditor and debtor with all its necessary consequences. The transaction as it has been recorded in the books of account has got to be worked out to its fullest extent. _;\forely because the goods have been supplied and the price thereof has been debited to the purchaser the rights and obligations of the vendor and purchaser inter se arc not in any manner affected. The vendor is bound tu fulfil all his obligations under the contract and continues to be liable for all the consequences of his default including rejection of his goods by the purchaser or a claim for d1images • s. c. R. SUPREME COURT REPORirs 96i 1953 for breach of wal'l'anty by him. The purchaser is equallv entitlec'l to reJ· ect the aoods or to claim the .

J 0 Keshav Mil'1s damages as on breach of warranty by the vendor and Ltd. all these rights and obligations have got to be worked v. out in spite of the fact that the entries are made in Oonunis•ion" of the books of account by the vendor in ;1ccordance with Incorne-tax, the mercantile system of accounting adopted by him. Bombay. The vendor could not say tha. t he is under no further Bhagwati J. obligation to the purchaser and that the purchaser must pay the price of the goods debitPd to him as a debt arising out of the book entry. The count in any action filed by the vendor against the purchaser would be a count for the price of goods sold rnre credited in the books of account according lo the mercantile system of accounting were at best "treated as having been received" which is neither "received" nor "deemed to be received" and therefore not within the purview of section. 4(1) (a). (1) [1938] 6 I. T. R. 603 at p. 614. 962 SUPRE.

VIE COUR'i; nEPORTS [1953] If then profits which have Leen thus credited cannot be said to be received nor deemed to have been receiv- A! ifls ed when the entries were made in the books of account, the contention urged before us by Mr. Kolah that of there could not be a second receipt of the amount in British lndia does not survive. [t is true that the words used in section 4(1) (a) rnlate to the first receipt after the accrual of the income. Once it is received bv " the party entitled to it, in respect of any subsequent dealing with the said amount it cannot be said to be "received" as income on that occasion. [Per Kania J, in B. ;JI. Kamdar (1)J. The "receipt" of income refers to the first occasion when the recipient gets the money under his own control. Once an amount is received as income, any remittance or transmission of the amount to another place does not result in "receipt", within the meaning of this clause, at the other place.

'l'his was definitely established by the Privy Council in Pond-icherry Rail1cay Co. v. Commis8-ioner of lncome- 'J'ax (') :i,ml in Commissioner of Income-tax v. J. Vlathi- 3 as ( ). If, therefore, the income, profits or gains have been once received by the assessee even though outside British India they do not become chargeable by reason of the moneys having been brought in British India, because what is chargeable is the first receipt of the moneys and not a subsequent dealing by the assessee with the said amount. In that event they are brought by the assessee as his own moneys which he has already received and had control over and they cease to enjoy the character of income, profits or gains. This ratio however does not apply to the facts of the present case before us. The moneys were neither received by the company nor could be deemed to have been received by it when the entries were made in the books of account at Petlad.

They had merely accrued or arisen to it and so far as the receipt thereof is concerned they were first received in British India when \hey were received by Messrs. Jagmohandas Ramanlal (r) [r946] r4 l. T. R. 14 at p. 39, (3) [1939] 66 I. A. z~. (z) [1931] 58 l. A. z39. • , . 1953 & Co. or by the various banks or shroffs in British India through 'whom the railway receipts were negoti- - Keshav i. ll1'll8 ated. The first receipt of the moneys was therefore Ltd. when they were paid as such by the merchants to v. Messrs. J agmohandas Ramanlal &Co. or to the various GommiBBioner of banks or shroffs as above. W'hatever paid by the Income·tox, merchants to these several parties were the sale pro- Bombay. ceeds of the goods which had been sold and delivered Bhagu·atiJ.

by the company to them and they were received within the meaning of section 4 (1) (a) of the Act by these several parties on behalf of tho company in British India at the time when these payments were made by the merchants to them. Mr. Kolah pressed into service the argument based on section 13 of the Act that the mercantilo svstem of accounting regularly adopted by the assessec \vas obliga. tory on the income-tax authorities for computation of his income. l'Vhile agreeing generally with that sub-mission in case of residents, we doubt whether that position would be available to a non-resident, who maintains his books of account outside British India according to the mercantile system. The section would only be relevant where the total profits of the assessee have to be computed, in which event he would be entitled to claim that they should be computed according to the syHtem of accounts maintained hy him. But the section would hardly be relevant where stra.

y items of income are caught iu taxable territories as received in taxable territories by a non-resident. The entries in the present ease were put in merely to prove that the sale proceeds were received outside British India where the entries were made. That contention however could not be sustained, as section 4 (1) (a) is concerned with cases of actual receipt and not with cases of pa-per receipts. Having regard to the observations. made above we have come to the conclusion that the High Court was right in holding that the two sums of Rs. 12,68,480 and Rs. 4,40,878 wBre the sale proceeds of the goods sold and delivered by the appellant to merchants in British India, that they were received by Messrs, 964- SUPREME COt'RT REPORTS [1953] J agmohanclas Itamanlal & Co.

and by the banks and Mills shroffa through whom the railway receipts were nego· tiatecl, on behalf of the appellant in British lnclia, that they were liable to tax under section4(1) (a) of the of Act as having been received in British India on its be· half, that there is nothing either in the facts and circumstances of 1ohe ease or in law why they should be ex-empted from such liability, that the a. nswers given to the questions which were ultimately considered by the High Comt were correct, and the appellant was rightly held liable for the tax on these two amounts subject to all just deductions and allowances. The appeal therefol'e fails and must stand dismissed with costs. Bo. SE, J. -I respectfully disagree. Section 3 of the Indian Income·t8~x Act provides that the "total income" is to be charged in accordance with the provisions of the Act. We have therefore to see what "total income" means. "Total income" is defined in section 2(15).

It means (not" inclmles" but means) the total amount of income, profits and gains "referred to in sub-section (I) of section 4 computed in the manner laid down in this Act. " Then-fore, the computation of all income referred to in section 4( 1) has to be "in the manner laid down in the Act ". Section 4 (apart from the provisos and explanations) is divided into three clauses, (a), (b) and (c). Clause (b) deals with residents and (c) with non-resident5. As (a) is general, it is legitimate to infer that it refers to both. Therefore, the words "received" and "deemed to be received " must be constrned in tho same sense in both cases except of course where it is otherwise provided in the Act, for sub-section (1) is made subject to the provisions of the Act. 'N' ow the words "deemed to be received" can be exduded from consideration at once because I agree that they are confined, and are intended to he confined to what I may call the deeming sections in the Act.

, that is to say, to cases where the deeming must be clone • 1953 under the express provisions of the Act. That leaves us with the wdrd "received" (I am of courne only deal- Keshav Mills ing with section 4(1) (a) which deals with "receipts" Ltd. and not with section 4( 1) (c) which refers to "accruals" v. and "arisals" and to that which is deemed to "accrue" Commissioner of Income-tax, or ''arise"). Bonibay. Now this, in my opinion, is to be contrasted with the words "accrue" and "arise" which are used in clauses (b) and (c). Though there may be overlapping in some cases, I do not think the three are intended to mean the same thing. The Privy Council thought in 1 Commissioner of Income-ta. r v. 1Jiathia8( ) that there is some variation in meaning between them and in Commissioner of Income-tax v. Chun-ilal B.

Mehta(') they drew attention to the antithesis between "accruing and arising in" and "received in'', though they also said in the earlier case that there is not a complete disjunction between them and that they are not three mutually exclusive qualifications (page 56); that is, that there may be some overlapping in cert:i,in cases. Next, we turn to section 6 which divides the various sources of income under various heads for the purposes of computation and chargeability and states that each head shall be "chargeable" "in the manner herein-after :i, ppearing". It is to be observed that the word "shall" has been user! and not" may" thereby imply-ing that there is no option in the matter. So far as business is concerned, the he:i,d is No. (iv) "Profits and gains of business etc. "' That carries us on to sections 10 and 13 which P. re-scribe the method of computation.

Here again, the language is imperative and in the case of a business the method of computation has to be in accordance with the method of auuounting regularly employed by the assessee: s00 Commissioner of Income-tax v. Kameshwar Singh(·). Now in the present case, the method of accounting was the mercantile system. The essential difference (r) [1939] 7 J. T. R. 48 at 56. (3) [1933] I I. T. R. 94 at IOO and IOI, (2) [1938] 6 I. T. R. 521 at 527. 966 SUPREME COCRT REPORTS [1953] between this and the cash basis system is that in the latter actual receipts and disbursements'are taken into account. In the former, sums which are due to the business are entered on the credit side immediately oJthey are legally due and before they are actually received and expenditures are entered the moment a legal liability to pay arises and before the actual clis-bursements.

The profit or loss at the encl of the accounting year is therefore based, not on a difference between ~hat was actually received and what was actually paid out, but on the difference between the right to receive and the liability to pay. I find it impossible in such a case to say that the taxation is on income, or profits and gains which were "received". It can only be on profits which ''accrued" or "arose" to the assessee in the accounting year: see the Privy Council in Feroz Shah v. Commissioner of Income-tax('). That, in my opinion, excludes section 4(1) (a) ttnd that in turn means that in such a case a resident is taxed under section 4(1) (b) and r1 non-resident under section 4( 1) (c). . N'ow, this to my mind is of vital importance. The primary object of the Income-tax Act is to tax and not merely to ascertain rm income. The computation of the income is subsidiary and is only for the purposes of ascertaining the quantum of the tax : see Goimnis-sioner of Income-tax v.

Karne8hwar Singh('). Therefore, if the legislature chooses to lay down different methods of computation and say that the taxation shall be on the amount so computed, it is essential that these methods be adhered to. In some cases this may be to the advantage of the assessee and in others it may operate to his disadvantage. But that is immater-ial. The importance lies in this. All that can be taxed in a given year are the profits and gains which are received or which arise or accrue in the " previous year", and if the Act directs that the profits are to bfil computed in a given case on "accruals" or "arisnls" and not on actual receipts it is essential that that b@ (1) [1933) l I. T. H. 219 at 224 and 225. (2) [1933] l l. T. R. 94 at IOO. S. C. R.

SUPRE~IE COlJRT RE1)0RTS 967 done ; and it follows from that that the tax in such a case can only be on the accruals or arisals and not on the actual receipts, for clearly you cannot tax on that which you are forbidden to compute in a case where the tax can only be levied on \\·httt is computable Gommiseioner under the Act. It is important to draw the distinction for this reason. The rate of tax varies from year to year, therefore if the book profits which are dirPcted to be taxed in a given year are, say, Rs. 10,000 and the actual receipts only Rs. 100, it makes a lot of difference which figure is taken; nor does it even itself out in the long run, for if the rate of taxation inereases in th(' following year and the state of the \rnsiness is just the reverse, namely that the book profits ? ,re only Rs. 100 whereas the actual receipts arising from the previous year's transiwtions are Its.

10,000, it will make a considern hie difference to the asses see in the aggregate of tax payable over the years, whether he pays on the basis of book profits or actual receipts in the two years. I am not able to draw tt di:;tinction between a resident and a non-resident in thrso matters. I can find no ground for holding that in the case of a resident the mercantile system must he adopted for computing the profits if that is the system of accounting regularly employed but that that need not be done in the case of a non-resident. If the assessee had been a resident company, the taxation would, in my opinion, have been under section 4(1) (b) on profits and gains which had accrued or arisen and not under section 4 (1) (a) on profits which had been received.

The same principle must, in my opinion, be applied in the case of a non-resident and therefo1·e section 4 (1) ( c) is attracted, provided the profits and gains haYe actually accrued or arisen in the taxable ten-itorics or they can, because of section 42, he deemed to haYc accrued or arisen there. If section 4 (I) (c) is not attracted, then the tax cannot be levied. Now, applying section 4 (I) (c), the question is where do the profits and gains arise or accrue in a casP 968 SUPREME cotrRT REPORTS [1953] like the present ? This is not free from. difficulty and various views have been, and can be, taken. But as these expressions have not been defined and as they are not words of art, I think they should be construed 0 ! in their ordinary meaning which businessmen would ordinarily and easily understand in a business transaction.

When goods are solcl it is to my mind evident that the profit or the loss on any particular transaction arises out of the sale, for until there is a sale there can be no profit. The profit may 1{ot be wholly attributable to the sale but that is 1dopted by the assessee cannot affect the substance of the transactions between the parties or affect their nature. The rights and liabilities of the parties inter se cannot be made to depend on the way in which one of them chooses to keep its books. But that is not the case when we come to the question of taxation for income-tax purposes. There the method of accounting is vital. But even there the substance of the transaction must be viewed, for the substance cannot alter by a mere method of accounting.

It is evident that if the assessee had been n>sident in British India and these transactions had ueen omitted from the books, the sums which ought to have been entered would be taxable as items which had escaped assessment even if there had been no actual receipts in that or in any following year. Therefore, it is not the entry in the books which attracts the taxation but the profits on the transaction itself, and when the mercantile system is used the profits arise when the right to receive them accrues and not when t. hc entry is made. 1f tho sys-tern is properly employed the e11try is made as soon as the ri~ht to receive the price arises and so for all practical 970 SUPREME COURT REPORTS [1953] purposes that is the date ordinarily referred to, lmt a man cannot manipulate the amount' of his tax by h h l choosing to enter or not to enter items w ic oug it to be entered on a particular date, as and when he of}Jleases. Now, the Rs.

4 lakhs odd represent actual receipts but that is not what is taxable when the computation is based on the mercantile system. What should be taxed, or rather taken into account for the purposes of taxation, are the figures entered in the accounting year as the sale price of the various transactions which the Rs. 4 lakhs represent. The profits which ttrise out of these transactions do not, on my view, escape tax because the profits accrue or arise in the taxable territories. But the figure on which the tax is to be computed is not the 4 lakhs odd which represent the actual receipts but another figure which unfortunately we have not been given. I am of course assuming that the figures were duly entered in the books at the proper time in accordance with the mercantile system of accounting. If they were not, then the Income-tax authorities have power to tax income which, for one reason or another, has escaped assessment. Turning to the Rs. 12 lakhs.

We know that the figure entered in the books relating to these transactions was Iis. 13,41,744. I am not clear whether that was entered in the accounting year with which we are concerned, though I gathered that that was the case. The actual receipts, which followed later, amounted to only Rs. 12,68,480. In my opinion, if anything is computable for the purposes of tax, it is the former figure (assuming all the entries arc in the accounting year) and not the latter. But in order to determine whether the profits on these transactions :ire taxable at all, we must examine the transactions. In these cases the sales were to merchants re~ident in Ahmedabad. But 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 195t Raml:11 and company and credited to the sales Keshav Mill• account in the books of the applicant:" · Lid. and later, Jagmohandas v.

"discharges its debts by making payments to the Commissioner of 1 1 applicants from time to time towards the balance n;,ome- ""'• in their said account in the books of the applicant omhay. Mills. The said amounts arc paid by the said firm by Bose J. paying the same to the credit of the applicant Mills with British Indian banks or shroffs. " Now, it is evident from this that Jagmohandas & Company do not merely guarantee payment by tho Ahmedabad buyers but actually make the payments, or the equivalent of payments, to the assessee company. So little do the buyers matter that their transactions are not even reflected in the accounts. All we have is Jagmohandas. It does not, in my opinion,' matter whether the actual buyers remained primarily and legally responsible to the assessee or not. The fact remains that in practice Jagrnohandas & Company actually met the obligations of the buyers and discharged their liabilities to the assessee.

It is equally clear that Jagmohandas & Company must have recouped themselves in some way from the buyers. The question is how. If tho whole of the transactions occurred outside British India and the buyers or their agents went to Petlad and received the goods there and pa. id Jagmohandas & Company outside British India, thf'n I am clear that the profits and gains did not accrue or arise in British India, simply because the goods were ultimately brought there. But if Jagmohan-cbs & Company or their agents were paid in British 1ndia, the profits and gains, in my opinion, arose there in the same way as in the 4 lakhs c>Lse. If Jagmohandas & Company were the actual agents of the assessee as were the banks in the other case, and the payments were made in the taxable territories, then the accrual and arising was direct.

If, however, they were not the agents in the strict sense of the term, then I am of opinion that section 42 would be attracted because at the very least there would be a "business connection", provided of course the payments were made in the taxable territories. Now, here again, I am looking to what was actually done in order to determine what the rights were, for of it is evident that what was done was done in pursuance of some agreement, express or implied, between the h h 1 d h h parties w ic . agreement regu ate t eir rig ts, and those rights in turn determine the place where the profits accrued or arose, or must, because of section 42, be deemed to have accrued or arisen. In my view, the question referred by the Income-tax Appellate Tribunal in its statement of the case does not reflect the trnc position because it concen-trates on the actual receipts. If the cash basis system of accounting was germane here, then I would agree that the Rs.

4,40,878 was part of the assessee's income in British India, and so also in the other case, provided the payments were made in British India. But it is 1 misleading to enquire what wou d have happened in circumstances which are not material in this case because of the mercantile system of accounting which was employed. As regards the High Court. The learned Judges reframed the question and answered it without sending the case back to the Income-tax Appellate Tribunal for a further statement of the case. That was not Htrictly proper. Hut, in my opinion, the reframed questions suffer from the same defect. In my opinion, the case should be sent back to the Income-tax Appellate Tribunal for a reframing of the questions along the lines I hnYe indicated and for a further statement of the case. Appeal di8missed. Agent for the appellants: Rajinder Narain. Agent for the respondents: G. H. Rajadhyaksha.

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