1. SALEEM AKHTAR, J. -The assessee filed an application under section 66 (1) of the Income-tax Act, and the learned Tribunal has referred the follow--ing question :- "Whether on the facts and in the circumstances of the case the Income-tax Appellate Tribunal was justified in holding that income of Rs. 80,794 and Rs. 42,951 could be assessed during the assessm ent years 1967-68 and 1968-69?"
2. The brief facts of the case are that the original assessment for the Assess--ment years 1967-68 and 1968-69 are re-opened under section 34 of the Income-- tax Act on the ground that two amounts of Rs. 80,794 and Rs. 42,951 refunded under section 27 of the Sales Tax Act on 29-9-1966 and 15-12-1967, respectively, were not included in the assessment of two years under consideration.
3. In response to the notice under section 34 the assessee instead of filing revised return for assessm ent years 1967-68 and 1968-69, filing revised returns for the years 1963-64, 1964-65 and 1965-66 on the plea that the refund of sales tax pertained to these years, and therefore, the assessm ent for the years 1967-68 and 1968-69 could not be re-opened. The Income-tax Officer did not accept this plea and made the assessment for the years under consideration during which the refunds were actually granted. In appeal the learned Tribunal observed as follows: - "After considering the factual position we are of the opinion that in this case admittedly the claim was not perfect nor the quantum of refund was ascertainable till the orders under section 27 were passed. The assessee's right, therefore, to receive these payments was in vacuum till 29-9-1966 and 16-12-1967. According to the system of account the appellant follows no entry in the accounts could, there--fore, be made in respect of these claims before these dates. Since the dates of ascertainment of the rights of the appellant fell in the assessment corresponding to the above two assessm ents no exception could be taken to the inclusion of this income in the assessment year in which the Income-tax Officer has assessed the same. In these circumstances we do not find any justification for interference with his order."
4. From the record the facts which emerge are that the assessee had paid sales tax during the assessm ent years 1963-64, 1964-65 and 1965-66. It had also applied for the refund which was granted on 29-6-1966 and 15-12-1967. The assessee's contention was that income with regard to the refund bad accrued to it during the respective assessment years to which the refund pertained and should have been included in the income pertaining to the said assessment years.
5. In this regard it will be convenient first to mention that the assessee maintains the account under the mercantile system. Mr. Iqbal Naim Pasha the learned counsel for the assessee has contended that in view of the provisions of law and the system of accounting followed by the assessee the amount of refund shall be deemed as income accrued on the date when the refundable sales tax was paid by it or in the alternative when it became entitled to get the refund. Section 4 of the Income-tax Act provides that sub--ject to the provisions of the Act, the total income of any previous year of any person `includes all income, profits and gains from whatever source derived which accrue or arise or deemed to accrue or arise to him in Pakistan during such year.' Therefore, the total income of an assessee is chargeable to tax which is received or deemed to be received or which may arise or accrue or deemed to arise or accrue to him during the previous year. This implies that if the income has accrued or deemed to accrue but has not been received then it can be charged to tax. The words "accrue and arise" have been considered in many decisions. In this regard reference can be made to the Cement Agency Ltd, v. Income-tax Officer Central Circle II.
6. Karachi 1965 PTD 337, and another PLD 1969 SC 318 where the Supreme Court of Pakistan observed as follows: - "The policy of the Act is to make the amount of income taxable when it is received either actually or constructively. So far as the word 'accrue' and `arise' are concerned, we are to take the ordinary dictionary meanings of these words. Since both the words have been used the provision in question they must be taken to have distinct meanings `Accrues' conveys the sense of growing up by way of addition of increase or as accession or advantage ; while the word `arise' connotes comes into existence or notice or present itself. It is, however, to be noticed that these two words have been used in contradistinction to the word `receive' indicating a right to receive. The words 'accrues' and `arises' represent a stage anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate."
7. In Ali & Roberts (Bahawalpur) Ltd. v. Commissioner of Income-tax 1966 PTD 94 after exhaustive examination of the case-law following observation was made: - "The words `accrue' and `arise' represent a state anterior to a point of time when the income is in fact received. "The meaning of the words 'arising' or 'accruing' as used in relation to only profits o gains, is frequently of importance in determining the year in which amounts paid to recipient are income for the purposes of income --tax. There is an important distinction between debts due to a trading income and unpaid in a particular year or period and other income which is not a trading receipt. Trading debts due but not yet paid must be included in arriving at the balance of profits or gains. With regard, however, to other income, there must be some-- thing coming in; but once there is income, the fact that it was not, by reason of some particular circumstances, received by the person entitled in the year in which it became due is immaterial. Income can be held to have 'accrued' only when the assesses acquired a right to receive it (Halsbury's Laws of England, para. 189). For instance damages claimed on account of breach of contract would accrue only when the suit is admitted by the defendant and not when merely a claim is made."
8. Reference can also be made to Octavious Steel & Co. Ltd, v. The Commissioner of Income-lax, Dadu PLD 1960 SC 371.
9. In mercantile system of accounting receivability is not the only test of accrual of income. An income which may have arisen, accrued or deemed to accrue without receiving it shall be included in the total income of the assessee and charged to tax. It is pertinent to note that accrual of income does not depend upon entry in the boors of account. In this background it has to be considered whether the refund amount shall be deemed to accrue (i) when the order for refund was passed or (ii) when it was received by the assessee or (iii) on the date when the assesses became entitled to the refund. In this regard Mr. Iqbal Naim Pasha has invited our attention Karachi Steam Navigation Ca. Ltd. v. Commissioner of income-tax 1967 PTD 276. In that case the assessee a Shipping Company during assessme nt year 1953-54 corresponding to accounting year ending 31-10-1952 entered into a contract with W. M. .J. S. M. Of Hongkong on 10-3-1952 to sell its vessel on the condition inter alia that the Company was to deliver the steamer "free from average, class maintained and special survey passed". The Company obtained the permission from the Government of Pakistan foe sale of the vessel, which reached Hongkong in April, 1952. It was discovered that -- Rs. 50,000 would cost to meet the aforestated condition of sale. The Government of Pakistan refused to release foreign exchange, to the extent of -- 50,000 and cancelled the permission for the sale of the vessel. The Company then sold the vessel as a scrap to another Company of Hong Kong. The first purchaser filed two suits against the Company for damages which was compromised on 18-10-1954 and the Company paid Rs. 53,534 in October, 1956 after obtaining necessary foreign exchange from the Government of Pakistan. The Company in its return for the assessm ent year 1953-54 claimed deduction of the travelling expenses, brokerange and damages from the sale price. The Income-tax Officer disallowed these deductions but in appeal the Appellate Assistant Commissioner and the Tribunal allowed deduction of all the expenses except the damanges as it was not wholly and exclusively expended for the purpose of business and that the expenditure could not be allowed in the assessment year 1953-54 as it was incurred and paid during the latter assessment years. After a review of case-law the learned Bench observed as follows :- "From the examination of the decisions, it can be conveniently summarised that tire broad working rule which emerges as a guide to the crediting or debiting in a tax computation of subsequently maturing credits o: debits is to enquire in which accounting period the right or liability swats established and to carry the item into the account in that year. If the title to the sum or any debit arose in one accounting period, the fact that the precise amount of the credit was not fixed during that period, but on a later date will not prevent the actual adjustment in the year to which the item `historically belongs'. In the present case before us if the assessee had to be assessed on the profits that accrued to him on the sale of the streamer during the assessment year 1953-54, all the allowances payable to him on this item had necessarily to be related to the same assessment year, although the expenditure was incurred by him at a later date in the subsequent assessment year. In fact it is doubtful if a deduc--tion legally permissible in respect of the profits on the sale of the steamer could have been allowed to him in any other assessment year."
10. Reliance was placed on Commissioner of Indian Revenue v. Newcastle Breweries Ltd. (1927) 12 Tax Cas. 927 Bernhard v. Gahun 13 Tax Cas. 723, Isaac Holden Sons Ltd. v. The Commissioner of Inland Revenue (?) Serverne (H. M. Inspector of Taxes) v. Dadswell 35 Tax Cas. 649 and A. Gajpalhi Naidu v.
11. Commissioner of Income-tax, Madras (1960) 40 I T R 280. In Bernhard's case following rule was laid down: - "If there is a liability which is subsequently determined, but which is nonetheless to be a liability existing at a particular date, the fact that it is, subsequently to that date, determined and ascertained at a later date ; but the payment is to be made as at that date when it rightly occurs in the accounts, even if the quantum of it cannot be fixed at that moment."
12. In Dadswell's case it was observed that "if on the discontinuance of a trade a payment for work already done 'had not been finally set--tled, accounts can be reopened so as to bring in a payment for such work, even though it was gratitious, which is made thereafter".
13. The rule seems to be that the debits or credits which exist in a particular year, on their maturity to a subsequent year will relate back to the years in which they accrued, or "historically belong".
14. Therefore, if the right to get refund existed in an accounting year but order for its refund is passed or refund is made in a subsequent year then such credit shall be deemed to have accrued in the account year when the assessee became entitled to such credit.
15. Having understood the meaning and interpretation of the words "accrue" and "arise" it would be proper and relevant to examine section 13 of the Income-tax Act which provides that income, profits and gains shall be computed for the purposes of sections 10 and 12 in accordance with the method regularly employed by the assessee. It empowers the Income-tax Officer to determine income and profit in such manner as he deems proper if no method of accounting has been regularly employed by an assessee or from the method employed the income and profit cannot be correctly deduced. Section 13, therefore, give an option to the assessee to choose any method of accounting for the purpose of maintaining the accounts provided the income, profit and gains can be properly deduced therefrom. 'The section is mandatory in nature and if the assessee chooses such method which is regular employed by him then unless it is bit by the proviso to section 13 the Department is bound to consider the matter in the light of the mode of accounting employed by the assessee. The two prevailing method mostly employed are the cash system and the mercantile system. According to the former a record is kept of actual receipt and actual payment, entries being made only when money is actual received or disbursed. In this system of accounting the tax in payable on the difference between receipts and the disbursement to the period in question. Under the mercantile system at the end of the financial year the assets and liabilities are valued and entered in they accounts and the difference between the two is the profit on which the tax is paid. In the words of Sir Iqbal Ahmed, C. J. In C. I. T. v. Sirtgar Bui 13 I T R 224=AIR 1945 All. 102 "under this system the net profit or loss is calculated after taking into account all the income all the expenditure relating to the period whether such income has been actually received or not and whether such expenditure has been actually paid or not. This is to say, the profit computed under this system is the profit actually earned, though not necessarily realised in cash or the loss computed under this system is the loss actually sustained though not necessarily paid in cash. The dis--tinguishing feature of this method of accountancy is that it brings into credit what is due immediately it becomes legally due and before it is actu--ally received, and it brings in debit expenditure the account for which a legal liability has been incurred before it is actually disbursed.
16. Under the mercantile system of accounting income loss and "gain" depend on accrual and not on actual receipt or disbursement".
17. Having considered the relevant provision of law and the manner in which account is to be maintained we have now to consider whether in the present case where the assessee was employing mercantile system of accounting the refund made under the Sales Tax Act shall be deemed to have accrued to it when the order for refund was made or when it became entitled to the refund. In this regard reference may be made to section 27 of the Sales Tax Act under which refund has been claim--ed. Under section 27 where partly manufactured goods are purchased by a licensed manufacturer and tax has been paid on these goods on im--portation or any previous sale, a refund of the amount of the tax so paid shall be made to the licensed manufacturer. The criteria for entitlement to claim refund as laid down under section 27 of the Sales Tax Act is that the claimant should be a licensed manufacturer, he purchased partly manufactured goods and tax has been paid on those goods on impor--tation or on previous sale. If these conditions are satisfied he will become entitled to refund. The satisfaction of the Sales Tax Officer is merely a procedural requirement and if the aforestated conditions are fulfilled, it will not effect the entitlement of the assessee to the refund. There is nothing on record to show that the conditions required by section 27 have not been satisfied by the assessee nor there is any dispute that the sales tax paid by the assessee was not paid by it in the assessment year in respect of which it is claiming addition in its in come. With these facts on record the only question that arises is that as the assessee has not been crediting these amounts in the account boors for the relevant years will it be entitled to relate back to the proper years or should it be taken into consideration in the year when the refund was trade. Mr. Nasrullah Awan has pointed out that as the assessee had failed to make entry in the relevant years it is not entitled to take benefits of these refunds by relating them back to the relevant years when sale tax was actually paid. In this regard Mr. Iqbal Naeem Pasha has relied on Karachi Steam Navigation Co. Ltd. v. Income Tax Officer 1967 PTD 276 which has been discussed above. The objection of the learned counsel for the Department is that the assessee emp--loyed mercantile system of accountancy and as such any claim in respect of the amounts not entered in the accounts books during the relevant period cannot be entertained. The entitlement for refund arose in the relevant year when sales tax was paid as the condition laid down by section 27 were satisfied within the same year and there fore, irrespective of the date of order for refund or actual refund or non inclusion in the accounts maintained under the mercantile system, the amount of refund shall relate back "historically" to the year when the assessee became entitled to its refund. The case would have bee completely different if the assessee would not have been entitled to claim refund in the year when it was paid but in the next year or thereafter.
18. Mr. Pasha has referred to Kedar Nath Jute Mfg. Co. Ltd. v. Commis--sioner of Income Tax (Central)
19. Cal. (1971) 82 I T R 363 (SC). In that case the assessee-Company followed mercantile system of accounting. It incurred a liability of Rs. 1,49,776 for payment of sales tax. The Income-tax Officer rejected the claim for deduction on the ground that the assessee had contested the sales tax liability in appeal and no provisions had been made in the books with regard to payment of that amount. The Supreme Court of India observed as follows "The main contention of the Solicitor-General is that the assessee failed to debit the liability in its books of accounts and, there--fore, it was debarred from claiming the same as deduction either under section 10 (I) or under section 10 (2) (xv) of the Act. We are wholly unable to appreciate the suggestion that if an assessee under some misapprehension or mistake fails to make an entry in the books of account and although, under the law, a deduction must be allowed by the Income-tax Officer, the assessee will lose the right of claiming or will be debarred from being allowed that deduction. Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter."
20. The entitlement to a refund or liability to pay sales tax is depen--dent on the provisions of law governing it. If the conditions for claim--ing refund are satisfied the assessee becomes entitled to it. Therefore, the relevant date for accrual of income on account of such refund is the date when assessee became entitled to it. The omission to include such amounts in the account books or passing of order for refund at a later date will not postpone the entitlement and accrual till the hap--pening of these events. So, ,'s the case with the accrual of liability, as well. The moment the assessee incurs an enforceable legal liability irrespective of the fact whether it has been challenged or not such liability will relate back to the relevant accounting year when it was incurred and became enforceable. .
21. We are of the view that on the facts and circumstances of the case, the assessee was entitled to relate back the refunds of sales tax to the years in which it became entitled to the refund. If different view is taken it may create most embarrassing and inequitable situation for the assessee.
22. If the Department's view that the refund should relate to the year in which the order for refund was passes: is accepted then it will clearly imply that if the gales Tax Officer passes a consolidated order for refund of sales paid in the past years, then this consolidated amount should be treated as income during the year order was passed. This will cause serious prejudice and hardship for the assessee. In such a situation the interpretation which is more equitable and just has to be adopted.
23. For these reasons, we answer the reference in the negative.