' R. M. SARAI, J.--Claim of allowability of interest and commission in 1959-60 and 1960-61 (1. T. R. No, 108 of 1982), expenditure on litigation and establishment in 1961-62 to 1965-66 (I. T. R. No, 185 of 1973), and bad debt in 1 66-67 (1. T. R. No, 1231 of 1976) by assessee shall principally depend on construction of agreement, dated 26th Obtober, 1954 entered between assessee, a firm registered and constituted with object of carrying on business as sole distributors for sale of yarn and cloth manufactured of three textile mills, and B. R. & Sons, their sole selling agents and the award given by Tribunal of Arbitration, Federation of Indian Chambers of Commerce on 27-8-1964 on dispute between them.
2. Although these references arise out of different orders passed by Tribunal but they stem out of same transaction, therefore, they are being disposed of by this common order. Under agreement of 1954 assessee was to invest Rs, 25 lakhs for distribution and sale of products, manufactured by textile mills which amount was always to remain invested. On delivery of goods to assessee, on consignment basis, against advance payment assessee was entitled to 5% interest from the date of payment till the sale of goods. Assessee was also entitled to 66# of the expenditure incurred by it on establishment etc. And on sale of goods it was to get commission of 11 %. The agreement appears to have remained in operation till November, 1958 when B. R. Sons wrote a letter to assessee complaining that it was not fulfilling its obligation and responsibility under the agreement. Similar letters were repeated on 1st and 9th December, 1958. Ultimately dispute was referred to arbitration in 1959. Claim and counter-clai mswere made. In July, 1964, award was given directing assessee to pay Rs, 2,50,0J0 in full and final settlement. None of these letters are on record nor they were produced by the learned Standing counsel despite specific order of this Court on application of assessee and grant of adjournments. But as the contents are mentioned in one or the other reference it is sufficient for disposal of these references.
3. In assessm ent year 1959-60 assessee bad debited a sum of Rs, 1,75,509.87 p. By way of interest to the account of Messrs B. R. Sons and B. R. Kothi in its books of Head Office and branches and had taken these amounts to its profit and loss accounts. Certain other amounts by way of travelling expenses, insurance and Bank Commissions etc. Were also shown as recoverable from Messrs B. R.
Sons. Consequently they were debited in the books of assessee in account of Messrs B. R. Sons. In the books of B. R. Sons Ltd., a sum of Rs, 2,68,237.77 p. Had been provided towards establishment, brokerage, distributor's commission, interest, etc. Of this sum of Rs, 2,88,237.77 p. Was due to assessee. These various amounts had been debited and charged to the profit and loss account of the company and liability thereof was shown as 'Liability for expenses'. In the balance-sheet it was noted, 'the figure of Rs, 12,79,362.04 p. Includes a provision of Rs, 2,85,266.01 p. By the company.
Disputed thus from the account books of B. R. Sons it is clear that the amount shown as debited in the name of assessee was not admitted but disputed. When assessee filed its return for 1959-60 for the period ending 10th June, 1959 it showed income of Rs, 3,07,431 p. But in Jan. 1964 assessee filed a revised return showing loss of Rs, 5,63,087 p. Alongwith revised return a covering letter of 23-1- 1964 was also sent to Income-tax Officer, Central Area, Kanpur stating that as a dispute had arisen between Messrs B. R. Sons and assessee in respect of interest, as also expenses claimed the assessee did not have any income in the assessment year in dispute rather had suffered huge losses. The deduction of Rs, 5,90,711 was also claimed as B. R. Sons had claimed the same from assessee in respect of loss on consignment of goods, interest etc. The revised return appears to have been filed due to various claims raised by B. R. Sons in dispute raised before arbitrator.
Similarly, for assessm ent year 1960-61 the assessee had debited a sum of Rs, 13,06,824.60 p. By way of interest in the account of Messrs B. R. Sons Ltd., and a return showing an income of Rs, 77,634 was filed on 23-12-1960. But on 4th March, 1964 a revised return showing a loss of Rs, 4,96,371 was filed again on the same basis i. e. The dispute raised before the arbitrator.
4. The Income-tax Officer did not find any merit in the claim of assessee as dispute between assessee and Messrs B. R. Sons had arisen after November, 19 8, the previous years relevant to assessm ent year 1959-60. Before I. T.
0. Numerous claims had been raised but when the matter came up before Appellate Assistant Commissioner, the assessee modiiied its claim and sought deduction of Rs, 2,34,197 only. Out of this Rs, 1,75,510 was in respect of interest debited to Messrs B. R. Sons in books of account of assessee, Rs, 17,224 was in respect of Commission and Rs, 13,441 was for brokerage. The Miscellaneous expenses claimed were at Rs, 28,022. The claim of assessee was that in view of the award given by the Arbitrators assessee was not entitled to get any amount from B. R. Sons. It was apparent, therefore, that the amount shown in the accounts of assessee as income was incorrect. According to assessee these entries were made on assumption that assessee was entitled to receive the same from Messrs B. R. Sons in different heads but once the claim was negatived by the Arbitrator it shall be deemed to reflect back in the assessment years in dispute and as nothing was found due against Messrs B. R. Sons, the assessee could not be deemed to have any income from this business. According to assessee what could be brought to tax was real income and not income which was notional only. The Appellate Assistant Commissioner accepted the claim. In futther appeal to the Tribunal by the department the appellate order was set aside and it was held that the award given by the Arbitrator did not abrogate or abridge rights of assessee to interest or commission to which it was entitled in the agreement dated 26-10-1954. The award was given in the context of the large claims made by Messrs B. R. Sons and the counter claims made by assessee of Rs, 60 lakhs and odd. In other words the Tribunal was of opinion that the award had nothing to do with interest and commission claimed by assessee. It was also found that the dispute before arbitrator was confined to claim and counter-claim in respect of volume of business carried on by assessee. It did not touch the controversy in respect of interest, brokerage and commission. Against this order assessee filed application under section 256(1) which was rejected by Tribunal but it was allowed by this Court and the Tribunal on direction of this Court referred the following questions of law : ASSESSMENT YEAR 1959-60 "Whether on the facts and in circumstances of the case, the amount of Rs, 1,75,510 interest merged in the profit and loss account but not actually realised could be assessed as income on accrual basis?"
ASSESSMENT YEAR 1960-61 "Whether on the facts and in the circumstances of the case, the amount of Rs, 2,42,118 interest and commission merged in the profit and loss account, but not actually realised could be assessed as income on accrual basis."
5. In assessm ent years 1961-62, 1962-63, 1964-65 and 1965-66, dispute was slightly different.
Agreement of 1954 had come to an end. Assessee returned loss while in year 1963-64 it declared a small profit. In all these years principal source of income was money lying with erstwhile principals on which interest was earned. Major portion of the expenses claimed every year was on litigation.
Other expenses were on establishment, rent, travelling, telephone, stationery etc. The I. T.
0. Held that since assessee did not carry on any business during these years it was entitled to claim these expenses as business expenditure. But as assessee had income from other source an estimated sum was allowed. In same years fees paid for income-tax representations was also allowed. Order was affirmed in appeal. In further appeal Tribunal held that business of assessee was sale and distribution and not financing, therefore, it was not entitled to claim expenditure incurred on recovery of advance payments made to principal for lifting of goods nor could it claim expenditure incurred on establishment for this purpose as there was complete ceasure of business.
Inference was drawn against assessee as after 1958 goods were lifted not on consignment basis but against cash payment. Litigation expenses were disallowed as it was not necessary for earning income from interest. Nor was it satisfied that assessee was required to incur any expenditure for earning interest on money lying with principal. On application of assessee under section 256 (I) the Tribunal referred the following questions of law".
"(1) Whether on the facts and in the circumstances of the case, the Tribunal was correct in holding that interest income assessed for the years 1961-62 to 165-66 was income from 'other sources' assessable under section 56 of the Income-tax Act, 1961 ?"
(2) Whether on the facts and in the circumstances of the case the Tribunal was correct in limiting the allowable expenditure to the amount of Rs, 1,000 in the assessment years 961-62 and 1963-64 and to Rs, 1,500 in assessm ent years 1962-63, 1964-65 and 1965-66 and disallowing the rest of the expenses including litigation expenses incurred by the assessee in conducting the arbitration proceedings before the Federation of Indian Chambers of Commerce and Industry, New Delhi."
6. In 1966-67 the dispute related to claim made by assessee that payment made by it in pursuance of award dated 27-8-1964 was revenue loss thus allowable as deduction. It was repelled by Tribunal as business had ceased in 1958. Further Tribunal held that claim of interest and commission in 1959-60 and 1960-61 having been repelled it shall be deemed that assessee received that amount and payment in pursuance of award having been made for outstanding of B. R. Sons the assessee could not claim it as revenue loss. For this year the Tribunal referred the following question of law.
"Whether on the facts and in the circumstances of the case, the Tribunal was correct in holding that the two sums of Rs, 1,75,510 and Rs, 2,52,118 claimed as bad debts or business loss and the sum of Rs, 2,50,000 and Rs, 17,812 representing payment and interest on the same as per terms of the award were not allowable items of expenditure or business loss?
I. T. R. No, 108 of 1982 (1959-60 and 1960-61)
7. It was found by Tribunal that agreement, dated 26th October, 1954 between assessee and its principals came to an end in November, 1958. Further, no credit note was issued by B. R. Sons in favour of assessee in respect of interest and commission. But the claim of assessee was rejected as the 'Award given by the arbitrators did not abrogate or abridge the rights of assessee to the interest or commission to which it was entitled under the agreement'. It also did not find any merit in claim of assessee that amount having not been paid it had no real income which could be taxed 'as nothing happened in the relevant previous years to show that the assessee ceased to have the right to the interest and commission, as provided in the agreement.' The letter dated 17th November, 1958 cannot be held to have such an effect. It only deferred the payment on account of the dispute.
8. In Assessm ent interest and commission, therefore, was included as income not because it was received but because assessee was entitled to it. Is taxability under Income-tax Act, on entitlement or income? If it is on the former then Tribunal, undoubtedly, was correct in its approach. But charge under section 4 of the Act is 'on total income of the previous year.' Although what would amount to income has been left to be determined, as in subsection (24) of section 2, definition of income is inclusive and not exhaustive, yet before it can be brought to tax it must accrue or arise. That is in the year in which it is sought to be taxed the assess= must earn it actually or constructively. That is fundamental. And that does not alter by method of accounting under section 145, one may adopt any system, cash or mercantile, for convenience of computation. But taxability arises only when income accrues. In one it is received in year in dispute, in other it is assumed to have accrued irrespective of payment. The assumption may, however, be erroneous or it may turn our that nothing accrued by act of parties or by operation of law. Such error or happening reflects back resulting in non-accrual. If it has not accrued that is no income was earned then it cannot be subjected to charge and occasion of taxing it becomes non-existent.
9. Even assuming that award did not abrogate or abridge rights of assessee to the entitlement of interest and commission, did it accrue in year in dispute? True, debit entry was made but on assumption that the amount was due from Messrs B. R. Sons. But no corresponding credit note was issued. Other siae treated agreement to have come to an end which could be terminated after three years by any of the parties. Such income has been described by Supreme Court in Commissioner of Income-tax v. Shoorji Vallabh Das ana Company (1) as 'hypothetical income'.
Whether such income can be taxed and if so when has been discussed thus : "No doubt, the Income-tax Act, takes into account two points of time at which the liability to tax is attracted, viz, the accrual of the income or its receipt, but the substtnce of the matter is the income.
If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a 'hypothetical income' which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulfed at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account. A mere book-keeping entry cannot be income, unless income has actually resulted."
' The Tribunal assumed accrual of income from entry in account-book. Mere entitlement could not result in income. 'Hypothetical income' should have materialised. In abscence of any finding to this effect rather circumstances being otherwise the order of Fribunal cannot be upheld. Argument of learned counsel for reveaue on strength of Karnani Potteries Ltd. v. Commissioner of!. T. (2) has no substance as order of Tribunal has been found to be erroneous on facts found by it.
I. T. R. No, 185 of 1973 (1961-62 to 1965-66)
10. In all these years it has been found by Tribunal that principal source of income was interest on money lying with erstwhile principals. But the income having been held to be from other sources the claim of assessee for deduction of expenses incurred by it on establishment etc. As expenditure wholly and exclusively for business purposes was repelled. It also did not find any merit in plea of assessee that alongwith business of distribution it also undertook financing, therefore, even after ceasure of distribution business the business ot financing cantinued. The Tribunal relying on clause
(5) of the agreement held that entire capital investment by the assessee was solely for the purposes of distribution busineis and although assessee was required to make advance payments to the principals before lifting goods but that was as part {{FOOT NOTE}}
(I) (1962) 46 IT R 144 (2) (1971) 82 IT R 547 : 1972 Tax L R 356 (S) {{FOOT NOTE}} of business arrangements and not a case of financing. It found that in absence of business of distribution the business of financing could not stand, therefore, the claim of assessee that it was carrying on two businesses, one of distribution and other of financing, could not be accepted. Nor did it agree that agreement of 1954 did not completely come to an end and it was only temporarily suspended. It found that assessee adopted the year ending Asarh Sudi 2, as its accounting year, which normally fell between 20th June and 19th July. And the agreement to carry on distribution business came to an end in 1958. This finding was arrived on recitals in claim and counter-claim made before Arbitration.
11. In order to appreciate correctness or otherwise of the finding recorded by the Tribunal it is necessary to mention some clauses of the agreement of 1954. In clause (4) it was provided 'that the distributors distinctly understand that the output of the three companies for the sale whereof they are responsible to make arrangement to reach a figure of 15 crores of rupees or more in a year and they assured that they will be in a position to finance the same : In clause (5) it was provided 'that assessee shall initially invest a capital of Rs, 25 lakhs which was always to be kept invested in the business of the sales and distribution of the products of three companies. 'If at any time they have surplus financing it may temporarily be invested. Other terms regarding payment of interest and commission have already been noticed earlier. There was thus no independent agreement for financing. But as held by Bombay High Court in Commissioner of Income-tax v.
Favre Leuba Company Ltd. (1), even in absence of specific agreement it could be inferred from, 'the nature of business and the advance paid by the assessee'. Business of assessee was no doubt distribution of cloth manufactured by textile mills. But for carrying it on the assessee had not only to invest Rs, 25 lakhs but to make payment in advance of goods lifted on consignment basis. It was also entitled to 66 of establishment expenses, namely rent of premises, payment of staff etc. Even the tribunal has found that assessee had to make advance payment. But it rejected assessee's claim because there was no such agreement. However, from these circumstances and clauses of agreement quoted earlier it appears the expenditure was incurred by assessee as commercial expediency and business necessity. Activity of manufacturing is closely associated with sale and distribution. They are part of same and are integrated. In absence of effective and proper distribution the activity of manufacturing was bound to be hampered. It could be carried on by manufacturer or they could entrust it to others. A person carrying on business of distribution is only an agent and works on behalf of person whose goods are to be marketed. For carrying it on effectively if the assessee invested fund or to use the words of Tribunal made advance payment due to business consideration there is no reason to hold that it did not amount to financing.
Learned Standing Counsel for Commissioner of Income-tax urged that this being not the question referred assessee was not entitled to raise it. In order to satisfy if the contention of learned counsel was correct, the questions raised in applications under section 256 were examined and from that it appeared that these questions were also raised but the Tribunal referred only two questions as it appeared to it to cover entire controversy raised by parties.
12. Learned counsel for assessee appears to be right in the submission that investment under agreement was stock-in-trade. And by termination of agreement the nature did not change.
Tribunal itself found principal source of income of assessee was interest from investment made. If it was {{FOOT NOTE}}
(1) (1979) 120 I T R 897 {{FOOT NOTE}} stock-in-trade then assessee was entitled to claim expenditure incurred by it for its recovery as business expenditure. In South Asia Industries (P) Ltd. v. Commissioner of I.T. (1) amount spent by assessee for purposes of preserving its business, even, though it was for appearing before Commissioner of Inquiry was allowable as business expenditure. As dispute had arisen between assessee and its principals and assessee had to incur expenditure in litigation for recovering the amount invested by it the expenditure was in connection with business. It is not the claim of department that it was excessive. The assessee, therefore, was entitled to claim deduction on litigation as well.
1. T. R. No, 1231 of 1976 (1966-67)
13. Claim of assessee that interest and commission in 1959-60 and 1960-61 did not accrue having been rejected by Income-tax Officer, it claimed the deduction of these amounts as bad debt in year in dispute in view of the award dated 27-8-1964 and payment made under it. As while deciding Reference No, 108 of 1982 it has been found that these amounts did not accrue at all the question of claiming them as bad debt has become academic only.
14. For reasons stated above questions referred to in the three references are answered as under : I. T. R. No, 108 of 1982
15. Both the questions for 1959-60 and 1960-61 are answered in the negative in favour of assessee and against the department by saying that the amount of interest and commission which was not actually realised could not be assessed as income on accrual basis.
I. T. R. No, 185 of 1973
16. Both the questions are answered in the negative in favour of assessee and against department.
I. T. R. No, 1231 of 1976
17. In view of answer to questions referred in I. T. R. No, 108 of 1982 the question has been rendered academic and needs no answer.
18. Assessee shall be entitled to its costs which is assessed at Rs, 200 in each reference. {{FOOT NOTE}}
(1) (1981) 132 I T R 144 : 1981 Tax L R 720 (Delhi) {{FOOT NOTE}}