1991 (6) TMI 61 - HC - Income Tax

Summary

Issues:
1. Assessment of compensation as income for a partnership firm undertaking contract works.
2. Determination of whether the compensation amount is a revenue receipt or a capital receipt.
3. Analysis of the accrual of income based on the mercantile system of accounting.
4. Interpretation of when the right to receive compensation accrued.

Analysis:
The judgment by the High Court of Orissa dealt with the assessment of compensation as income for a partnership firm engaged in contract works. The firm maintained its accounts under the mercantile system and was awarded a sum of Rs. 2,32,000 as compensation by an arbitrator. The primary issue was whether this compensation should be treated as a revenue receipt or a capital receipt. The firm contended that the compensation should be considered income for the years in which the contract was executed, i.e., 1966-67 to 1968-69, and not for the assessment year 1977-78 as done by the tax authorities.

The court analyzed the accrual of income under the mercantile system of accounting. It was highlighted that the right to receive income should be determined based on when it accrued. Referring to the case law CIT v. A. Gajapathy Naidu, it was established that if the right to receive income arose in a specific accounting year, it should be included in the income of the succeeding assessment year. The court emphasized that the Income-tax Officer cannot relate back income that accrued in a subsequent year to an earlier year.

The judgment concluded that the right to receive the compensation accrued only when the award was made on November 5, 1976. Before the award, the right was considered inchoate. The court noted that the claim made before the arbitrator did not confer the right to receive the compensation, which only materialized upon the award. Therefore, even though the firm maintained accounts under the mercantile system, the compensation was deemed to have accrued in the accounting year ending on March 31, 1977, and was rightly taxed in the assessment year 1977-78.

In summary, the court upheld the tax authorities' decision to treat the compensation as income for the relevant assessment year, rejecting the firm's argument that it should be considered income for the years when the contract was executed. The judgment clarified the principles of income accrual under the mercantile system of accounting and emphasized the importance of determining the timing of when the right to receive income actually accrued.