1959 (5) TMI 3 - SC - Income Tax

Whether in view of the fact that the sum of ₹ 43,692-11-9 had been entered on the credit side in the books of account even though it was not money actually received but only money treated as received on the basis that it was due and receivable, the sum of ₹ 24,809 which had been entered as debit, being the liability of the appellant undertaken by it to earn those receipts, should be deducted in determining the taxable profits and gains of the appellant? Held that - It is to be noted that the appellant had led evidence before the Income-tax authorities in regard to this estimated expenditure of ₹ 24,809 and no exception was taken to the same in regard to the quantum, though the permissibility of such a deduction was questioned by them relying upon the provisions of section 10(2) of the Act. It, therefore, follows that the conclusion reached by the High Court in regard to the disallowance of ₹ 24,809 was wrong and it should have answered the referred question in the affirmative. Appeal allowed.

Summary

Issues Involved:
1. Whether the appellant was entitled to a deduction of Rs. 24,809 in the computation of its profits and gains for the assessment year 1948-49.

Issue-Wise Detailed Analysis:

1. Entitlement to Deduction of Rs. 24,809:
The central question was whether the appellant, who used the mercantile method of accounting, could deduct Rs. 24,809 as an expense in the computation of its profits and gains for the assessment year 1948-49. The appellant, engaged in land development, sold plots and received part of the sale price upfront while the balance was secured by a charge on the land. The appellant undertook to carry out certain developments (roads, drainage, lighting) within a reasonable time, which was incorporated in the sale deeds.

The appellant debited Rs. 24,809 in its books as the estimated expenditure for these developments, arguing that the liability had arisen even though the actual expenditure had not been incurred. The Income-tax Officer disallowed this claim, stating that the expenses were not actually incurred and the estimate was not based on real expenses. This disallowance was upheld by the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal, which held that the liability was contingent, not accrued.

The High Court also answered in the negative, criticizing the Tribunal's case statement but dealing exhaustively with the arguments presented. The High Court held that since the whole amount was received without making the promised expenditure, no deduction could be allowed.

The Supreme Court, however, disagreed with the High Court's conclusion. It emphasized that under the mercantile system of accounting, both receipts and liabilities are recognized when they become due, not necessarily when they are received or paid. The Court cited the principle from Keshav Mills Ltd. v. Commissioner of Income-tax, which states that the mercantile system brings into credit what is due and into debit what is legally liable before actual receipt or payment.

The Court distinguished the present case from Peter Merchant Ltd. v. Stedeford, where the liability was contingent. Here, the liability to carry out developments was absolute and unconditional, incorporated in the sale deeds, and thus accrued at the time of the sale, even if the actual expenditure was to be made later. The Court also referred to Simon's Income Tax, which supports the deduction of accrued liabilities.

The Supreme Court concluded that the liability was an accrued one, and the estimated expenditure could be deducted under the mercantile system of accounting. It stated that the Income-tax authorities could scrutinize the estimate but could not deny the deduction of an accrued liability. The Court also observed that the High Court erred in limiting the scope of section 10(2)(xv) of the Income-tax Act and should have considered section 10(1), which allows for the deduction of necessary expenses to determine the true profits and gains of a business.

The Court held that the sum of Rs. 24,809 was an allowable deduction under section 10(1) of the Income-tax Act, as it represented an accrued liability incidental to the appellant's business. The Court allowed the appeal, set aside the High Court's judgment, and answered the referred question in the affirmative, awarding costs to the appellant.