1974 (11) TMI 5 - SC - Income Tax

Whether the sum representing the managing agency remuneration for the period April 1 1956, to June 30, 1957, was deductible in the computation of the income of the previous year ending on 30th June, 1958, relevant for the assessment year 1959-60 - assessee s liability to pay remuneration arises only when the Government conveyed its approval - appeal is accordingly allowed, the answer given by the High Court to the question referred is answered in the affirmative and in favour of the assessee

Summary

Issues:
1. Deductibility of managing agency remuneration in income computation.
2. Application of mercantile system of accounting.
3. Interpretation of section 326 of the Companies Act, 1956.

Detailed Analysis:

1. The primary issue in this case was whether the managing agency remuneration of Rs. 97,188 for the period April 1, 1956, to June 30, 1957, was deductible in the computation of income for the assessment year 1959-60. The company claimed this amount as a deductible expenditure for the relevant year when the Government approved the new agreement with managing agents. The Income-tax Officer, Appellate Assistant Commissioner, and Tribunal rejected the claim, emphasizing the mercantile system of accounting. The High Court also ruled against the company, stating that the approval retroactively validated the remuneration from April 1, 1956. However, the Supreme Court disagreed, highlighting that liability must accrue before claiming a deduction, regardless of the accounting system used.

2. The second issue revolved around the application of the mercantile system of accounting by the company. The court explained the distinction between cash basis and mercantile basis accounting, emphasizing that under the mercantile system, a deduction can only be claimed when a legal liability has accrued. Despite following the mercantile system, the company could not claim the deduction until the liability for the managing agency remuneration had actually arisen, which occurred upon the Central Government's approval of the new agreement with managing agents.

3. The interpretation of section 326 of the Companies Act, 1956, was crucial in determining the timing of liability for the managing agency remuneration. The section mandated Central Government approval for the appointment or reappointment of managing agents. The court clarified that the company's liability to pay the remuneration only accrued upon the Government's approval, as specified in the section. The retrospective approval by the Central Government dated September 2, 1957, made the liability effective from April 1, 1956, but the actual liability arose only upon approval, not before. The court emphasized that the liability was contingent upon the Government's approval, as outlined in section 326, and not merely on the date of agreement between the parties.

In conclusion, the Supreme Court allowed the appeal, disagreeing with the High Court's decision and ruling in favor of the assessee. The court emphasized the importance of liability accrual before claiming deductions, regardless of the accounting system used, and clarified the significance of Central Government approval in determining the timing of liability for managing agency remuneration.