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TMI Blog1990 (8) TMI 216X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee, was the guarantee fund relating to the three contracts. The said sum was calculated at the rate of 5% on the total value (including taxes etc.) of the contracts as detailed below : -------------------------------------------------------------------------------------------------------------------------------------------------- Name of the buyer Contract price 5% of contract price -------------------------------------------------------------------------------------------------------------------------------------------------- Warana Rs. 53,66,720 Rs. 2,68,336 Dutta Rs. 53,66,720 Rs. 2,68,336 Konark Rs. 29,90,000 Rs. 1,49,500 ------------------------- Rs. 6,86,172 -------------------------------------------------------------------------------------------------------------------------------------------------- The sum was straightaway deducted from sales turnover and shown as a liability in the balance sheet. The assessee's case before the ITO was that the guarantee-fund retained by the buyers did not accrue to it and hence the sum in question was rightly deducted from the aggregate contract price and shown as a liability. 3. On an examination of the contracts in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case of CIT v. Nadiad Electric Supply Co. Ltd. [1971] 80 ITR 650. 6. The CIT(A) approached the matter from two angles, namely, (i) the concept of real income, and (ii) the existence of a legally enforceable claim. 7. According to him, the substantive clauses of the contracts would show that "the appellant had only a contingent right to demand payment to the extent of 5% of the contract value and in the circumstances, no debt can be said to have accrued and consequently no amount may be credited in the books of the assessee, even in mercantile system of accounting". Again, "the rendering of services under the above contracts does not bring into existence a right to enforce payment from the three customers to the extent of 5 % of the contract value, unless otherwise the conditions spelt out in the warrantee clause are satisfied. Since this warrantee clause contains two crucial periods, income in real terms to the extent of 5% of the contract value could be said to accrue or arise only after the expiry of such periods and only after proper performance of the contracts by the assessee. The presence or absence of entries in the account looks is not conclusive to prove accrual of inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ery in question did not function properly or there were any defects in them. This would clearly show that the liability is one that is uncertain, that is to say, one that may or may not arise. The liability is, therefore, a contingent liability. 13. Shri Tilkchand then contended that 5% of the value of the contract was not withheld by the buyers. The contracted amount was fully paid. The assessee gave a bank guarantee only and it is a matter of record that no claim was made during the relevant year of account by the buyers in respect of the said guarantee. 14. Continuing his argument, Shri Tilakchand contended that none of the cases referred to or relied upon by the CIT(A) is relevant. As a matter of fact, the Supreme Court decision in the case of Morvi Industries Ltd. supports the department's case. In the case before us, not only the right to the income had accrued, but also the income was received in full by the assessee. In the circumstances, therefore, contended by Shri Tilakchand, the Supreme Court decision in the case of Punjab Distilling Industries Ltd. v. CIT [1959] 35 ITR 519 is squarely applicable to the case before us. 15. In view of the foregoing, therefore, contend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) Decision of the Delhi Bench 'E' of the Tribunal in Qantas Airways Ltd. v. ITO [1979] 13 CTR (Delhi) (Trib.) 10 ; and (ii) Decision of the Pune Bench of the Tribunal in ITO v. Wanson (India) Ltd. [1985] 5 ITD 102. 17. In reply, Shri Tilakchand vehemently contended that this is a case of contingent liability and hence the assessee is not entitled to revenue deduction in respect of the provision made. The cases referred to and relied upon by the assessee's counsel cannot avail the assessee, because they turned on different sets of facts. 18. We have looked into the facts of the case. We have considered the rival submissions. We may at the outset notice certain facts that are material for the resolution of the issues before us. 19. In this case, we are concerned with two contracts -- the Warana contract dated July 17, 1981, and the Dutta contract dated August 7, 1981. Clause 7 of the Warana contract, which deals with the guarantee which the assessee had undertaken to provide, reads as follows : "7. Guarantee : (a) All the machinery and equipment will conform to the specifications, material and workmanship given in the Appendix 'A'. Any fabricated/manufactured equipment found de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as payable on the assessee's giving a bank guarantee for the stipulated amount. And it is common ground not only that the assessee did give a bank guarantee, but also that, on the furnishing by the assessee of such a guarantee, the respective buyers released the final instalment of the purchase price. 22. This brings us on to the bank guarantee furnished by the assessee. In respect of both the contracts, the bank guarantee was given by Indian Overseas Bank, and the terms of the guarantee are couched in identical terms. After reciting the factum of the assessee's having given the buyers a guarantee for performance on the terms and conditions contained in the relevant clause of the contract, the Letter of Guarantee goes on to detail the bank's liability in this regard in the following terms : "1. We, Indian Overseas Bank guarantee that the Machinery and equipment (to be) supplied by the Supplier shall conform to the specifications, material and workmanship given in the appendix A of the Agreement and any fabricated/manufactured equipments found defective during the period of one year from the date of commissioning/18 months from the date of supply, whichever is earlier, shall be re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tee given by the Indian Overseas Bank are in consonance with those contained in the relevant clauses of the contract. Thus, the Letters of Guarantee combines themselves to the defects/minimum performance during the stipulated period only. Beyond the stipulated period, however, the bank guarantee will not be operative. (v) The question of the bank's honouring the letter of guarantee is conditional on the assessee's failingl refusing to honour the stipulations contained in the guarantee clauses of the contracts. (vi) Even here, the bank's liability will be limited to the 'proportionate value of the particular defective material or part'. 24. One more material fact needs to be noticed and that relates to the manner in which the assessee has exhibited in its books of account the sale consideration received from the two buyers. The assessee did not credit to the Profit and Loss A/c the aggregate sale consideration in full it deducted from the aggregate sale consideration the guarantee money calculated at the rate of 5% of the contract price, and credited the remainder to the Profit and Loss Account. The guarantee money was exhibited in the balance sheet under the head 'Liabilities'. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t when that is paid in cash, the shares were realisable and could have been turned into cash, if the appellants had been pleased to do so. I cannot think that income-tax is due or not according to the manner in which the person making the profit pleases to deal with it." 29. In the case before us, the assessee had received the sale consideration in full. Hence the profit embedded in the sale consideration was simultaneously realised or received by the assessee. With the result, sec. 5(1)(a) of the Act will get activated to bring to charge on receipt basis, the entire profit arising out of the two transactions. In other words, there is no warrant for leaving out of reckoning the sum of Rs. 5,36,672. 30. Yet, Shri Vijayaraghavan vehemently contends to the contrary and, in this regard, invites us to accept the following propositions : (i) The assessee is contractually obligated to give guarantee to the buyers on the terms and conditions contained in the contract. The value of the guarantee was also quantified on a reasonable basis. The contractual liability of the assessee in this regard was given shape and substance in the form of the bank guarantee given to the buyers. And since ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmined with substantial accuracy. Unlike a reserve, which is a stand-by created out of profits of the business to meet contingencies which are unknown and which cannot be foretold on the basis of knowledge of current facts, a provision is a charge against profit and it is created to meet liabilities which are known and enforceable. To be entitled to be called a provision, it is enough that the liability in question is known and enforceable ; it is not necessary that the liability must be capable of being quantified at the time when a provision therefor is made. 34. Central to the concept of a known, present, enforceable liability is the concept of 'debt owed' The expression 'debt owed' came up for consideration by the Supreme Court in the case of Kesoram Industries & Cotton Mills Ltd. v. CWT [1966] 59 ITR 767. While examining the matter, the Supreme Court quoted with approval the following : (i) " ... a debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation, debitum in praesenti, solvendum in futuro" (per Lindley L.J. in Webb v. Stenton). (ii) "But the distinction must be borne in mind between the case where there is an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture which was deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure. (See in this connection, the observations of this court in Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66. A distinction is often made between an actual liability in presenti and a liability de futuro, which for the time being is only contingent. The former is deductible but not the latter." 37. The question that arises for consideration in this case is whether the guarantee money can be properly be regarded as a debt in praesenti, solvendum in futuro. The answer is : No. It is but a contingent liability. 38. The assessee has no doubt given certain guarantees to the buyers on the terms and conditions contained in the contract. The assessee has also given a bank guarantee in that regard. But, a debt properly so called does not arise out of these circumstances. The arising or accrual of the guarantee-related debt depends upon many contingencies. Thus, the defects mentioned in the guarantee clause may or may not arise within the guarantee period. Should they arise, the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ossed when he held that the existence of a liability meant that real income had not accrued to the assessee. As will be demonstrated presently, "provision" and "real income" operate in different fields. 43. In view of the foregoing, therefore, we reject the first proposition canvassed by Shri Vijayaraghavan. 44. Shri Vijayaraghavan's second proposition is that, by reason of the contractual obligation to provide guarantee to the buyers, the assessee's right to receive the guarantee money is postponed till after the expiry of the guarantee period. Implicit in this proposition is that what is exigible to tax is the real income of the assessee and that the guarantee money is not the real income of the assessee. 45. A preliminary remark or two may be made. Shri Vijayaraghavan's first proposition, namely, that the provision relating to the guarantee sum is revenue deductible can be understood only on the basis that the entire income had accrued to the assessee and was also received by the assessee, and yet there was the subsisting enforceable liability in respect of which a revenue deductible provision was made. His second proposition, interestingly, proceeds on the diametrically oppo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4. We are unable to agree. As far back as in 1940, in Bank of Chettinad Ltd. v. CIT [1946] 8 ITR 522 (PC). Sir Lancelot Sanderson observed : "Their Lordships think it necessary once more to protest against the suggestion that in revenue cases "the substance of the matter" may be regarded as distinguished from the strict legal position. In Inland Revenue Commissioners v. Duke of Westminster (1936 AC 1) disapproval of this doctrine was expressed in the opinions of Lord Tomlin and Lord Russell of Killowen. A passage from the opinion of Lord Russell of Killowen at page 24 may usefully be cited. It is as follows: "I confess that I view with disfavour the doctrine that in taxation cases the subject is to be taxed if in accordance with a Court's view of what it considers the substance of the transaction, the Court thinks that the case falls within the contemplation or spirit of the statute. The subject is not taxable by inference or by analogy, but only by the plain words of a statute applicable to the facts and circumstances of his case." 50. In the case of CIT v. B. M. Kharwar [1969] 72 ITR 603, the Supreme Court of India had occasion to deal with the suggestion that in revenue cases ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nection with the guarantee given by the bank. Even so, the money blocked with the bank cannot be deemed to be guarantee fund retained by the buyers. 53. There is yet another reason why the third proposition of Shri Vijayaraghavan must fail. In cases where one of the parties to the contract is authorized by the terms and conditions of the contract to retain a part of the money payable by it to the other party to the contract and to release it after the expiry of a stipulated period, what happens is that, by reason of such retention, the right to receive the income embedded in the guarantee fund retained is postponed. For a fact, in cases such as Janatha Contract Co. v. CIT [1976] 105 ITR 627 (Ker.), Chanchani Bros. Construction (P.) Ltd.'s case, and Simplex Concrete Piles India (P.) Ltd.'s case it has been held that where there is a stipulation postponing the time for payment of the whole or part of the balance until after the expiration of the stipulated period, the payment of the money retained would not have become due to the contractor. Since the payment of the money retained by one of the parties to the contract does not become due till after the stipulated period, the accrual ..... X X X X Extracts X X X X X X X X Extracts X X X X
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