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TMI Blog1991 (3) TMI 79X X X X Extracts X X X X X X X X Extracts X X X X ..... sponding previous year ended on March 31, 1978. The entire production of the assessee is supplied to the Health Services Department of the Kerala Government. The Government had been sanctioning ad hoc advances to be adjusted later against the supplies. Some difficulties arose in following this practice and the Director of Health Services pointed out to the Government that adjustment of advances could not be made because the prices of the items have to be fixed by the Government of India. Further advance could not be made to the assessee-company and that created a grave financial situation for the assessee. The Director of Health Services, therefore, suggested to the Government that the advances already paid may be adjusted on the basis of the tentative price approved by the firm and further advances may be sanctioned so as to enable them to continue further production. An indemnity bond was executed by the chairman of the company to the effect that if the price structure fixed by the Government is lower than the rate, fixed by the firm, the excess payment would be adjusted against future supplies. If the price fixed was higher, a claim could be referred for the balance amount. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o. It was thereafter that the aforesaid question was referred to this court for decision. It is urged on behalf of the Revenue that the assessee is following the mercantile system of accounting and credit once taken cannot be excluded on a reconsideration of finalised accounts. This contention found favour with the assessing authority who refused to exclude the amount as required by the assessee. It is settled law that the income of the assessee will have to be determined according to the provisions of the Income-tax Act and in consonance with the method of accounting followed by the assessee. The precise question which we are called upon to consider in this reference is whether the amount sought to be excluded is the real income of the assessee. To ascertain whether it is real income or not, it is advantageous to look into the distinguishing feature of the mercantile system of accountancy from the other system, viz., cash system of accounting. Two broad systems of accounting to determine the profits and gains of a business are referred to as "cash basis" and "mercantile basis". The distinction between the mercantile system and the cash system has been explained by the Supreme Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i Vallabhdas and Co. [1962] 46 ITR 144, held that if income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about "hypothetical income" which does not materialise (emphasis supplied). The Supreme Court further held that if 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, But, in cases Where the income can be said not to have resulted at, all, there is obviously neither accrual nor receipt of income, even though an entry is made to that effect in certain circumstances in the books of account. In Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 the Supreme Court observed that the relinquishment by the assessee of its remuneration after it had become due was of no effect and that the amount was liable to be taxed. The question that arises for consideration in this reference is whether the amount sought to be excluded had already accrued and subsequently been given up by the assessee. A claim was no doubt made by the assessee on the basis of the agreement entered into between the assessee and the Government by whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... terialised to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to his system of accounting. It was held that where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following the mercantile system of accounting. It was further observed that even if the assessee makes debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialised, there can be no liability to tax on hypothetical income. This court also had occasion to consider this aspect in CIT v. Kerala Financial Corporation [1985] 155 ITR 228. There it was held that if, on the construction of the transaction, income is found not to have arisen or accrued, any entry in the books of account showing accrual of income would not attract tax merely by reason of such entry. The Supreme Court in Sutlej Cotton Mill's Ltd. v CIT [1979] 116 ITR 1, observed that the way in which entries are made by an assessee in his books of account is not determinative of the question whether the assessee has earned any p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of income at source under any statute or by overriding title, then there is no income to the assessee. (6) The conduct of the parties in treating the income in a particular manner is material evidence of the fact whether income has accrued or not. (7) Mere improbability of recovery, where the conduct of the assessee is unequivocal, cannot be treated as evidence of the fact that income has not resulted or accrued to the assessee. After debiting the debtor's account and not reversing that entry-but taking the interest merely in suspense account cannot be such evidence to show that no real income has accrued to the assessee or has been treated as such by the assessee. (8) The concept of real income is certainly applicable in judging whether there has been income or not but, in every case, it must be applied with care and within well-recognised limits. Learned counsel for the Revenue has a contention that the amount had been transferred to the profit and loss account, and the amount once credited cannot be excluded in view of the method of accounting followed by the assessee. Learned counsel cited the decision of the Privy Council in CIT v. Kameshwar Singh [1933] 1 ITR 94. In t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en it is received. What the partners did in this case, as I have said, was to decide among themselves that what they had previously regarded as a liability of the firm they would not, for practical reasons, regard as a liability ; but that does not mean that at that moment they received something, nor does it mean that at that moment they imprinted upon some existing asset a quality different from what it had possessed before. There was no existing asset at all at that time. All that they did, as I have already pointed out, was to write down liability item in their balance-sheet, and how in the world by effecting that operation you can be said to have converted a sum received years and years ago into something which it never was, is a thing which, with all respect, passes my comprehension." In the case before the Madras High Court, the amounts were received during 1955 and 1959 as trading receipts. It was observed that the result of the transfer to the profit and loss account is merely to close that particular account and that did not, in any manner, affect either the rights of the assessee or its obligation to the tax department. It was further observed that there has been no ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rds the price of medicines supplied to the Director of Health Services during 1974-75 and 1975-76. That claim was made in accordance with the Government Order G. O. R1-34 dated October 10, 1975. The Government order was issued in pursuance of an indemnity bond executed by the assessee to the effect that, if the price structure fixed by the Government of India is lower than the rate now fixed by the firm, the excess payments will be adjusted against future supplies and if, on the contrary, the price fixed is higher, the balance amount can be claimed by the firm from the Government. It was on the basis of this indemnity bond and subsequent order of the Government that the assessee made the claim which was turned down by the Government. By that time, the amount had been included in the profit and loss account. In the proceedings under section 144B, the assessee filed a revised return claiming exclusion on the basis of the Government Order rejecting the claim. In these circumstances, the .Commissioner of Income-tax was right in observing that a mere claim cannot clothe the expectation with the character of income and that the treatment given by the assessee in his accounts in regard to ..... X X X X Extracts X X X X X X X X Extracts X X X X
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