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TMI Blog1964 (4) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... ducing the profits of the business for the year in question. The appeal, therefore, must be allowed and the answer to the question referred to the High Court will be in the affirmative - - - - - Dated:- 16-4-1964 - Judge(s) : K. SUBBA RAO., J. C. SHAH., S. M. SIKRI JUDGMENT The judgment of the court was delivered by SHAH J.----The respondents are a firm constituted under a deed dated December 12, 1947. The firm originally consisted of three partners : K. N. Damodara Mudaliar, A. Krishnaswami Mudaliar and V. Thangaraja Mudaliar. K. N. Damodara Mudaliar acquired for the firm for Rs. 1,00,000 the exploitation rights which were to enure for four years in a cinematograph film Apoorva Chinthamani for the North Arcot, the South Arcot and the Chingleput Districts and for Pondicherry. For the period December 25, 1947, to August 2, 1948, which was " the previous year " corresponding to the assessment year 1949-50 the firm filed a voluntary return declaring that Rs. 28,643 were earned by the exploitation of the film. In the statement submitted by the firm the total receipts credited in the firm's books were Rs. 1,46,849 and against that amount were debited Rs. 18,206 as e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alone challenged and it was submitted that the sum of Rs. 4,000 was the true value of the assets at the end of the previous year, Damodara Mudaliar the retiring partner having relinquished his rights repre senting half share for Rs. 2,000 only. The Appellate Assistant Commissioner rejected the contention, holding that the valuation of the exploitation rights for the unexpired period in the deed of dissolution dated August 15, 1948, was " dictated by extra-commercial considerations ", and confirmed the valuation of Rs, 65,000 made by the Income-tax Officer. Even in appeal to the Income-tax Appellate Tribunal, Madras, the respondent firm merely contended that the valuation of the exploitation rights for the unexpired period was excessive. The Tribunal partially upheld the plea, and reduced the valuation to Rs. 40,000 as on August 2, 1948, and directed modification of the assessment on that footing. Pursuant to an order issued by the High Court of Madras in a petition under section 66(2) the Tribunal stated the case and referred the following question : " Whether on the facts and circumstances of this case the Tribunal was justified in applying the proviso to section 13 of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecalled that the Income-tax Officer had in the order of assessment observed that the firm had not made a stock valuation of the film and had merely taken the excess collection over the purchase value and had submitted its return of income on that basis. No express order was recorded by the Income-tax Officer that in his opinion the income, profits or gains of the business could not properly be deduced from the method of accounting employed by the firm, but it is implicit in what is stated by him that without valuation of the unexpired exploitation rights the profits of the year of account could not be computed. With this view, it appears, the Appellate Assistant Commissioner agreed. In appeal to the Appellate Tribunal the only plea raised was that the Income-tax Officer had erred in estimating the value of the unexpired exploitation rights at Rs. 65,000. That was partially accepted, and the value was reduced to Rs. 40,000. It is difficult to appreciate how any question about the regularity of the proceedings of the Income-tax Officer by the adoption of the mercantile system of accounting and by the application of the proviso to section 13 of the Income-tax Act arose from the ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Tribunal in paragraph 15 of the statement of the case : "In all trading cases the true profits cannot be deduced from any system of maintaining accounts, whether cash or mercantile, unless the opening and closing stocks are brought into the picture at cost or market price whichever is lower it will not avail an assessee to say that in his cash system, he had not made any profit on his cash sales till all his stock is disposed of. Income-tax is an annual levy and the profits of each year require to be ascertained for that Purpose as accurately as circumstances permit. If, therefore, in any system of accounting maintained by the assessee, otherwise acceptable, the stocks are left out of account, the aforesaid proviso, it is humbly submitted, necessarily has to be invoked even if it were for the sole purpose of adjusting the book figures for the stock figures." Correctness of this view especially in the context of a trading venture by the exploitation of a wasting asset, but which is the assessee's stock-in-trade, falls to be considered. Section 13 of the Indian Income-tax Act was incorporated for the first time in the income-tax legislation in India by the Income-tax Act, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed and to determine whether the income, profits and gains of the assessee could properly be deduced therefrom. But the section only deals with the computation of income, profits and gains for the purposes of sections 10 and 12 and does not purport to enlarge or restrict the content of taxable income, profits and gains under the Act. Section 2(15) of the Act defines " total income " as meaning total amount of income, profits and gains referred to in sub-section (1) of section 4 computed in the manner laid down in the Act. Section 4(1) lays down what income shall be included in the total income, and sections 10(2), 12(2), 12B(2), 14, 15A, 15B, 15C, and 16 prescribe the manner of computation of income, profits and gains in different circumstances, and also prescribe special exemptions. Section 13 does not directly impinge upon the application of these provisions : it merely prescribes that the computation of taxable profits shall be made according to the method of accounting regularly employed. Where in the opinion of the Income-tax Officer the income, profits and gains cannot properly be deduced from the method of accounting, it is open to the Income-tax Officer to compute the inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commencement or at the close of the year is taken, according to the mercantile method actual cash receipts during the year and the actual cash outlays during the year are treated in the same way as under the cash system, but to the balance thus arising, there is added the amount of the outstandings not collected at the end of the year and from this is dedncted the liabilities incurred or accrued but not discharged at the end of the year. Both the methods are somewhat rough. In some cases these methods may not give a clear picture of the true profits earned and certainly not of taxable profits. The quantum of allowances permitted to be deducted under diverse heads under section 10(2) from the income, profits and gains of a business would differ according to the system adopted, This is made clear by defining in sub-section (5) the word " paid " which is used in several clauses of sub-section (2) as meaning actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under section 10. Again where the cash system is adopted, there is no question of bad debts or outstandings at all, in the case of mercantile system against the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the department had done was to make the assessment on the basis that the system of accounting adopted by the assessee was mercantile system which the assessee had never adopted, and thereby computed the profits of the assessee, by taking into consideration valuation of the closing stock which was not an incident of the cash system. The Income-tax Officer had in the view of the High Court no power under the proviso to section 13 " to force a different system on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock. " In coming to that conclusion, in our judgment, the High Court erred. Note the facts : an amount of Rs. 1,00,000 was paid by the firm for acquiring a wasting asset, which was to be exploited for the benefit of the partnership. The price paid for acquiring the asset was debited as an outgoing. At the end of the year there was a total collection of Rs. 1,46,849, by the exploitation of the asset. The expenses for carrying on the business amounted to Rs. 18,206. The result according to the respondent firm was a net profit of Rs. 28,647. This was arrived at by posting the outgoing for acquiring its stock-in-trade as a proper ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the system, whether it is cash or mercantile, as observed by Croom-Johnson J. in a trading venture it would be impossible accurately to assess the true profits without taking into account the value of the stock-in-trade at the beginning and at the end of the year. Reference may also be made to Whimster and Co. v. Commissioners of Inland Revenue in which Lord President Clyde observed at page 823: " In computing the balance of profits and gains for the purposes of income-tax, . . . two general and fundamental commonplaces have always to be kept in mind. In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income-tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ke the requisite adjustments, and even appropriate modification of the rule suggested by Fletcher-Moulton L.J. to ascertain the taxable profits. It is true, as observed by Lord Buckmaster in Naval Colliery Co. Ltd. v. Commissioners of Inland Revenue, that the principle of determining the profits of the trade by valuing everything at the beginning and at the end of the accounting period and by finding the difference may not be universally applicable in all cases, and needs material modification. The formula suggested in the Spanish Prospecting Co.'s case was sought to be applied to a case in which excess profits duty was assessed. The assessee, a mining company, was unable to work its colliery on account of a strike. The assessee sought to introduce into its account which normally ended on June 30, 1921, the estimated expenses for repairing the damage (which though arising in the account period was restored later) on the plea that the expenses were in the nature of liability of business and properly debitable before they were actually incurred. The House of Lords rejected that contention. It was in this context that Lord Buckmaster observed that the accountancy rules applicable to w ..... X X X X Extracts X X X X X X X X Extracts X X X X
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