1. This appeal has been filed by the department against the order dated 30-11-1981 of the Commissioner (Appeals), relating to the assessment year 1978-79, the previous year of which ended on 30-9-1977.
2. The assessee is a private limited company deriving income from resale of dyestuffs and chemicals, etc., for earning commission. During the previous year under consideration, the assessee sold some goods for and on behalf of Plastic Resins and Chemicals Ltd. In accordance with an agreement which was in force since September 1973, and became entitled to receive a commission of Rs. 53,982 from the said party. The assessee took credit of this amount in its books by debiting the amount to the aforesaid party. It filed the return before the ITO, accordingly. However, the assessee later came to know that Plastic Resins and Chemicals Ltd. was not at all in a position to pay any commission to the assessee. The assessee got this information from the balance sheet of Dhrangadhra Chemical Works Ltd. for the accounting year ending 31-3-1979. It may be stated that Dhrangadhra Chemical Works Ltd. was the holding company of Plastic Resins and Chemicals Ltd. In the aforesaid balance sheet, there was a note of the auditors to the following effect: The estimated realisable value of the fixed assets of Plastic Resins and Chemicals being lower than the amount due to secured creditors of that company, the amount due to this company from Plastic Resins and Chemicals Ltd. being unsecured loan amounting to Rs. 1,66,13,968 has been written off as bad and irrecoverable debt. Amounts due to the company from Plastic Resins and Chemicals Ltd. for supplies of materials, furnace oil and services and for arrears of interest aggregating to Rs. 1,00,31,063 was written off during 1978-79.
Since the holding company of the assessee's debtor had written off a huge amount of more than Rs. 1 crore as bad and irrecoverable and as the accumulated losses of Plastic Resins and Chemicals Ltd. far exceeded its paid-up capital and reserves, the assessee came to the conclusion that the commission of Rs. 53,982 will never be receivable by it. In other words, the assessee knew that it had made a mistake in taking credit for the aforesaid commission as if it were income whereas in reality, the said commission never resulted in or materialised into income. It so happened that the assessment for the assessment year 1978-79 was still open. Hence, the assessee filed a revised return on 13-11-1980 claiming that the commission of Rs. 53,982 was erroneously taken into account as income, and that the same never resulted in any income, and, hence, claiming that the said amount should be excluded from the income of the assessee. The ITO did not accept the claim of the assessee on the ground that the commission under consideration had already become receivable according to the mercantile system of accounting followed by the assessee, and that the assessee had actually taken credit of the same in its books of account. According to the ITO, even if the said commission is finally proved to be not receivable, it had still to be included in the income of the assessee. In this view of the matter, he taxed the sum of Rs. 53,982.
3. The assessee appealed to the Commissioner (Appeals) and contended that the action of the ITO was not justified. It was urged that the holding company of the assessee's debtor had recognised the hopeless financial position of Plastic Resins and Chemicals Ltd. and had written off a huge amount of more than Rs. 1 crore, and so, the question of the assessee ever realising the sum of Rs. 53,982 never arose at all.
Reliance was placed on the decision in the case of CIT v. Motor Credit Co. (P.) Ltd. [1981] 127 ITR 572 (Mad.). In that case, it was held that income cannot be said to have accrued merely on the ground that the assessee had been following the mercantile system of accounting, or merely because the assessee makes a debit entry to that effect. If no income has materialised, there cannot be a liability to tax on a hypothetical income. Reliance was also placed on the decision in the case of CIT v. Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC), wherein it has been held that only the real income and not hypothetical income is liable to tax under the Act. The Commissioner (Appeals) considered the above contentions. He agreed with the assessee that there was absolutely no chance of recovery of the commission under consideration, and no amount was, in fact, recovered till the date of order, namely, 30-11-1981. Respectfully following the decision in the case of Motor Credit Co. (P.) Ltd. (supra), he held that no real income has resulted out of the mere entries made by the assessee in its books of account, or from the mere system of accounting followed by the assessee. Hence, he directed the ITO to delete the sum of Rs. 53,982.
4. Aggrieved by the above decision of the Commissioner (Appeals), the department is in appeal before us. Shri M.N. Nambiar, the learned representative for the department, urged before us that the learned Commissioner (Appeals) erred in his decision. He stated that the commission under consideration had already accrued, due to the assessee, during the year under consideration and the same had been duly taken into account in the assessee's books. If they are subsequently found to be irrecoverable, then the proper course for the assessee was to write off the amount as bad debt and claim the same as such in a subsequent year. He pointed out that the assessee had, in fact, written off this amount in the assessment year 1980-81, and claimed it as bad debt in that year. He also stated that the ITO has, however, disallowed the assessee's claim for deducting the bad debt in the assessment year 1980-81, on the ground that it was premature. It appears that the matter rested there, because the Commissioner (Appeals) had allowed the claim of the assessee during the assessment year 1978-79, which is now before us. The point made out by Shri Nambiar is that once the income is accrued, it has to be taxed irrespective of the fact whether the said amount was found to be receivable or not at a later date. He relied on the decision in the case of Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC). He further referred to the decision in the case of CIT v. Confinance Ltd. [1973] 89 ITR 292 (Bom.) and urged that subsequent events could not undo the earlier accrual of income. Referring to the decision of Motor Credit Co. (P.) Ltd.'s case (supra), relied on by the Commissioner (Appeals), Shri Nambiar stated that the facts in that case were different inasmuch as there was no credit in the books of the assessee. Hence, he urged that the decision of the Commissioner (Appeals) deserved to be vacated and that of the ITO deserved to be restored.
5. Shri Ajay Thakkar, the learned representative for the assessee, on the other hand, supported the order of the Commissioner (Appeals). He stated that the theory of 'real income' was first enunciated by the Supreme Court in the case of CIT v. Chamanlal Mangaldas & Co. [1960] 39 ITR 8. In this case, it was held that the amount which arose or accrued and which the managing agent had the right to receive was not affected by the manner in which the entry was made. He then referred to the decision in the case of Shoorji Vallabhdas & Co. (supra), wherein the doctrine of real income was further elaborated by the Supreme Court. In this case, it was held that if income does not result at all, there cannot be a tax, even though in bookkeeping, an entry is made about a 'hypothetical income', which does not materialise. His point was that income liable to tax under the Act must be real income, but not hypothetical income. Further, the taxability of an item docs not depend upon the entries made in the books by the assessee. According to the assessee, no income materialised in this case, and so, the amount under consideration was not taxable even though the assessee erroneously made entries in its books. He strongly relied on the decision in the case of Motor Credit Co. (P.) Ltd. (supra) for the proposition laid down therein, namely, that no real income liable to tax would arise if the income did not materialise ultimately, even though there are entries to the contrary in the books of the assessee. Then he referred to the decision in the case of CIT v. Ferozepur Finance (P.) Ltd. [1980] 124 ITR 619 (Punj. & Har.), wherein a similar view has been taken. In this case, the High Court followed the principles laid down in Chamanlal Mangaldas & Co.'s case (supra), Shoorji Vallabhdas & Co.'s case (supra) and also the decision of the Bombay High Court in the case of H.M.Kashiparekh & Co. Ltd. v. CIT [1960] 39 ITR 706. In the last mentioned case, the Bombay High Court held that it was the income of the assessee that is liable to tax, and in ascertaining the real income, the fact that the assessee followed the mercantile system of accounting did not have any bearing. Finally, he referred to the decision of the Madras High Court in the case of CIT v. Devi Films (P.) Ltd. [1983] 143 ITR 386. In this case, the Madras High Court reviewed the earlier decisions on the subject. The High Court followed the decisions in the cases of Motor Credit Co. (P.) Ltd. (supra) and H.M. Kashiparekh & Co. Ltd. (supra). They also cited in support the decision in the case of Ferozepur Finance (P.) Ltd. (supra). They have distinguished the case of Morvi Industries Ltd. (supra). Further, they have referred to the decision in the case of Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC). Shri Ajay Thakkar strongly relied on this decision for the proposition that where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following mercantile system of accounting, and even if the assessee makes a 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 a hypothetical income. The question whether real income has materialised 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. He also referred to the decision in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC) for the proposition that whether the assessee is entitled to a particular deduction or no will depend on the provisions of law relating thereto and not on the view which the assessee might take on its rights; nor can the existence or absence of entries in his books of accounts be decisive or conclusive in the matter. Shri Ajay Thakkar urged that the above principle equally applies to items sought to be taxed as income, 6. We have considered the contentions of both the parties as well as the facts on record. The question that is raised in this appeal is as to whether the sum of Rs. 53,982 credited by the assessee in its books of account as commission receivable from Plastic Resins and Chemicals Ltd. can be taxed as accrued income in the hands of the assessee. The principles relating to the theory of real income are now well settled.
The Madras High Court in the case of Devi Films (P.) Ltd. (supra) has laid down these principles after considering the previous case law on the subject. The principles laid down by the Madras High Court are that the liability to taxation is based on the statute and an assessee is not liable to be taxed because of his mistake. Accounting entry does not create any estoppel as against the assessee and in favour of the department. The theory of real income being liable to taxation, is not based on any accounting principle or accounting entries. The question whether real income has materialised to the assessee has to be considered with reference to commercial and business realities of the situation, and not with reference to the system of accounting followed by the assessee or the entries made by him in the books according to his understanding. These principles are culled out from the decisions of the Supreme Court in the cases of Chamanlal Mangaldas & Co. (supra), Shoorji Vallabhdas & Co. (supra) and Poona Electric Supply Co. (supra).
In this case, the Madras High Court considered and approved their earlier decision in the case of Motor Credit Co. (P.) Ltd. (supra). In that case, the assessee was doing the business of financiers under hire purchase scheme. Money had been advanced to a party carrying on bus transport business. The routes of that party were taken over by the State transport corporation. The party defaulted in making the payments of the instalments. The assessee saw that there was no prospect of recovering even the principal amount. It did not, therefore, credit any entry due from the party even though it followed the mercantile system of accounting. The ITO, however, included the accrued interest in the total income of the assessee. The Tribunal deleted the same. On a reference, the Court upheld the decision of the Tribunal. It observed that though the assessee had adopted the mercantile system of accounting, no interest could be assessed in its hands on accrual basis as it would be very unrealistic on the part of the assessee to take credit for a highly illusory interest. In the case of Devi Films (P.) Ltd. (supra), the assessee had advanced some money to a film producer.
The arrangement was that the assessee would receive the distribution rights of the film, and will be entitled to distribution commission.
Out of the realisations, the assessee was to deduct the distribution commission and apply the balance towards the principal amount advanced by him. The assessee found that the realisation was so poor that even the principal amount could not be recovered. It had made entries in its books of account, for three years in succession crediting the distribution commission receivable by it, and debiting the film producer's account, in which the original advance was also debited. The case of the assessee was that it was not in a position to realise even the principal amount and so there was no question of getting any distribution commission at all. Even though he had made entries in its books of account as if the distribution commission has accrued and receivable by it, the assessee argued that those entries did not result in or materialise into real income; hence, they could not be taxed. The Tribunal upheld the claim of the assessee, and the High Court upheld the decision of the Tribunal, observing that the case of Motor Credit Co. (P.) Ltd. (supra) broke new ground. The theory of real income had so far been applied only in two types of cases, namely (i) where there was a surrender of income which may in theory have accrued, and (ii) where there is a diversion of income by overriding title. In the case of Motor Credit Co. (P.) Ltd. (supra), the theory of real income was extended to a third category, namely, where in reality no income accrues. In such a case, neither the entries made in the books, nor the system of accounting followed by the assessee can convert a hypothetical income into a real one liable to tax. The High Court distinguished the case of Morvi Industries Ltd. (supra) on the ground that the said Supreme Court decision turned on the fact that the relevant resolution was passed after the accounting year, when the commission had accrued, and that case was not concerned with the theory of real income vis-a-vis the method of accounting followed by the assessee.
7. In our opinion, the aforesaid principles support the case of the assessee. The facts of the case before us are that it was entitled to certain commission as a result of an old agreement. The assessee credited the commission amount in its books. However, it later on discovered that the commission was not realisable at all and so it remained illusory. After looking into the resolution passed by the holding company writing off a debt of more than Rs. 1 crore and looking into the balance sheet of Plastic Resins and Chemicals Ltd., wherein the accumulated losses far exceeded the paid-up capital and reserves, no reasonable man can entertain any hope of recovery of any debt from that party. In such a case, two courses were open to the assessee. If the assessment is still open, then it could file a revised return under Section 139(5) of the Income-tax Act, 1961 ('the Act') claiming that the commission wrongly credited in the books as income was, in fact, not income and should be excluded from the computation of total income.
The assessee did exactly this. The other course of action open to the assessee was to write off the amount in a subsequent year, and claim it as a bad debt. If the assessment of the year under consideration was already complete, then there would have been no choice left to the assessee, but to claim it as bad debt in a subsequent year. In our opinion, the two courses are not mutually exclusive. Both the remedies are available to the assessee if the assessment is still open. As stated earlier, the assessment was still open in this case, and so, the assessee filed a revised return claiming that the commission did not materialise in any real income at all. Following the various authorities referred to earlier, and the case of Devi Films (P.) Ltd. (supra), in particular, we hold that the claim of the assessee in the revised return filed by it was well-founded, and has been rightly accepted by the Commissioner (Appeals).
8. We have considered the arguments of the learned representative for the department. The mere fact that no credit entry was made in the books in the case of Motor Credit Co. (P.) Ltd. (supra), did not make the facts of that case distinguishable from that of the case before us.
Nothing turned on the fact as to whether an entry was made in the books or not. The question was whether income had resulted or materialised in a commercial sense. Similarly, the case of Morvi Industries Ltd. (supra) is also distinguishable on the same reasons as stated by the Madras High Court in the case of Devi Films (P.) Ltd. (supra) and reproduced earlier. In the case of Confinance Ltd. (supra), the Bombay High Court was considering whether in a case where the assessee was following the mercantile system of accounting, interest accrued but not received could be brought to tax. That case was not concerned with the theory of real income. Hence, this case is of no help to the department. On the contrary, there are certain observations therein which are in keeping with the principles already stated earlier, and helpful to the assessee. The Court had observed that in examining any transaction, the Court would have more regard to the reality of the situation rather than the purely theoretical or doctrinaire aspect of it, and greater emphasis will be laid on the business aspect of the matter viewed as a whole when that can be done without disregarding the statutory language. In the case before us, no prudent businessman can expect to receive any part of the commission under consideration after the aforesaid resolution passed by the holding company of the assessee's debtor. If one takes the realities of the situation into account, the commission under consideration cannot, in our opinion, be regarded as real income in accordance with the principles laid down by the aforesaid authorities.
9. In the result, we uphold the order of the Commissioner (Appeals), and dismiss the appeal.