N.K. Agrawal, J.
1. The following question of law has been referred by the Income-tax Appellate Tribunal (for short 'the Tribunal'), at the instance of the Department under Section 256(1) of the Income-tax Act, 1961 (for short, 'the Act') :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that Rs. 1,45,490 received by the assessee under post warranty services charges was not assessable in the assessment year 1978-79 and, therefore, the Commissioner of Income-tax had no jurisdiction to pass order under Section 263 ?'
2. The assessee was engaged in the purchase and sale of Massey Fergu-son Tractors and Royal Enfield Motor Cycles and their parts, besides doing repairing of tractors and motor cycles. The assessee filed a return of income for the assessment year 1978-79 (accounting year ending on June 30, 1977), declaring income of Rs. 1,11,190. The assessee had shown, in its balance-sheet, a sum of Rs. 2,01,236 on the liabilities side under the head 'Post warranty service advances' (P. W. S. advances). The assessee had received advances from the buyers of tractors to cover the service charges of tractors for a period of one year after the expiry of the warranty period of one year. The assessee explained before the Assessing Officer that there was an obligation on the part of the assessee to provide free services to the tractors under warranty for one year as required by the manufacturers. After the expiry of the warranty period of one year, further period of one year was also covered by the assessee for servicing the tractors and, for those services of the post-warranty period, the assessee received money from the buyers.
3. The Assessing Officer examined the quarterly receipts of the money and looked into the period covered by each quarterly receipt and treated, on proportionate basis, a sum of Rs. 15,953 as the income of the assessee.
4. The Commissioner of Income-tax took notice of the assessment under Section 263 of the Act on the ground that the assessment order was erroneous and prejudicial to the interests of the Revenue. The Commissioner's suo motu action under Section 263 of the Act was primarily based on the belief that the money collected by the assessee under the PWS Scheme was in the nature of trading receipt during the year in which it was collected from the buyers. Since the assessee had credited that amount to the account styled 'P. W. S. Advances Account' and had taken the credit balance to the balance-sheet, the Commissioner took the view that it should form part of the assessee's trading receipt of the year under assessment. The Commissioner noticed that a credit balance of Rs.55,746 was brought forward from the preceding year (1977-78} in the aforesaid account and the sum of Rs. 1,64,810 received by the assessee from the customers towards P. W. S. charges during the year under assessment was further credited. A sum of Rs. 19,320 was shown as outgoings under that head. The balance or the net amount was, however, not taken to the profit and loss account but directly to the balance-sheet. The Commissioner, therefore, held that these were trading receipts directly connected with the business of servicing and repairs of tractors. Service charges received in advance would not alter its character as income. The Commissioner set aside the assessment order and directed the Assessing Officer to reframe the assessment.
5. In appeal filed by the assessee, the Tribunal held that the view taken by the Assessing Officer was correct. The Assessing Officer had actually treated, as income of the year, 75 per cent. of the amount received by the assessee for the quarter ending September 30, 1975, 50 per cent. of the amount received for the quarter ending December 31, 1975, and 25 per cent. of the amount for the quarter ending March 31, 1976. Thus, the Assessing Officer included Rs. 15,953 only to the assessee's income. The money received by the assessee became income at the time when service was rendered by the assessee to the buyers. The assessee did not become the owner of the amount or could not appropriate it till service was rendered in lieu of which money was received in advance.
6. Shri B. S, Gupta, learned senior counsel for the Department, has argued that the view taken by the Commissioner was appropriate inasmuch as money had been received by the assessee as a consideration for the services to be rendered by it. There was no dispute that the assessee had provided free service to the purchasers of the tractors for one year from the date of purchase and had agreed to provide further service for the next one year under the P. W. S. scheme. Though the P. W. S. charges were received at the time of the sale of the tractors, those were not part of the sale price. The purchasers, who desired to avail of the scheme known as 'P. W. S. scheme' for one year after the expiry of the warranty period, paid money towards the charges under that scheme at the time of the purchase. Though it was not part of the sale price but a voluntary payment to join the P. W. S. scheme, it was a trading receipt in the hands of the assessee. Shri Gupta has argued that accrual of income cannot follow the receipt of money. If once the money was received and there was no dispute that it was a revenue receipt, there would be the only conclusion that it was assessable in the year of receipt.
7. The assessee is maintaining its accounts on the mercantile system. If the accounts are so maintained, whenever the right to receive money in the course of a trading transaction accrues or arises, the income is deemed to accrue or arise. Where the accounts are maintained on cash basis, receipt of money and not the accrual of the right to receive is the determining factor. Income is liable to be taxed on the basis of its accruing or arising to the assessee or its receipt by the assessee during the relevant previous year. The accrual or arising of income is dependent on the method of accounting employed by the assessee. In the cash system of accounting, the accrual or arising of the income will be simultaneous with its receipt. Under the mercantile system of accounting, the accrual of income is independent of its receipt. The regular mode of accounting determines the mode of computing the taxable income and the time at which the tax liability is attracted. Where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee was following the mercantile system of accounting. The taxability normally depended upon the system of accounting followed by the assessee. Even in the case of an assessee following the mercantile system of accounting, a mere claim by the assessee in respect of an amount without the right to claim cannot form the basis for taxability. Where the assessee followed the cash system of accounting, the taxability is to be based on receipt basis and not on accrual basis.
8. The incidence of tax is in accordance with the provisions of the Income-tax Act. Receipt, either actual or deemed, is not made a condition precedent to taxability. The profits or gains are taxable if they have accrued or arisen or are, under the Act, deemed to have accrued or arisen to the assessee in the accounting year. Generally speaking, income must accrue first, receipt normally follows the accrual. In other words, the right to receive must come into existence before the actual receipt takes place. Receipt, by itself, is not sufficient to attract tax. It is only receipt as 'income' which would attract tax. Every receipt by the assessee is, therefore, not necessarily income in his hands. It bears the character of income at the time when it accrues in the hands of the assessee and then it becomes exigible to tax.
9. What is relevant to determine whether money received was income or simply an advance, is the initial character of the receipt and not the head under which the amount is credited in the books of account. If no income has resulted, it cannot be said that income accrued merely on the ground that the assesses had been following the mercantile system of accounting. In a case of sale, title to 'immovable property of the value of rupees one hundred or above' passed to the transferee only when the sale deed was executed and registered. But, the title to movables passed when they were delivered to the transferee. In a case of rendering of service, income would accrue at the time of such rendering.
10. In the case of the assessee before us, money was paid by the buyers towards P. W. S. charges. Services were required to be rendered by the assessee for one year after the expiry of the warranty period, that is to say, one year after the date of receipt of money. The assessee was also bound to refund the deposit to a member of the scheme if that member so desired. The assessee had refunded a sum of Rs. 19,320 to those persons who did not want to continue as members of the scheme. Every receipt was thus not necessarily income.
11. Shri B. S. Gupta, learned senior counsel for the Department, has argued that accrual could not occur after receipt. It was admittedly a revenue receipt. The only dispute was as to when it was liable to be assessed. If the assessee had to refund any money, he could claim deduction at that time. Since the assessee was following the mercantile system of accounting, the receipt was liable to be assessed in the year in which it accrued.
12. Shri Gupta has drawn our attention to certain decisions which we shall hereinafter refer to.
13.The Andhra Pradesh High Court in Badri Narayan Balakishan v. CIT : [1965]57ITR752(AP) , was looking into a case of an assessee who had collected, as a commission agent, certain money by way of sales tax from customers to whom sales had been made on commission. The collections, so made, were credited to a separate account called the 'deposit account' and not treated as part of the sales-proceeds. It was held that the amounts were part of every transaction and formed part of the price charged by the assessee. The amounts were consequently assessable as trading receipts.
14. The Delhi High Court in CIT v. Motor and General Finance Ltd. : [1974]94ITR582(Delhi) , was once examining the case of a company which carried on the business of distribution of cinema films. Under clause 2 of the agreement with a sub-distributor for the exhibition of pictures, the sub-distributor was to deposit a sum of Rs. 5,000 for each picture. Under clause 3, an advance of Rs. 32,500 on each costume picture and Rs. 25,000 for each social picture were to be paid. It was held that both the amounts were received on capital account.
15. The third case on which Shri Gupta has placed reliance is also from the Delhi High Court in Uttam Singh Duggal and Co. P. Ltd. v. CIT : [1981]127ITR21(Delhi) . There, the assessee had received certain money in the calendar year 1957 during which no work was done and received certain more money in the next calendar year during which work was done for 12 months. The assessee treated both the amounts as loans or advances when received, and debited the expenditure involved in providing the shuttering in the profit and loss account. It did not bring the entire amount as a receipt in the year 1958 but credited the amount to the profit and loss account in 1959 on the ground that the actual accrual took place only when the work was completed. It was held that in the year 1957, when the work had not started, the first instalment received by the assessee could be treated as an advance payment but, when the work was actually done in the year 1958, the amounts received had to be accounted for in the profit and loss account as being payment for work done. The income had accrued and was also received by the assessee. The condition that if the assessee failed to perform the work in time that amount was refundable was a kind of penalty and did not affect accrual. In the event of the amount becoming refundable due to a default, the question, whether it had to be written back in the accounts, will have to be considered.
16. The Bombay High Court in CIT v. Batliboi and Co. Pvt. Ltd. : [1984]149ITR604(Bom) , had also an occasion to examine a case of a dealer in machinery. He used to debit deposits from intending purchasers of machinery which were later adjusted towards the purchase price of the machinery sold. The surplus deposits were not generally refunded to the customers. Such excess deposits, which the assessee was unable to refund to the customers, were transferred to the profit and loss account. However, the assessee claimed before the Income-tax Officer that the amount, so transferred, did not represent a taxable receipt. The Income-tax Officer negatived the claim of the assessee. The Appellate Assistant Commissioner held that the amounts having been originally received as deposits were impressed with the character of trust money and, as such, were not taxable receipts. It was held that the excess deposit was not held by the assessee for the benefit of the depositors but it was in respect of a specific transaction of sale. It was adjustable towards purchase price of the machinery sold and had a close connection with the transaction of sale. Since the assessee had transferred the excess deposits remaining in its hands, to the profit and loss account, it was assessable to tax as a trading receipt.
17. This High Court has also examined a case of deposit in Punjab Steel Scrap Merchants' Association Ltd. v. CIT . The assessee, in that case, was a dealer in scrap iron and received from its constituents, deposits in round figures in advance for the supply of scrap they required, If the price of scrap iron was more than the amount deposited, the assessee recovered the excess. Where the price of scrap iron delivered was less than the amount deposited and a surplus remained with the assessee, the constituents did not sometimes claim the excess amount. The unclaimed credit balances over three years old were transferred by the assessee to its profit and loss account. It was held that amounts were payments towards price of scrap iron which was to be supplied to the constituents and were essentially trading receipts.
18. As has been seen from the facts arising in the case of the assessee in hand, the assessee had made adjustment of the amount received from the P. W. S. advances account to the workshop income account during the quarter in which the work of repairs and servicing was done. The amount, received one year earlier, was thus not relevant to the assessee's income and was dependent upon the services rendered by the assessee. The assessee did not become the owner of the amount and could not appropriate it till service was rendered in lieu of which it was received in advance. The assessee could legally claim the amount after rendering the services. Part of the amount could be treated as income in the year under assessment on the basis of the accrual of the right to appropriate the money. The deposited amount was transferred as income as soon as service was rendered. The assessee treated the amount received as income by transferring it to the workshop income account. Thus, adjustment of the advance money towards income was made, keeping in view the period in which actual services were rendered. The question is as to when the money is to be treated as income. Since the receipt was relate-able to a particular period in future, it would fructify and mature into income during that period and not earlier. The assessee was regularly following the system of adjustment. The money received from the buyers could not be treated to be income unless the right to appropriate it towards the services had accrued or arisen. So long as the right did not exist, the money received from the buyers remained advance money. It is the appropriation of the money towards the object and purpose for which it was received, which is relevant.
19. The deposits or advances received by the assessee became trading receipts when the assessee became entitled to appropriate the same to its income at the time of rendering the service. The question is answered in the affirmative, i.e., against the Revenue and in favour of the assessee.