1. These two appeals by the assessee were heard together and are disposed of by a common order.
2. The assessee, a company in which the public is not substantially interested, is engaged in the business of generally fabricating and installing machinery, on contract basis. Its customers include Bharat Petroleum Corporation Ltd., Hindustan Petroleum Corporation Ltd., Rashtriya Chemicals & Fertilisers Ltd., Kribhco, Cochin Refineries Ltd., Madras Refineries Ltd., etc. The modus operandi is that its customers place purchase orders on the assessee for the fabrication of various items of machinery. Having regard to the highly technical nature of the work involved, the purchase orders invariably consist of a plurality of jobs, each of which is given a separate identification number. Once the purchase orders are placed by the customers on the assessee and the constituent jobs identified, the assessee-company prepares various designs and drawings and sends them on to its customers for their approval. On the said drawings and designs being approved, fabrication work starts. This task entails, inter alia, the purchase of raw materials locally. At times, the raw materials are imported by the assessee from abroad.
3. The terms and conditions on which the purchase orders are to be executed are in some cases contained in the purchase orders themselves.
In certain other cases, the terms and conditions are incorporated in a separate document. It is unnecessary to notice in detail the various terms and conditions under which the purchase orders are executed by the assessee for its customers. It would suffice if we note one particular condition which has given rise to the controversy before us; and that condition relates to "delayed delivery" of the machinery concerned. In all the contracts, the stipulated delivery period is guaranteed, the delay in the delivery inviting a penalty calculated at a certain percentage for each week of delay, subject to the maximum of the stipulated percentage of the value of either the undelivered portion of the machinery or even in some cases of the value of the purchase order. Thus, for example, the purchase orders of Bharat Petroleum Corporation Ltd. stipulated: Delivery period quoted is guaranteed under a penalty leviable @ % per week of delay, subject to a maximum of 5 per cent of order value.
The purchase orders of Rashtriya Chemicals and Fertilisers Ltd., on the other hand, stipulates: In case of delayed delivery of equipment/material, total price shall be reduced @ 0.5 per cent per complete week of delay, subject to a maximum of 5 per cent.
4. Having thus ensured that the stipulated delivery period was strictly adhered to on pain of stipulated pecuniary penalty for delayed delivery, the customers naturally retained for themselves the discretion not only to extend the stipulated period of delivery, but also to waive, either wholly or in part, the penalty leviable under the delayed delivery clauses. And, in the very nature of things, delays did occur in the delivery of the machinery, with the result the assessee became liable to pay the prescribed penalty. It is also a matter of record that the assessee did approach its customers to have the penalty payable under the delayed delivery clauses waived wholly or in part. At times, it succeeded in its attempt, and at others it failed.
5. We may now notice the mode and mechanics adopted by the assessee for purposes of raising bills for the purchase orders executed by it against its customers. As already pointed out, each purchase order consisted of various jobs. Having regard to the large sums of money involved in each purchase order, the assessee was naturally raising what are popularly known as "part bills" in respect of the various jobs executed by it. Initially, it would appear, the bills were raised in respect of the entirety of the value of the job done, and the entire bill amount was credited to contract billing account. If the assessee's customers did not enforce the delayed delivery clause, no difficulty arose, because no further adjustment entries needed to be passed. In cases where the customers enforced the delayed delivery clause, the amount of the cut or deduction enforced by them used to be debited to the profit and loss account. Subsequently, the assessee introduced a slight modification. It no doubt raised bills against its customers for the 100 per cent of the value of the job done. Simultaneously, however, it transferred the penalty amounts payable under the delayed delivery clause to sundry debtors' account.
6. Later on, another variation was tried. Under this method, it raised bills against its customers in respect of only 95 per cent of the value of the job done. This obviously meant that the assessee had left out of reckoning the penalty of the maximum of 5 per cent leviable under the delayed delivery clauses.
7. In some other cases, on the assessee's giving a bank guarantee to the required extent, the customers used to pay the invoice amount in full, leaving the penalty matter to be decided separately.
8. In the context of its assessment to income-tax, the assessee was naturally faced with the problem of the treatment to be given to the penalty that it had rendered itself liable to pay, owing to the delay in the delivery of the machinery. Initially, it would appear, the assessee was claiming revenue deduction in respect of the penalty payable under the delayed delivery clause only in the year in which the waiver was determined. Subsequently, the assessee set up a claim that, the penalty payable under the delayed delivery clause being automatic and, what was more, the waiver, wholly or in part, of the penalty payable being entirely a matter of its customers' discretion, it was entitled to revenue deduction, on accrual basis, in respect of the entirety of the penalty payable by it under the delayed delivery clause. Should the customers subsequently waive the penalty, wholly or in part, then the amount waived would be accounted for in the accounts relating to the previous year in which the penalty matter was finally decided, and offered Yor taxation in the assessment year(s) concerned.
9. We may now notice what exactly happened in the previous year relating to the assessment years 1984-85 and 1985-86, now before us.
10. In its accounts relating to the accounting period ending on 31-3-1984 (being the previous year relevant to the assessment year 1984-85), the assessee had debited its profit and loss account with a sum of Rs. 9,70,389 under the head "Liquidated damages", the term signifying the penalty payable by the assessee in certain cases under the delayed delivery clause. It had also transferred to sundry debtors account a sum of Rs. 13,55,556. As pointed out earlier, the said adjustment was made on the footing that, the contract building account having been credited with 100 per cent of the value of the Job done and the assessee being automatically liable to pay penalty under delayed delivery clause, income to the extent of the sums transferred to the sundry debtors account did not accrue to the assessee.
11. In some other cases, it had billed its customers with 95 per cent of the value of the job done. Here again, the assessee's point was that what with the delayed delivery clause operating against the assessee, 5 per cent of the job value did not accrue to it.
12. Thus an aggregate sum of Rs. 26,77,120, according to the assessee, did not represent its income.
13. As respects the accounting year ending on 31-3-1985 (being the previous year relevant to the assessment year 1985-86), an aggregate sum of Rs. 20,79,590 represented "liquidated damages" payable by the assessee under the delayed delivery clause, and, according to the assessee, was, as such, not exigible to tax.
14. Clearly, the assessee's case was that, the penalties stipulated under the delayed delivery clause being payable in full by the assessee, unless waived, wholly or partly, by its customers in their absolute discretion, an enforceable present liability to pay the penalty had accrued, and that, consequently, the assessee was entitled to leave the said sum out of reckoning for purpose of computing its taxable income.
15. The aforesaid arguments did not find favour with the Assessing Officer who was in this regard impelled by the following considerations: (a) The delayed delivery clause in the agreement does not state that the entire amount of the contract wall not accrue to the assessee if there is a delay. It only states that if the assessee fails to execute the order by the specified date, the customer shall have the right to recover from the assessee as penalty 1/2 per cent of the order value per week of delay, subject to a maximum of 5 per cent of the order value/total price. Thus, the clause only states that the customer has a right to impose a penalty for delay in delivery. Any delay in delivery of the goods does not automatically mean that the assessee will have to forego 5 per cent of the contract value.
(b) The assessee's contention that 100 per cent of the order value does not accrue to the assessee, is not correct. 'The assessee itself used to raise invoice for 100 per cent value of the contract.
For Excise and Sales-tax purposes also 100 per cent of the contract amount is taken into account. For Income-tax purposes, the assessee thereafter makes a reverse entry for 5 per cent of the contract amount, which is not correct for the reasons mentioned above.
(c) The Allahabad High Court has held in CIT v. Lachhman Das Mathura Das [1980] 124 ITR 411 4 Taxman 16 that the provision of reduction in the contract price by 1/2 per cent per week of contract value in the case of delay is not a liability in praesenti The Commissioner of Income-tax (Appeals), Madras VI, in his order in IT Appeal No. 137 of 1984-85 dated 15-3-1985 in the case of Seshasayee Industries Ltd. for the assessment year 1983-84 upheld a disallowance of Rs. 12,85,687 on similar grounds.
16. The Assessing Officer, therefore, brought to charge a sum of Rs. 26,77,120 in the assessment for the assessment year 1984-85. In the assessment for the assessment year 1985-86, though the aggregate "liquidated damages" was Rs. 20,79,590, the Assessing Officer, taking into account the fact that a sum of Rs. 4,45,286 out of the said sum was included in the sum of Rs. 26,77,120 brought to charge in the assessment for the assessment year 1984-85, restricted the addition to Rs. 16,34,304.
17. The assessee was unsuccessful before the first appellate authority on this issue. The considerations which weighed with him in this regard were: (i) The delayed delivery clauses give the customers only a right to impose a penalty in case of delay. The customers may or may not make use of the right. The waiver of the penalty imposable being left to the discretion of the customers, and the customers having in some instances actually waived wholly or in part the penalty leviable, the case could not be regarded as one providing for automatic levy of penalty. Consequently, there was no question of the liability to pay the penalty arising merely because there was delay in the delivery of goods. "As and when the matter is finally settled...the appellant would be entitled to deduct the amount as settled by the party concerned".
(ii) The Allahabad High Court in Lachhman Das Mathura Das's case (supra) held that, before a claim for damages can be allowed even in cases where the assessee follows, the mercantile system of accounting, the liability must be inpraesenti i.e., it must be an actual liability and not one which may arise in future... The facts in the present case are identical...In view of the decision of the Allahabad High Court, the appellant is not entitled to deduct the sum...
(iii) All along it was the practice of the assessee to credit the contract billings account with the full invoice value of equipments supplied to parties. But during the previous year relevant to the two assessment years under consideration, the assessee made a departure from the said practice. In some instances, having credited the contract billings account with the full invoice value, the assessee subsequently transferred 5 per cent of the invoice value to sundry debtors account. In some cases, it credited the contract billings account with 95 per cent of the invoice value only. In certain other cases, having credited the contract billings account with the full invoice value, the assessee debited, on accrual basis, 5 per cent of the value of the invoices to the P. and L. A/c. The said departure from the practice followed all along by the assessee could not be explained otherwise than by the fact that, in the relevant years of account, the assessee's income had gone up considerably. Hence, the departure could not be countenanced.
(iv) The delayed delivery clauses restricted the penalty leviable to a maximum of 5 per cent of the order value. Yet, in a couple of instances, the amount in respect of which the assessee had claimed revenue deduction on accrual basis, exceeded the said percentage.
This phenomenon was not explained.
The sum and substance of the view taken by the first appellate authority was that during the relevant previous years, no enforceable liability had crystallised as respects the penalty imposable under the delayed delivery clauses; that such a liability arose only when the matter was finally settled by the customers at their discretion; and that, consequently, the assessee would be entitled to revenue deduction for the penalty actually payable by it only in the previous year in which the customers had finally settled the matter.
18. In view of the foregoing, therefore, the CIT (Appeals) declined to interfere in the matter.
19. There was yet another common bone of contention, and that related to the cash compensatory support received by the assessee. In the previous year relevant to the assessment year 1984-85, the assessee had received a sum of Rs. 1,78,621 as cash compensatory support. In the immediately succeeding year of account, it had received a sum of Rs. 11,04,817 as cash compensatory support. Rejecting the assessee's contention that the receipts in question were on capital account, the Assessing Officer brought the said sums to charge. The assessee took up the matter in appeal before the CIT (Appeals), contending that as has been held by the ITAT, Delhi Bench (Special Bench) in the case of Gedore Tools (India) (P.) Ltd. v. IAC [1988) 25 ITD 193, the receipt in question was a capital receipt and hence not liable to tax. The first appellate authority rejected this claim, relying on the Madras case of CIT v. India Pistons Repco Ltd. and the Madhya Pradesh case of Gwalior Rayon Silk Mfg. (Wvg.) Co. Ltd. v. CIT [1983] 143 ITR 590 14 Taxman 21. Shri Ramamani, the learned counsel for the assessee, took us through the facts and circumstances of the case, and contended at the outset that, in the case before us, there is no device or scheme for evasion or avoidance of tax. The contracts for supply of machinery contain a built-in clause for levy of penalty for the delay in the supply of the items concerned. A plain reading of the provisions of the delayed delivery clauses will indicate that the mere factum of delay entails penalty. What is more, the quantum of penalty is particularised or specified in the contracts. With the result, the moment the assessee delayed the delivery of the goods contracted to be supplied, the assessee's customers got a right to enforce the penalty clause. And concomltantly the assessee became liable to pay the penalty. This, taken in conjunction with the fact that the assessee did not at any time dispute its liability to pay the penalty, would mean that, by reason of the delay on its part, it lost its right to receive 100 per cent of the invoice value. Consequently, the assessee was justified in taking into account, on accrual basis, the penalty payable under the delayed delivery clauses. Further, in the year in which the assessee's customers actually waived, wholly or in part, the penalty imposable, the assessee had offered the sum in question for taxation.
22. No doubt, continued Shri Ramamani, the customers could extend the stipulated delivery period, or waive, wholly or in part, the penalty stipulated under the delayed delivery clauses. But these are matters that depend on the customers' good sense, their pleasure. Hence, given the true legal consequence of the delayed delivery clause, in so far as the assessee is concerned, it cannot be said that the accrual of the liability gets postponed to the time when the customers, in their pleasure, waive wholly or in part, the penalty leviable or extend the due date of delivery. In other words, from the point of view of the assessee, the mere factum of delay in the delivery of goods, which, as pointed out earlier, the assessee did not dispute, entails penalty. It should, therefore, follow that the assessee was justified in taking into account, on accrual basis, the penalty payable by it under the delayed delivery clauses.
23. Shri Ramamani then contended that, the quantum of the penalty leviable for delayed delivery of goods being specified in the contract itself, the provisions of Section 74 of the Contract Act would come into play. In cases of the type under consideration, the legal effect of Section 74 is that the party complaining of delay is to receive only reasonable compensation not exceeding the stipulated amount. What is significant in this regard is that, in such cases, if the party who committed the breach does not dispute the penalty payable, the person complaining of delay is entitled to enforce the penalty clause in full.
And, by the same token, the person who committed the breach becomes liable to pay the penalty in question. This is exactly what had happened in the case before us and, consequently, no objection could possibly be taken to the assessee's quantifying the penalty payable for the delayed delivery strictly in accordance with the provisions of the delayed delivery clauses and in claiming, on accrual basis, a revenue deduction in respect thereof.
24. In support of the aforesaid contentions, Shri Ramamani referred to and relied upon the following: (ii) CIT v. Swadeshi Cotton and Row Miis (P.) Ltd. [1964] 53 ITR 134 (SC) In this connection, Shri Ramamani highlighted the fact that in the case of K.C.P. Ltd. (supra) a Special Bench of the ITAT had examined closely the provisions of Section 74 of the Contract Act and had held that since in that case (as in the case before us) the agreements stipulated the damages payable for delayed delivery, there was nothing wrong in the assessee's accounting for, on accrual basis, the damages stipulated in the said clauses. According to Shri Ramamani, the said decision squarely applies to the case before us.
25. Continuing his arguments, Shri Ramamani drew our attention to the fact that the Allahabad case of Lachhman Das Mathura Das (supra), referred to and relied upon by the lower authorities, was distinguishable. There, the mere failure of the contractor to perform his part of the contract by the time fixed by the contract or any extension thereof, did not automatically entail the levy of penalty.
The significant requirement in that case was that the failure on the part of the contractor must have had the consequence of rendering the plant incapable of being used commercially and efficiently. This naturally entailed inquiries into the attendant circumstances with a view to ascertaining whether the failure on the part of the contractor had the direct consequence of rendering the plant incapable of being used commercially and efficiently. In the case before us, on the contrary, the mere failure on the part of the assessee to stick to the delivery schedule entailed penalty. And what was more, the assessee before us did not dispute its liability to pay the penalty. He, therefore, urged that the Allahabad case cannot avail the Department.
26. Shri Ramamani then drew our attention to the fact that one of the points which had weighed with the CIT (Appeals) in deciding the issue against the assessee was that, in some instances, the amounts in respect of which the assessee had claimed revenue deduction, on accrual basis, in respect of the penalty payable excceeded the maximum of 5 per cent stipulated under the delayed delivery clauses. Shri Ramamani produced full details of the relevant purchase orders in question and pointed out that the liability for penalty in respect of which revenue deduction was claimed by the assessee, on accrual basis, did not exceed the stipulated 5 per cent. The misunderstanding has arisen, because while some of the jobs under a particular purchase order were executed in the previous years relevant to the assessment years now before us, certain other jobs under the said purchase orders had been executed in the earlier previous years. The assessee had quantified the penalty payable under the delayed delivery clauses strictly in accordance with the provisions of those clauses, and for this purpose had naturally taken into account the total value of the purchase order in cases where the contracts stipulated that the maximum penalty leviable would be 5 per cent of the purchase order. Since the CIT (Appeals) had restricted his attention only to the invoice value of the jobs executed during the previous years relevant to the two assessment years in question, it appeared to him as though the assessee had claimed revenue deduction in excess of the stipulated maximum penalty payable by the assessee. The fact of the matter was that, while quantifying the penalty payable under the delayed delivery clauses, the assessee had ensured that the terms of the clauses were strictly followed.
27. In view of the foregoing, therefore, contended Shri Ramamani, the assessee, is entitled to succeed.
28. On his part, Shri Alam, the learned Departmental representative, strongly supported the impugned orders of the lower authorities. He first contended that the CIT (Appeals) was justified in placing reliance on the Allahabad case of Lachhman Das MathuraDas (supra). In this regard, he also referred to and relied upon the following cases: 29. The second limb of Shri Alam's argument was that the case before us was one of change in the method of accounting - a change not supported by valid reasons. It is a matter of record that initially, the assessee was crediting to the contract billing account with the 100 per cent of the invoice value. Subsequently, it adopted different methods of accounting. In some cases, having credited the contract billing account with 100 per cent of the invoice value, the assessee transferred 5 per cent of the value to sundry creditors. In certain other cases, it credit the contract billing account with only 95 per cent of the invoice value. In some other cases, it debited the P & L A/c with 5 per cent of the invoice value. According to the learned departmental Representative, the aforesaid departures from the method of accounting regularly followed by the assessee were resorted to only with a view to reducing the assessee's tax liability, particularly in the years in which the assessee's income had registered a rather steep increase.
Since the liability to pay a penalty under the delayed delivery clauses accrued only when the customers took a final decision in that regard, the said departures from the system of accounting regularly followed by the assessee had no purpose other than reducing the assessee's tax liability. This cannot be countenanced.
30. Dealing particularly with the B.P.C.L. contracts, the learned Departmental Representative pointed out that the said customer had released the entire amount payable under the contract, by obtaining from the assessee a bank guarantee in respect of the penalties that might be imposed under the delayed delivery clauses. Thus, under the said contracts, the assessee had received 100 per cent of the invoice value, which was chargeable to tax on receipt basis. It should, therefore, follow that the assessee could not be permitted to carve out 5 per cent of the invoice value on the footing that it was liable to pay penalty under the delayed delivery clauses. Secondly, the Departmental Representative wondered how, having paid the full value of the invoices, the B.P.C.L. would enforce the delayed delivery clauses, should it find that there was no case for waiving any part of the penalty imposable thereunder.
31. In view of the foregoing, therefore, contended ShriAlam, the impugned orders of the lower authorities did not invite any interference.
32. In his reply, Shri Ramamani contended, first, that, as already pointed out, the Allahabad case was distinguishable on facts.
The Calcutta case of Roberts McLean & Co. Ltd. (supra), is also distinguishable because in that case, the High Court was concerned with a dispute settled by arbitration. In the case of Gemini Cashew Sales Corpn. (supra), the Supreme Court was concerned with Section 25FF of the Industrial Disputes Act and consequently, the ruling of the Supreme Court in that case will not be applicable to the case before us.
In the case of Indian Molasses Co. (P.) Ltd. (supra), the Supreme Court was examining the issue whether the liability therein was a liability in praesenti or was a contingent liability, and came to the conclusion that the liability was a contingent one. The liability in the case before us, on the contrary, is clearly a present, enforceable liability. Therefore, the assessee is entitled to succeed.
33. We have looked into the facts of the case. We have considered the rival submissions.
34. We may clear the decks as it were by dealing first with the exigibility issue relating to the cash compensatory support received by the assessee. With the 1990 amendment to Sections 2(24), and 28 of the Income-tax Act, 1961, the decision of the Special Bench of the ITAT Delhi, in the case of Gedore Tools (India) (P.) Ltd. (supra), is no longer good law. The amendments are retroactive in effect. We, therefore, decline to interfere in the matter and dismiss the related grounds.
35. To turn now to the main issue of the case. In the case before us, the contracts for supply of machinery entered into by the assessee-company with its customers contained a delayed delivery clause. Obviously, time was the essence of the contract and hence the inclusion of the delayed delivery clauses. These clauses clearly stipulated not only the penalty payable for every week of delay in the delivery of the machinery contracted to be supplied by the assessee but also fixed a ceiling on the penalty that could be levied. It is a matter of record that the assessee did fall, in quite a few instances, to stick to the stipulated delivery schedule, and thus rendered itself liable to penalty under the delayed delivery clauses.
36. The question that arises for consideration is whether the aforesaid liability is a liability in praesenti or a liability de futuro. The assessee's case is that the liability is a liability in praesenti because it did in fact fail to stick to the stipulated delivery schedule thereby rendering itself to a penalty, and further because it did not dispute its liability to pay penalty. Having thus accepted the penal, pecuniary consequences of the delay caused by it in delivering the goods in question, it had incurred a liability in praesenti, which is revenue deductible. Of course, it did approach its customers with a request for waiver of the penalty and did succeed in some cases in getting the penalty waived, wholly or in part. But this fact alone would not be fatal to its claim for more reasons than one. First, the liability accrued first and the plea for waiver made later. These two matters were clearly independent of each other. Secondly, whether its plea for waiver would be accepted by its customers, depending as it did on the customers' good sense, their pleasure, was clearly contingent when the plea was made.
37. The Department's case, on the contrary, is that since the assessee moved its customers for waiver of the penalty, an enforceable liability could be said to have arisen only when the customers accepted the assessee's plea, wholly or in part. According to the Department, the liability to pay the penalty contemplated by and under the delayed delivery clauses was at best a contingent one.
38. Secondly, the assessee had without any justification departed from the method of accounting regularly followed by it, namely, of crediting 100 per cent of the invoice value to the contract billing account in the first instance and to claim a revenue deduction in respect of the penalty actually imposed by the customers in the previous year in which the assessee's plea for waiver was finally accepted.
39. It is also the Department's case that as respects customers like BPCL who had released in full the invoice value on the assessee's furnishing a bank guarantee, the liability was clearly a contingent one.
40. Before examining the issues involved in this case, we may make a preliminary observation. As pointed out earlier, the purchase orders placed by the assessee's customers for supply of machinery invariably contain a delayed delivery clause. In certain cases, the said clause talks of penalty; while in others, it talks of liquidated damages. For a fact, the lower authorities also have used both the terms. The use of these two different expressions, as we see it, does not have a material bearing on the issues involved before us, because Section 74 of the Contract Act has done away with the troublesome distinction between 'penalty' and 'liquidated damages', by simple expedient of encompassing both 'penalty' and 'liquidated damages'.
41. The case before us is one of breach of contract. A contract may provide for unliquidated damages in the event of its breach, or again it may provide for liquidated damages for its breach. It is well-settled that a claim for liquidated damages stands on the same footing as a claim for unliquidated damages. The only difference is that, in the former case, should a dispute arise, the injured party can get reasonable compensation not exceeding the stipulated maximum. This is by virtue of the provisions of Section 74 of the Contract Act. It is equally well-settled that "a party in breach of contract does not incur eo instantia pecuniary liability; nor does the injured party become entitled to claim a debt". To elucidate, a mere claim that there has been a breach of contract will not do. It will have to be proved that the breach did in fact occur. This, again, per se will not suffice. It will have to be proved that the party complaining of the breach was put to a pecuniary loss as a result of the breach of the contract. Even here, if the pecuniary loss suffered is negligible the courts are more likely to refuse to entertain claims for damages, by applying the doctrine of deminimis. Where a suit for damages is entertained by the court of law, the right to receive damages and the corresponding liability to pay damages accrue or arise only when the matter is finally decided by the highest court of the land, assuming, of course, that the parties to dispute take the matter up to that level.
42. There is, however, a significant exception to the above rule. And that is a situation in which the party in breach accepts, without demur, without dispute, the claim of the injured party for pecuniary compensation for the damages caused to him by the breach. Acceptance, thus, is the key.
In some cases, the acceptance may be late in coming when then the accrual of the liability to pay the damage is co-eval with the acceptance of the liability. For example, when the claim for damages is not initially accepted and the matter reaches the court, the acceptance by both the parties of the judgment and decision of a lower court, will signal the accrual of the right to receive and the concomitant liability to pay the compensation decreed by the court. Again, such an accrual may be signalled by (a) the acceptance by both the parties of an arbitrator's award, or (b) the parties to the dispute entering into a memorandum of compromise under the aegis of the court, or even outside the court.
43. In other words, as respect a contract inter partes, the right to receive and the corresponding liability to pay damages accrues or arises when the claim is accepted by the parties to the dispute, or when the matter is finally adjudicated upon.
44. The above legal principles govern both liquidated and unliquidated damages.
45. The case before us is clearly one of liquidated damages, inasmuch as, through the instrumentality of the delayed delivery clauses, the assessee and its customers had assessed the damages at which they rate the breach of the delivery schedule, and had incorporated their assessment into the contracts. And the assessee did delay the delivery of the goods on some occasions. But the basic fact and indeed the one that holds the key to the issue before us is that the assessee did not dispute its liability to pay liquidated damages under the delayed delivery clauses. It did not go to the court of law, invoking the provisions of Section 74 of the Contract Act; nor did it seek a reference of the matter to an arbitrator.
All that it did was to approach its customers with a plea for waiver, citing various extenuating circumstances such as : (i) prolonged and progressively increasing power cut during the relevant period; (ii) delay occasioned by those who were to execute sub-orders; (iii) labour absenteeism; (iv) change in Government policy, necessitating the obtaining of N.O.Cs. from SAIL/ MMTC; (v) force majeure such as floods, and the like. As we see it, the very plea for waiver is itself an admission on its part that it had committed breach of contract, by failing to stick to the delivery schedule, thereby rendering itself liable to penalty. Stated differently, the plea for waiver can be understood on no other premise than that the assessee had recognised the right of its customers to enforce the delayed delivery clauses.
A mere plea for waiver, without any more, does not mean anything.
Unless accepted by the customers, it remains what it is -- Just a pious wish, an optimistic hope. This would mean that, unlike the assessee's liability to pay liquidated damages, which is a liability in praesenti (owing to the assessee's not disputing the penal, pecuniary consequences of the breach of the stipulated delivery schedule), waiver of damages is clearly contingent upon the customers' accepting the assessee's plea.
There is a related aspect of the matter that is noteworthy. As already pointed out, the assessee's customers had, in some cases, partly waived the damages recoverable from the assessee. And the Department has not brought on record any evidence to show that, having succeeded in securing part waiver to start with, the assessee had agitated the matter before the court of law, raising the plea that, despite the part waiver, the damages finally demanded by its customers were still unreasonably high, and hence it was entitled to the protective umbrella of the provisions of Section 74 of the Contract Act.
(a) The assessee, in some instances, did delay the delivery of the goods which it had contracted to supply. The assessee did not deny the said factum of delay.
(b) As a direct consequence of its failure to stick to the stipulated delivery schedule, the assessee rendered itself liable to penal pecuniary consequences stipulated in the delayed delivery clauses. The assessee did not dispute this factum also.
(c) It should, therefore, follow that, as respects the liquidated damages stipulated in the delayed delivery clauses, the assessee incurred a liability in praesenti. with the customers simultaneously getting a right to receive the stipulated amount.
(d) The fact that the assessee approached its customers with a plea for waiver does not alter the aforesaid position. This is because the acceptance of the assessee's plea was contingent upon the customers' good sense, their pleasure. In other words, the mere fact that the assessee had made a plea for waiver or even the further fact that in some instances the customers had accepted the plea, wholly or in part, does not have the effect of postponing the accrual of the liability of the assessee to pay liquidated damages to the point of time when its plea was accepted, wholly or in part, by its customers.
47. We, therefore, hold that the assessee is entitled to succeed in its claim.
48. One of the points urged by the learned Departmental Representative, it may be recalled, was that in the case before us, the assessee had changed its method of accounting without sufficient cause and that consequently, it was not entitled to its claim. As we see it, this argument, missing as it does the essence of the mercantile system of accounting, is without force. The method of accounting does not determine the ambit of taxation. This idea was elucidated by the Madras High Court in the case of CIT v. Motor Credit Co. (P.) Ltd. [1981] 127 ITR 572 thus: In the mercantile system of accounting credit entries are made in respect of amounts as soon as they became legally due and even before they are actually received and similarly the expenditure for which legal liability has been incurred, are immediately debited even before the amounts in question are actually disbursed. The point of time at which tax liability is attracted depends upon the system of accounting regularly employed by the assessee and in the case of mercantile system of accounting, liability to tax is attracted as soon as the income accrued. Regular mode of accounting only determines the mode of computing taxable income and the point of time at which the tax liability is attracted. It cannot determine or affect the range of taxable income or the ambit of taxation, 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. 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 materialized there can be no liability to tax a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account but, what should be considered is, whether the income has really materialised or resulted to the assessee. 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.
49. The learned Departmental Representative also urged that in cases where the assessee's customers had, on the assessee's furnishing bank guarantee, released the full amount, the assessee would not be justified in accounting for the liquidated damages on accrual basis.
This argument is also without force. The basic issue is whether the assessee was fastened with a liability under the delayed delivery clauses, which it did not dispute. And our finding is that such a liability had arisen. Therefore, the furnishing of bank guarantee and the like are matters strictly between the assessee and its customers.
Such arrangements cannot either obliterate the liability or postpone it.
50. In this connection, we may here add that in the case of ITO v.Servall Engg. Works (P.) Ltd. [1990] 35 ITD 482, the ITAT, Madras Bench 'B' had considered the legal effect of the assessee's furnishing a bank guarantee to its customers. But there the bank guarantee came to be given in totally different circumstances. And the enforcement of the guarantee was contingent upon the happening of many events. It was, therefore, held in that case that the assessee could not rely merely on the factum of its having furnished a bank guarantee either to claim that no income had accrued to it, or to contend that a liability in prasenti had accrued. The said decision, therefore, cannot avail the department.
51. In view of the foregoing, therefore, we hold that the assessee is entitled to succeed in its claim. We accordingly direct the Assessing Officer to allow the assessee's claim. He is, of course, free to verify the arithmetical accuracy of the claim made by the assessee. Again, needless to add, as respects the assessment year 1985-86, in the view that we have taken of the matter, there will be no need to make the adjustments that the Assessing Officer had made in a sum of Rs. 4,45,286; and the quantum of the revenue deduction admissible to the assessee would be determined strictly in accordance with the liability in respect of the liquidated damages that had accrued during the previous year relevant to that assessment year.