JUDGMENT [ENTITY], J.
The Question:
The question involved in this appeal is:
"Whether on a true and proper construction of the contract with the Indian Railways and their letters dated 3-5-1986 and 15-4-1988 the appellant is entitled to deduction in respect of the demand of Rs. 46,82,142 made by the Indian Railways during the previous year relevant to the assessment year 1987-88 and the purported findings of the Tribunal that the liability had not crystallized and rejecting the said claim are based on any material and or even arrived at by ignoring the relevant materials and or by taking into consideration irrelevant and or extraneous materials and or are otherwise arbitrary, unreasonable and perverse."
The facts:
2. In order to appreciate the situation, we may briefly refer to the facts. The assessee had entered into a contract with the Railways for supplying certain materials. The contract contained a condition that in case of rejection of the material supplied, the replacement would be at the cost of the assessee /contractor. In this case, there was rejection not once but twice, namely, after the first rejection, the goods were returned to the supplier at a foreign country from whom the goods were imported and the goods were replaced. The replacement was also rejected and the goods were returned to the foreign supplier. These facts are not in dispute. Subsequently, the Railway Authorities on 3-5-1986 (page 131 of the PB) demanded a sum of Rs. 46,82,142 on account of the expenditure incurred in the transaction pursuant to the terms and conditions of the purchase order dated 29-7-1982 being a warranty obligation on the part of the assessee. The Railway had also on 15-4-1988 (page 134 of the PB) asked the assessee to refund the commission received by the assessee from the Railways in respect of the supplies so made. Admittedly, the assessee, till today, neither has paid the demand made by the Railways nor has refunded the commission received by it from the Railways. The period of limitation as available to the Railways is 30 years under [SECTION] of the Schedule to the [ACT].
2.1 Admittedly, the assessee maintained its accounts under the mercantile system. The assessee admitted the amount and reflected the same in his accounts. These accounts were reflected in the balance sheet signed by the assessee or its authorized agent. This is also not in dispute. In this background the assessee claimed deduction of the said amount as loss arising in the relevant assessment year when the demand was made, namely, 1987-88. The assessing officer did not allow the deduction. The Commissioner of Appeals allowed the same. Whereas the learned Tribunal reversed thejudgment of the Commissioner of Appeals and disallowed the deduction. The present appeal arises out of this order.
Submission on behalf of the Appellant/Assessee :
3. Mr. [ENTITY], learned Senior Counsel, ably assisted by Mr. [ENTITY], submitted that in terms of [SECTION] of the [ACT], in case the liability ceases, it would be offered to tax in the year when the liability would cease. Therefore, the liability reflected in the accounts cannot be ignored. If the liability cannot be ignored, then there is no alternative for the Income-tax Authorities but to allow deduction of the loss reflected in the accounts. According to him, the assessee is entitled to reflect the loss in the accounts maintained under the mercantile system as soon he admits the liability.
3.1 According to him, the admission of such liability is something different from the acknowledgement contemplated under [SECTION] of the [ACT]. It has nothing to do with the recoverability of the amount by the creditor of the assessee. There is a distinction between an acknowledgement of liability in the accounts maintained by the assessee for the purpose of income-tax and an acknowledgement for the purpose of recoverability of such amount extending the period of limitation under [SECTION] of the [ACT] by the person entitled to enforce such liability against the assessee.
3.2 He relied on the decision in [PRECEDENT]) and [PRECEDENT]). Relying upon the decision in [PRECEDENT]'s case (supra), Mr. [ENTITY] submitted that the assessee has a duty to maintain accounts if he follows the mercantile system to show all admitted loss to the extent of his admission and it goes no further than that and such admission can be reflected in the accounts on the date when the admission is made by the person against whom the assessee admits the liability. According to him, this admission is required to be interpreted in this case as he proposes to submit.
Submission on behalf of the Respondent/department:
4. Mr. [ENTITY], learned Senior counsel for the department, on the other hand, contended that the liability alleged to have accrued in 1982 and was demanded after expiry of four years in 1986 and under the [ACT] there being no special period of limitation in respect of claim by the Government, the residuary clause in [SECTION] of the Schedule to the [ACT] would be applicable for filing the arbitration application under [SECTION] of the [ACT], which was then operating in the field. Therefore, the claim having been barred by limitation, and admittedly the assessee having not paid the amount, and no arbitration having been initiated by the Railways nor by the assessee, and no suit having been filed by the Railways, the liability reflected in the accounts has no foundation; and as such the entry in the accounts can be treated to be an entry without substance. According to him, only when the liability is crystallized, then only there is a scope of admission of liability, which could be reflected in the accounts. In such circumstances, it was rightly ignored by the assessing officer and the learned Tribunal.
4.1 According to him, there being no acknowledgement in writing signed by the assessee to the Railways the reflection of the liability in the accounts cannot be treated to be an admission as was contemplated in the ratio decided in [ENTITY] case (supra). He relied on the decision in [PRECEDENT] to support his contention. According to him, [SECTION] is of no help in this case.
[ACT]: Limitation : How far applicable:
5. After having heard the learned counsel for the parties, we may first take up the point relating to the [ACT] raised by Mr. [ENTITY]. In our view, this question is of academic interest so far as the facts and circumstances of the present case is concerned. Inasmuch as [ACT] does not prohibit filing of an independent suit in a civil court. It the party wanted the arbitration agreement to be enforced, the only remedy was under [SECTION] of that Act. [SECTION] of the first schedule to the [ACT] refers to any suit filed by Government prescribing 30 years limitation under which the Railways would be entitled to file a suit at least till 2012 if not till 2016. That apart the question of application of the [ACT] may also be imported in the facts and circumstances of the case by demanding an arbitration after the 1996 Act has come into operation which would bring about the applicability of the 1996 Act in the present case which is an issue complicated and can be decided in an appropriate proceeding. Therefore, we need not dilate on all those questions and leave it at that simply by holding that the point that has been raised by Mr. [ENTITY] is of academic interest and will not be of any importance to the question now we are supposed to answer.
Whether in the Mercantile system of accounts the loss could be reflected:
6. So far as the question of maintenance of accounts is concerned, if the assessee follows the mercantile system, in that event, he is bound to reflect all admitted loss to the extent of his admission and no further. In [ENTITY] case (supra), the court was concerned with the question as to whether the assessee was liable to reflect anticipated loss in his account maintained under the mercantile system. Dealing with such question, this court had held that if the argument of the department is to be accepted, the result would be that an assessee would have to write up his books of account not according to his views of the transaction he has entered into but according to the claims made on him by others irrespective of the questions as to whether he admitted the same or not. It had held that when the assessee admits loss or when the loss is ascertained, it certainly is his duty to bring the same into debit as soon as the admission is made or the ascertainment takes place. The mercantile system of bookkeeping does not seem to cast on the assessee any obligation to take note of whatever claims good or bad may be raised against him.
6.1 This decision relied on the decision in [PRECEDENT] and held that according to the judgment of the Supreme Court in [PRECEDENT]'s case (supra), the liability must accrue or alise in order that a sum of money may be deductible in respect therefor. It may be that in a particular case an assessee's denial of a contract may not be of any avail to him and judged in the light of all the circumstances of the case it may be said that a loss had accrued sometime before the assessee was prepared to acknowledge it but unless the assessee acts mala fide, the court did not see any reason why the assessee should not be allowed to contest the claim raised against him and make provision therefor in his accounts only when he finds himself in a position not to dispute the liability any further. Having regard to the ratio laid down therein, it appears that a discretion is left with the assessee to admit or not to admit a liability but to reflect the liability as soon he admits the liability in the accounts.
6.2 In [PRECEDENT] (supra), it was held that such liability accrues if admitted only when the demand is made, but not when the liability alleged to have accrued, even when the demand was made in any earlier accounting year relevant for any earlier assessment year.
6.3 The ratio laid down in these decisions clearly lay down that the assessee is liable to reflect the liability in the accounts when admitted by him, or when the demand is made against him, or when the liability is ascertained; and the assessee is at liberty to reflect the same when he chooses to admit the liability, i.e., either when the demand is made or when the liability is ascertained or when he admits the liability. This reflection of the loss in the accounts under the mercantile system is well taken care of by [SECTION] of the [ACT], which empowers the Incometax Authority to charge the liability so reflected in any earlier years to income-tax as soon or in the assessment year the liability ceases to exist. Therefore, the entry made can neither be said to be without any substance nor can be ignored by the assessing officer.
Admission vis-a-vis acknowledgement of liability:
7. The admission contemplated for the purpose of reflection in the accounts maintained in the mercantile system has to be construed differently for the purpose of income-tax than that is to be construed under the [ACT] for the purpose of extending limitation under [SECTION] of the [ACT]. Under the [ACT], an acknowledgement extends the period of limitation enabling the creditor to recover the amount from the debtor. Even then [SECTION] of the [ACT] refers to an acknowledgement in writing signed by the parties against whom the liability is enforceable. It does not specify anything that such liability is to be made in a particular manner and to be communicated to the creditor.
7.1 Mr. [ENTITY] refers to a decision in [PRECEDENT] and submits that a liability reflected in the accounts and shown in the balance sheet signed by the party or by his authorized agent is also construed to be an admission. But that is neither here nor there. We need not go into such question. [SECTION] of the [ACT] contemplates of an acknowledgement of liability, whereas we are concerned with admission of liability. That acknowledgement has a different connotation for the purpose of recoverability of the amount and enforcement of the liability against the person acknowledging. In case the ingredients of [SECTION] of the [ACT] is not satisfied, then the liability ceases and there is no scope of recoverability of the liability or enforcement of the liability from or against the debtor assessee. Whereas an admission entitling the assessee to reflect the loss in the accounts is for the purpose of income-tax where the scope of recoverability is immaterial. If ultimately the amount is recovered, the loss is affirmed. If it ceases to be recoverable or the liability ceases, the amount becomes chargeable to tax in the year of cessation of liability in terms of [SECTION] of the [ACT]. Under the [ACT], no limitation operates in relation to the chargeability of such a loss entry till the loss ceases on any subsequent assessment year as a whole or in part even spreading over to different assessment years as the case may be.
7.2 There is a clear distinction between an acknowledgement contemplated under the [ACT] and an admission for the purpose of reflecting a liability or loss in the accounts maintained under the mercantile system by the assessee for the purpose of the [ACT].
7.3 The decision cited by Mr. [ENTITY] in Trading Engineer's case (supra) does not seem to be applicable in the facts and circumstances of the case, where the question was completely different viz., as to whether the assessee was liable to reflect an amount sought to be recovered from him by a proceeding or not. In case it was shown or it was not shown, both could be corrected under [SECTION] on the basis whereof the said decision proceeded where the assessee did not admit the liability.
Conclusion:
8. Admission of liability for the purpose of making entry of loss or reflection of liability in the accounts maintained in the mercantile system for the purpose of claiming deduction of loss in course of assessment is distinct from acknowledgement of liability vis-a-vis the creditor. Inasmuch as if the amount becomes recoverable vis-a-vis the creditor, i.e., the liability ceases to be recoverable, the loss becomes income to the assessee chargeable to tax on the year of such accretion. The assessee is entitled to make such entry in the accounts maintained in mercantile system as soon he admits the liability. Therefore, he is entitled to the deduction of the loss in computing the income of the assessment year in which such entry is made, subject, however, to [SECTION] of the [ACT].
Order:
9. The appeal is allowed.
9.1 In the circumstances, we answer the question in the affirmative.
9.2 The order of the learned Tribunal is set aside and that of the Commissioner of Appeal is affirmed.
9.3 There will, however be no order as costs.
[ENTITY], J. - I agree.