Case: Nonsuch Estate Ltd Vs. The Commissioner Of Income-Tax, Madras

managing agents. For the assessment year 1959-60 for which the previous year was July 1, 1957 to June 30, 1958, a total sum of Rs. 97,188/- was shown as managing agents remuneration payable during that year. This amount was made up as under:Amount"Proportionate remuneration for 3 months at 5 per cent on the net profits for the period ending on 30-6-1956 paid during the year ending on 30-6-19589,320Remuneration at 5 per cent on the net profit of the year ending on 30th June, 1957 paid during the year ending on 30-6-1958.71,368Managing Agents expenses for the year ending 30th June, 1957 recouped during the year ending on 30th June, 195813,200Proportionate Managing Agents expenses for the year ending on 30th June, l956 recoupedduring the year ending on 30-6-19583,30097,188"4. Though this sum did not pertain to the previous year relevant to the assessment year 1959-60, the Company claimed it as deductible expenditure for that year on the ground that the sum became payable only during that year when the Government accorded its approval to the new agreement. The Income-tax Officer rejected this claim on the view that the approval of the Central Government was necessary only for actual payment and "the assessee should have ascertained the liability for each year and claimed it on the mercantile basis which was the system adopted by the assessee company". The Appellate Assistant Commissioner and the Tribunal also took the same view. The High Court answered the question referred to it against the assessee on the following reasoning:"......... There was undoubtedly an understanding between the managing agency and the assessee as to the new terms of remuneration which actually were given effect to by making debit entries in the remuneration account then and there. It is true that at the time the debit entries were made, approval of the Central Government had not come. But when-it came actually later, it gave legal effect to the debit entries, not from the date of the approval but from April 1, 1956. That being the case, the refusal of the deduction, in our opinion was right"In our judgment the High Court was in error in answering the question referred to it against the assessee. It appears that the Income-tax authorities, the Tribunal and the High Court all laid special emphasis on the fact that the Company followed the mercantile system of accounting. The distinction between the two methods of accounting, one on the cash basis and the other on the mercantile basis is well known. In Commr. of Income-tax, Madras v. A. Gajapathy Naidu, (1964) 53 ITR 114 = (AIR 1964 SC 1653 ) this Court explained the difference between the two methods quoting with approval an extract from a Judgment of the Allahabad High Court in Commr. of Income-tax U. P. and V. P. v. Kalicharan Jagannath, (1961) 41 ITR 40 (All) . In Ganjapathy Naidus case (1964) 53 ITR 114 = (AIR 1964 SC 1653 ) this Court said:"It is common place that there are two principal methods of accounting for the income, profits and gains of a business; one is the cash basis and the other, the mercantile basis. The latter system of accountancy "brings into credit what is due immediately it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed"."However, even an assessee following the mercantile system of accounting is not entitled to claim a deduction until liability for the sum for which deduction is claimed has accrued. The reasons given by the High Court overlook the plain terms of Section 326 of the Companies Act, 1956. Section 326 so far it is material for the question involved in this case, is in these terms:"Section 326. (I) In respect of any company........(a) ..............(b) unless the approval of the Central Government has been obtained for such appointment or re-appointment.(2) The Central Government shall not accord its approval under sub-section (1) in any case, unless it is satisfied -(a) that it is not against the public interest to allow the company to have a managing agent;(b) that the managing agent proposed is, in the opinion, a fit and proper person to be appointed or re-appointed as such, and that the conditions of the managing agency agreement proposed are fair and reasonable; and(c) that the managing agent proposed has fulfilled any conditions which the Central Government requires him to fulfil."5. Section 326 prohibits the appointment or reappointment of a managing agent unless the Central Government approved such appointment or re-appointment. The Central Government would not accord its approval unless the requirement specified in clauses (a), {b) and (c) of sub-section (2) of the section have been fulfilled. Therefore, it cannot be assumed that the Central Government will approve every proposed appointment or re-appointment of a managing agent.Thus in the instant ease it is only when the Central Government conveyed its approval to the appointment of M/s. Harrisons and Crosfield Limited as managing agents by its letter dated September 2, 1957 that the appointment became effective and the Companys liability to pay the remuneration of the managing agents accrued. The position here is not that the liability had arisen earlier and its quantification only depended on the approval of the Central Government. It is true that the liability became effective from April 1, 1956, a date anterior to the relevant previous year, but that is because the Central Government chose to give its approval retrospective operation. The liability in these circumstances cannot be said to have arisen from any date prior to September 2, 1957 when the approval was given as Sec. 326 contains an absolute prohibition against the appointment or re-appointment of a managing agent before the approval of the Central Government was obtained. In our opinion, the position is quite clear from the terms of Section 326 and we do not consider it necessary to refer to the authorities cited by the learned counsel for either side.

Decision (1 = appeal accepted, 0 = rejected): 1

Explanation:
1[ds]In our judgment the High Court was in error in answering the question referred to it against the assessee. It appears that theauthorities, the Tribunal and the High Court all laid special emphasis on the fact that the Company followed the mercantile system of accounting. The distinction between the two methods of accounting, one on the cash basis and the other on the mercantile basis is well known. In Commr. ofMadras v. A. Gajapathy Naidu, (1964) 53 ITR 114  = (AIR 1964 SC 1653 ) this Court explained the difference between the two methods quoting with approval an extract from a Judgment of the Allahabad High Court in Commr. ofU. P. and V. P. v. Kalicharan Jagannath, (1961) 41 ITR 40 (All) . In Ganjapathy Naidus case (1964) 53 ITR 114  = (AIR 1964 SC 1653 ) this Courtis common place that there are two principal methods of accounting for the income, profits and gains of a business; one is the cash basis and the other, the mercantile basis. The latter system of accountancy "brings into credit what is due immediately it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actuallyeven an assessee following the mercantile system of accounting is not entitled to claim a deduction until liability for the sum for which deduction is claimed has accrued. The reasons given by the High Court overlook the plain terms of Section 326 of the Companies Act, 1956.Section 326 prohibits the appointment or reappointment of a managing agent unless the Central Government approved such appointment or