Case: Keshav Mills Ltd Vs. Commissioner Of Income-Tax, Bombay

2. The appellant is a company registered in the Baroda State as it then was prior to its merger with India. It manufactures textile goods in Petlad in the Baroda state and after the goods are manufactured they are sold by the Company ex-mills. The Company employs Messrs. Jagmohandas Ramanlal and Co. as guaranteed brokers. That firm guarantees the sale price of goods sold by the company ex-mills to the purchasers from Ahmedabad and receives commission as consideration for the guarantee and the work which it does for the company. The company is a nonresident and its accounts are maintained according to the mercantile system.3. In the assessment year 1942-43 (the previous year being the calendar year 1941) the total sales of the goods by the company amounted to Rs. 29,68,808. In making the assessment on the company for that assessment year the following three amounts were considered for the purpose of determining the companys liability to British Indian tax.(a) Sale proceeds recovered through Messrs. Jagmohandas Ramanal and Co. ... Rs. 12,68,480(b) Sale proceeds through British Indian Banks and Shroffs received by means of drafts or hundies drawn on by the company. ... Rs. 4,40,878(Railway receipts handed over to British Indian Merchants by the Banks on payment).(c) Sale proceeds received by cheques on British Indian Banks and Hundies on British Indian Shroffs and merchants, and Collected by the Banks and Shroffs ... Rs. 6,71,735Total ... Rs. 2381,0934. As regards item (a) the company debited the account of the firm of Messrs. . Jagmohandas Ramanlal and Co. with Rs. 13,41,744 which represented sales made by the company to merchants of Ahmedabad whose payments were guaranteed by that firm, and credited the sales account with the amount of the bills. Messts. Jagmohandas Ramanlal and Co. collected the amounts of the bills from the merchants at Ahmedabad and credited the sums recovered in the companys accounts with banks/or Shroffs at Ahmedabad and also made disbursements under instructions of the company to the creditors of the company in British India. All these payments were credited by the company to the account of Messrs. Jagmohandas Ratnanlal and Co. and during the relevant accounting year the company thus received Rs. 12,68,480 against the total debits of Rs. 13,41,744.5. As regards item (b) the company received Rs.4,40,878 by drawing hundies or drafts for the amounts of its sales bills (including the forwarding charges and the cost of transit from the mills premises to the station) on the merchants in favour of recognised banks and Shroffs in British India, by sending the same to those banks or Shroffs with the railway receipts duly endorsed in favour of the merchants and by instructing the banks or Shroffs to recover the amounts including the costs of transmitting the same to them. The amounts of these sales bills were debited by the company to the accounts of the respective merchants and credited to the sales amount and the sums recovered by the banks or Shroffs from the merchants in British India against the delivery of the relative railway receipts were on receipt of the same by the company, credited to the accounts of the respective merchants in their books of account.6. As regards item (c), the company received Rs. 6,71,735 from the merchants by cheques and hundies drawn on banks and Shroffs in British India in favour of the company. These cheques and hundies were negotiated by the company in Petlad and sent back for credit to its accounts with those banks and Shroffs. The said cheques and hundies were cashed in British India and the sale proceeds remitted by the banks and Shroffs to the company. The amounts of the sales bills were debited to the accounts of the merchants in the books of the company when the goods were invoiced to the merchants and these amounts were credited with the moneys thus received by the company from the merchants.7. The Income-tax Officer brought to tax the profits derived by the company represented by the said three items in the assessment year on the basis that the sale proceeds having been received in British India the profits were received in British India. The Appellate Assistant Commissioner on appeal held that Profits from items (a) and (c) were exempt from British Indian tax while those represented by item (b) were rightly taxed. The Department filed an appeal to the Appellate Tribunal against the decision of the Appellate Assistant commissioner in regard to items (a) and (c) and the company filed an appeal in respect of item (b). The Appellate Tribunal held in regard to item (a) that the merchants in British India were not absolved either in law or in fact from their responsibility to pay to the company its dues by virtue of the debit entries in the account of Messrs. Jagmohandas Ramanlal and Co. and in regard to item (b) that the payment of the amounts due was a condition precedent to the delivery of goods by the banks in British India on behalf of the company. The Tribunal therefore held that profits arising from items (a) and (b) were rightly subjected to tax. As regards item (c) the Tribunal held that Rs.received by the assessee company directly from the merchants in British India by cheques and hundies drawn on banks and Shroffs in British India in favour of the company but were negotiated in Petlad and sent for credit to the companys account. The amounts were received at Petlad and once they were received there, they could not be held to have been received again in British India.The Department asked the Tribunal to refer to the High Court the question of law arising on item (c) and the company asked the Tribunal to refer to the High court the question of law arising on items (a) and (b) and the Tribunal therefore referred the following question of law to the High courton the facts and in the circumstances of the case, the sums of Rs. 12,68,480, Rs. 4,40,878 and Rs. 6,71,735, or any of them, which represents receipts by the assessee company of its sale proceeds in British India, include any portion of its income in BritishThe High Court held that Rs. 12,68 480 were received in British India and included the Profits and gains of the business of the assessee company. It held that Rs. 4,40,878 also were received in British India and the company was liable in respect of that amount. In regard to the item for Rs. 6,71,735 the High Court found that the facts stated by the Tribunal were not sufficient to enable it to reach a decision and therefore directed that the Tribunal should submit a supplementary statement of case setting out the several aspects set out in the judgment. The High Court reframed the questions in regard to the two items of Rs. 12,68,480 and Rs. 4,40,878 in the manner following :(1) Whether the sums of Rs. 12,68,480 and Rs. 4,40,878 were sale-proceeds of the goods sold by the assessee to merchants in British India or were debts due by the said merchants?(2) Whether if they were sale-proceeds, they were received in British India? and answered them by stating that they were sale-proceeds and they were received in British India. There was also a third question which was comprised in the reference and that question was framed as under:Whether the profits of the assessees business are included in the sums of Rs. 12,68,480 and Rs. 4,40,878?This question was also answered by stating that they were included in these two sums. The company obtained leave from the High Court to appeal against the decision in regard to the two sums of Rs. 12,68,480 and Rs. 4,40,878 and hence this appeal.

Reasoning: In regard to the item of Rs. 4,40,878 even though the amounts of the sales bills were debited in the first instance by the company to the accounts of the respective merchants in the books of account at Petlad the relative railway receipts were sent by the company to banks or Shroffs in British India together with drafts or hundies in connection with the same with instructions that delivery of the railway receipts should be given to the respective merchants against payment and the amounts of the sales bills were thus paid by the respective merchants to the banks or Shroffs in British India and were transmitted under the instructions of the company by the banks and Shroffs in British India to the company at Petlad. Prima facie, therefore, the amounts of the sales bills in both the cases whether they were paid to Messrs. Jagmohandas Ramanlal and Co. or to the banks or shroffs through whom the railway receipts were negotiated were paid by the merchants in British India and were received by Messrs. Jagmohandas Ramanlal and Co. and the banks or Shroffs on behalf of the company in British India. The receipt of these amounts thus fell within S. 4(1) (a) of the Act and the profits or gains of this business thus were received in British India by or on behalf of the company.The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of book keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system 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. The profits or gains of the business which are thus credited are not realised but having been earned are treated as received though in fact there is nothing more than an accrual or arising of the profits at that stage. They are book profits. Receipt being not the sole test of chargeability and profits and gains that have accrued or arisen or are deemed to have accrued or arisen being also liable to be charged for income-tax the assessability of these profits which are thus credited in the books of account arises not because they are received but because they have accrued or arisen.It is clear that under these circumstances there is no receipt of the moneys at all, either actual or constructive, in cash or in kind, by actual payment or by adjustment or settlement of accounts. There is also no scope for the argument that even though these sums may not be said to be either actually or constructively received they should be "deemed to be received." The expression "deemed to be received " only means deemed by the provisions of the Act to be received. The phrase statutory receipt might be conveniently employed to cover income which is "deemed to be received," and instances of such statutory receipts are to be found in the provisions of theis true that the words used in S. 4 (1) (a) relate to the first receipt after the accrual of the income. Once it is received by the party entitled to it, in respect of any subsequent dealing with the said amount it cannot be said to be "received" as income on that occasion.Mr. Kolah pressed into service the argument based on S. 13 of the Act that the mercantile system of accounting regularly adopted by the assessee was obligatory on the income-tax authorities for computation of his income. While agreeing generally with that submission in case of residents, we doubt whether that position would be available to a non-resident, who maintains his books of account outside British India according to the mercantile system. The Section would only be relevant where the total profits of the assessee have to be computed, in which event he would be entitled to claim that they should be computed according to the system of accounts maintained by him. But the Section would hardly be relevant where stray items of income are caught in taxable territories as received in taxable territories by a non-resident. The entries in the present case were not in merely to prove that the sale proceeds were received outside British India where the entries were made. That contention, however could not be sustained, as S. 4 (1) (a) is concerned with cases of actual receipt and not with cases of paper receipts.20. Having regard to the observations made above, we have come to the conclusion that the High Court was right in holding that the two sums of Rs. 12,68,480 and Rs. 4,40,878 were the sale proceeds of the goods sold and delivered by the appellant to merchants in British India, that they were received by Messrs. Jagmohandas Ramanlal and Co. and by the banks and Shroffs through whom the railway receipts were negotiated, on behalf of the appellant in British India, that they were liable to tax under S. 4 (1)(a) of the Act as having been received in British India on its behalf, that there is nothing either in the facts and circumstances of the case or in law why they should be exempted from such liability, that the answers given to the questions which were ultimately considered by the High Court were correct, and the appellant was rightly held liable for the tax on these two amounts subject to all just deductions and allowances. The appeal, therefore, fails and must stand dismissed with costs.Now in the present case, the method of accounting was the mercantile system. The essential difference between this and the cash basis system is that in the latter actual receipts and disbursements are taken into account. In the former, sums which are due to the business are entered on the credit side immediately they are legally due and before they are actually received end expenditures are entered the moment a legal liability to pay arises and before the actual disbursements. The Profit or loss at the end of the accounting year is therefore based, not on a difference between what was actually received and what was actually paid out, but on the difference between the right to receive and the liability to pay. I find it impossible in such a case to say that the taxation is on income, or profits and gains which were "received." It can only be on profits which "accrued" or "arose" to the assessee in the accountingwere the goods in the present caseif there are no books, the profits on such a transaction would accrue in the place where the money is to be paid and the good are to be handed over. I cannot see how that can alter by reason of the method of accounting employed. Accordingly, I agree that the method of accounting adopted by the assessee cannot affect the substance of the transactions between the parties or affect their nature. The rights and liabilities of the parties inter se cannot be made to depend on the way in which one of them chooses to keep its books. But that is not the case when we come to the question of taxation for income-tax purposes. There the method of accounting is vital. But even there the substance of the transaction must be viewed, for the substance cannot alter by a mere method of accounting. It is evident that if the assessee had been resident in British India and these transactions had been omitted from the books, the sums which ought to have been entered would be taxable as items which had escaped assessment even if there had been no actual receipts in that or in any following year. Therefore, it is not the entry in the books which attracts the taxation but the profits on the transaction itself, and which the mercantile system is used the profits arise when the right to receive them accrues and not when the entry is made. If the system is properly employed, the entry is made as soon as the right to receive the price arises and so for all practical purposes that is the date ordinarily referred to, but a man cannot manipulate the amount of his tax by choosing to enter or not to enter items which ought to be entered on a particular date, as and when he pleases.Now the Rs. 4 lakhs odd represents actual receipts but that is not what is taxable when the computation is based on the mercantile system. What should be taxed, or rather taken into account for the purposes of taxation, are the figures entered in the accounting year as the sale price of the various transactions which the Rs. 4 lakhs represent. The profits which arise out of these transactions do not, on my view, escape tax because the profits accrue or arise in the taxable territories. But the figure on which the tax is to be computed is not the 4 lakhs odd which represent the actual receipts but another figure which unfortunately we have not been given. I am of course assuming that the figures were duly entered in the books at the proper time in accordance with the mercantile system of accounting. If they were not, then the Income-tax authorities have bower to tax income which, for one reason or another, has escaped assessment.Now it is evident from this that Jagmohandas and Company do not merely guarantee payment by the Ahmedabad buyers but actually make the payments, or the equivalent of payments, to the assessee company. So little do the buyers matter that their transactions are not even reflected in the accounts. All we have is Jagmohandas. It does not, in my opinion, matter whether the actual buyers retrained primarily and legally responsible to the assessee or not. The fact remains that in practice Jagmohandas and Company actually met the obligations of the buyers and discharged their liabilities to the assessee. It is equally clear that Jagmohandas and Company must have recouped themselves in some way from the buyers. The question is how. If the whole of the transactions recurred outside British India and the buyers or their agents went to Petlad and received the goods there and paid Jagmohandas and Company outside British India, then I am clear that the profits and gains did not accrue or arise in British India, simply because the goods were ultimately brought there. But if Jagmohandas and Company or their agents were paid in British India, the profits and gains, in my opinion, arose there in the same way as in the 4 lakhs case. If Jagmohandas and Company were the actual agents of the assessee as were the Banks in the other case, and the payments were made in the taxable territories, then the accrual and arising was direct. If, however, they were not the agents in the strict sense of the term, then I am of opinion that S. 42 would be attracted because at the very least there would be a "business connection", provided of course the payments were made in the taxable territories.In my view, the question referred by the Income-tax Appellate Tribunal in its statement of the case does not reflect the true position because it concentrates on the actual receipts. If the cash basis system of accounting was germane here, then I would agree that the Rs. 4,40,878 was part of the assessees income in British India, and so also in the other case, provided the payments were made in British India. But it is misleading to enquire what would have happened in circumstances which are not material in this case because of the mercantile system of accounting which was employed.43. As regards the High Court. The learned judges reframed the question and answered it without sending the case back to the Income-tax Appellate Tribunal for a further statement of the case. That was not strictly proper. But, in my opinion, the reframed questions suffer from the same defect.In my opinion, the case should be sent back to the Income-tax Appellate Tribunal for a reframing of the questions along the lines I have indicated and for a further statement of the case.