Case ID: 760

Judgment:
: Civil Appeal No. 213 of 1955. Appeal from the judgment and order dated June 26	 1953 of the Calcutta High Court in I.T.R. No. 34 of 1952. A.V. Viswanatha Sastri	 Y. C. Talukdar and Sukumar Ghose	 for the appellant. K.N Rajagopal Sastri and. D. Gupta	 for the respondent. May 12. The Judgment of the Court was delivered by BHAGWATI J. This appeal with a certificate under article 135 of the Constitution read with section 66A(2) of the Indian Income tax Act raises the question as to whether the appellant "	as entitled to a deduction of Rs. 24	809 in the computation of its profits and gains for the assessment year 1948 49. The appellant deals in land and property and carries on land developing business and in the course of the said business	 it buys land	 develops it so as to make it fit for building purposes and sells it at a profit in plots. The developments undertaken are in the main	 187 that roads are to be laid out	 a drainage system to be provided and street lights installed and they are to be maintained till the sample are taken over by the Muncipality. The whole of the development is not carried out before the land is sold	 nor the whole of the sale price received in cash at the time of the sales. The procedure followed is that when a plot is sold	 the purchaser pays about 25 % of the purchase price in cash and undertakes to pay the balance with interest at a certain rate in ten annual installments which he secures by creating a charge on the land purchased. The appellant	 in its turn	 undertakes to carry out the developments within six months from the date of the	 sale but this time is not of the essence of the contract and what the appellant undertakes is to carry out the 'developments within a reasonable time. The tinderbox is incorporated in the deed of sale itself	 whereas the security is given by the purchaser by means of a separate document. In the accounting year relating to the assessment year 1948 49 the appellant sold a number of plots and received a portion of the sale price from the purchasers according to the scheme mentioned above. The appellant maintains its accounts in the mercantile method under which money not actually received but only treated as received on the basis that it was due and receivable is entered in the books of account on the credit side. Even though the appellant did not receive the whole of the price	 viz.	 Rs. 43	692 11 9	 it entered in the credit side of its books of account the whole of that sum representing the full sale price of the lands sold during the accounting year though only a sum of Rs. 29	392 11 9 was actually received in cash from the purchaser and the balance of Its. 14	300 represented the unpaid balance retained by the purchasers the payment of which was secured by creating charge on the said lands as also the interest received or receivable in the year of account tinder the deeds of charge. The whole of this sum of Rs. 43	692 11 9 was	 however	 credited in the books of account by the appellant according to the mercantile system of accounting adopted by it. 188 In so far as under the terms of the deeds of sale the appellant had undertaken to carry out the developments within six months from the date of sale it estimated a sum of Rs. 24	809 as the expenditure for the developments to be carried out in respect of the plots which had been sold during the year and debited the same in its books of account on the ground that the liability for the said sum of Rs. 24	809 had actually arisen	 the appellant being bound to provide the facilities it had undertaken to do	 even though no part of that amount represented any expenditure actually made during that year. In the course of its assessment to income tax for the year 1948 49	 the appellant claimed a deduction of the said sum of Rs. 24	809 in the computation of the profits and gains of its business. The Income tax Officer disallowed that claim on the ground that the expenses had not been actually incurred in the year of account and also on the ground that the estimate had not been proved to be based on a consideration of the real expenses which the Company would have to incur for the purpose. The Appellate Assistant Commissioner	 on appeal	 confirmed the disallowance by the I.T.O. on the ground that there was as yet no accrued liability and on the further ground that as the development would be carried out in the future	 the expenditure estimated at current prices could not be allowed. On appeal taken by the appellant before the Income. tax Appellate Tribunal	 the Tribunal	 held that it was by no means certain what the actual cost would be when the developments were carried out and that although the appellant had undertaken to carry out certain developments	 it could bring expenses into account only when the expenses were actually incurred. The Tribunal accordingly dismissed the appeal. The appellant thereafter made an application before the Tribunal requiring it to refer to the High Court under section 66(1) of the Income tax Act certain questions of law arising out of its order. The Tribunal thereupon stated a case and referred the following question to the High Court for its decision: 189 Whether on the facts and circumstances stated above	 the sum of Rs. 24	809 can legally be allowed as an expense of the year under consideration. " The statement of case drawn by the Tribunal was severely criticized by the High Court as under: " Unfortunately	 the treatment of the question by the authorities below has been of a somewhat summary character	 presumably because it was raised and argued before them in a superficial form. But even if such was the case	 there is hardly any justification for the Tribunal failing to realise it least what facts were required to be found and stated. The statement of case is sketchy and bare and like most of the statements we have to deal with during this session	 has hardly any appearance of a case seriously stated. " In spite of the above observations the High Court dealt with the question and after dealing exhaustively with the arguments which were urged be fore it by the learned Counsel for the appellant answered the question in the negative. On an application made by the appellant	 however	 the High Court granted the requisite certificate under article 135 of the Constitution to appeal to this Court and lience	 this appeal. The question which really arises for our determination in this appeal is whether having regard to the fact that the appellant 's method of accounting	 viz.	 the Mercantile method was accepted by the Income Tax Officer and the receipts appearing in the books of account included the unpaid balance of the sale price of the plots in question	 the amount of liability undertaken by the appellant to earn those receipts was to be deducted even if there had not been actual disbursement made by it during the accounting year. Put in other words	 the question was whether in view of the fact that the sum of Rs. 43	692 11 9 had been entered on the credit side in the books of account even though it was not money actually received but only money treated as received on the basis that it. was due and receivable	 the sum of Rs. 24	809 which had been entered as debit	 being the liability of the appellant 190 undertaken by it to earn those receipts	 should be deducted in determining the taxable profits and gains of the appellant. The mercantile system of accounting is well known and this method has been explained in a judgment of this Court in Keshav Mills Ltd. vs Commissioner of Income tax	 Bombay (1). " 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 main ground on which the claim of the appellant for deducting this sum of Rs. 24	809 "	as disallowed by all the authorities below was that the expenditure was not actually incurred in the year of account	 it was by no means certain what the actual cost would be when the developments " are carried out and that there was as yet no accrued liability but only a contingent liability undertaken by the appellant	 even though the undertaking was incorporated in the deeds of sale themselves. The following were the developments undertaken to be carried out by the appellant as appears from the order of the Appellate Assistant Commissioner: " There was a condition in the Conveyance deeds that the appellant does hereby covenant with the purchaser that the appellant shall complete the construction of roads	 drains	 provide suitable pucca surface drains on both sides of the roads and shall also make arrangements for lighting up the said roads and shall maintain the said roads	 drains	 lights till the same are taken over by the Municipal Besides provision for roads	 drains	 etc. 	 t~he ~Deed provides for filling u~p of low lands and there is a clause in the Conveyance Deed which shows that the ~appellant 's shall at his own cost ~fi.11 the low lands and tank with earth and bring the same to road level. " (~1) II9531 ~S.C.R. ~95o	 958~ 191 This undertaking having been incorporated in the deeds of sale themselves there was certainly a liability undertaken by the appellant to carry out these developments within six months from the dates of those deeds. Time was of course not of the essence of the contract and the appellant therefore was at liberty to carry out that undertaking within a reasonable time. That	 however	 did not absolve it in any manner whatever from carrying out the undertaking and the purchasers were in a position to enforce the undertaking by taking appropriate proceedings in that behalf. Reliance was placed on behalf of the Revenue on the case of Peter Merchant Ltd. vs Stedeford (Inspector of Taxes) (1) in which a distinction was drawn between an actual i.e.	 legal liability	 which is deductible	 and a liability which is future or contingent and for which no deduction can be made. The facts of that case were that the Company which carried on the business of managing factory canteens	 had contracted with a factory owner to maintain the crockery	 cutlery and utensils used in the canteen otherwise known as the light equipment in its original quantity and quality. The cost of replacement was admittedly a proper deduction in computing profits	 as was also any sum paid to a factory owner in settlement of the value of shortages on termination of the contract. Owing to war and. other circumstances it was impossible or impracticable for the Company to obtain replacements in some cases	 and the obligations under the contracts with the factory owners in those cases still remained to be performed. in the accounts for the year deductions had been made both of the amounts actually expended on replacements and the amounts which the company was liable to expend when the equipment became available. The Company claimed to be entitled to deduct in computing its profits amounts representing at current prices	 the liability to effect replacements as soon as the required equipment became obtainable. The former amounts were allowed as deductions	 and the latter the Court of Appeal (reversing the decision (1) 192 of the Court below) held not to be deductible. The basis of the decision was that the real liability under the contract was contingent	 not actual	 since the obligations of the company were not such that it might be sued for the cost of 'replacements at current prices	 but only for possible damages for breach of contract in the event of the factory owner preferring a claim under the contract	 and since no legal liability could arise until such a claim was made	 the liability had to be regarded as contingent and not deductible. It is clear from the above that on the facts and circumstances of that case the Court held that it was not an accrued liability but was merely a contingent one and if that was the case only the sums actually expended could be deducted and not those which the company was liable to expend in the future. Simon in his " Income tax "	 Second Edition	 Vol. II	 at p. 204 under the caption " Accrued Liability " observes as under	 after citing the case mentioned above: . "In cases	 however	 where an actual liability exists	 as is the case with accrued expenses	 a deduction is allowable; and this is not affected by the fact that the amount of the liability and the deduction will subsequently have to be varied. A liability	 the amount of which is deductible for income tax purposes	 is one which is actually existing at the time of making the deduction	 and is distinct from the type of liability accruing in Peter Merchant8 Ltd. vs Stedeford (lnspector of Taxes) which although allowable on accountancy principles	 is not deductible for the purpose of income tax. " Approaching the question before us in the light of the observations made above we have got to determine what was the nature of the liability which was undertaken by the appellant in regard to the development of the lands in question	 whether it was an accrued liability or was one which was contingent on the happening of a certain event in the future. There is no doubt that the undertaking to carry out the developments within six months from the dates of 193 the deeds of sale was incorporated therein and that undertaking was unconditional	 the appellant binding itself absolutely to carry out the same. It was not dependent on any condition being fulfilled or the happening of any event	 the only condition being that it was to be carried out within six months which in view of the fact that the time was not of the essence of the contract meant a reasonable time. Whatever may be considered a reasonable time under the circumstances of the case	 the setting up of that time limit did not prescribe any condition for the carrying out of that undertaking and the undertaking was absolute interms. If that undertaking imported any liability on the appellant the liability had already accrued on the dates of the deeds of sale	 though that liability was to be discharged at a future date. It was thus an accrued liability and the estimated expenditure which would be incurred in discharging the same could very well be deducted from the profits and gains of the business. Inasmuch as the liability which had thug accrued during the accounting year was to be discharged at a future date the amount to be expended in the discharge of that liability would have to be estimated in order that under the mercantile system of accounting the amount could be debited before it was actually disbursed. The difficulty in the estimation thereof again would not convert an accrued liability into a conditional one	 because it is always open to the Income tax authorities concerned to arrive at a proper estimate thereof having regard to all the circumstances of the case. That it can be so done is illustrated by Gold Coast Selection Trust Ltd. v Humphrey (Inspector of Taxes) (1) where a particular asset which could not be immediately realised in a commercial sense was valued in money for income tax Purposes in the year of its receipt and it was observed by Viscount Simon: " It seems to me that it is not correct to say that an asset	 such as this block of shares	 cannot be valued in money for income tax purposes in the (1) 	 469. 25 194 year of its receipt because it cannot	 in a commercial sense	 be immediately realized. That is no reason for saying that it is incapable of being valued	 though	 'if its realization cannot take place promptly	 that may be a reason why the money figure set against it at the earlier date should be reduced in order to allow for an appropriate interval. Supposing	 for example	 the contract conferring the asset on the taxpayer included a stipulation that the asset should not be realized by the transferee for five years	 and that if an attempt was made to realise it before that time	 the property in it should revert to the transferor. This might seriously reduce the value of the asset when received	 but it is no reason for saving that when received it must be regarded as having no value at all. The Commissioners	 as its seems to me	 in fixing what money equivalent should be taken as representing the asset	 must fix an appropriate money value as at the end of the period to which the appellant 's accounts are made up by taking all the circumstances into consideration. " As in the case of assets received during the accounting year which could not be immediately realized in a commercial sense	 so in the case of liabilities which have already accrued during the accounting year	 though they may not have to be discharged till a later date. It will be always open to the Income tax authorities to fix an appropriate money value of that liability as at the end of the accounting period by taking all the circumstances into consideration and the estimate of expenses given by the assessee would be liable to scrutiny at their hands having regard to all the facts and circumstances of the case. The High Court was	 therefore	 clearly in error when it stated: " In view of all the circumstances of the case it must in my opinion	 be held that the amounts of sale price	 not received in cash	 were also received and for the purpose of earning the receipts the assessee spent	 besides giving the lands	 nothing more than a promise. Since the whole amount was actually received in the year of account before and 195 without making the promised expenditure	 no question of allowing a deduction of any expenditure from such receipts of the year arises. " If then the estimated expenses which would have to be incurred in duly discharging that liability which was undertaken by the appellant and was incorporated in the deeds of sale could be deducted in accordance with the mercantile system of accounting adopted by the appellant and accepted by the I.T.O.	 is there anything in the Income tax Act which would prevent this debit being allowed as a deduction in the computation of the profits and gains of the appellant 's business? The appellant	 had	 it appears	 claimed this deduction as and by way of expenditure wholly laid out for the purposes of its business under section 10(2)(xv) of the Income tax Act. On an interpretation of that provision	 the High Court was inclined to hold	 though it did not decide the question	 that to the extent that a definite liability had accrued about which all preliminary proceedings causing the accrual of the liability in a concluded form had already been gone through although the actual disbursement had not yet taken place	 section 10(2)(xv) would cover accrued liabilities though the amount may not actually have been expended on the footing that the liability being certain	 the amount was as good as spent and on that basis there would be room in the clause for debits which are proper debits under the mercantile system of accounting. It	 however	 distinguished the present case on the ground that the liability here was a floating liability	 the measure of which depended upon the will of the appellant and the discharge of which rested only in a promise and that the expenses were entirely at large and the development work itself merely so. Apart	 however	 from the question whether section 10(2) (xv) of the Income tax Act would apply to the facts of the present case	 the case is in our opinion	 well within the purview of section 10 (1) of the Income tax Act. The appellant here is being. assessed in respect of the profits and gains of its business and the profits and gains of the business cannot be determined unless and until he expenses or the obligations which have been incurred are set off against the receipt 's The expression profits and gains has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date. As was observed by Lord Herschell in Bussel vs Town and County Bank	 Ltd.( '): " The duty is to be charged upon I a sum not less than the full amount of the balance of the profits or gains of the trade	 manufacture	 adventure	 or concern '; and it appears to me that that language implies that for the purpose of arriving at the balance of profits all that expenditure which is necessary for the purposes of earning the receipts must be deducted	 otherwise you do not arrive at the balance of profits	 indeed	 otherwise you do not ascertain	 and ' cannot ascertain	 whether there is such a thing as profit or not. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to me to be the meaning of the word " profits " in relation to any trade or business. Unless and until you have ascertained that there is such a balance	 nothing exists to which the name " profits can properly be applied. " A similar opinion was expressed in the Gresham Life Assurance Society V. Styles (2) : " When we speak of the profits or gains of a trader we mean that which he had made by his trading. Whether there be such a thing as profit or gain can only be ascertained by setting against the receipts the expenditure or obligations to which they have given rise. " These are no doubt observations from the English cases dealing with English statutes of Income tax	 but the general principles which can he deduced therefrom (1) 	 424 (2) 197 are	 nevertheless	 applicable here and it was stated by Lord Macmillan in Pondicherry Railway Co.	 Ltd. vs Commissioner of Income tax	 Madras (1) " English authorities can only be utilised with caution in the consideration of Indian Income tax cases owing to the difference in the relevant legislation	 but the principle laid down by Lord Chancellor Halsbury in Gresham Life Assurance Society vs Styles (supra)	 is of general application unaffected by the specialities of the English Tax system. " The thing to be taxed"	 said his Lordship	 "is the amount of profits or gains ". The word " profits "	 I think	 is to be understood in its natural and proper sense in a sense which no commercial man would misunderstand. " ' It may be useful to observe at this stage that prior to the amendment of the Indian Income tax Act in 1939	 bad and doubtful debts were not treated as deductible allowance for the purpose of computation of profits or gains of a business	 The Privy Council in the Income tax Commissioner vs Chitnavis observed: " Although the Act nowhere in terms authorises the deduction of bad debts of a business	 such a deduction is necessarily allowable. What are chargeable to income tax in respect of a business are the profits and gains of a year; and in assessing the amount of the profits and gains of a year account must necessarily be taken of all losses incurred otherwise you would not arrive at the true profits and gains. " The High Court in disallowing the claim of the appellant in the present case only considered the provisions of section 10 (2)(xv) of the Act and came to the conclusion that on a strict interpretation of those provisions the sum of Rs. 24	809 was not an allowable deduction. Its attention was drawn by the learned Counsel for the appellant to the provisions of section 10(1) of the Act also but it negatived this argument observing that under the Indian Act	 the profits must be (1) (193i) L. R. 58 1. A. 239	 252. (2) (1932) L. R. 59 I. A. 290	 296. 198 determined by the method of making the statutory deductions from the receipts and any deduction from the business receipts	 if it was to be allowed	 must be brought under one or the other of the deductions mentioned in section 10(2) and that there was no scope for any preliminary deduction under general principles. It was	 however	 held by this Court in Badridas Daga vs The Commissioner of Income tax(1) " It is to be noted that while section 10(1) imposes a charge on the profits or gains of a trade	 it does not provide how those profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions	 but it is well settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable under section 10(1). " Venkatarama Aiyar	 J.	 who delivered the Judgment of this Court then proceeded to discuss the cases of Commissioner of Income tax vs Chitnavis(2)	 Gresham Life Assurance Society vs Styles (3) and Pondicherry Railway Co. vs Income tax Commissioner(4)	 and observed:" The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2)	 whether it is admissible or not will depend on whether	 having regard to accepted commercial practice and trading principles	 it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established	 then the deduction must be allowed	 provided of course there is no prohibition against it	 express or implied	 in the Act. Turning now to the facts of the present case	 we find that the sum of Rs. 24	809 represented the estimated expenditure which had to be incurred by the appellant in discharging a liability which it had already undertaken under the terms of the deeds of sale of the lands in question and was an accrued liability which according to the mercantile system of accounting the appellant was entitled to debit in its books of account (1) 	 14. (2) (1932) L.R. 59 I.A. 290	 296. (3) (4) (1931) L.R. 58 I.A. 239	 252. 199 for the accounting year as against the receipts of Rs. 43	692 11 9 which represented the sale proceeds of the said lands. Even under section 10(2) of the Income tax Act	 it might. possibly be urged that the word " expended was capable of being interpreted as " expendable "or to be expended " at least in a case where a liability to incur the said expenses had been actually incurred by the assessee who adopted the mercantile system of accounting and the debit of Rs. 24	809 was thus a proper debit in the present case. We need not however base our decision on any such consideration. We are definitely of opinion that the sum of Rs. 24	809 represented the estimated amount which would have to be expended by the appellant in the course of carrying on its business and was incidental to the same and having regard to the accepted commercial practice and trading principles was a deduction which	 if there was no specific provision for it under section 10(2) of the Act was certainly allowable deduction	 in arriving at the profits and gains of the business of the appellant under section 10(1) of the Act	 there being no prohibition against it	 express or implied in the Act. It is to be noted that the appellant had led evidence before the Income tax authorities in regard to this estimated expenditure of Rs. 24	809 and no exception was taken to the same in regard to the quantum	 though the permissibility of such a deduction was questioned by them relying upon the provisions of s.10(2) of the Act. It therefore follows that the conclusion reached by the High Court in regard to the disallowance of Rs. 24	809 was wrong and it should have answered the referred question in the affirmative. Before we conclude	 we are bound to observe that having accepted the receipts of Rs. 43	692 11 9 in their totality even though a sum of Rs. 29	392 11 9 only was actually received by the appellant in cash	 thus making the ' appellant liable for income tax on a sum of Rs. 14	300 which had not been received by it during the accounting year	 it was hardly open to the Revenue to urge that the sum of Rs. 24	809 should not have been allowed as a permissible deduction before 200 arriving at the profits or gains of the appellant which were liable to tax. Consistently enough with this attitude	 the Revenue ought to have expressed its willingness to treat only a sum of Rs. 29	392 11 9 as the actual receipt of the appellant during the accounting year and made up the computation of the profits and gains of the appellant 's business on that basis. The Revenue	 however	 did nothing of the sort and insisted upon having its pound of flesh	 asking us to delete the whole of the item of Rs. 24	809 from the debit side of the account which it was certainly not entitled to do. We accordingly allow the appeal	 set aside the judgment of the High Court and answer the referred question in the affirmative. The respondent will of course pay the appellant 's costs throughout. Appeal allowed.

Summary:
The appellant company carried on land developing business and sold land after development on a profit. The whole of the development was not carried out before the land was sold nor the whole of the sale price received in cash at the time of the sale. In the accounting year in question the appellant sold a number of plots and received a portion of the sale price but as it maintained its accounts in the mercantile method it entered the whole price receivable	 viz.	 Rs. 43	692 11 9	 in credit side though only Rs. 29	392 11 9 was actually received and debited a sum of Rs. 24	809	 being the estimated expenditure for the developments it had	 by terms incorporated in the deeds of sale	 under taken to carry out within six months thereof	 although no part of it was actually spent during that year. The appellant claimed a deduction of the said sum of RS. 24	809 in computation of the profits and gains of its business during the assessment year. The Income tax Officer	 while accepting the method of accounting adopted by the appellant	 disallowed the 'claim on the ground that no expenses had actually been incurred and the estimate was only a probable one. The Appellate Assistant Commissioner as well as the Income tax Appellate Tribunal confirmed the disallowance on appeals and the High Court	 on a reference under section 66(1) of the Income tax Act held against the appellant. The question was whether the deduction claimed was a legally allowable expense of the year in question. Held	 that the liability which was undertaken by the appel lant under the deeds of sale was an accrued liability and not a contingent one. Although the time of six months was not of the essence of the contract	 the undertaking it had given was unconditional and absolute in terms and the liability must be held to have accrued on the execution of the deeds of sale though it was to be discharged at a future date. Keshav Mills Ltd. vs Commissioner of Income tax	 Bombay	 [1953] S C.R. 950	 referred to. Peter Meychant Ltd. vs Stedeford (Inspector of Taxes)	 distinguished. 24 186 The difficulty in estimating such a liability for purposes of debit under the mercantile system of accounting could be no ground for treating an accrued liability as a conditional one	 since it was always open to the Income tax authorities to arrive a proper estimate thereof having regard to all the circumstances of the case. Gold Coast Selection Trust Ltd. vs Humnphrey (Inspector Taxes)	 [19481 A.C. 459	 referred to. Regard being had	 therefore	 to the accepted commercial practice and trading principles	 the estimated deduction	 even if it did not come under any of the specific provisions Of section 10(2) of the Act	 was certainly an allowable deduction under section 10(1) of the Act	 there being no prohibition	 either express or implied	 against it in the Act and	 consequently	 the question must be answered in the affirmative. Badridas Daga vs The Conimissioncr of Income tax	 ; Russel vs Town and Country Bank Ltd.	 ; Gyesham Life Assurance Society	 vs Styles	 ; Pondichcry Railway co Ltd. vs Commissioner of Income tax	 Madras	 (1913) L.R. 58 .A. 239 and Income tax Commissioner vs Chitnavis	 (1932) L.R. 59 I.A. 290	 referred to.