The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997 Equivalent citations: AIR 1997 SUPREME COURT 2350, 1997 AIR SCW 2239, 1997 TAX. L. R. 642, (1997) 4 JT 493 (SC), (1997) 91 TAXMAN 351, 1997 (2) UPTC 1202, 1997 (3) SCALE 409, 1997 (4) SCC 530, (1997) 3 SUPREME 642, (1997) 3 SCR 539 (SC), (1997) 139 CURTAXREP 564, (1997) 225 ITR 746, (1997) 3 SCALE 409 Author: S.C. Agrawal Bench: S.C. Agrawal PETITIONER: THE GODHRA ELECTRICITY CO. LTD. AHMEDABAD Vs. RESPONDENT: THE COMMISSIONER OF INCOME TAX, GUJARAT-II, AHMEDABAD DATE OF JUDGMENT: 03/04/1997 BENCH: S.C. AGRAWAL, G.B. PATTANAIK ACT: HEADNOTE: JUDGMENT: J U D G M E N T S.C. AGRAWAL, J. : These appeals by certificate granted under section 261 of the Income Tax Act 1961 (hereinafter referred to as the Act) have been filed by the Godhra Electricity co. Limited, (hereinafter referred to as the assessee company ) against the judgment of the Gujarat High Court dated February 24-25 1982 in Income Tax References Nos. 288 of 1975 ,73 of 1978. The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  1 Income Tax Reference no. 288 of 1975 related to the assessment year 1969 -70 while Income Tax Reference No. 73 of 1978 related to the assessment years 1970-71 and 1971-72 and Income Tax Reference No. 171 of 1978 related to assessment year 1972-73. On November 19, 1922 the then Government of Bombay granted a licence under the Indian Electricity Act, 1910 to Lady Sulochana Chinubhai & Company authorising it to generate and supply electricity to the consumers in Godhra area. The assessee company is the successor of the said licensee. On the recommendations of rating committee constituted under section 57(2) of the Electricity (supply) act, 1948 the State Government had fixed the charges for supply of electricity and motive power by the assessee company with effect from February 1, 1952. After the amendment of the Electricity (supply) act, 1948 in 1956 the assessee company increased the charges for motive power from January 1, 1963 to 35 np. per unit with a maximum of Rs. 7 per month for every installation and a few months thereafter on June 22, 1963 the assessee-company increased the rated for electricity supplied for light and fans to 70 np. per unit with a minimum of Rs. 5 of every installation with effect from July 1, 1963 this unilateral increase in the rates foe supply of motive power as well as electricity for lights and fans led to the institution of two representative suits by the consumers (civil suits Nos. 152 of 1963 and 50 of 1964 in the court of Civil Judge (senior Division) at Godhra wherein in the right of the assessee company to unilaterally increase the charges in respect of motive power and lights and fans was challenged the said suits were decided by trial court in favour of the consumers and the decree of the trial court was affirmed in appeal by the Assistant judge Panchmahals at Godhra. The second appeals filed by the assessee company were dismissed bu the learned single judge of the Gujarat High Court on April 11, 1966 but the letters patent Appeals (L.P.As. Nos. 42 and 43 of 1966 filed by the assessee company against the said judgment of the learned single judge were allowed by the Division Bench of the High Court by judgment dated December 3, 1968 and both the representative suits filed by the consumers were dismissed. It was held that under the Electricity supply act, 1948 as amended in 1956 the assessee company was entitles to enhance the charges unilaterally subject to the conditions prescribed in the sixth schedule to the said Act. the said judgment of the Division Bench of the Gujarat High court was affirmed by this court by judgment dated February 26, 1969 in Jindas oil mill ors. v. Godhra Electricity co. 1969 (3) SCR 836. During the pendency of this litigation in the various courts the assessee-company was not able to realise the enhanced charges from the consumers. after the decision of this court on February 26, 1969 some of the citizens of Godhra mer the minister of Industries mines and power government of Gujarat with a view to persuading him to intervene and restrict the assessee-company from recovering the enhanced rated from the consumers thereafter the under secretary to the Government of Gujarat in the Industries Mines and power department addressed a letter dated march 19, 1969 to the assessee-company suggesting that the company may be advised to maintain the status quo for the rates to the consumers are concerned and also to continue the existing street light agreement for at least six months. The chief Electrical Inspector was requested to go through the accounts of the assessee-company for year to year and report to the Government the actual position about the reasonable return earned by the assessee-company on may 16, 1969 some of the consumers filed another representative suit (suit No. 118 of 1969 against the assessee-company in the Court of civil judge (junior Division ) at Godhra challenging the right of the assessee-company to recover the consumption charges at the enhanced rates. In the said suit it was claimed that the decision of this court was only of academic interest as in April, 1965 the The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  2 assessee-company began to purchase in bulk electrical energy and that the assessee- company began to purchase in bulk electrical energy at 10 paise per unit from the Gujarat Electricity board and it had to work merely as distributing agency and had to collect the charges and not generate electrical energy and that the assessee-company would earn more profits even if it supplied electricity at 31 paise per unit to the consumers of motive power and that it would earn a reasonable return even on the basis of the existing rates an interim injunction was granted by the trial Court in that suit a written statement was filed by the assessee-company contesting the said suit but when the suit came up for bearing no evidence was led to controvert the evidence produced on behalf of the consumers since at that point of time the undertaking of the assessee- company was under the management of the collector of Godhra and he did not give any instructions to the favour appearing on behalf of the assessee-company with the result that the said lawyer reported no instructions. The said suit was decreed in favour of the consumers by the civil judge by his judgement dated June 20, 1974 and a declaration was granted to the effect that the assessee-company shall not recover the charges exceeding 31 np. per unit for lights and fans and 20 np. per unit for motive power. The interim injection which had been granted against disconnection or dis- connection or discontinuance of the supply was made absolute on the same terms on which it was initially granted. during the course of hearing before the High Court it was stated by the learned Advocate General appearing for the assessee- company that an appeal was in fact filed against the said judgement but the plaintiffs by their application dated July 27, 1979 sought permission of the court to withdraw the suit with liberty to file a fresh suit on the same cause of action and when necessary and the trial judge by order of even date permitted the plaintiffs to withdraw the suit with liberty to file a fresh suit on the same cause of action if and when necessary and the trial judge by order of even date permitted the plaintiffs to withdraw the suit and granted them the liberty sought while the said suit was pending before the trial court the Gujarat state electricity board in exercise of power conferred on it by section 6(1) of the Indian electricity Act 1910 read with clause (2) of the terms of the licence sought to exercise its option to purchase the electrical undertaking of the assessee-company by issuing a notice dated November 81971. the assessee- company filed a writ petition (special civil Application no. 1752 of 1972 in the Gujarat High court challenging the validity of the said notice. During the pendency of the said writ petition the government of Gujarat issued an order under Rule 115(2) of the defence of India rules 1971 taking over the management of the undertaking of the assessee - company with effect from November 19 1972 and the collector of Godhra was authorised by the said order to take over the management of the undertaking of the assessee company the said writ petition was ultimately dismissed by the High court by is judgment dated October 16-17 of 1973 in the appeal filed by the assessee -company against the said judgment in this court an interim order was passed directing the collector of Godhra to hand over the undertaking to the Gujarat state electricity board and in accordance with the said direction the Government of Gujarat on December 20 1973 instructed the collector of Godhra to hand over the management of the undertaking to the Gujarat state Electricity board which was done on the next day and thereafter the notification issued under Rule 115(2) of the defence of Indian Rules 1971 was cancelled on may 4 1974. Upto assessment year 1963 -64 the assessee-company was assessed on the basis of the accounts maintained according to the mercantile system for the subsequent assessment years i.e from 1964-65 to 1967-68 the assessee-company deducted a total amount of Rs. 10,87,828\- from the total earnings in respect of sale of electrical energy on the ground that the said amount was not actually The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  3 recovers by it from the consumers since the consumers had filed a suit against the assessee-company and had obtained interim relief in that behalf. The particulars of the deductions made for the aforesaid four assessment years were as under:- ------------------------------------------------------------ Assessment Year Amount Deducted ------------------------------------------------------------ 1964-65 Rs. 2,59,777/- 1965-66 Rs. 3,16,953/- 1966-67 Rs. 3,89,761/- 1967-68 Rs. 1,21,337/- ----------------------------------------------------------- The aforesaid disputed amounts were shown by the assessee-company on the liability side in the balance sheet under the head "Disputed increase in rates charged to customers(consumer) carried forward pending settlement of disputes in the District court" IN the assessment year 1968 -69 there was an adjustment of the claim amounting to Rs. 3,54,152/- while making the assessment for the assessment year 1969-70 the income Tax officer included the said amount of Rs. 7,33,676/- on the ground that the suit filed against the assessee-company be the consumers was decide in favour of the assessee-company by this court during the accounting year 1968-69 and the assessee-company has the legal right to recover the said amount and on the basis of the accountancy followed by the assessee-company the amount of Rs. 7,33,676/- will have to be taxed as the income that has accrued to the asseeeee-company on account of the decision of this court in the assessment year 1969-70. The said addition made by the income tax officer was however deleted by the appellate assistant commissioner on appeal on appeal on the view that no legally enforceable claim had accrued to the assessee-company during the previous year by which it could recover the arrears of motive power and electricity for lights and fans from the consumers the income tax appellate tribunal (hereinafter referred to as the tribunal on further appeal held that the question of fixing a reasonable return was still an open issue since it was a subject matter of further litigation wherein as a result of the decision of civil judge junior division Godhra the assessee-company was restrained from recovering the charges more than the 31 paise per unit for lights and fans and 20 paise per unit for motive power from the customers and that the right to receive the increased rated had not crystallized accounting to the Tribunal the claim at the increased rates as made by the assessee-company and on the basis of which necessary entries were made in the books, represented only hypothetical income and the impugned amount as brought to tax by the income Tax officer did not represent the income which had accrued to The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  4 the assessee- company during the relevant previous year. On an application by the Revenue the Tribunal referred following question of law for the opinion of the Gujarat High court :- "whether the Tribunal was right in law in holding that the amount of Rs. 7,33,676/- which had accrued to the assessee during the previous year and which was brought to tax by the Income tax officer did not represent the income and therefore could not be included in computation of the total income of the assessee." ON the basis of the said reference Income Tax Reference No. 288 of 1975 was registered in the High court. Similarly in respect of assessment years 1970-71 and 1971-72 the Income tax officer included the sums of Rs. 2,63,465/- and Rs. 2,98,077/- respectively as income that had accrued to the assessee-company in those years and was taxable the said addition was deleted by the Appellate Assistant commissioner on appeal by the Tribunal on application moved by the Revenue the following question of law was referred to the High court for its opinion :- "Whether the tribunal was right in law in holding that the amount of Rs. 2,63,465/- for assessment year 1970-71 and Rs. 2,98,077/- for assessment year 1970-72 which had accrued to the assessee during the previous year and which was brought to tax by the income tax officer did not represent the income of the assessee and therefore not liable to be included in computation of the total income of the assessee ?" On the basis the said reference Income Tax Reference No. 73 of 1978 was registered in the High court . For the assessment year 1972-73 the income tax officer included a sum of Rs. 3,17,741/- as income that had accrued and was taxable in the hands of the assessee company which addition was deleted by the Appellate Assistant commissioner and the said order of the Appellate Assistant commissioner was upheld by the tribunal the following questions were referred by the tribunal to the high court for opinion. "1. whether the income tax appellate tribunal was right in holding that the amount of Rs. 3,17,741/- which had accrued to the assessee during the previous year and which was brought to tax by the income tax officer did not represent the income and therefore it could not be included in the computation of the total income of the assessee ? 2. Whether on the facts and in the circumstances of the cast the receipt of Rs. 3,17,741/- could be subjected to tax in the assessment year in question as the income of the assessee ? The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  5 On the basis the said reference, Income tax reference No. of 1978 was registered in the High court. All the three references were disposed of by the High court by a common judgment dated February 24-25 1982 the High court has held that the assessee-company was following the mercantile system of accounting and that even under this system in order to visit the assessee-company with the obligation to pay tax the profit must become actually due no matter when it is received and that income cannot be said to have accrued to an assessee-company if it is based on a mere claim not backed by any legal or contractual right to receive the amount at a subsequent date. the High court has held that in the mercantile system of accounting it is the real income as distinguishes from a hypothetical income which can be brought to tax. In view of the decision of the Division Bench of the High court allowing the letters patent Appeals of the assessee-company which judgment was affirmed by this court on February 26 1969 the High court has held that the assessee-company had a legal right to recover the consumption charge at the enhanced rate from the consumers as regards the letter from the under secretary to the Government of Gujarat Industries Mines and power Department dated March 19, 1969 the High court has observed :- "We do not know if this letter was a directive to the assessee under any provision of law but in any case it was it was in the from of a suggestion which, if accepted enured for a period of six months only therefore the contention of the learned advocate general that income could not be said to have accrued to the assessee within a few days after the supreme court dismissed the appeals filed by the consumers does not appeal to us in any case the request made by the state Government was to maintain the status quo for a period of six months only that letter did not take away the right of the assessee to recover consumption charges at the enhanced rates from its consumers." As regards the representative suit (suit No. 118 of 1969) which was filed by the consumers in the court of civil judge (junior division at Godhra the high court has observed that "the said suit concerned the recovery of enhanced charges for the period subsequent to 31st march 1969 and not prior thereto " The High court rejected the contention urged on behalf of the assessee-company that no real income had accrued to the assessee-company in the facts and circumstances of this case since the assessee-company was legally entitled to recover the consumption charges from the consumers at the enhanced rates and at no point of time had the assessee-company forgone or given up its right to recover the enhanced rates from its consumers on that view of the matter the High court answered the questions mentioned above against the assessee-company and in favour of the Revenue by order dated January 15, 1983 the Hight Court granted certificate of fitness to appeal to this court against the said judgment. Hence these appeals. Shri S. Ganesh the learned counsel appearing for the assessee-company has submitted that in the facts and circumstances of this case it must be held that no real income had accrued to the assessee-company on account of enhanced charges for electricity since the assesseee-company was The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  6 not able to recover the said enhanced charges from the consumers in view of the protracted litigation during the period from 1963 to 1969 and thereafter on account of the letter from the under secretary to the Government of Gujarat dated March 19 1969 asking the assessee-company not to charge the enhanced rates for at least six months and the subsequent suit (suit no. 118 of 1969) filed by the consumers in 1969 and the taking over of the management of the assessee-company by the collector Godhra in pursuance of the order passed under Rule 115(2) of the Defence of India Rules 1971. It has been urged that though the assessee- company was following the mercantile system of accounting but in the mercantile system also tax can be imposed only if there is real income and income tax cannot be imposed on hypothetical income. The learned counsel has placed reliance on the decisions of this court in commissions of Income Tax Bombay city-I V. Messrs. Shoorji Vallabhdas and Co., (1962) 46 ITR 144; Commissioner of Income tax West Bengal-II V. Birla Gwalior (P) Ltd. (1973) 89 ITR 266; Poona Electric Supply Co. Ltd. V. Commissioner of Income tax Bombay City-I (1965)57 ITR 521 R.B Jodha Mal Kuthiala V. Commissioner of income tax Punjab (1971) 82 ITR 570 and state bank of Travancore v. commissioner of Income tax Kerala (1986) 158 ITR 102. Under the Act income charged to tax is the income that is received or is deemed to be received in India in the previous year relevant to the year for which assessment is made or on the income that accrues or arises or is deemed to accrue or arise in India during such year. The computation of such income is to be made in accordance with the method or accounting with the method or accounting regularly employed by the assessee. It may be either the cash system where entries are made on the basis of actual receipts and actual outgoings or disbursements or it may be the mercantile system where entries are made on accrual basis i.e. accrual of the right to receive payment and the accrual of the liability to disburse or pay. In commissioner of Income tax Bombay city-I v. Messrs. Shoorji Vallabhdas and co.(supra) it has been laid down :- "Income tax is a levy on income no doubt the Income Tax act takes into account two points of time all which the liability to tax is attracted viz the accrual of the income or its receipt; but the substance of the matter is the income. if income does not result at all there cannot be a tax even though in book keeping an entry is made about a hypothetical income which does not materialise."[P. 148] This principle is applicable whether the accounts are maintained on case system or under the mercantile system. If the accounts are maintained under the mercantile system what has to be seen is whether income can be said to have really accrued to the assessee-company. in H.M. Kashiparekh & co. ltd. v. commissioner of Income Tax (1960) 39 ITR 706 the Bombay High court had said :- "Even so, (the failure to produce account losses we shall proceed on the footing that the assessee- company having followed the mercantile system of account there must have been entries made in its books in the accounting year in respect of the amount of commission in our judgment we would not be justified in attaching any particular importance in this case to the fact that the company followed mercantile system of The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  7 accounting. They would not have any particular bearing in applying the principle of real income in the facts of this case". The said view was approved by this court in commissioner of Income Tax v. Birla Gwalior (p) Ltd. (supra) where the assessee maintained its accounts on the mercantile system. In that case this court after referring to the decision in Morvi Industries Ltd. V. commissioner of Income Tax, (1971)82 ITR 835 which was also a case where the accounts were maintained on mercantile system has said :- "Hence it is clear that this court in Morvi Industries case did emphasise the fact that the real question for decision was whether the income had really accrued of not it is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income "[p. 273] In Poona Electric supply co. Ltd. V. commissioner of Income Tax Bombay city-I (supra ) this court has said :- "Income tax is a tax on the real income i.e. the profits arrived at on commercial principles subject to the provisions of the income tax act." In that case the court has approved the following principle laid down by the Bombay High court in H.M. Kashiparekh & co. Ltd. v. commissioner of Income tax (supra):- "The principle of real income is not to be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect or managing agency commission is made agreed to or given on grounds of commercial expediency simply because it takes place some time after the close of an accounting year In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it will lay greater emphasis on the business aspect of the matter viewed as whole when that can be done without disregarding statutory language." In state bank of Travancore v. commissioner of income tax Kerala (supra ) after considering the various decisions of this court sabyasachi Mukharji J. (as the learned chief justice then was ) has said :- "An acceptable formula of co- relating the notion of real income in conjunction with the method of accounting for the purpose of taxation is difficult to evolve besides any strait jacket formula is bound to create problems in its application to every situation it must depend upon the facts and circumstances of each case when and how does an income accrue and what are the consequences that follow from actual of income as well settled the accrual must The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  8 be real taking in go account the actuality of the situation whether an accrual has taken place or not must in appropriate cases be judged on the principles of real income theory After accrual non charging of tax on the same because of certain conduct based on the ipse dixit of a particular assessee cannot be accepted in determining the question whether it is hypothetical income or whether real income has materialised or not various factors will have to be taken into account it would be difficult and improper to extend the concept of real income to all cases depending upon the ipse dixit of the assessee which would then become a value judgment only what has really accrued to the assessee has to be find out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner and dovetailing of these factors together but once the accrual takes place on the conduct of the parties subsequent to the year of closing an income which has accrued cannot be made "no income ." [P. 154] If the matter is examined in the light of the aforementioned principles laid down by this court it must be held that even thought the assessee-company was following the mercantile system of accounting and had made entries in the books regarding enhanced charges for the supply made to the consumers no real income had accrued to the assessee- company in respect of those enhanced charges in view of the fact that soon after the assessee-company decided to enhance the rates in 1963 representative suits (civil suits Nos. 152 of 1963 and 50 of 1964) were filed by the consumers which were decreed by the trial court and which decree was affirmed by the appellate court and learned single judge of the High court and it is only on December 3 1968 that the letters patents Appeals filed by the assessee-company were allowed by the division bench of the high court and the said judgment by the consumers in this court and the same were dismissed by the judgment of this court and the same were dismissed by the judgment of this court dated February 26 1969. shortly thereafter on march 19 1969 the under secretary to the Government of Gujarat wrote a letter advising the assessee-company to maintain the status quo for the rates to the consumers for at least six moths and the chief Electrical inspector was directed to go through the accounts of the assessee-company from year to year and to report to the Government about the actual position about the reasonable returns earned by the assessee-company on may 16 1969 another representative suit (suit no 118 of 1969) was filed by the consumers wherein interim injunction was granted bu the court and which was finally decreed in favour of the consumers on June 23 1974 it would thus appear that after the decision was taken by the assessee-company to enhance the charges it was not able to realise the enhanced charges on account of pendency of the earlier representative suits of the consumers followed bu the letter of the under secretary to the government of Gujarat and the subsequent suit of the consumers and during the pendency of the subsequent suit the management of the undertaking of the assessee-company was taken over by the Government of Gujarat under the Defence of India rules 1971 and the undertaking was subsequently transferred to the Gujarat state Electricity Board. The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  9 It is no doubt true that the latter addressed bu the under secretary to the Government of Gujarat to the assessee-company had no legally binding effect but one has to look at things from practical point of view [see : R.B. Jodha Mal Kuthiala v. commissioner of Income tax Punjab (supra)]. The assessee-company being a licensee could not ignore the direction of he state government which was couched in the form of an advice whereby the assessee- company was asked to maintain the status quo for at least six months and not to take steps to recover the dues towards enhanced charges from the consumers during this period Before the expiry of the period of six months the subsequent suit had been filed by the consumers and during the pendency of the said suit the undertaking of the assessee- company was taken over bu the government of Gujarat under the defence of India Rules 1971 and subsequently it was transferred to the Gujarat state Electricity Board and as a result the assessee-company was not it a position to take steps to recover the enhanced charges. The High court has observed that the subsequent suit that was filed on May 16 1969 related to recovery of enhanced charges for the period subsequent to March 31, 1969 and not prior thereto. We have however perused the judgment of the joint Judge (junior Division) Godhra dated June 20 1974 in the said suit which was annexed as Annexure "d" to the statement of the case. The said judgment does not show that the suit was confined to the period subsequent to march 31, 1969. On the other hands it shows that the plaintiffs in that suit were challenging the enhancement in charges made in 1963 and had sought a declaration that the assessee- company was not entitled to recover more than 31 paise per unit for light and fans and 20 paise per unit for motive power and the trial court while decreeing the said suit had given a declaration in these terms. The said declaration is not confined to the period subsequent to March 31,1969. The question whether there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity has to be considers by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the income tax officer while passing the assessment orders in respect of the assessment years under consideration. The Appellate Assistant commissioner was right in deleting the said addition made by the income tax officer and the tribunal had rightly held that the claim at the increased rates as made by the assessee-company on the basis of which necessary entries were made represented only hypothetical income and the impugned amounts as brought to tax by the income tax officer did represent the income which had really accrued to the assessee-company during the relevant previous years. The High court in our option was in error in upsetting the said view of the Tribunal . In the result the appeals are allowed the impugned judgment of the high court is set aside and the questions referred bu the tribunal for options are answered in favour of the assessee-company and against the Revenue. But in the circumstances there will be no order as to costs. The Godhra Electricity Co. Ltd. ... vs The Commissioner Of Income Tax, ... on 3 April, 1997  10