Case Law Companies Act Non such Estate Ltd Vs The Commissioner of Income-Tax Madras

Case Law Companies Act

Non such Estate Ltd Vs

The Commissioner of Income-Tax Madras






CITATION: 1975 AIR  428  1975 SCR  (2) 806 1975 SCC  (3) 443


ACT: Income-tax Act. 1922-Assessee followed mercantile system  of accounting  Debited  in  books  each  year  managing  agency remuneration for three years Claimed deduction in the  third year  on  receipt of approval from  Central  Government  for reappointment  of managing agents as required under  s.  326 Companies Act-Whether assessee should have claimed deduction in each assessment Year.

HEADNOTE: The   assessee  who  followed  the  mercantile   system   of accounting  debited  in its account books  certain  sums  of money  as  remuneration  of  the  managing  agents  for  the assessment  years  1957-58 to 1959-60.  For the  purpose  of income-tax  the  company added back the sum to  its  taxable income and claimed the whole sum as a deductible expenditure in  the assessment year 1959-60 on the ground that  the  sum became  payable  only during that year when  the  Government accorded its approval to the new managing agency  agreement. The  income-tax Officer rejected the claim holding 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 since he followed the mercantile  system of accounting.  This view was  upheld  by the  Appellate  Assistant Commissioner  and  the  Income-tax Appellate Tribunal. The  High  Court held that although at the  time  the  debit entries  were  made in the account books  of  the  assessee, approval  of the Central Government had not  been  received, when  it  came  later, it gave legal  effect  to  the  debit entries  with  retrospective effect from April 1.  1956  and that the refusal of deduction by the Income-tax Officer  was right.

Allowing the appeal to this Court, HELD : The High Court was in error in answering the question against  the  assessee.   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 High Court overlooked  the  plain terms  of  s.326 of the Companies Act, 1956 under  which  it could  not  be  assumed that the  Central  Government  would approve  every  proposed appointment  or  re-appointment  of managing agent. [809A; D; 810A] In  the instant case it is only when the Central  Government conveyed its approval to the appointment of managing  agents by  its letter dated September 2, 1957 that the  appointment became  effective  and the Company’s liability  to  pay  the remuneration of the managing agents accrued.  The liability became effective from April 1, 1956  because  the  Central Government   chose  to  give  its   approval   retrospective operation.   The liability could not be said to had  & risen from  any date prior to September 2, 1957 when the  approval was  given. Section 326 of the Companies Act  contains  an absolute   prohibition  against  the  appointment   or   re- appointment  of  a  managing agent before  the  approval  of Central Government was obtained. [810B-C]

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1554 of 1970. Appeal. by Special Leave from the Judgment & Order dated the 19th  August, 1968 of the Madras High Court in Tax Case  No. 18 of 1 965. G.   B.  Pai, A. G. Manessea, D. C. Mathur and K.  K.  John, for appellant. B. B. Ahuja and S. P. Nayar, for the respondent. 807 The Judgment of the Court was delivered by GUPTA, J. This is an appeal by special leave from a judgment of the  Madras High Court in a reference under section 66(1) of the Income Tax Act, 1922.  The appellant, Nonsuch  Estate Limited,  is  a public limited company incorporated  in  the ‘year  1924 under the Companies Act, 1913.   The  appellant, referred  to hereinafter as the Company, derives its  income from  tea  grown in its estate for which it is  assessed  to income-tax.  M/s.  Harrisons and Crosfield Limited have been the managing agents of the Company from the beginning.   The following  question relating to the assessment year  1959-60 was referred to the High Court :

“Whether on the facts and in the circumstances of   the case,  the  sum  of   Rs.   97,188/- representing the Managing Agencyremuneration for  the        period  1-4-1956  to  30-6-1957  was deductible in the computation of the income of previous year  ending  on  30th  June   1958, relevant for the assessment year 1959-60.” The relevant facts leading to the reference are these.   The managing  agents of the Company were entitled to  commission at  the  rate of 11 per cent on all sales of tea  and  other producers  of the Company and a further sum of  Rs.  12,000/- per  annum  for secratarial work.  There  was,  however,  no written. agreement embodying the terms.  After the Companies Act,  1956 came into force on April 1, 1956 it  was  decided that  there  should  be a fresh  managing  agency  agreement between  the Company and its managing agents  in  conformity with  the  provisions of the said Act.   A  fresh  agreement drawn  up and submitted by the managing agents was  approved by   the   Company.    The  new   agreement   proposed   the reappointment of M/s.  Harrisons & Crosfield Limited as  the managing agents of the Company for a period of 10 years on a remuneration of 5 per cent commission on the net profits  of the Company computed in the manner laid down in sections 349 to  351  of  the Companies Act, 1956 subject  to  a  minimum remuneration  of Rs. 12,000/- per annum.  The revised  terms were to take effect from April 1, 1956.  As required by sec. 326 of the Companies Act, the new agreement was sent to  the Central  Government  for approval by a  communication  dated august  3,  1957  enclosing a  formal  application  for  the purpose  in  Form  25,  On September 2,  1957  by  a  letter addressed  to  the  Company  the  Government  conveyed   its approval to “the appointment of M/s.  Harrisons & Crosfields Ltd. as the Managing agents…….. for a period of 10 years with effect from 1st April 1956, on a remuneration of 5  per cent  commission on the net profits of the Company  computed in  the  manner as laid down in Sections 349 to 351  of  the Companies Act, 1956 subject to a minimum remuneration of Rs. 12,000/- (Rupees twelve thousand only) per annum payable  to the  Managing Agents, in the event of absence or  inadequacy of  profits  in  any  financial year.”  On  receipt  of  the approval,  the  Company  by  a  resolution  adopted  at   an extraordinary  general meeting of its shareholders  held  on October  4,  1957 reappointed M/s.   Harrisons  &  Crosfield Limited  on  the terms stated above.  In terms  of  the  new agreement the existing agency agreement between the  parties stood cancelled with the expiry of March 31, 1956. 808

The  Company  follows the mercantile system  of  accounting. For  the period April 1, 1956 to June 30, 1956, the  Company credited a sum of Rs. 9320/- to the account of the  managing agents as their remuneration in accordance with the terms of the  proposed  new  agreement.  This was  disclosed  in  the published accounts of the Company for the year July 1,  1955 to  June 30, 1956 relevant to the assessment  year  1957-58. For  the purpose of assessment of income-tax, however,  the Company  added  back  the said sum of  Rs.  9,320/-  to  its taxable income.  In the next accounting year ending on  June 30,  1957 relevant to the assessment year 1958-59  the  same process was followed with regard to the remuneration payable to the 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 .lm15 ”

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 30-6-1958 9,320 Remuneration  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   71,368 Managing Agents expenses for the year ending 30th June 1957 recouped during the year ending  on 30th  June 1958.13,200 Proportionate Managing Agent’s expenses for the   year ending on 30th June 1956 recouped during     the year ending on 30-6-19583,300 97,188. 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 809 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  Commissioner of Income-tax, Madras  v.  A. Gajapathy  Naidu(1),  this Court  explained  the  difference between  the  two methods quoting with approval  an  extract from a Judgment of the, Allahabad High Court in Commissioner of Income-tax v. Singari Bai(2). In Gajapathy Naidu’s(1) case this Court said: ”


It  is  commonplace  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 sec. 326 of the Companies Act,  1956.   Sec. 326 so far it is material for the question involved in  this case, is in these terms : “Sec.    326.)


1) 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 appoi nted 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.” (1) 53 I.T.R. 114.

(2) 13 I.T.R. 224. 810 Section 326 prohibits the appointment or re-appointment of a managing  agent unless the Central Government approved  such appointment or re-appointment.  The Central Government would not accord its approval unless the requirements 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 reappointment of a managing agent.  Thus  in the  instant  case 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  Company’s  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  sec. 326  and  we do not consider it necessary to  refer  to  the authorities cited by the learned counsel for either side. The appeal is accordingly allowed, the answer given by  the High Court to the question referred to it is discharged  and the question is answered in the affirmative and in favour of the assessee. The appellantwill be entitled to its  costs in this Court and in the High Court. P.E.R. Appeal allowed. 811

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