G.K. Misra, C.J. -
(1.) THE following question of law has been referred to this court under Section 256(1) of the Income-tax Act, 1961 :
" Whether, on the facts and in the circumstances of the case, the Tribunal was justified in deleting the income from contract work on the ground that there was no real income, even though the assessee adopted the mercantile system of accounting ? "
(2.) RELEVANT facts may be given in short to appreciate the point of law arising out of the appellate order. The assessee is a registered firm of four partners and derives income from various sources. The accounting period in question ended with 24th of March, 1961. The year of assessment is 1960-61. The assessee maintained the mercantile method of accounting.
During the previous year relevant to the assessment year under reference, the assessee undertook a project styled as " D. B. K. Railway Project". The assessee failed to render any income from this source. From the balance-sheet of the assessee the Income-tax Officer found that the assessee had made a credit of Rs. 1,34,028 and a debit of Rs. 2,18,442. A debit balance of Rs. 84,414 had been carried over to the next year as an item on the asset side. The assessee's case was that Rs. 2,18,442 had been spent for the construction of the railway when the contract was rescinded by the railways not to be further worked out and in connection with that expenditure the assessee had received Rs. 1,34,021 towards "on account" bills by way of advance. The accounts were not closed and the balance amount payable to the assessee after deducting the actual payment was carried over to the next year as an item on the asset side. The Income-tax Officer did not accept the expenditure of Rs, 2,18,442 as having been incurred as the assessee did not produce accounts from which the expenses could be fully verified and no work-in-progress register was produced. The Income-tax Officer thus rejected the assessee's claim of having spent Rs. 2,18,442. He accepted Rs. 1,34,028, the amount received as representing the total expenditure invested in the contract work. He estimated the net profits as 15 par cent. of the gross receipts which on calculation came to Rs. 20,103. This amount was included in the total net income of the assessee.
The assessee carried an appeal to the Appellate Assistant Commissioner. Oh the identical reasoning that proper accounts were not furnished by the assessee in support of the expenditure and for the failure of the assessee to reveal the proper ' income by preparing profit and loss statements in time the appeal was dismissed. The appellate authority, however, reduced the net profits from 15 per cent. to 121/2 per cent. whereby the assessee got a relief of Rs. 3,350. The net income was determined at Rs. 16,753 on this head.
The assessee carried a second appeal before the Income-tax Appellate Tribunal. The Tribunal was of the view that, as the payment under the contract work had not been finally adjusted, there was no real income accruing to the assessee in the accounting year and as such the amount of Rs. 16,753 could not be taken into consideration for enhancing the net income of the assessee in the appropriate assessment year.
The reference was filed at the instance of the Commissioner of Income-tax,
Before we examine the question of law, we may notice one important fact that a memo, was filed by Shri Mohanty on behalf of the assessee that a suit was filed by the railway authorities On 27th of November, 1967, to recover a sum of Rs. 89,946 from the assessee. The Tribunal in paragraph 14 of its judgment referred to such a suit and took it into consideration for arriving at the conclusion that the assessee had no real income in the accounting year. Law is well settled that no authority should act upon any statement of an advocate in the course of hearing without any materials in support of it. As it now transpires, this suit was filed in November, 1967, and, the Tribunal should not have at all taken into consideration this fact while sitting in appeal over the judgment of the Appellate Assistant Commissioner. The filing of the suit would be excluded from consideration in determining the real issue involved in this case.
In Commissioner of Income-tax v. Sri Bijoy Kumar Das, 1971 2 CWR 481, the essential difference between the mercantile and cash basis systems of accounting was indicated. The essential difference between the two lies in the fact . 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 and expenditures are entered the moment a legal liability to pay arose and before the actual disbursements. In the mercantile system the profit or loss at the end of the accounting year is based not on the 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.
Anticipated losses and contingent liabilities cannot be claimed under the mercantile system of accounting. Under that system an income accrues or arises when the assessee acquires a right to receive the same. When an Income-tax Officer proceeds to include a particular income in the assessment, under the mercantile system he shall have to find out when the right to receive the amount accrued. (See Commissioner of Income-tax v. A. Gajapathy Naidu, 1961 53 ITR 114. and Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Private Ltd., 1964 53 ITR 134.).
The assessee entered Rs. 2,18,442 on the debit side under the mercantile system. This he could validly do in law if the following conditions had been satisfied :--
(i) The assessee had a legal liability to pay the amount before the actual disbursement was made.
(ii) The whole of it was purported to be devoted towards revenue expenditure and no part of it was towards capital expenditure.
To examine the true nature of this entry, to assess the real income, the assessee is to produce books of accounts for the satisfaction of the taxing authorities. As proper accounts were neither maintained nor produced, the Income-tax Officer and the Appellate Assistant Commissioner did not accept the debit entry as representing the true state of affairs. The account books and the debit entry were rejected by them. . The Tribunal has not recorded any finding to the contrary. In other words, the Tribunal has not held that the assessee had produced acceptable accounts and that the debit entry of Rs. 2,18,442 is genuine.
If the debit entry of Rs. 2,18,442 is rejected as unacceptable, then the only other material available for determining the real income is the receipt of Rs. 1,34,028 from the railways which had been entered by the assessee on the credit side. This amount represents payment made -to the assessee towards expenditure either already incurred or for which the assessee had a legal liability to make disbursement. This entry was rightly treated as income accrued to the assessee as he acquired a right to receive the amount.
On that footing the Appellate Assistant Commissioner was justified in estimating 121/2% per cent. of this amount as net profits or real income to be added to the total income.
(3.) IF the debit entry of Rs. 2,18,442 was rejected as not genuine, then there is no question of any adjustment of the credit and debit entries. The credit entry alone stands.
The fact that in 1967 the railways filed a suit for recovery of Rs. 89,946 out of Rs. 1,34,028 paid by them in 1961 is wholly irrelevant. If the railways would ultimately get a decree and recover any amount from the assessee, then the same would be adjusted as a business loss in the accounting year in which recovery is to be made.
The mercantile system of accounting cannot be stretched to embrace all sorts of provisional, notional or contingent payments which the assessee considers he might be called upon to pay. (See New Victoria Mills Co. Ltd. v. Commissioner of Income-tax, 1966 61 ITR 395.).
On the aforesaid analysis, we are satisfied that the Tribunal's view is contrary to law. The question referred is answered in the negative.
The reference is allowed. There will be no order as to costs.
S.K. Ray, J.