SENGUPTA, J. - (1.) IN this reference made at the instance of the Revenue, the Tribunal has referred to the following question for the opinion of this Court under s. 256(2) of the IT Act, 1961 ('the Act'): "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that income from deferred guarantee commission did not accrue or arise in the year in which the guarantee agreements were entered and in that view was correct in holding that the income from deferred guarantee commission should be spread over the period to which the guarantee commission related and should be assessed proportionately ?"
(2.) THE relevant facts are as under: The assessee, the Bank of Tokyo Ltd., is a non-resident banking company. The assessment year involved is 1981-82. The assessee-bank had shown in the accounts 'deferred guarantee commission' receivable in the year under reference at Rs. 23,67,228. It made a provision for unexpired portion of guarantee and submitted that the guarantee commission receivable in respect of the future period should not be taxed in the year under reference respect of the future period should not be taxed in the year under reference since it was following mercantile system of accounting. However, the IAC (Assessment), observed that the guarantee commission received is not in the nature of advance. According to him, the parties on whose behalf the guarantee commission paid. The assessee-bank, according to IAC (Assessment), acquires the right to receive the whole of the guarantee commission for the entire period covered by the guarantee the moment the guarantee bond is executed and even though the assessee is following the mercantile system of accounting, the IAC (Assessment) held that the entire guarantee commission is assessable in the year of receipt notwithstanding that it may relate to more than 12 months and /or the guarantee period may extend beyond the period covered by the previous year relevant to the year under assessment. On appeal, the CIT (A) deleted the addition made by IAC (Assessment) in the light of the Tribunal's decision in earlier years on this point. The Tribunal also maintained the finding of the CIT (A) following its earlier order dt. 10th Dec., 1984 passed in respect of the asst. yrs. 1976-77 to 1979-80. The Tribunal noted the assessee's Explanation before the authorities below that the assessee issued bank guarantee to different clients for varying periods. It has been a practice of the assessee to take into account the proportionate commission relatable to the year for which the accounts are drawn up an commission for the unexpired period mentioned in the bank guarantee is carried forward in the balance sheet and is accounted for in the year to which such commission pertains. Reference was also made before the Tribunal to the rules regarding issue of bank guarantee as framed by the Foreign Exchange Dealers' Association of India Rules , which, according to the Tribunal, was the relevant rule, was quoted in paragraph 14 of its said order as under: "(a) If the guarantee be redeemed (i.e., returned duly cancelled) before the expiry of the extra six months, the proportionate overcharge may be refunded. (b) The Commission for the full specified period of liability shall be collected at the time of signing a guarantee, except in respect of guarantees covered by r. 15 II (6)." Some specimen copies of the guarantee contracts for varying periods were also placed for consideration by the Tribunal. It was stated on behalf of the assessee that bank guarantees were generally issued for periods extending 12 months and according to the accounting practices systematically and consistently followed by the bank year after year, the commission relatable to each year was being proportionately accounted for in the books of the assessee. In other words, the commission; relatable to the unexpired period of guarantee was deferred and shown separately in the balance sheet under the head 'Acceptances, endorsements and other obligations'. Referring to the allegation of the IAC (Assessment) as to the alleged non-refund of guarantee commission to the clients. it was submitted on behalf of the assessee before the Tribunal that if the obligations under the guarantee were over before completion of the guarantee period, the guarantee contract necessarily had to be revoked and that guarantee commission relatable to the unexpired period was required to be refunded to the clients in terms ;of r. 16 as framed by the Foreign Exchange Dealers' Association of India Rules. Five sample cases were placed before the Tribunal on behalf of the assessee to show that the guarantee commission in respect of the unexpired period was factually refunded by the assessee-bank to its different clients. On behalf of the Department, it was submitted before the Tribunal that the entire guarantee contract was irrevocable and the right to receive guarantee commission accrued and arose as soon as the agreement was entered not and this right did not get deferred merely because the bank had the option to realise the commission in installments. It was also argued on behalf of the Department that the method of accounting even though consistently followed by the assessee was irrelevant in this respect. In reply, it was submitted before the Tribunal on behalf of the assessee that since the bank was consistently following mercantile system of accounting and recording the guarantee commission in different years to which it actually related and since such system of accounting had all along been accepted by the tax authorities in the past for and up to the asst. yr. 1975-76, it was not competent for the tax authorities to make a deviation in this respect in making the assessment from the asst. yr. 1976-77 and onwards. Particular reference was made to s. 145 of the Act and it was contended that guarantee commission being business income the Department was bound to accept the consistent method of accounting followed by the assessee in this respect, particularly when it was nobody's case that the correct profits cannot be determined by the method followed by the assessee and more so when such method had all along been accepted by the Department in the past. The Tribunal held and observed that the system of accounting followed by the bank was bona fide and there was no evidence on record to show that the accounting procedure; followed by the bank in recording guarantee commission was defective so as to render it impossible to deduce the profits of the bank correctly. The Tribunal felt that the tax authorities below were not justified in assessing the guarantee commission for the unexpired period in the year under reference since the same did not relate to the relevant previous year. The Tribunal also noted that it was never disputed by the Departmental representative that up to the asst. yr. 1975-76, the method of accounting followed by the bank in respect of the issue of bank guarantee commission had been accepted in framing assessments of the bank, In this view of the matter, the Tribunal deleted the addition made by the IAC (Assessment) in regard to the guarantee commission relating to the period beyond the previous year under reference. The submissions made on behalf of the assessee before us are as under: (a) The assessee-bank has been consistently following mercantile system of accounting, According to this system, the bank guarantee commission is being recorded consistently in the books of account and being offered for taxation on the basis of the period to which it relates, In other words, where the guarantee commission relates to a period beyond the previous year, the proportionate guarantee commission is deferred and shown as income only in the later year to which it relates. (b) The guarantee commission is assesssable as business income under the head 'profits and gains of business or profession' and in view of s. 145(1) the IT authorities were bound to accept the method of accounting consistently followed by the assessee-company in this regard. The tax authorities were not competent to depart from the method of accounting followed by the assessee- bank when such method of accounting had all along been accepted by the tax authorities for and up to the asst. yr. 1975-76- See CIT vs. K.Sankarapandia Asari and Sons (1980) 19 CTR (Mad) 264 : (1981) 130 ITR 541 (Mad) and Manilal Kher Ambala and Co. vs. A,G.Lulla, Seventh ITO (1988) 72 CTR (Bom) 44 : (1989) 176 ITR 253 (Bom). (c) No defect whatsoever has been pointed out by the tax authorities in the method of accounting consistently followed by the assessee. The Tribunal has recorded and held in paragraph 17 at page 102 of the paper book that the system of accounting followed; by the bank in this respect was bona fide. This is a finding of fact and has not been challenged by the tax authorities in the present reference. (d) The Tribunal has also recorded a finding of fact that the assessee bank has been refunding guarantee commission to its different; clients in those cases where guarantee contract was revoked prematurely. In other words, the assessee-bank has been refunding guarantee commission for the unexpired period; of guarantee in case the guarantee contrast was revoked earlier. This finding negatives the stand taken and /or allegation made by thew IAC (Assessment) to the effect that the guarantee contract was irrevocable and the bank was not refunding the guarantee commission for the unexpire period. It was contended on behalf of; the Revenue that the commission was payable initially and not year by year. That being the mandatory requirements, the right to receive accrued at the point of time the guarantee agreement is entered. The finding of the Tribunal on the following aspects has not been however, challenged by the Revenue: (i) Under r. 16 framed by the Foreign Exchange Dealers' Association of India the guarantee commission was refundable, if the guarantee is cancelled before the expiry of the full period. (ii) The assessee was following mercantile system of accounting and under this system, income for more than 12 months cannot be assessed. The guarantee commission accrues month by month and merely because the guarantee commission is received in advance, the entire amount cannot be assessed in the year of receipt till the period, for which the guarantee is given and the commission is received, expires. In our view the issue is not whether sub-s. (1) of s. 145 shall apply in the case or not. The question is whether the commission income should accrue year by year over the period of the debt repayment guaranteed or at a time, Indisputable fact is that the assessee followed mercantile system, therefore, the income is exigible to tax upon accrual. The bank receives the commission for the entire period of the debt repayment which it guarantees when the guarantee agreement is entered. The Revenue contends that the right to receive the commission being a one-time right, its accrual shall coincide with the commencement of the service rendered by way of guaranteeing the debt repayment; it is immaterial that the repayment covers more than on previous year. Therefore the entirety of the commission accrues at a time. The assessee-bank on the other had, submits that the service having a spread of years the accrual should be year by year. The Revenue's contention that the accrual of the entire commission is a point of time accrual is not tenable. The contesting submissions boil down to one question whether accrual is co-eval with the payability, the same may be payable but may not be apportionable until the happening of an event; in the present case the expiry of the period, for, the guarantee beyond the expiry date of the previous year the right to receive for unexpired period, for, the guarantee beyond the expiry date of the previous year remains in a suspense. It may or may not fructify into an actual right to receive for the subsequent period of the term of the guarantee as the sooner determination of the guarantee is a contingency not ruled out by the agreement. It is only upon certain conditions being fulfilled, viz., the guarantee running the full course or period of the debt guaranteed, that the right to the entirety of the commission can be said to have accrued. To this proposition, as we have seen, r. 16 lends support. Clause (a) of the rule clearly indicates that commission though payable at the beginning for the full specified period of the debt shall, however, fall refundable in the event of the guarantee being redeemed before full time. Clause (a) of the said rule is the sheet anchor; of the assessee's claim that the full commission though payable date the outset does not crystallise into perfect right to receive so far as unexpired period; is related because the payability or receivability from the view of the assessee-bank is counter-balanced by the refundability, diluting the right to receive into a contingent right as regards the unexpired period of the guarantee. The receipt in the unexpired period; may turn out to be refundable as an over-charge in sooner redemption of the debt and the guarantee. The Revenue has founded its case on cl. (b) of the said rule which makes it mandatory for the client of the assessee-bank whose liability the bank guarantees to pay the commission for the full specified period at the time of execution of the guarantee. Seemingly the two clauses in the rule may create a dilemma but the dilemma is not real. The appeal to reasonable construction can very well resolve it. We consider that the Revenue by declining to accept the payment relatable to the unexpired period as an advance which may turn out refundable in the end has taken an unreasonable approach. If the terms of the agreement require that payment has to be mandatorily made in advance, it cannot necessarily lead to the construction that payability itself creates accrued right to receive the entire amount of the guarantee as one-time acctual. The payability has to be contrasted and pitted against the further requirements of the bank having of refund the advance turning out eventually to be an over-charge for sooner redemption of the guarantee than contemplated. Thus, in our view, the payability, even though mandatory, merely creates a tentative right to receive commission for unexpired period of the guarantee and not a perfected right. The right becomes perfected and crystalised only with the expiry of the unexpired period. If we take a total view and read cumulatively the two cls. (a) and (b) of r. 16, we can very reasonably come to this indifference that the intention of the rule is first of place the guarantor with the amount of the commission for the full period running alongside an obligation on its part to refund whatever may in the end become commission; over-charged. It is not only reasonable but also legitimate to take such view in the perspective of the total plan containing in r. 16. We may here quote the following observation of Bhagwati, J. From E.D.Sassoon and Co. Ltd. vs. CIT (1954) 26 ITR 27 (SC): ".........If income has accrued to the assessee it is certainly earned by him in the sense that he has contributed to its production or the parenthood of the income can be traced to him. But in order that the income can be said to have accrued to or earned by the assessee it is not only necessary that the assessee must have contributed to its accruing or arising by rendering services or otherwise but he; must have created a debt in him favour. A debt must have come into existence and he must have acquired a right to receive the payment. Unless and until his contribution or parenthood is effective in bringing into existence a debt or a right to receive the payment or in other words, a debitum in praesenti, solvendum in further it cannot be said that any income has accrued to him. .......": Of course, in that case, the question was whether the managing agents working for a part of the accounting year and subsequently assigning the agency to two different parties for the rest part; of the year in the course of the year could claim pro rata commission for managing agency. The Supreme Court in the majority decision found on the examination of the managing agency agreement that it was incorrect to apportion the commission between the assessee and its assignees and tax death of them in respect of their share of the commission because law is that the commission accrues after the expiry of the year, and there could be no concept of part commission for a broken period or part of a year.
(3.) THE decision is of assistance in that it lays down that accrual requires the debt to have been created in favour of the person in respect of the income, i.e., the claim could have accrued. Here, even though the debtor paid the assessee entire commission for guarantee agreement, no debt is actually created in favour of the assessee for the entire amount, a right remaining vested in the Bank's Customer to recall the payment for; unexpired period in case of sooner redemption of the guarantee. Thus, no debt is created at the outset in favour of the assessee for such entire amount.;