D.K. Seth, J. - (1.) "Whether, on a true and proper construction of the contract with the Indian Railways and their letters dt. 3rd May, 1986, and 15th April, 1988, the appellant is entitled to deduction in respect of the demand of Rs. 46,82,142 made by the Indian Railways during the previous year relevant to the asst. yr. 1987-88 and the purported findings of the Tribunal that the liability had not crystallized and rejecting the said claim are based on any material and or even arrived at by ignoring the relevant materials and or by taking into consideration irrelevant and or extraneous materials and or are otherwise arbitrary, unreasonable and perverse."
(2.) In order to appreciate the situation, we may briefly refer to the facts. The assessee had entered into a contract with the Railways for supplying certain materials. The contract contained a condition that in case of rejection of the material supplied, the replacement would be at the cost of the assessee-contractor. In this case, there was rejection not once but twice, namely, after the first rejection, the goods were returned to the supplier at a foreign country from whom the goods were imported and the goods were replaced. The replacement was also rejected and the goods were returned to the foreign supplier. These facts are not in dispute. Subsequently, the Railway authorities on 3rd May, 1986 (p. 131 of the paper book) demanded a sum of Rs. 46,82,142 on account of the expenditure incurred in the transaction pursuant to the terms and conditions of the purchase order dt. 29th July, 1982, being a warranty obligation on the part of the assessee. The Railway had also on 15th April, 1988 (p. 134 of the paper book), asked the assessee to refund the commission received by the assessee from the Railways in respect of the supplies so made. Admittedly, the assessee, till today, neither has paid the demand made by the Railways nor has refunded the commission received by it from the Railways. The period of limitation as available to the Railways is 30 years under Article 112 of the Schedule to the Limitation Act, 1963. "Admittedly, the assessee maintained its accounts under the mercantile system. The assessee admitted the amount and reflected the same in his accounts. These accounts were reflected in the balance sheet signed by the assessee or its authorized agent. This is also not in dispute. In this background the assessee claimed deduction of the said amount as loss arising in the relevant assessment year when the demand was made, namely, 1987-88. The AO did not allow the deduction. The CIT(A) allowed the same. Whereas the learned Tribunal reversed the judgment of the CIT(A) and disallowed the deduction. The present appeal arises out of this order."
(3.) Mr. J.P. Khaitan, learned senior counsel, ably assisted by Mr. Sanjay Bhowmick, submitted that in terms of Section 41 of the IT Act, in case the liability ceases, it would be offered to tax in the year when the liability would cease. Therefore, the liability reflected in the accounts cannot be ignored. If the liability cannot be ignored, then there is no alternative for the IT authorities but to allow deduction of the loss reflected in the accounts. According to him, the assessee is entitled to reflect the loss in the accounts maintained under the mercantile system as soon he admits the liability. (1) According to him, the admission of such liability is something different from the acknowledgement contemplated under Section 18 of the Limitation Act. It has nothing to do with the recoverability of the amount by the creditor of the assessee. There is a distinction between an acknowledgement of liability in the accounts maintained by the assessee for the purpose of income-tax and an acknowledgement for the purpose of recoverability of such amount extending the period of limitation under Section 18 of the Limitation Act by the person entitled to enforce such liability against the assessee. (2) He relied on the decision in CIT v. Shewbux Jahunlal (1962) 46 ITR 688 (Cal) and Sutna Stone & Lime Co. Ltd. v. CIT. Relying upon the decision in Shewbux Jahunlal (supra), Mr. Khaitan submitted that the assessee has a duty to maintain accounts if he follows the mercantile system to show all admitted loss to the extent of his admission and it goes no further than that and such admission can be reflected in the accounts on the date when the admission is made by the person against whom the assessee admits the liability. According to him, this admission is required to be interpreted in this case as he proposes to submit. ;