The Commissioner Of Income-Tax, Madras v. A. Krishnaswami Mudaliar And Others

Section: CONCLUSION 1961 .April 16 . THE COMMISSIONER OF INCOME-TAX, MADRAS. A. KRISHNASW AMI MUD ALI AR AND OTHERS [K. SUBBA RAO, J. C. SHAH AND S. M. SIKRI. JJ.J Income-tax-Trading adventure-Profits of business Com-putation-Value of stock-in-trade-Inclusion of Value at the end of year of account-Necessity-Assessee's method of accoun-tancy-Powers in Income-tax Officer in computing profits-In-dian Income-tax Act, 1922 (11 of 1922) s. 13 proviso. The assessee firm acquired for Rs. 1,00,000/- the exploitation rights of a cinematograph film which were to enu're for four years. For the period, December 25, 1947 to August 2, 1948, which was the previous year corresponding to the assessment year 1949-50 the firm filed a voluntary return declaring that Rs. 28,643/- were earned by the exploitation of the film. In the statement submitted by the firm the total receipts credited in the firm's books were Rs. 1,46,849/- and against that amount were debited Rs. 18,206/- as expenditure and Rs. 1,00,000/- as the amount disbursed for acquiring the exploitation rights. The Income-tax Officer was of the view that from the statement of account which omitted to include at the close of the account year the value of the right in the film for the unexpired period, the profits of the firm could not properly be deduced. Accord-ingly, he estimated the value of the rights for the unexpired period of exploitation to which the firm was entitled on August 2, 1948, at Rs. 65,000/- and computed the net profits of the firm .as an unregistered firm at Rs. 93.642/- and assessed income-tax and super-tax payable by the firm on that footing. In the ap-peals filed against the order or assessment, only the correctness of the estimated value of the rights of the film at Rs. 65,000/-was challenged. and the Appellate Tribunal reduced the valua-tion to Rs. 40,000/-. On reference, the High Court of Madras took the view that it was the cash system that the assessee had adopted, that valuation of the closing stock was not an incident of that system for ascertaining the profits and that the Income-tax Officer had no power under the proviso to s. 13 of the Indian Income-tax Act, 1922, to force a different system on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock. Held: In a trading venture, for computing the true profits of the year, the stock-in-trade must be taken into account, what-ever method of book-keeping was adopted; and the High Court was in error in holding that because the assessee had maintai.ned his accounts in the cash system it was not open to the Income-tax Officer to add to the receipts from the business the value of the stock-in-trad• at the end of the year for the purpose of properly deducing the profits of the business for the year in question. There was not warrant in the case of assuming that the Income·tnx Officer sought to displace the method of accountancy adopted by the assessee; it was only by applying the proviso to s. 13 of the Indian IncomHax Act, 1922, that the Income-tax Officet made the computation upon the basis and in the manner in which in his opinion profits rould be properly deduced. CIVIL A'PPEALLATE JURISDICTION: Civil Appeal No. 250 of 1963. Appeal by special leave from the judgment and The Comm.......,. Qfder dated February 2, 1960 of the Madras High Court in °1 i:;;a"• Case Referred No. 1 of 1955. v. A. Krilh.......,,.. Mudaliar and OtA.,, - R. Ganapathy Iyer and R. N. Sachthey, for the appel- Mudaliar and OtA.,, lant. S. Narayanaswamy and R. Gopalakrislman, for respon- dent nos. 1 and 3-6. April 16, 1964. The Judgment of the Court was deliver-ed by. Shah, J. 776 1964 777 1964 779 1964 lant. SHAH, J.-Respondents to this appeal are a firm con-stituted under a deed dated December 12, 1947. The firm originally consisted. of three partners: K. N. Damodara Mudaliar. A. Krishnaswami Mudaliar and v. Thangaraja Mudaliar. K.N. Damodara Mudaliar acquired for the firm for Rs. 1,00,000 /- the exploitation rights which were to ensure for four years in a cinematograph film "Apoorva Chinthamani" for the North Arco!, the South Arcot and the Chingleput districts and for Pondicherry. For the period, December 25, 1947 to August 2, 1948--which was "the pre-vious year" corresponding to the assessment year 1949-50-the firm filed a voluntary return declaring that Rs. 28,643 /-were earned by the exploitation of the film. In the statement mbmitted by the firm the total receipts . credited in the lrm's books were Rs. 1,46,849 /-, and against that amount ;vere debited Rs. 13,206/- as expenses and Rs. 1,00,000/- as :he amount disbursed for acquiring the exploitation rights. rhereby in the computation of the profits of the business, the irm debited the amount paid for acquiring the rights of ex-J!oitation of the film. but did not take credit for the value ~f the unexpired exploitation rights at the end of the "pre-vious year". On August 15, 1948, a deed of dissolution of the partnership was executed. and Damodara Mudaliar sold with effect from August 6, 1948, his half interest in the assets of the partnership to Krishnaswami Mudaliar for Rs. 2,000/-and retired from the partnership. On August 27, 1948 a trial balance-sheet of the firm's books of account was prepared showing a cash balance of Rs. 190 /12 i 4, a debit against Krishnaswami Mudaliar for Rs. 2.64 Ii 8 / 8 and credits in favour of Damodara Mudaliar and Thangaraja Mudaliar respectively for Rs. 1.888/2/11 and Rs. 944/2/ I. Thereafter Krishnaswami Mudaliar, Thangaraja Mudaliar and V. S. Lakshmanan (an outsider) formed thems~lves info another partnership to exploit the film for the unexpired period. From this , partnership Krishnaswami Mudaliar retired on February 22, 194? agreeing to receive Rs. 12000 /- for his 1964 six sixteenth share in the assets of the fmn on the date of PM Oommisaione' retirement. of lncome-taz, Mo4ra1 v. In h Mo4ra1 v. In t e assessment of the respondent h firm for the year .d. Krishruiswami 1949-50 the Second Additional Income-ta" Officer, Vellore Mtuialiar•ml Olhet-sdeclined to accept the statement of account that the firm had Shah, J. earned till August 2, 1948, a net profit of only Rs. 28,643/-as truly representing the profits of the firm. He observed that "no stock valuation of the picture has been taken but only the excess collection over purchase value has been re-turned'', indicating thereby that in his view from the state-ment of account which omitted to include at the close of the year the value of the rights in the tilm for the unexpired period the profits of the firm could not properly be deduced. The Income-tax Officer estimated the value of the rights for the unexpired period of exploitation to which the firm was entitled on August 2, 1948 at Rs. 65.l)()O,. and computed net profits of the firm as an unregistered firm at Rs. 93,642/-and assessed income-tax and super-tax payable by the firm on that footing. 781 1964 In appeal by the firm to the Appellate Assistant Com-missioner, the correctness of the estimated value of the ex-ploitation rights of the film at Rs. 65.000.[1]- was alone chal-lenged and it wa~ submitted that the sum of Rs. 4,000 /- was the true value of the assets at the end of the previous year, Damodara Mudaliar the retiring partner having relinquished his rights representing half share for Rs. 2.000!- only. The Appellate' Assistant Commissioner rejected the contention, holding that the valuation of the exploitation rights for the unexpired period in the deed of dissolution dated August 15, 1948 was "dictated by extra-commercial considerntions". and confirmed-the valuation of Rs. 65,000/- made by the Income-tax Officer. Even in appeal to the Income-tax Appellate Tribunal, Madras, the respondent firm merely contended that the valuation of the exploitation rights for the unexpired period was excessive. The Tribunal partially upheld the plea, and reduced the valuation to Rs. 40.000!- as on August 2, 1948, and directed modiHcation of the assessment on that footing. Pursuant to an order issued by the High Court of Madras in a petition under s. 66(2) the Tribunal stated the --case and referred the following question: "Whether on the facts and circumstances of this case the Tribunal was justified in applying the proviso to s. 13 of the Income-tax Act and in confirm-ing the assessment on a mercantile basis of ac-counting." 1964 01 Irt.;·taz, v."" 1964 The High Court held that it was open to the assessee to maintain accounts according to a recognised system of ac- Ti.. Oommi#imur counting and the assessee having adopted the cash system of 01 Irt.;·taz, accounting, and the Tribunal having a~~igned no reasons for v."" discarding that system in the computation of the profits the A. K~"""""'""' Tribunal was in error in making the assessment on the basis Mudaloa• a.a Oilier• ()f the mercantile system of acct>unting. Shah, J. The High Court observed: - "When we reach the position that it was the cash system that the assessee had adopted in this case, and that valuation of the closing stock was not an incident of that system for ascertaining the profits, it should be obvious that the Income-tax Officer had no power under the proviso to s. 13 to force a different system on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock." The High Court accordingly answered the question re- ferred in the negative. Against the order, with ~pccial, leave, this appeal is preferred. The question to be determined in this appeal is whether in the computation of the income of the firm under the head "Profits and gains of business" the Income-tax Officer was bound by the method of accounting in which the cost of acquisition of the film of which the exploitation rights were . held was debited at the commencement of the year, but the value of the film at the end of the year was ignored. Section 10 of the Indian Income-tax Act, 1922, provide~ that tax shall be payable by an assessee under the head "Profits and gains of business, profession or vocation" in respect of the profits or gains of any business, profession or vocatibn carri-ed on by him. Such profits or gains have to be computed after making the allowances set out in sub-s .. (2). Section 13 provides that the income, profits and gains shall be comput-ed, for the purposes of ss. 10 and 12, in accordance with the method of accounting regularly employed by the assessee. provided that. if no method of accounting has been regular-ly employed or if the method employed is such that, in the opinion of the Income-tax Officer. the income, profits and gains cannot properly be deduced therefrom, then the com· putation shall be made upon such basis and in such manner as the Income-tax Officer may determine. It may be recalled that the Income-tax Officer had in the order of assessment observed that the firm had not made a stock valuation of the film and had merely taken the excess c:ollcction over the purchase value and had submitted its 781 1964 782 and had submitted its 1964 1964 return of income on that basis. No express order was re-T ht Oommi,.i<mer corded by the Income-tax Officer that in his opinion the in-0/ J_;':._m•·ta>, come, profits or gains of the business could not properly be v • ..., deduced from the method of accounting employed by the A. Krj-ahnaswami firm, but it is implicit in what is stated by him that without Mudaltar and 011,,rs valuation of the unexpired exploitation rights the profits of Shah, J. the year of account could not be computed. With this view, it appears, the Appellate Assistant Commissioner agreed. In appeal to the Appellate Tribunal the only plea raised was that the Income-tax Officer had erred in estimating the value of the unexpired exploitation rights at Rs. 65,000 /-. That was partially accepted, and the value was reducro to· Rs. 40,000 /-. It is difficult to appreciate how any question about the regularity of the proceedings of the Income-tax Officer by the adoption of the mercantile system of accounting and by the application of the proviso to s. 13 of the Income-tax Act arose from the order of the Tribunal. The High Court has ur,der the Income-tax Act power to call upon the Appellate Tribunal to state a case, only if the High Court is not satisfied· about the correctness of the decision of the Tribunal that no question of law arises from the order of the Tribunal. The grounds of appeal filed before the Tribunal and before the Appellate Assistant Commissioner make it abundantly clear that the question as to the applicability of the proviso to s. 13 to the profits disclosed by the respon-dent firm was never challenged. Nor can it be said that the Tribunal "forced the x x x firm to adopt ror the pur-pose of computation of its profits" a &ystem of accounting other than the one adopted by the firm. Jn the title of the order by the Income-tax Officer it was recited that the method of accounting adopted by the firm was "mercantile", but that does not amount to saying that he proposed tc compute the income on the basis that the accounts should be re-written on the mercantile system. The question referred to the High Court asks fur advice on the justification for applying the proviso to s. 13, and computation of the income on the basis of the mercantile system of accounting. On neither of these two branches there was any argument raised by the firm before the Tribu-nal. But we do not propose to dispose of this appeal on the limited ground that the question ~s framed did not arise oUt of the order of the Tribunal and need not be answered. The grounds given by the High Court in support of their answer to the question referred raise a matter of principle of some importance in the computation of income of an assessee carrying on a trading ven