(Appeals by certificate from the judgment and order, dated June 30, 1980 of the Allahabad High Court in I.T.Rs. Nos.31 and 137 of 1976).

(a) Income-tax----

----Income---Underwriting commission ---Assessee underwriting public issue of shares by companies---Purchase of un-subscribed shares by assessee-- Underwriting commission on such shares not taken to profit and loss account but adjusted to reduce cost of shares---Is in accordance with principles of accounting---Underwriting commission in respect of shares subscribed by assessee---Not separately assessable as income.

In the case of public companies, when shares are offered to the public for subscription, it is usual to make certain of obtaining the necessary capital by having the shares underwritten. The word "underwriting" means that a person agrees to take up shares specified in the underwriting agreement if the public or other persons fail to subscribe for them. The consideration for this contract takes the form of payment of commission, called "underwriting commission". Underwriters are thus paid for the risk they expose themselves to, in placing of shares before the public. The payment of underwriting commission is permissible under section 76 of the Companies Act, 1956.

The assessee was a State undertaking. It had been incorporated with the object of developing industries in the State of Uttar Pradesh and with that end in view it financed industrial projects or enterprises whether owned or run by the Government, a statutory body, private company, firm of individuals, etc. One of the clauses for financing the companies by the assessee was that on the shares of such companies subscribed by the public, the assessee was entitled to get commission as well as brokerage and in case the shares of such companies were not subscribed by the public in toto, the assessee was obliged to subscribe for those shares at face value but was entitled to underwriting commission and brokerage in the same manner as if the shares of such companies were subscribed by the public. The method adopted by the assessee was that, where the shares had to be subscribed by the assessee itself, instead of crediting the underwriting commission and brokerage to its profit and loss account, it used to reduce the cost of the shares held by it as stock-in-trade. During the previous year relevant to the assessment year 1970-71, the assessee had earned by way of underwriting commission a sum of Rs.1,01,250 and brokerage to the extent of Rs.33,719 while the assessee offered a sum of Rs.12 535 out of the aforesaid receipts as its taxable income. In the previous year relevant to the assessment year 1971-72, the assessee earned by way of underwriting commission and brokerage a sum of Rs.1,15,000 and no part of it was included in its taxable income. While making the assessment the Income-tax Officer added the entire amount received by the assessee by way of underwriting commission and brokerage as part of the taxable income for both the assessment years. On appeal, the Appellate Assistant Commissioner held that the underwriting commission was assessable as the assessee's income in the year in which it accrued, but that the brokerage was not, and had to be adjusted against the cost of shares taken. On further appeal by the assessee, after referring to various books on accountancy, the Tribunal held that the underwriting account was a part of the profit and loss account, which included not only the income from underwriting commission and brokerage but was debited by the expenses and the cost of shares, which the underwriter was called upon to take and as such the underwriting commission could not be taken into consideration leaving aside the other items of this account. The Tribunal held that the underwriting commission in respect of the shares held by the assessee would reduce the cost of the shares and would not be separately assessable as the assessee's income. The High Court upheld this view. On appeal to the Supreme Court:

Held, dismissing the appeal, that in the accounts maintained by the assessee the underwriting commission was first adjusted towards the cost of the shares that werc underwritten and thereafter, the commission on shares not subscribed by the assessee was taken to the profit and loss account. The Tribunal had found that the said practice followed by the assessee was in consonance with principles of accountancy governing underwriting accounts. The underwriting commission earned by the assessee m respect of the shares, which were not subscribed by the public and were purchased by the assessee could not be treated as a part of its taxable income.

(b) Income-tax -------

----Income---Accounting---Principles of commercial accounting should ordinarily be applied in ascertaining profits and gains.

In order to determine the question of taxability, well-settled legal principles as well as principles of accountancy have to be taken into account It is a well accepted proposition that "for the purposes of ascertaining profits and gains, the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes".

U.P. State Industrial Development Corporation Ltd. v. C.I.T (1981) 130 ITR 835 affirmed.

I.R.C. v. Cock Russell & Co. Ltd. (1949) 29 TC 387; Kedarnath Jute Manufacturing Co. Ltd. v. CIT (1971) 82 ITR 363; 28 S.T.C 672 (SC); Mohammed Meerakhan (P.M.) v. CIT (1969) 73 ITR 735 (SC); Morvi Industries Ltd. v. CIT (1971) 82 ITR 835 (SC); State Bank of Travancore v. CIT (1986) 158 ITR 102 (SC) and Whimster and Co. v. I.R.C. (1925) 12 TC 813 (C. Sess) ref.

P.A. Choudhary, Senior Advocate (Dhruv Mehta and B.K. Prasad, Advocates with him) for Appellant.

Manoj Swarup and Mrs. Lalitha Kohli, Advocates for Respondent.

JUDGMENT

S.C. AGRAWAL J.---These appeals, by the certificate granted under section 261 of the Income-tax Act, 1961 (hereinafter referred to as "the Act"), have been filed by the Revenue against the judgment of the Allahabad High Court (see (1981) 130 I.T.R. 835), dated June 30, 1980 in Income-tax References Nos.31 and 137 of 1976. By the said judgment the High Court has answered the following question against the Revenue and in favour of the U.P. State Industrial Development Corporation (hereinafter referred to as "the assessee") (at page 839):

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that underwriting commission in the case of shares held by the assessee itself and not actually subscribed by others was reducing the cost of the shares in the hands of the assessee and was not separately taxable as the assessee's income of that year?"

The references relate to the assessment years 1970-71 and 1971-72.

The assessee is a State undertaking. Its shares are wholly subscribed by the State of Uttar Pradesh. It has been incorporated with the object of developing industries in the State of Uttar Pradesh and with that end in view it finances industrial projects or enterprises, whether owned or run by the Government, a statutory body, private company, firm or individuals, etc. One of the clauses for financing the companies by the assessee was that on the shares of such companies subscribed by the public the assessee was entitled to get commission as well as brokerage on the sale of shares of such companies and in case the shares of such companies were not subscribed by the public in toto the assessee was obliged to subscribe those shares at face value but was entitled to underwriting commission and brokerage in the same manner as if the shares of such companies were subscribed by the public. The method adopted by the assessee was that instead of crediting the underwriting commission and brokerage to its profit and loss account in the case of such companies the shares of which had to be subscribed by the assessee itself, it used to reduce the cost of the shares held by it as stock-in- trade. During the previous year relevant to the assessment year 1970-71, the assessee had earned by way of underwriting commission a sum of Rs.1,01,250 and brokerage to the extent of Rs.33,719 while the assessee offered a sum of Rs.12,535 out of the aforesaid receipts as its taxable income. In the previous year relevant to the assessment year 1971-72, the assessee earned by way of underwriting commission and brokerage a sum of Rs.1,15,000 and not part of it was included in its taxable income. While making the assessment, the Income-tax Officer added the entire amount received by the assessee by way of underwriting commission and brokerage as part of taxable income for both the assessment years. The Appellate Assistant Commissioner, however, held that the underwriting commission was assessable as the assessee's income in the year in which it accrues, i.e., in the year in which underwriting agreement was made. But as regards brokerage he held that brokerage on the share held by the assessee was not includible in the income of the assessee and that it had to be adjusted against the cost of the shares taken. The assessee filed appeals against the orders of the Appellate Assistant Commissioner before the income-tax Appellate Tribunal (hereinafter referred to as "the Tribunal"). The Revenue did not question the order of the Appellate Assistant Commissioner regarding brokerage. The Tribunal held that the underwriting commission in respect of the shares held by the assessee would reduce the cost of the shares and would not be separately assessable as the assessee's income. The Tribunal has observed:

"And this difference by way of commission and brokerage is charged by the underwriter because it agrees to subscribe for a large amount of the capital of the company. As such whatever amount the underwriter earns as underwriting commission, it does not automatically become its income. It is postponed unless the risk of taking or not taking the shares is over. If the shares are fully subscribed, the institution gets commission, but it does not pay for the capital. In that event, the commission earned by the corporation is an income and it could be taken into the profit and loss account of the assessee. But, if the assessee subscribes some shares out of the underwritten shares, the commission relating to those shares goes towards the cost and, therefore, no income is earned by the underwriter. "

After referring to various books on accountancy, namely, Accountancy by William Pickles, 3rd Edn. Page 1144 (Chapter XXVI): Book Keeping and Accounts by Ernest Evan Spicer and Ernest C. Pegler, 10th Edn. Page 650; Dicksee's Auditing, 17th Edn. Page 279; and Auditing Theory and Practice by R.K. Montgomery, 2nd Edn. Page,215-216, the Tribunal had held that the underwriting account is a part of profit and loss account, which includes not only the income from underwriting commission and brokerage but the same is debited by the expenses and the cost of shares, which the underwriter is called upon to take and as such the underwriting commission could not be taken into consideration leaving aside the other items of this account. According to the Tribunal, if the nature of the underwriting account is taken into consideration, the practice followed by the assessee to first adjust the brokerage and underwriting commission towards the cost of the shares, which are underwriting by it, but the commission and brokerage earned on shares not subscribed by it are taken to the profit and loss account, was absolutely correct and was in accordance with accountancy principles and, since there is no contrary provision in the Act, the system followed by the assessee must be respected. At the instance of the Revenue, the Tribunal has referred the question abovementioned for the opinion of the High Court.

The references were considered by the High Court alongwith Income-tax Reference No.37 of 1976 relating to the assessment years 1965-66, 1966-67, 1967-68, 1969-70 wherein also a similar question had been referred for the opinion of the High Court. The High Court agreed with the view of the Tribunal and has held that the commission earned by the assessee as underwriter in respect of the shares offered by the company and purchased by the public, would undoubtedly by the profit of the assessee which has to be accounted for in its profit and loss account, but so far as the shares agreed by the assessee to be underwritten and purchased by it are concerned, the transaction in substance results in the assessee purchasing those shares for a consideration which is equal to the face value of the shares as reduced by the amount of commission and brokerage and in such a case, the amount of underwriting commission and brokerage merely goes to reduce the value of the shares and it cannot be considered to be the income of the assessee. The High Court, however, felt that the question whether the underwriting commission in relation to shares which the assessee itself subscribed as underwriter went to reduce the cost of those shares or whether such underwriting commission could be taxed as income is a substantial question of law general importance and, therefore, it granted a certificate of fitness for appeal to this Court under section 261 of the Act. Hence, these appeals.

In the case of public companies, when shares are offered to the public for subscription, it is usual to make certain of obtaining the necessary capital by having the shares underwritten. The word "underwriting" means that a person agrees to take up shares specified in the underwriting agreement if the public or other persons fail to subscribe for them. The consideration for this contract takes the form of payment of commission, called "underwriting commission". Underwriters are thus paid for the risk they expose themselves to in placing of shares before the public. The payment of underwriting commission is permissible under section 76 of the Companies Act, 1956.

The question that falls for consideration is whether the underwriting commission in respect of shares which could not be subscribed by the public and had to be purchased by the assessee has to be regarded as the income of the assessee or it goes towards reducing the cost of the shares so purchased. In the accounts maintained by the assessee, the underwriting commission is first adjusted towards the cost of the shares that are underwritten and thereafter the commission on shares not subscribed by the assessee is taken to the profit and loss account. Tribunal has found that the said practice followed by the assessee was in consonance with principles of accountancy governing underwriting account. The Tribunal, after referring to the authoritative books on accountancy, has held that the underwriting commission is a part of the profit and loss account which includes not only the income from underwriting commission and brokerage but the same is debited by the expenses and the cost of shares, which the underwriter is called upon to take and as such, underwriting commission could not be taken into consideration leaving aside the other items of this account and, therefore, the underwriting commission in respect of the shares purchased by the assessee could not be treated as taxable income in the hands of the assessee. The High Court has agreed with the said view of the Tribunal.

The main contention urged by learned counsel appearing for the Revenue in support of the appeals was that the entitlement to reduction is to be governed by the provisions of law and not by the accounting practice adopted by the assessee and in support of his submission learned counsel has placed reliance on the decisions of this Court in Kedarnath Jute Manufacturing Co. Ltd. v. C.I.T (1971) 82 I.T.R 363; Morvi Industries Ltd. v. C.I.T (1971) 82 I.T.R. 835 (SC), and State Bank of Travancore v. C.I.T. (1986) 158 I.T.R. 102 (SC).

In our opinion, this contention is devoid of force. The accounting practice followed by the assessee in the instant case was in consonance with the general principles of accountancy governing underwriting accounts. It is a well accepted proposition

that "for the purposes of ascertaining profits and gains the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes. (See Whimster & Co. v. Commissioner of Inland Revenue (1925) 12 T.C. 813 (C. Sess); Commissioner of Inland Revenue v. Cock Rusell & Co. Ltd. (1949) 29 T.C. 387 (KB)). This proposition has been affirmed by this Court in P.M. Muhammad Meerakhan v. C.I.T. (1969) 73 I.T.R 735. In the said case it has been observed (at page 743);

"For that purpose it was the duty of the Income-tax Officer to find out what profit the business has made according to the true accountancy practice."

The decisions on which reliance has been placed by learned counsel for the Revenue do not depart from this principle.

In Kedarnath Jute Manufacturing Co. Ltd. v. C.I.T. (1971) 82 I.T.R. 363, this court was considering the question whether the amount of sales tax paid or payable by the assessee is an expenditure within the meaning of section 10(2)(xv) of the Indian Income-tax Act, 1922. The said claim of the assessee was disallowed by the Income-tax Officer on the ground that the assessee was following the mercantile system of accounting and had made no provision in its books with regard to the payment of that amount. Upholding the claim of the assessee for deduction of the said amount, this Court has held that whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence of absence of entries in the books of account be decisive or conclusive in the matter. In this case, the question whether the principles of accounting have to be taken into account for ascertainment of profit did not fall for consideration. The decision in Morvi Industries Ltd. v. C.I.T. (1971) 82 I.T.R. 835 (SC) also does not deal with this question. In that case this court has explained the meaning of the word "accrued" used in section 4(1)(b)(i) of the Indian Income-tax Act, 1922, and has observed that income can be said to have accrued when it becomes due and the postponement of the date of payment has a bearing only so far as time of payment is concerned but it does not affect the accrual of income.

State Bank of Travancore v. C.I.T. (1986) 158 I.T.R. 102 (SC) was a case where the assessee-bank, instead of carrying the interest on sticky advances, i.e., advances which had become extremely doubtful of recovery, to the profit and loss account, had credited it to a separate account called "the Interest Suspense Account". The question was whether the said interest was taxable. Tulzapurkar, J., in his dissenting judgment, held that the said income was not an income and was not taxable and observed that even in the mercantile system of accounting it is only the accrual of real income which is chargeable to tax and accrual is matter of substance to be decided on commercial principles having regard to the business character of the transactions and the realities and specialities of the situation and cannot be determined by adopting a purely theoretical or doctrinaire or legalistic approach. The learned judge has referred to standard text books on accountancy to show that in case of interest on sticky loans the practice of debiting the accounts of the concerned debtors with interest and carrying the same to an Interest Suspense Account instead of the interest account or the profit and loss account is a well-recognised and accepted practice of commercial accountancy which is wholly consistent with the mercantile system of accounting. Sabyasachi Mukharji, J. (as the learned Chief Justice then was), however, held that the interest on sticky advances had accrued according to the mercantile system of accounting because the assessee-bank had debited thy respective parties with the interest and that after the close of the accounting year the assessee-bank without giving up the interest, which it could have, as a bad debt, did not offer it for taxation but carried it to the Interest Suspense Account. and that carrying certain amount which had accrued as interest without treating it as a bad debt or irrecoverable interest but keeping it in a suspense account was repugnant to section 36(1)(vii) read with section 36(2) of the Act. The learned Judge, after taking note of the recognised books on accountancy to which reference had been made by Talzapurkar, J., observed (at page 151);

"Even if in a given circumstance, the amounts may be treated as interest suspense account for accountancy purpose, that would not affect the question of taxability as such. This must be determined by well-settled legal principles and principles of accountancy which have been referred to hereinbefore."

Ranganath Misra, J., (as the learned Chief Justice then was), concurred with the reasonings and conclusions of Mukharji J. The aforementioned observations of Mukharji, J. also postulate that for determining the question of taxability well-settled legal principles as well as principles of accountancy have to be taken into account. In that case the learned Judge held that without treating the amount which had accrued as interest as a bad debt or irrecoverable interest but keeping it in the suspense amount was repugnant to section 36(1)(vii) read with section 36(2) of the Act and, therefore, even if the amount might be taken to the Interest Suspense Account for accounting purposes, that would not affect its taxability as such.

In the present case, the Tribunal, after referring to authoritative books on accountancy, has found that the assessee was maintaining the accounts correctly in accordance with the principles of accountancy applicable to underwriting accounts and keeping in view the said principles the underwriting commission on the shares which were not subscribed by the public and were purchased by the assessee could not be treated as profit earned by the assessee in the transaction and the said commission could only be treated as reducing the price of the shares purchased by the assessee. The Tribunal has also stated that there is no contrary provision in the Act. Learned counsel for the Revenue has not shown that the accountancy practice followed by the assessee is repugnant to any provision of the Act. In the circumstances, it must be held that the Tribunal has not committed any error in taking the view that the underwriting commission earned by the assessee in respect of the shares which were not subscribed by the public and were purchased by the assessee could not be treated as a part of its taxable income. The question referred was, therefore, rightly answered by the High Court against the Revenue and in favour of the assessee.

As a result, the appeals fail and are accordingly dismissed. No order as to costs:

M.B.A./1455/FCAppeals dismissed.