WELDING RODS MANUFACTURING CO. VS COMMISSIONER OF INCOME-TAX
1999 P T D 778
[225 I T R 525]
[Gujarat High Court (India)]
Before N. J. Pandya and S. D. Pandit, JJ
WELDING RODS MANUFACTURING CO.
Versus
COMMISSIONER OF INCOME-TAX
Income-tax Reference No.83 of 1983, decided on 16/08/1996.
Income-tax--
----Business expenditure---Deduction---Mercantile system of accounting-- Assessee manufacturing welding rods---Obtaining on loan welding rods from its sister concern to be returned on demand---Provision made for additional liability on account of rise in price of wire rods---Provision made is allowable deduction though amount not actually spent.
The assessee-firm manufactured welding rods. It maintained its accounts on the mercantile system. The assessee obtained on loan welding rods from its sister concern with an agreement to return the same on demand. In the assessment years 1973-74, 1974-75 and 1975-76, the assessee had taken on loan 347.402,292.017 and 104.803 tonnes of wire rods respectively from its sister concern. None of the goods were returned by the assessee in the accounting year relevant to the assessment year 1976-77. The assessee had provided for an additional liability in respect of 639.419 tonnes at the rate of Rs.810.56 being Rs.5,18,237.31, on account of the rise in price of wire rods from Rs.2,525.56 to 3,336.04 in the year 1974-75 (assessment year 1975-76). The said claim of Rs.5,18,237.31 was not allowed by the Income-tax Officer. On appeal the Commissioner (Appeals) and, on further appeal, the Tribunal affirmed the order of the Income-tax Officer. On a reference at the instance of the assessee:
Held, (i) that in the assessment years 1973-74, 1974-75 and 1975-76, the assessee had taken on loan 347.402, 292.017 and 104.803 tonnes of wire rods respectively from its sister concern and, under the contract between the assessee and the sister concern, the assessee was liable to return the same on demand. Consequently, the assessee must make provision in its accounts of the prices of the said loan in view of material taken on loan, so as to enable it to purchase the same in the open market. The rate of the goods shown by the entry in the assessee's account was not challenged nor was it alleged to be an inflated one. The amount of Rs.24,82,756.36 was an estimated amount which would have to be expended by the assessee in the course of its business in order to return the raw materials taken as loan. From the said amount of Rs.24,82,754.36, the assessee had correctly deducted the amount of Rs.16,14,891.05 which was claimed in the previous two years. Out of the remaining amount of Rs.8,67,836.31 the amount of Rs.5,18,237.31 was on account of rise in price of the raw material from Rs.2,525.56 to Rs.3,336.04. It was not at all possible to arrive at the profit of the assessee's business without the said entries.
(ii) That the assessee had not spent the amount of the entry in question as well as the main entry of Rs.24,82,754.36. But in the mercantile system of accounting the businessman has to take into consideration his liabilities, which might be even contingent in order to arrive at what is real business profit in that year. He has to take into consideration his legal liabilities. It was not the claim of the department that under specific or implied provision of the Income-tax Act, he could not make the entry in question unless he had actually expended that amount. The entry in question in the liability account for Rs.5,18,237.31 was correct and proper.
(iii) That, therefore, the Tribunal was not right in law in not allowing deduction of Rs.5,18,237 claimed by the assessee in respect of the goods taken on loan by it from its sister concern.
Aruna Mills Ltd. v. C.I.T. (1957) 31 ITR 153 (Bom.); Badridas Daga v. C.I.T. (1958) 34 ITR 10 (SC); Calcutta Co. Ltd. v. C.I.T. (1959) 37 ITR 1 (SC); Keshav Mills Ltd. v. C.I.T. (1953) 23 ITR 230 (SC) and New India Industries Ltd. v. C.I.T. (1993) 203 ITR 933 (Guj.) ref.
J. P. Shah for the Assessee.
M. J. Thakore for the Commissioner.
JUDGMENT
S.D. PANDIT, J.---The Income-tax Appellate Tribunal has referred the following question to this Court at the instance of the assessee, Welding Rods Manufacturing Co., under section 256(1) of the Income Tax Act, 1961:
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in not allowing deduction of Rs.5,18,237 claimed by the assessee in respect of the goods taken on loan by it from Ahura Welding Electrode Mfg. Co. Ltd., Coimbatore?"
The assessee is a firm, which manufactures welding rods. For the said business, the assessee-firm obtained op loan basis raw material mainly wire rods from sister concern, Ahura Welding Electrode Mfg. Company Ltd., Coimbatore, as the said raw material had become scare. The said sister concern of Coimbatore was unable to use its full quota of wire rods on account of cut of electricity in Tamil Nadu State. The loan agreement between the sister concern and the assessee was that when required by them (sister concern) the wire rods would be returned which meant the quantity of wire rods obtained on loan basis returnable of the same quality and quantity. No time or date was fixed for returning of the raw material wire rods. The quantity of wire rods taken on loan in the three accounting years was as under:
| Assessment year | Quantity taken on loan |
| 1972-73 | 347.412 tonnes |
| 1973-74 | 292.013 |
| 1974-75 | 104.803 |
None of the goods were returned by the assessee for the year (assessment year) 1976-77. It has shown in the liability for purchase account as under:
Increase in liability of wire rods taken in past:
| 1972-73 | 347.402 |
| 1973-74 | 292.013 |
| 1974-75 | 104.803 |
| | 704.222 |
| Valued at 3,364.4Rs.24,82,756.36 |
| Less: Provision made up to last year Rs.16,16,891.05 |
Thus, the assessee had provided for an additional liability of 639,419 tonnes at the rate of 810.56 (Rs.3,336.04-2,525.56) Rs.5,18,237.31 on account of the rise in price of wire rods from Rs.2,525.56 to Rs.3,336.04 in the year 1974-75 (assessment year 1975-76). The said claim of Rs.5,18,237,31 was not allowed by the Income-tax Officer. Though the assessee had challenged that order by preferring appeals before the Commissioner of Income-tax (Appeals), Baroda, as well as Income-tax Appellate Tribunal it did not succeed. Hence, it moved the Appellate Tribunal to make reference and accordingly this reference has come before us.
It is an admitted fact that the assessee is maintaining its accounts on the mercantile system. There is also no dispute about the fact that the assessee had taken the wire rods on loan from the sister concern of Ahura Welding Electrode Manufacturing Co. Ltd., Coimbatore, as shown in its account, with an agreement to return the same on demand. It is also necessary to mention here that the assessee had- shown the entries in the liability account for the assessment years 1973-74 and 1974-75 of 347.402 and 292.017 tonnes at the rate of Rs.2,525.56 for Rs.16,14,891.05. And in the assessment year 1975-76 the entry of 104.803 tonnes at the rate of Rs.3,336.04, Rs.3,49, besides the entry of Rs.5,18,237.31 on account of difference in rate of loan of goods taken in the accounting years 1973-74 and 1974-75. It is very pertinent to note here that the assessee's entries in the liability account of Rs.16,14,891.05 for the assessment years 1973-74 and 1974-75 and of Rs.3,49,626 for 1975-76 are accepted and allowed by the Department. In the background of these admitted facts, the question referred to us is to be considered and decided.
In examining any transaction or entry in the mercantile system of accounts, the Court must have more regard to the reality and specifically to the situation rate than to a purely technical aspect. It must give greater emphasis on the business aspect of the matter by viewing the transaction as a whole, of course without disregarding the statutory language. In the case of Keshav Mills Ltd. v. C.I.T. (1953) 23 ITR 230, the apex Court has observed that the mercantile system of accounting brings into credit what is due immediately it becomes legally due and before it is actually received and it brings into debit the amount for which a legal liability is incurred before it is actually disbursed. A liability, the amount of which is deductible for income- tax purposes is one, which is actually existing at the time of making deduction. In the instant case it is an admitted fact that in the assessment years 1973-74, 1974-75 and 1975-76 the assessee had taken on loan 347.402, 292.017 and 104.803 tonnes of wire rods respectively from its sister concern and as per the contract between the assessee and the sister concern, the assessee was liable to return the same on demand. Consequently, the assessee must make provision in its accounts of the prices of the said loan in view of material taken on loan so as to enable it to purchase the same in the open market. It is very pertinent to note that the rate of the goods shown by the entry in the assessee's account is not challenged or is not alleged to be an inflated one. The amount of Rs.24,82,756.36 is an estimated amount which will have to be expended by the assessee in the course of his business in order to return the raw materials taken as loan. From the said amount of Rs.24,82,754.36, the assessee has correctly deducted the amount of Rs.16,14,891.05 which was claimed in the previous two years. Out of the remaining amount of Rs.8,67,836.31, the amount of Rs.5,18,237,31 is on account of the rise in price of the raw material from Rs.2,525.56 to Rs.3,336.04. It is not at all possible to arrive at the profit of the assessee's business without the said entries. The profit of a business is the surplus by which the receipts from the business exceed the expenditure necessary for the purpose of earning these receipts. That seems to us the meaning of "profits" in relation to a business.
In the case of Badridas Daga v. C.I.T. (1958) 34 ITR 10 (SC), it has been observed as under (at page 14):
"It is to be noted that while section 10(1) imposes a charge on profits or gains of a trade, it does not provide how those profits are to be computed. Section 10(2) enumerates various items, which are admissible as deductions, but it is well-settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable under section 10(1). "
Thereafter, discussing an earlier decision it has been further observed as under (at page 15):
"The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to the accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act."
We would also like to quote the observations of the then Chief Justice M. C. Chagla of the Bombay High Court in the case of Arunga Mills Ltd. v. C.I.T. (1957) 31 ITR 153 which run as under (at page 163):
"Now, we have had occasion to point out in several decisions that what the Income-tax Act purports to tax is business profits, and business profits are the true profits of a business as ascertained according to commercial principles. There may be an expenditure or there may be a loss which may not be an admissible loss under any of the provisions of section 10(2) and yet such an expenditure or loss would have to be allowed in order to determine what were the true profits of a business, and it is the duty of every one who has anything to do with taxing business-people to understand what are the principles of commercial expediency. Unless one understands these principles it is difficult to make a proper assessment sin a business or on a businessman."
Now, let us turn to the facts of the reference made to us and consider the same in the light of the above observations; we are not in the least hesitant to record our considered opinion that unless the disputed entry is allowed it is not possible to know and find out the assessee's profit which are taxable, No doubt the assessee has not spent the amount of the entry in question as well as the main entry of Rs.24,82,754.36. But, in the Mercantile system of accounting, the businessman has to take into consideration his liabilities which might be even contingent in order to arrive at what is real business profit in that year. He has to take into consideration his legal liabilities. It is not the claim of the Department that under any specific or implied provision of the Income-tax Act he could not make the entry in question unless he had actually expended that amount.
Thus, in view of the above discussion, we are of the view that the entry in question in the liability account for Rs.5,18,237.31 is correct and proper and the same must be accepted by the Department. This conclusion of ours is supported by the decision of the Supreme Court in the case of Calcutta Co. Ltd. v. C.I.T. (1959) 37 ITR 1. In that case, the appellant sold a plot of land for Rs.43,692 on the condition to carry out the development of laying out roads, providing drainage system and installing lights, etc. The appellant had received on the date of transaction only Rs.29,392 and the remaining amount was to be recovered in instalments. He had credited in his accounts Rs.43,692 representing the full price and at the same time made a debit entry of Rs.24,809 as estimated expenditure towards development as per the mercantile system of accounting. He had made the debit entry of Rs.24,809 without actually spending any amount which he was to spend some time in future. Hence, the said entry was not accepted by the Commissioner of Income-tax. But the said debit entry was approved and accepted by the apex Court in the said case.
The learned Advocate for the assessee has cited before us the case of New India Industries Ltd. v. C.I.T. (1993) 203 ITR 933 (Guj.). But it is a case covered by section 43-A of the Income-tax Act, section 43-A is a special provision consequential to changes in rate of exchange of currency. But the observations by the Division Bench of this Court in that case are meeting the contention of Mr. Thakore, learned Advocate for the Department, that the assessee is not entitled to make the said entry for Rs.5,18,237.31, when he has not actually spent the amount. Those observations at page 940 are as under:
"In our opinion, when the assessee purchased assets at a price, its liability to pay the same arose simultaneously. Merely because the said liability was to be discharged in instalments, it cannot be said that the liability did ,not exist or accrue till the instalments became due and payable."
Therefore, in view of all the above discussion and for the reasons recorded above, we answer the reference in the negative and in favour of the assessee. Reference is thus answered accordingly with no order as to costs.
Pronounced in the open Court on this 16th day of August, 1996.
C.M.A./1741/FC Reference answered.