Income-tax---

----Accounting---Cash system of accounting---Valuation of closing stock ---Assessee engaged in sales circulation business ---Assessee receiving monies from a subscriber---Subscriber to sell coupons to three other persons and when cycle was complete subscriber to get a gift article and as regards incomplete cycle assessee not obliged to send gift or return money ---Assessee not entitled to deduct value of gift articles re mine with him from gross receipts of business.

The assessee was engaged in a business under the name and style of "Srinivasa Circulation Scheme", which involved the assessee inviting a person to choose a gift and becoming entitled to that gift on his paying a sum of Rs. 5 and thereafter three persons whom he was required to suggest paying Rs. 15 each for obtaining similar coupons and giving the names of other purchasers of similar coupons. Any person who sent the money order or bank draft for Rs. 45 alongwith the coupon duly filled up would receive the article that was mentioned in the coupon together with three sets of nine coupons. In the assessment for the assessment year 1974-75, the Income-tax Officer added the value of closing stock of gift articles to the amount received by the assessee and thereafter deducted the value of the opening stock and the amount spent on the purchase of gift articles. The addition of the closing stock of gift articles was disputed by the assessee. The assessee claimed that the subscription from the completed cycle alone should be treated as the income and not the amount received from the subscribers who did not complete the cycle. The Tribunal held that the system of accounting followed by the assessee should be accepted or in the alternative the gross calculation made by the assessee should be taken into account and, therefore, the value of the gift articles relatable to those subscribers should be deducted for arriving at the total income. On a reference:

Held, that under the Scheme operated by the assessee, the assessee received monies from all those who subscribed to the Scheme. The assessee was liable to send gift articles only to those subscribers whose cycle was complete and to the other three subscribers also, who purchased the coupons in the manner required by the assessee. In cases where the cycles were not complete there was no liability to send any gift. The assessee also was not required to return the money paid to the subscriber in cases where the cycles were incomplete. The monies received from the subscribers irrespective of whether the .cycle was complete .or incomplete were all part of its gross income and the expenditure incurred on the purchase of gift articles was the expenditure incurred for running the business. The closing stock-in-trade was therefore required to be taken into account while computing the profit and loss r the Scheme. The assessee was not entitled to deduct from the gross receipts the value of those articles which continued to remain with him at the end of the assessment year and which had to be treated as part and parcel of the closing stock which was very much available to the assessee for use in the subsequent year for the very same business purpose.

CIT v. A. Krishnaswami Mudaliar (1964) 53 ITR 122 (SC) ref.

C.V. Rajan for the Commissioner.

S. Shanmugam for N. Inbarajan for the Assessee.

JUDGMENT

R. JAYASIMHA BABU, J. ---As the questions referred to us are common, both these tax cases are taken up together and disposed of by this common order.

The assessment years are 1974-75 and 1977-78, respectively.

The answer to these questions referred to us depends upon the manner in which the closing stock is required to be treated in the case of an assessee who followed the cash system of accounting. The assessee was engaged in a business under the name and style of "Srinivasa Circulation Scheme", which involved the assessee inviting a person to choose a gift and becoming entitled to that gift on his paying a sum of Rs.5 and thereafter three persons, whom he was required to suggest paying Rs.15 each for obtaining similar coupons and giving the names of other purchasers of similar coupons. The printed pamphlet sets out is detail the manner in which the said Scheme operates. The relevant portion of the said pamphlet issued by the assessee is set out below:

"Please get a coupon of our company from your friend or from the company by paying rupees five. Please mark your address and any one article you require and send it back to the company. After receiving your coupon, we will register it and send three coupons by V.P.L. for Rs.15 plus V.P.L. charges. Now you have to give the coupons to three persons for Rs.5 each and take the money for yourself and ask them to fill up the coupons with their names and full address and send it to us.

We will send to each of your three parties three coupons each for Rs.15 plus postal charges by V. P.L. As soon as the parties concerned clear the V.P.Ls. you will receive from us the article that you have mentioned in your coupon."

Clauses 5 and 6 of the terms and conditions of the Scheme read as follows:

"5. Any person sending money order or bank draft for Rs.45 alongwith the coupon duly filled up will receive the article that is mentioned in the coupon together with three sets of (nine) coupons.

6. Coupons should be returned duly filled within three months of their receipt.

Coupons received after three months will not be attended to."

The pamphlet further states that the member, who subscribes to the Scheme can get any one of the following articles for Rs.5.

"Eversilver articles:

1. Tiffin carrier 1,

2. Kothu chatti 1,

3. Sambar vali 1,

4. Kuja 1. "

During the assessment year 1974-75, the assessee received in all a sum of Rs.13,28,867. The Income-tax Officer added the value of closing stock of gift articles to that sum. Thereafter, he deducted the value of the opening stock and the amount spent on the purchase of gift articles. As the other calculations made by the Income-tax Officer are not relevant for the purpose of these cases, they are not referred to. The valuation of the closing stock of gift articles was disputed by the assessee, who claims that as the assessee had followed the cash system of accounting, the closing stock ought not to have been deducted. It was the further claim of the assessee that only the amount which represents the subscription from the completed cycle should be treated as the income and not the amount received from the subscribers, who did not complete the cycle.

The Commissioner (Appeals) having accepted the assessee's appeal, the Income-tax Officer had chosen to file an appeal against the order of the Commissioner to the Tribunal. The Tribunal held that the system of accounting followed by the assessee should be accepted or in the alternative the gross calculation made by the assessee should be taken into account and, therefore, the value of tile gift articles relatable to those subscribers should be deducted for arriving at the total income. The Tribunal does not seem to have noticed the fact that in the order of assessment the value of the opening stock, i.e., the amount invested for the purchase of gift articles, in the entire year had been deducted and that it was only the value of the closing stock that had not been deducted. The Tribunal was in agreement with the Income-tax Officer that when deduction is allowed for the gift articles, the amounts received by the assessee in respect of broken cycles also should be treated as the income of the assessee and those amounts were not liable to be excluded.

At the instance of the Revenue, the following questions have been referred to us as arising out of the order of the Tribunal:

"(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the method employed by the Income-tax Officer for determining the assessee's income from the `sales circulation business' was not correct?

(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in concluding that the entire value of gift articles is to be set off against the subscription relatable to broken cycles, 'when they have held, that there is no obligation cast upon the assessee either to return the amount or to send the gift articles without receiving the full amount?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee's income from `sales circulation business' should be computed by taking the gross receipts and allowing the gift articles relatable thereto especially when it is difficult to arrive at the value of the gift articles relating to broken cycles and incomplete cycle?"

Under the Scheme operated by the assessee, the assessee received monies from all those who subscribed to the Scheme. The assessee was liable to send gift articles only to those subscribers, whose cycle was complete and to the other three subscribers also, who purchased the coupons in the manner required by the assessee. In cases where the cycles were not complete, there were no liabilities to send any gift. The assessee also was not required to return the money paid by the subscribers in cases where the cycles were incomplete. The assessee had claimed that he had purchased large quantities of gift articles for the purpose of meeting the claims of the subscribers, in all cases where the cycles were complete. The gift articles in cases where the cycles were incomplete remained with the assessed, since he was not required to send the same to the subscribers. All the monies received by the assessee from the subscribers, irrespective of whether the cycle was complete or incomplete are part of its gross income. The expenditure incurred on the purchase of gift articles is the expenditure incurred by the assessee for the purpose of running the business. The Income-tax Officer had, therefore, rightly deducted the amount representing such expenditure as also the opening stock from the gross income during the year, after adding to the gross income the value, of the closing stock of the gift articles, as they had not been utilized for meeting any obligation during the year in relation to its business.

The question whether the closing stock-in-trade shall be taken into account for computing the true profits for the year was considered by the Supreme Court in CIT v. A. Krishnaswami Mudaliar (1964) 53 ITR 122, wherein it was held that whichever method of book?keeping is adopted, in the case. of a trading venture for computing the true profits of the year the stock-in-trade must be taken into account. If the value of the stock-in-trade is not taken into account, in the ultimate result, the profit or, loss resulting from trading is bound to get absorbed or reflected in the stock-in-trade unless the value of the stock-in-trade remains unchanged at the commencement of the year and at the end of the year.

It was not the case of the assessee in these cases that the stock?-in-trade remained the same at the commencement and at the end of the year. The closing stock-in-trade was, therefore, required to be taken into account, while computing, the true profit and loss of the assessee under the Scheme. The assessee was not entitled to deduct from the gross receipts the value of those articles, which continued to remain with him at the end of the assessment year and which are to be treated as part and parcel of the closing stock, which was very much available to the, assessee for use in the subsequent year for the very same business purpose. To the extent that such articles were utilised in the subsequent years, the assessed would be entitled to, claim that expenditure for that year.

Our answers to all the questions referred to us are in the negative, in favour of the Revenue and against the assessee. The Revenue shall be entitled to a cost in a sum of Rs.1,000 (Rupees one thousand only).

M.B.A./723/FC?????????????????????????????????????????????????????????????????????????????????? Reference answered.