Kerala H.C : Where assessee, an exporter, was following mercantile system of accounting, gain on account of foreign exchange difference on outstanding export bills would accrue to assessee when it became entitled to receive sale consideration in foreign exchange irrespective of time of receipt

High Court Of Kerala

CIT VS. Mahavir Plantations (P.) Ltd.

Section : 5, 145

K.M. Joseph And K. Vinod Chandran, JJ.

IT Appeal No. 37 Of 2002

October 18, 2013


K. M. Joseph, J. – The purported substantial questions of law raised in appeal are as follows :

“(i) Whether, on the facts and in the circumstances of the case and the system of accounting maintained by the assessee being mercantile, the Tribunal is right in law and fact in deleting the addition of Rs. 5,37,909 on the ground that there is no accrual of income because foreign exchange was not received on June 11, 1981, and the payments were received much later only through ECGC and is not the conclusion of the Tribunal wrong and against fundamentals ?

(ii) Whether, on the facts and in the circumstances of the case, is not the deletion of Rs. 5,37,909 by the Tribunal against facts and law ?”

2. The respondent which is an assessee under the Income-tax Act which also deals with in exports, had credited to its profit and loss account a sum of Rs. 5,37,909 representing the estimated amount of exchange difference on outstanding Sudan export bills. But the respondent contended that the said amount did not represent any income received or accrued as on the date of the balance-sheet and, therefore, the same should be excluded in the determination of income from its Cochin office. According to the respondent-assessee, the said amount had not accrued during the previous year which ended on June 30, 1981. The Assessing Officer rejected the contentions finding that the respondent was entitled to receive the sale consideration in foreign exchange. When the prevailing exchange rate is taken into consideration, the assessee is entitled to receive the Indian currency equivalent to the sale bills raised and the estimation difference is now credited to the export sales, it is found. The exchange difference, in view of the system of accounting (mercantile) being followed by the assessee was rightly taken credit. The Commissioner of Income-tax (Appeals) confirmed the disallowance. However, the Tribunal allowed the assessee’s appeal, holding that since realisation of the sale proceeds in foreign exchange depended on the repatriation of the funds, there is no accrued income in the hands of the assessee. The Revenue carried the matter in appeal before the High Court which remanded the matter back. The High Court took the view that the correct factual position relating to the entry made on June 11, 1981, has not been properly explained by the respondent-assessee or considered by the Tribunal. On remand, we notice the following line of argument taken by the assessee :

“The learned counsel submitted that the significance of the date, with reference to which the exchange rate fluctuation is credited in the profit and loss account is the date, the exchange rate of which was applied for crediting the last shipment. The learned counsel has filed before us two annexures, A and B, containing the details of the export shipments and ECGC policy taken by the assessee. He invited our attention to annexure A containing the statements of shipments and pointed out that the last shipment was on June 12, 1981, and the value credited by the bank is with reference to the exchange rate applicable on the previous day, i.e., June 11, 1981. The learned counsel submitted that this is a reasonable and scientific method applied by the assessee. It is in this context the date was adopted as June 11, 1981, as against the usual date of June 30, 1981, which should have been applied for passing adjustment entries.”

The Tribunal held that there was no accrual of income because foreign exchange was not received on June 11, 1981, but the payments were received much later only through ECGC. The Tribunal deleted the assessment of Rs. 5,37,909 credited by the assessee.

3. We heard the learned senior counsel for the Revenue and the learned counsel for the assessee.

4. Learned senior counsel for the Revenue would contend that the approach of the Tribunal is clearly insupportable. Admittedly, the respondent-assessee was maintaining its accounts by following the mercantile or double entry system of accounting, which meant that the income would be reflected on the basis of accrual and not receipt. In other words, it was not necessary that there should be actual receipt of income. In this case, admittedly, the assessee has itself credited its accounts with the sum in question. Learned senior counsel would then pose the question as to how it is open to the assessee to turn round and question the said amount being exigible to tax. The following case law was canvassed before us :

(1) In Godhra Electricity Co. Ltd. v. CIT [1997] 225 ITR 746/91 Taxman 351 (SC), the apex court held, inter alia, as follows (headnote) :

“Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt ; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book keeping, an entry is made about a hypothetical income, which does not materialise.”

That was a case where the Government of Bombay had given a licence to a company authorising it to generate and supply electricity. The assessee-company was the successor. The appellant enhanced its rates unilaterally. Two representative suits were instituted. During the pendency of the litigation, the company was not able to realise the enhanced charges. The citizens of the area met the Minister and thereafter the Under Secretary to the Government wrote to the assessee suggesting that the company may maintain status quo for the rates. There was yet another suit filed by the consumers which was decreed in their favour, prohibiting the company from recovering charges exceeding certain amounts. The undertaking of the company was taken over by the State Government. The company was being assessed on the basis of the accounts maintained according to the mercantile system. The assessee deducted certain sums on the ground that it was actually not recovered by it from the consumers. The Assessing Officer included a sum on the ground that the suit against the company was decided in favour of the assessee. The addition was deleted by the Appellate Assistant Commissioner which was upheld by the Tribunal. The additions made for the subsequent assessment years were also likewise deleted. The High Court, however, held that the assessee-company had a legal right to recover sums at the enhanced rate. It is in the facts of this case that the court held as aforesaid. While the said suit was pending before the trial court, the Gujarat State Government took over the undertaking. The court took the view that though the assessee-company was following the mercantile system of accounting and has made entries in the books regarding their enhanced charges, no real income had accrued to the assessee-company in respect of those enhanced charges. It is only a hypothetical income, was the view of the apex court.

(2) In CIT v. United Provinces Electric Supply Co. [2000] 244 ITR 764/110 Taxman 134 (SC), the matter arose under section 41 of the Income-tax Act, 1961. Section 41(2), inter alia, provided that the amount determined as provided therein shall be chargeable to income-tax, as the income of the business or profession of the previous year in which the money is payable for the building, machinery, plant or furniture became due. It was a case of a sale by way of compulsory acquisition. The balancing charge under section 41(2) is taxable in the previous year in which the money payable became due. That was a case where the board paid final compensation in a sum of Rs. 3,35,84,552. The assessee, however, was dissatisfied and took up the matter before the Arbitrator. Since the Arbitrator has failed to make an award, the matter was referred to an umpire. The Income-tax Officer took the amount of Rs. 3,35,84,552 and computed the written down value of those assets and further determined the profit under section 41(2) which was added to the income of the assessee. The apex court held as follows (headnote) :

“that, presuming that the assessee was entitled to additional amounts other than what was paid by the acquiring authority, yet for the purpose of tax, moneys payable became due and were paid and received. In case the assessee received any additional amount, that would be taxable subsequently as profits in accordance with the provisions of the Act. There was no question of piecemeal assessment, as under sub-sections (1) and (4) of section 41 also the sum deemed to be a business profit is to be taxed as income in the year in which it is received.”

(3) In Southern Technologies Ltd. v. Jt. CIT [2010] 320 ITR 577/187 Taxman 346 (SC), the apex court held, inter alia, as follows (page 608) :

“Theory of ‘real income’

An interesting argument was advanced before us to say that a provision for NPA, under commercial accounting, is not an ‘income’ hence the same cannot be added back as is sought to be done by the Department. In this connection, reliance was placed on ‘Real income theory’.

We find merit in the above contention. In the case of Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC) at page 530, this is what the Supreme Court had to say :

‘Income-tax is a tax on the “real income”, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions under the provisions of the Income-tax Act. There is a clear-cut distinction between the real profits and statutory profits. The latter are statutorily fixed for a specified purpose.’

To the same effect is the judgment of the Bombay High Court in the case of CWT v. Bombay Suburban Electric Supply Ltd. [1976] 103 ITR 384 at page 391, where it was observed as under :

‘Income-tax is a tax on the real income, i.e., profits arrived at on commercial principles subject to the provisions of the Income-tax Act, 1961. The real profits can be ascertained only by making the permissible deductions.’

The point to be noted is that the income-tax is a tax on ‘real income’, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. Therefore, if by the Explanation to section 36(1)(vii) a provision for doubtful debt is kept out of the ambit of the bad debt which is written off then, one has to take into account the said Explanation in computation of total income under the Income-tax Act failing which one cannot ascertain the real profits. This is where the concept of ‘add back’ comes in. In our view, a provision for NPA debited to the profit and loss account under the 1998 Directions is only a notional expense and, therefore, there would be added back to that extent in the computation of total income under the Income-tax Act.”

5. We must refer to the judgment of this court in ITR No. 152 of 1995, CIT v. Mahavir Plantations Ltd. [2000] 244 ITR 571/110 Taxman 147 (Ker.) pursuant to which the impugned order has been passed by the Tribunal. Therein the court had inter alia held as follows (page 572) :

“The Tribunal held that exchange difference, as worked out by the assessee, did not relate to last day of the previous year, but was on an ad hoc basis. It further held that basic question at issue was whether the entries passed in the books of the assessee, which keeps its accounts on mercantile system of accounting taking credit for fluctuation in foreign exchange rate have really resulted in accrual of income to the assessee or in other words, whether any income arose to assessee as a result of such fluctuation. It was held that no income arose or accrual as a result of fluctuation in foreign exchange rates. The further issue before the Tribunal was whether the assessee was entitled to deduction on the commission paid by it abroad in respect of its exports. Applying the ratio of decision of this court in CIT v. Kerala Nut Food Co. [1991] 192 ITR 585 (Ker), it was held that the matter was to be decided in favour of the assessee. So far as question relating to fluctuation in foreign exchange rate is concerned, learned counsel for the Revenue submitted that the assessee itself had included the income in profit and loss account. Having done so, it was precluded from taking the hypothetical stand that it was not to be treated as income. Learned counsel for the assessee submitted that what is to be assessed is real income and merely because an entry has been made unless the same related to an income, the assessment should not have been done. So far as the other question related to weighted deduction is concerned, learned counsel for parties accepted that the question is covered by decision of this court in Kerala Nut Food Co.’s case [1991] 192 ITR 585 (Ker).

The factual position is really confusing and the assessee has added abundantly to it. No satisfactory explanation was given as to why figure was indicated in the financial statements filed, including the same in profit and loss account. It is to be noted that in the total export sales as indicated in financial statements, variation in the figure relating to foreign exchange rate was included. Thereafter, a note was added that same did not constitute an income and should be excluded. No explanation, whatsoever, has been given except evasively stating that to avoid confusion, same was included. If that be so, it is not open to the assessee to turn around and say that same did not form an addition to consideration as sale price. Additionally, the figure did not represent the factual position on the last date of accounting period, i.e., March 31, 1981, but related to the rate applicable on June 11, 1981. This aspect does not appear to have been considered by the Tribunal. It was for the assessee to show the correctness of the figures and if called upon, to the explain relevance of the entry. In view of the aforesaid confused factual position, we think it proper to direct the Tribunal to get the correct picture of the factual position. The assessee is to be given an opportunity to explain about the entries made, and the background in which they were made. It is true, as contended by learned counsel for the assessee, that actual income has to be assessed. But, when it had given figures which later on was claimed to be not relevant, requirement was placed on it to explain under what circumstances entries have been made and for what purpose. It is not open to an assessee to make irrelevant entries and then ask the Department to find out and tax annual income. Instead of answering the reference, we direct the Tribunal to hear the matter afresh keeping in view the observations made herein above.”

6. What the Tribunal held in the impugned orders are, the last shipment was on June 12, 1981. The credit entry was made on the previous date, i.e., on June 11, 1981. The Tribunal found that the previous year of the assessee ended on June 30, 1981. In fact the High Court has noted that the last date of the accounting period is March 31, 1981. The finding is further that there is no accrual of income because foreign exchange was not received on June 11, 1981, and the payments were received much later only through ECGC. We are of the view that the approach made by the Tribunal is insupportable. Admittedly, the respondent-assessee is maintaining its accounts on the mercantile system of accounting. Admittedly, the assessee has credited its own accounts with Rs. 5,37,909 being the difference arising on account of foreign exchange fluctuation. Unlike the fact situation in Godhra Electricity Co. Ltd. case (supra), where there was absolutely no possibility of the assessee recovering the amount, the same is not the position here. May be the assessee has received the amount much later. But the time of receipt is relevant only when accounts are being maintained on the basis of the receipt system. When admittedly the assessee is maintaining the accounts on the mercantile system, the Tribunal ought not have found when there is no accrual of income for the reason that foreign exchange was not received on June 11, 1981. The fact that foreign exchange was not received on June 11, 1981, is completely irrelevant having regard to the system of accounting followed. In fact the finding is that the payments were received much later. This is not a case where the payments were not received. May be there were difficulties in actual realisation of amounts. But that cannot detract from the accrual of income. The question of accrual is essentially related to the question whether the assessee became entitled to receive the amount. If once the question is answered in favour of the assessee, namely, the assessee was entitled to get the amount then necessarily the further question would be that when the assessee would be entitled to get the amount. Once both these questions are answered, then the further question as to when actually the assessee received the amount falls into insignificance in a situation where accounts are maintained under the mercantile system of accounting.

7. In such circumstances, we are of the view that the Revenue must succeed. Accordingly, we allow the appeal and answer the questions of law in favour of the Revenue and against the assessee. The order of the Tribunal will stand set aside and the order passed by the Assessing Officer will stand restored.

[Citation : 360 ITR 22]

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