Commissioner of Income Tax vs Arvind Industries

S.B. Majmudar, J.—At the instance of the Revenue, the following two questions have been referred for our opinion by the Income Tax Appellate Tribunal Ahmedabad :

"(1) Whether, on the facts and in the circumstances of the case the Tribunal was right in law in holding that the messing expenses in question were not in the nature of entertainment expenditure within the meaning of section 37(2B) of the Act ?

(2) Whether, on the facts and in the circumstances of the case, the tribunal was right in law in holding that the liability of the assessee to pay sales tax for the period from July 17, 1971, to October 19, 1971, arose during the Samvat year 2028, namely, the previous year relevant to the assessment year 1973-7 ?"

In order to appreciate the background in which these questions have been referred for our opinion, certain relevant facts will have to be noted at this stage. 1973-74 is the assessment year. The assessee, a registered firm, carried on the business of running a solvent extraction plant. Samvat year 2028 constitutes the previous year. The total income was assessed by the Income Tax Officer on April 15, 1976, at Rs. 6,71,357. The assessee, with a view to getting the benefit of exemption from payment of sales tax for five years under the incentive scheme pronounced by the government of Gujarat, set up a new solvent extraction plant at Junagadh in Junagadh district. After obtaining the necessary certificate from the industries officer, Junagadh, as regards the setting up of the said plant, the assessee obtained sales tax exemption certificate dated March 3, 1971. The result was that the assessee''s sales in connection with the products of the new solvent extraction plant got exemption from payment of sales tax during time the certificate was in force. On September 2, 1972, i.e., during the previous year relevant to the assessment year 1973-74, however, the assessee-firm was informed by the sales tax authorities that the said exemption certificate had ceased to be effective from July 17, 1971. The result was that the assessee-firm became liable to pay sales tax amounting to Rs. 98,884 for the period from July 17, 1971 to October 19, 1971 (forming part of Samvat year 2027 relevant to Income Tax assessment year (1972-73) and Rs. 4,64,403 for the period from October 20, 1971, to November 15, 1972 (corresponding to Samvat year 2028 relevant to Income Tax assessment year 1973-74). The assessee claimed in the Income Tax assessment under consideration deduction of the said two amounts totalling Rs. 5,63,287 as sales tax liability contending that the said liability for sales tax arose for the first time in September, 1972. The Income Tax Officer rejected the said claim.

The second disputed claim centered round Rs. 20,894 which was an amount spent by the assessee during the relevant year on messing charges. The mess was run by the assessee for the benefit of its staff members and clients. This claim was disallowed by the Income Tax Officer on the ground that they were entertainment expenditure within the meaning of section 37(2B) of the Act.

The assessee carried the matter in appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner, by his order dated March 29, 1976, took the view that the assessee''s liability to pay sales tax of Rs. 5,63,287 arose for the first time in September, 1972, when the sales tax authorities withdrew the exemption as aforesaid. The appellate Assistant Commissioner system of accounting and, consequently, on accrual basis, the aforesaid full amount covering the sales tax liability be deducted from the income returned by the assessee for the year in question as a permissible deduction.

So far as messing expenses were concerned, the Appellate Assistant Commissioner disallowed Rs. 1,200 pertaining to messing charges of partners of the assessee-firm. Balance of Rs. 19,694 was allowed by the Appellate Assistant Commissioner by holding that they were not entertainment expenses. The Revenue carried the matter in appeal to the Tribunal. The Tribunal dismissed the appeal and confirmed the findings and conclusion which the Appellate Assistant Commissioner reached on these two amounts.

Before the Tribunal, it was submitted by the Revenue that, even if, by following the mercantile system of accountancy, sales tax liability could be deducted from the returned income for the assessment year 1973-74, only an amount of Rs. 4,64,403 for the period from October 20, 1971, to November 15, 1972, could be so deducted, but the balance of Rs. 98,884 by way of sales tax liability for the sales effected by the assessee for the period covered by the earlier assessment year 1972-73 forming part of Samvat year 2027 could not be deducted from the returned income of the assessee for the relevant assessment year 1973-74. As noted earlier, the aforesaid two questions have been referred for our opinion. We shall now deal with these questions seriatim.

Question No. 1 : So far as this question is concerned, it is squarely covered against the Revenue by a decision of this court in the case of CIT v. Patel Brothers & Co. Ltd. and Commissioner of Income Tax, Gujarat II Vs. Patel Brothers and Co. Ltd., . This court has taken the view that "if the provision of food, drinks or any amusement to a client, constituent or customer is on a lavish and extravagant scale, or is of wasteful nature, it is entertainment per se. However, if the provision of food or drinks to a client, constituent or customer is in the nature of the bare necessity, or by way of ordinary courtesy, or as an express or implied term of the contract of employment spelled out from long-standing practice or custom of trade or business, it will not amount to entertainment". On the facts of the present case, it is not the contention of the Revenue that the disputed amount of Rs. 19,694 represented any lavish or extravagant expenditure. On the contrary, it has been found as matter of fact by the appellate Assistant Commissioner as well as by the Tribunal that the mess was being run at the relevant point time by the assessee for the benefit of its staff members and clients, that the provision for food made by the assessee was not on a lavish and extravagant scale or of wasteful nature and that such provision was made on the basis of long standing practice or custom of trade or business. Having regard to these and other factors such as the nature and magnitude of the assessee''s business and following the principles laid down by this court in CIT v. Gautamkumar Rajendrakumar and Commissioner of Income Tax, Gujarat II Vs. Patel Brothers and Co. Ltd., , in Reference Nos. 64 and 151 of 1974, decided on November 12, 1975, the aforesaid expenses could not be treated as entertainment expenses within the meaning of section 37(2B) of the Act. The said finding of the Tribunal is well justified on the record of the case and is squarely covered against the Revenue by the ratio of the aforesaid decision of this court. The first question, therefore, will have to be answered in the affirmative, in favour of the assessee and against the Revenue.

Question No. 2 : So far as this question is concerned, it has to be kept in view that the assessee was following the mercantile system of accounting. During the earlier year, viz., 1972-73, referable to Samvat year 2027, the assessee''s sales were all covered by the exemption certificate issued by the sales tax authorities and by the time the assessee completed its accounts, i.e., on Diwali of Samvat year 2027, there was no occasion for the assessee to insert any entries about sales tax liability on these sales. It was only in the next year, viz., relevant assessment year with which we are concerned, i.e., assessment year 1973-74, that, for the first time, it was brought to the notice of the assessee that the exemption certificate stood cancelled with effect from July 17, 1971. It is because of this information in the relevant current assessment year that the assessee became liable to pay sales tax on the concerned sales on and from July 17, 1971. It is true that the said sales tax liability had accrued covering part of the earlier year but only because of that it cannot be said that liability to pay sales tax had accrued to the assessee in the earlier year at the time when the accounts were closed for the relevant earlier year up to Samvat year 2027. The Tribunal was, therefore, perfectly justified in taking the view that splitting up of total amount of Rs. 5,63,287 into two sub-parts, viz., (i) Rs. 98,884 for the period from July 17, 1971, to October 19, 1971, referable to Samvat year 2027 and (ii) Rs. 4,64,403 for the period from October 20, 1971, to November 15, 1972 (corresponding to Samvat year 2028), for the assessment year in the present case was not possible. It has to be kept in view that, as held by the Supreme Court in The Kedarnath Jute Mfg. Co. Ltd. Vs. The Commissioner of Income Tax, (Central), Calcutta, , when the assessee was following the mercantile system of accounting, sales tax liability had to be accounted for on accrual basis even though the liability was in dispute. The decision of the Supreme Court in The Kedarnath Jute Mfg. Co. Ltd. Vs. The Commissioner of Income Tax, (Central), Calcutta, squarely gets attracted to the facts of the present case. Whether sales tax liability was in dispute or not would, therefore, pale into insignificance. That is precisely the reason why the Tribunal has not referred for our opinion the question whether the balance amount of Rs. 4,64,403 by way of sales tax liability for the sales effected by the assessee during the relevant assessment year corresponding to Samvat year 2028 can be deducted from the returned income of the assessee or not. The short controversy with which we are concerned on question No. 2 pertains to the balance amount of Rs. 98,884 for the relevant months of the earlier year. For that amount also, there was no occasion for the assessee, when the accounts were closed for Samvat year 2027, to effect any deduction as that eventuality had not occurred at that time. It is now well settled that entries made as per the mercantile system of accounting cannot be reopened because of an eventuality that may occur in the subsequent years, vide Commissioner of Income Tax, Madhya Pradesh, Nagpur and Bhandara Vs. Swadeshi Cotton and Flour Mills Private Ltd., , wherein the Supreme Court has taken the view that, where an assessee followed the mercantile system of accounting, the system of reopening of accounts does not fit in with the scheme of the Income Tax Act. As far as receipts are concerned, there can be no reopening of accounts and the position is the same is respect of expenses. Consequently, on accrual basis, sales tax liability could have been brought on the books only when the assessee was informed in 1972 about the withdrawal of sales tax exemption and not prior thereto. Consequently, the entire sales tax liability, even though spilling over to the earlier year, had to be taken into consideration on accrual basis only in the current assessment year 1973-74. The Tribunal was, therefore, perfectly justified in taking the view that liability to pay sales tax on account of withdrawal of sales tax exemption arose for the first time in September, 1972. Consequently, though sales tax liability of Rs. 98,884 related to a period which projected backward to the earlier assessment year covering the sales effected from July 17, 1971, to October 19, 1971, such liability, for the purpose of accounting, arose in September, 1972, and therefore, the liability to pay the entire amount of Rs. 5,63,287 arose for the first time within the accounting period relevant to the assessment year in question. The said conclusion is well-justified in the facts of the present case and, in the light of the settled legal position emanating from the Supreme Court decision in The Kedarnath Jute Mfg. Co. Ltd. Vs. The Commissioner of Income Tax, (Central), Calcutta, . Question No. 2, therefore, also will have to be answered in the affirmative, in favour of the assessee and against the Revenue. Reference disposed of accordingly with no order as to costs.