Commissioner of Income Tax vs A.V.M. Ltd.

Balasubrahmanyan, J.—This reference raises an interesting point. The assessee is a company carrying on business as a distributor of

cinematograph films. The assessee gives the positive prints of films to distributors, who exhibit them in their cinema houses. The consideration

received from them by the assessee goes by the name of ''collections''. To the assessee such collections are receipts from the assessee''s trade in

the distribution of films. Before or at the time of handing over the prints for exhibition to an exhibitor, the assessee received what is called a security

deposit. It is said that the deposit is taken by the assessee for the due fulfillment of the terms of the agreement between the parties. The amount in

deposit being for this purpose, viz., for the fulfillment of the terms of the agreement, it will not remain with the assessee in deposit when the

agreement is fulfilled or completed. The deposit is, thus, a returnable or a refundable deposit. But it might so happen, in the exigencies of business

that the deposit would be sometimes retained by the assessee. It would get depleted or even wholly disappear as and when the film distributor

does not send the collections, but instructs the assessee to set off or adjust his security deposit as against the overdue collections or both the

parties may agree at the time of entering into their deal, or sometime afterwards to keep the deposit for the purpose of adjustment either wholly or

in part as against the dues of the exhibitor towards payment of collections. It, however, may happen that even after adjustment in this manner, there

might be some balance still left in deposit with the assessee. Such was the case here. Several film exhibitors, who had taken films for exhibition in

their theatres, had made security deposits with the assessee in as many as 181 cases. However, even after the final settlement of their accounts

with the assessee, they did not happen to take back their deposits or what was left of them. This might be either because of oversight on the part of

the exhibitors concerned or because they had hopes of continuing their business relationship with the assessee even after the termination of the

particular agreement in question. Whatever be the reason, the deposits remained with the assessee. The peculiarity of this was that after some time,

while the amounts of money deposited were Still with the assessee, the assessee, however, had lost touch with those who had made those

deposits. Many of them were small fry and while the assessee tried to contact them, they were not traceable. For five years or more, the assessee

waited and waited, but none of them came forward to claim the deposits. In sheer desperation, the assessee decided that it had better appropriate

the deposits to itself. This act might not mean that if on some future day any of them turned up and demanded the deposits back, the assessee can

refuse to part with the money, for, under the law, a deposit strictly so called, which is refundable to the depositor, might be regarded as creating a

special kind of relationship. Sometimes, it is regarded as a fiduciary relationship but even if it was regarded as a deposit made between two

contracting parties, as in the present case between the assessee as a film distributor and the various film exhibitors, the deposit would be repayable

on demand or after the particular purpose is served. Although in one sense, a deposit creates a debtor-creditor relationship between the parties, it

is not really equivalent to a borrowing or advance. The creditor, who is the depositor, can always sue for the return of the deposit and recover

money within three years of the demand for its refund. Thereafter, the action may be barred, but even the bar of suit would not, as it is well known,

destroy the debt, it only puts a stop to the remedy. Thus, the character of the deposit as a deposit would never get lost.

What the assessee did in this case was that when it had waited for a sufficiently long number of years, it called it a day and appropriated or

misappropriated the deposit if that is a better description of what was done with the unclaimed deposits. This was done by means of appropriate

book entries in the books of account of the assessee. It needs some explanation as to how this, was done in the books. When initially, a deposit is

received, the assessee gives credit to the film exhibitor for the amount and debits the deposit account. While actual collections from the theatres,

when sent by the film exhibitor, are trading receipts of the assessee and even advances towards collections must also be treated as trading receipts,

a deposit, although it is a kind of receipt of money, cannot be regarded as a trading receipt. Some accountants may show a deposit in suspense

account. But the assessee here showed it as a debit in the deposit account and gave credit to the particular exhibitor concerned, who made the

deposit. This entry in the accounts showed that the assessee was a debtor to the film exhibitor concerned. In other words, it was a liability. The

collections obtained from the exhibitor were receipts of the assessee''s trade which the assessee was entitled to receive and to appropriate. A

deposit money, while it was a receipt in connection with the business, could not be dealt with by the assessee as a receipt of its trade, but must be

shown and continued to be shown as its liability because it is ultimately to be refunded to the person who deposited it. In other words, although the

deposit itself comes to be made only because of a business relationship between the assessee and the depositor concerned, the liability itself cannot

be regarded as a trading liability, nor the receipt by the assessee of the deposit as a trading receipt. Being a liability, in this sense, therefore, the

deposits were shown as a liability on the liabilities side of the assessee''s balance sheet. Apparently, if the assessee-company had continued the

same position in the balance sheet in this case, it would have shown this liability as a liability towards ''sundry creditors''. But the assessee decided

to regard those deposits as no longer refundable and, hence, no longer a liability. The assessee could have done one of two things in its accounts. If

the deposits have been separately credited in a separate savings bank account or other bank account specially created for that purpose, the

moment the assessee wished to regard the deposits as no longer repayable, the assessee could have withdrawn the amount and used the same in

some way, as if it were its own fund. If the assessee were a private person, he could have spent the deposits so withdrawn for personal expenses.

But the assessee in this case is a company which could only take out the money represented by the deposit by some method known to it, and

acceptable to its character as an incorporated company. Shortly stated, the only way by which a limited company can take some money or asset

out of its business is to show it as part of its distributable profits and then take it out of the coffers of the company by way of distribution of

dividends to its shareholders.

When the assessee decided not to refund the deposits, but to treat the money as its own, it had choice of two things to do from the point of view

of its balance sheet. It could write down the liability as a liability to creditors and at the same time, it could write down the assets side by some

means. But there was another method which was adopted in this case by the assessee. What the assessee did was to transfer the liability under the

deposit account and convert it as profits of the year. The amount at the credit of the film exhibitors was, thus, debited and a corresponding credit

was given to the profit and loss account. Since profit is always a credit balance in the profit and loss account, the operation by which the assessee

debited the depositor''s account and credited the profit and loss account had the effect of swelling the credit balance to the shareholders. In the

balance sheet, however, this operation would have made little or no difference since what was a liability under the sundry creditors account had the

effect of swelling the credit balance in the profit and loss account and thereby increase that particular item on the liabilities side of the balance sheet.

The result did not in any way make any difference to the overall liabilities of the assessee. What was a liability to the sundry creditors, merely

shifted from that position and became a liability towards the credit balance of the profit and loss account. This method did not entail any alteration

on the assets side. They remain the same.

The ITO regarded these book entry transactions as involving the accrual of a profit to the assessee, which the ITO regarded as a trading profit.

The assessee, however, contended that no profit at all was involved in the process when it decided not sic to the liability for the reason that the

depositors were not traceable or not available. The assessee''s contention in effect was that when it received a money as a deposit, the amount did

not become at any subsequent point of time its trading receipt or income, merely because it determined not to refund the amount, which it was

under an obligation to repay to the depositor. It was not an income at the point of time when it was received as a deposit; neither could it become

income at the point of time when the decision was taken not to refund it. If any receipt was not in its origin a trading receipt but only a repayable

deposit, then it may not, thereafter, become a trading receipt either because the depositor did not want it back or because the assessee was

determined to appropriate or misappropriate it to its own use after searching in vain for the depositor to take it back.

The ITO, however, viewed the fact that the amount of deposit was credited by the assessee to the profit and loss account and on this basis, the

ITO regarded the transfer of Rs. 27,501.69, which represented the unclaimed or unadjusted deposits from the exhibitors of films, as part of the

trading receipts of the assessee. Since the transfer entries were effected in the year ended 31-10-1971, the ITO regarded the amount as part of

the trading profits of the assessee for the assessment year 1972-73.

The assessee appealed against this particular tax treatment of the amount of Rs. 27,501.69. Before the AAC, two versions were rendered on

behalf of the assessee in regard to the nature of the deposits, one was that the deposits were in the nature of an advance to be set off or adjusted

as against the dues by the exhibitors towards payment of collections to the assessee, the other was, that it was strictly to be a security deposit,

which were refundable by the assessee to the exhibitors concerned at the time when the exhibitors handed back the positive prints to the assessee.

It is not clear from the order of the AAC as to which version he accepted as the one which was properly receivable on the facts of the case. He,

however, proceeded to hold that the ITO was not right in assessing as part of the trading receipt the unadjusted deposits. But, he sustained an

addition to the extent of Rs. 103, the reason for which is not quite clear.

The department thereafter filed an appeal before the Tribunal questioning the correctness of the decision of the AAC. On behalf of the

department, it was urged before the Tribunal that the deposits had been received by the assessee, not de hors the assessee''s trade, but only in the

normal course of the assessee''s trade of leasing out films to film exhibitors. In this situation, it was urged, the deposits, when they were

subsequently appropriated by the assessee without being refunded, could only be regarded as part of the trading profits of the assessee,

particularly because the assessee itself had treated them as part of the profits in the profit and loss account.

The Tribunal, however, did not accept these contentions. The Tribunal approached the question by first deciding what precisely was the nature

of the obligation created by the deposits of money by the film exhibitors. According to the Tribunal, the deposits, when received by the assessee,

created a liability on the assessee''s part. This liability, according to the Tribunal, did not cease at any subsequent point of time. Strictly, from the

point of view of the relationship brought about by the deposit, the film exhibitors were creditors and the assessee was a debtor in respect of the

deposits and this was how the books of account of the assessee exhibited the relative positions of these two parties in all the earlier years. This

being so, according to the Tribunal, a trading liability can by no means be converted into an income in the circumstances which happened in the

present case. The fact that the assessee took a decision not to discharge the liability but chose to appropriate the same would not, according to the

Tribunal, have the effect of transforming a liability into a trading receipt. The Tribunal referred to one or two decided cases as broad principles to

support the principle that a liability can in no circumstance assume the character of a trade receipt merely because the liability in some way or other

was repudiated or forgone.

In this reference made by the Tribunal at the instance of the Commissioner, Mr. J. Jayaraman, their learned standing counsel, made two

submissions. In the first place, he urged that the amount of Rs. 27,502, although referred to in the discussion as a deposit, must be regarded in a

sense as an advance made by the film exhibitors towards their obligation to make over a part of their theatre collections to the assessee. If the

deposits were in substance merely advances towards payment of collections, then, according to the learned counsel, it could hardly be urged that

these deposits could be regarded as liabilities. The learned counsel submitted that if the collections received by the assessee from the film exhibitors

have got to be regarded as trading receipts of the assessee''s trade in a business of film distribution, then it stands to reason that any money

received by the assessee by way of advance towards collections must also be treated as bearing the same character, viz., trading receipts.

As earlier pointed out, the record does not make it quite clear whether the monies deposited by the film distributors with the assessee were

deposits pure and simple or whether they also partook the character of advances. It is, however, unnecessary to go into this factual issue, because

the amount which is in question in the present reference, viz., Rs. 27,502, only represents the net amount remaining to the credit of the film

exhibitors after all the adjustments had been made against them. With reference to this amount, therefore, it cannot be suggested by the department

that it bears any character other than that of a deposit. If they were merely advances in the final reckoning of accounts, these advances would

necessarily have been already adjusted. The fact that those balances still remain with the assessee shows that to the extent of the balance, at least,

they still retain the character as refundable deposits. If so much is granted, then the argument addressed by the department''s learned counsel that

the amount must be regarded as being on a par with a mere advance towards collection must fall to the ground. There is a world of difference

between an advance towards a trading receipt and a mere refundable deposit. Both are, no doubt, receipts, but in one case the advance is merely

a pre-payment of the obligation to hand over the collections, in the other case, the money paid into the hands of the assessee is to be kept separate

and dealt with only in accordance with any subsequent agreement between the parties.

Mr. Jayaraman then submitted that even as a deposit, the receipt of deposit must be held to be in the course of the assessee''s business of

distribution of films. We agree that the deposits were not obtained by the assessee in any activity other than the assessee''s trade as a film

distributor. But, the question is not whether the transaction, as such, is in the course of trade or not. The question rather is, whether the deposit

constitutes a trading receipt of the business taxable as a trading receipt. It is in this context that the deposit has a significant difference from a mere

advance towards collections payable by the film exhibitors to the assessee.

We have earlier referred to the approach of the Tribunal to the question on hand, viz., from the point of view of the deposit being regarded as

creating a liability in the assessee to wards the film exhibitors. It seems to us that the more appropriate method of dealing with the tax treatment of

the unadjusted deposits is to view them from the receipt side. The deposits, as much as any other payments in, must be regarded as receipt of the

assessee. That is why, in the assessee''s accounts, credit will have to be given and in fact has been given to the various film distributors, who had

made the deposits. There can be no doubt at all that at the time when the deposits were made, they were receipts of money by the assessee. But

the deposits differ from the other receipts from, the film distributors, viz., theatre collections, in this sense, namely, whereas the deposit, at the time

it was received, was not to be regarded as part and parcel of the trading receipts, the other monies received from the film exhibitors bore the

character of trading receipts whether they were actual collections or advances towards future collections. It is in this sense that when a receipt did

not bear the character of a trading receipt, it cannot subsequently become a trading receipt. This is a much better way of solving the problem than

by saying that a trading liability cannot become part of the trading receipts of the assessee. As the Tribunal, itself had pointed out, appropriate

provision has been made in the income tax Act, 1961 (''the Act'') for situations in which what has been allowed as a trading liability in the

assessment of the assessee of an earlier year can yet be connected with a subsequent trading receipt either by a receipt of some benefit or by a

remission or cessation of the liability in the subsequent year. It may be remarked that much of the discussion before the Tribunal as well as before

the AAC was taken up with the task of finding out whether section 41(1) of the Act can be fitted in with the facts of the case. This was plainly an

unnecessary enquiry, because it was common ground that at no point of time in the earlier assessments, did the assessee claim and obtain any

deductions in respect of these deposits treating them as trading liabilities. A reference to section 41(1) clearly shows that it is intended to apply only

in cases where an allowance or deduction had already been made in a former assessment towards any trading liability or expenditure actually

incurred by the assessee. Apparently, the entire discussion having been started on its course on the basis of section 41(1), the Tribunal pursued the

discussion by the observation that the amount which once figured as a liability in the assessee''s books cannot thereafter get itself converted into a

trading receipt. The Tribunal itself had referred to some cases, chief of which was MORLEY (INSPECTOR OF TAXES) Vs. TATTERSALL., .

It is, however, unnecessary for us to refer to this case or the other authorities, which the learned standing counsel for the department referred to

before us. in the view we take that the deposits did not shed their character as deposits, despite the fact that the assessee regarded itself as no

longer bound by an obligation to refund the deposits. It may be that the approach made by the Tribunal from the liability side of the question is only

the other side of the coin to the approach made by us from the receipt side of the question. In any case, we entirely agree with the conclusion of

the Tribunal that the amount of Rs. 27,502 cannot be brought to tax as chargeable receipts from trade.

Before leaving the case, one other point needs to be clarified. In the course of assessment, the ITO, as already stated, had analysed the nature

of the deposit while making the assessment. He observed that the exhibitors paid into the hands of the assessee those deposits at the time of

distribution of films. Having said so, the ITO followed up the finding by observing that the receipts of money by way of deposit in the hands of the

assessee cannot be regarded as a receipt against a capital asset. It would appear that on the basis of this remark he proceeded to hold the

transactions to be on the revenue side since those were in the ordinary course of the assessee''s business. The flaw in the ITO''s reasoning is that if

the receipt cannot be regarded as a receipt against capital, it cannot, by a mere process of elimination, be regarded as part of the chargeable

trading receipt. Another error involved in the ITO''s logic is that since the money in question was received by the assessee not by way of parting

with a capital asset, automatically the money in its hands must be regarded as chargeable trading receipts. The ITO overlooked that there may be

receipts and receipts of different kinds in the course of the assessee''s carrying on of its trade. Some receipts may be of a capital character. Some

receipts may be trading receipts to be brought into the reckoning as part of the trading profits, but, there may yet be certain other receipts, which

may be neither capital receipts nor trading receipts, but cannot nevertheless be brought to tax even though they happened to get into the hands of

the assessee in the course of trade. The security deposits in the present case must, in our opinion, be given the status of this peculiar kind of

receipts.

The question for our answer in this reference had been formulated by the Tribunal thus:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in deleting the sum of Rs. 27,399, representing the balance of

security deposits, which have been received by the assessee during the course of its business from its exhibitors and adjusted by the assessee in its

accounts as its income for the assessment year 1972-73 7

Having regard to the discussion in the foregoing paragraphs, our formal answer to the question is in the affirmative and against the department, The

assessee will have its costs from the department. Counsel''s fee Rs. 500. One set