Commissioner of Income Tax vs Dhakeshwar Prasad Narain Singh of Amawan

Macpherson, J.—The assessee, besides being a leading landholder, conducts a money-lending business upon which he has been assessed to Income Tax (as a Hindu undivided family). He made an application on 28th November 1931, requiring the Commissioner of Income Tax to refer to the High Court the question of law:

Whether it is open to the Income Tax Officer to regard interest unrealised as taxable income,

alleged to arise out of the appellate decision u/s 31, Income Tax Act, 1922, of the Assistant Commissioner, dated 7th November 1931, and the Commissioner has made the present reference of 13th October 1933 (not within sixty days but after nearly two years) purporting to be u/s 66(2) of the Act formulating the question for opinion as:

Whether in the circumstances of this case, the assessee is liable to be taxed on his income from money-lending on the mixed cash and accrued basis which has been followed in his assessments of previous years?

(partly perhaps because their Lordships of the Judicial Committee deprecate the statement of a question of law in an abstract form and divorced from the facts of the particular case and partly for other reasons which will later appear), and expressing his own opinion that the answer is in the affirmative. As is well known, Section 66(2) is indifferently framed: see also Shiva Prasad Gupta v. Commissioner of Income Tax 1929 All 819. The Commissioner''s statement of the case (which is to be read with the decisions of the Income Tax Officer and of the Assistant Commissioner which are his Annexures A and B) also is obscure. A rather full exposition of the position is thus required as to ascertain what "the circumstances of the case" are. In the years previous to the year of assessment, which is 1931-32, the assessee submitted with his return of income two statements in support or explanation which are designated A and B. Statement A purported to show the interest which had accrued during the year on loans to borrowers from whom no realisation had been made during the year and against whom no suit had been filed; and statement B purported to show the realisations from those borrowers from whom full or part realisation had been made during the year. From the aggregate realisation shown in statement B the assessee deducted so much as had been shown as accrued interest in statement A furnished in previous years and so had then been taxed, and the aggregate of the balance so arrived at, and of the accrued interest shown in the statement A for the year was the sum which he showed in his return as his profit for the year liable to Income Tax. The profit so shown was accepted as a correct computation u/s 13 after scrutiny of his books of account and other documents the alternations being usually unimportant (except apparently in respect of 1930.31 where the interest accruing during the year on a debt then under suit, was, as will appear later, also, assessed).

The method of accounting employed by the assessee during some fifteen years for computation of his profit is thus a combination of the cash (actual realization) basis and the accrual (otherwise called the mercantile or commercial) basis, or as it is expressed in the question propounded, the "mixed cash and, accrued basis."

For the year 1931-32, however, the assessee filed only statement B and made the claim that he should be assessed on the cash basis only, the same deduction being made as in previous years, (that is to say, of interest realized in the year under assessment on which tax had in previous years been realized on the accrual basis as being included in the statement A of those years). The income from interest which he showed was Rs. 222-15-9 as against over Rs. 11,000 shown in 1930-31 (apart from rupees 15,669-8-0 mentioned below) and over Rs. 30,000, shown in 1929-30. The Income Tax Officer thereupon took action u/s 23(2) and Section 22(4) and the assessee caused to be produced the evidence and documents on which he relied in support of his return, and upon an examination of the assessee''s accounts which admittedly exhibited no change of system from previous years, and his documents, the Income Tax Officer calculated therefrom "the assessable income" (or profits, as defined in "Spanish Prospecting Company") of the year by taking, the state of the business at the end of 1336-F (1929-30) and at the end of 1337-F (1930-31) and comparing the assets of the business at the two dates. Finding from Ex. A the total investment up to the end of 1337-F., he deducted therefrom the aggregate of the total investment up to the end of 1336-F., and of the new loans advanced in 1337-F., and held as follows:

In the, income return the assessee showed only Rs. 222-15-9 as income from interest on the basis of actual realization (cash basis), whereas the previous records show that the assessee''s method of accountancy has all along been mercantile (accrued basis). The assessee''s own accounts show that he calculates accrued interest in all cases in accordance with the stipulation in the bond and goes on raising the principal from year to year by the addition of accrued interest in the Lahna Bahi. So his method of accountancy is clearly mercantile, which has been rightly followed in the past and there is no justification to change the method of accountancy in the current year."

There is thus a definite finding that the assessee follows the mercantile system of accounting and the last sentence is reminiscent of Foster v. Commissioner of Income Tax (1929) 3 ITC 435. The assessee''s petition of appeal has been printed, but the order in appeal is only intelligible in the light of a further petition filed on the day before judgment was delivered. It is there pointed out that the argument on his behalf was that he did not keep his accounts on the commercial basis, his cash books showing only his cash receipts, and alternatively that if he was assessed on the accrued basis, he was at least entitled to deduction of Rs. 15,885-14-0 of which Rupees 15,669-8-0 was accrued interest of 1929-30 taxed in 1930-31 in the account of Ramprasad Singh while under suit in the civil Court. The decision in appeal sets out, first, that it was admitted that the computation of profits if it was to be made on the accrued basis, was correct, subject to the deduction of the said sum of Rs. 15,669-8-0 on which tax had actually been deducted in the previous year, and subject to another deduction which is here immaterial. It then goes on to say that the assessee next claimed that he ought not to be assessed on the accrual basis at all. On this plea the Assistant Commissioner sets out that the assessee''s money-lending accounts consist of the personal accounts of his debtors wherein entry is made of the accrued interest from year to year and of the amount actually realized in each case, but neither the accrued nor the realized interests are totalled or accounted for in an interest account and no profit and loss is computed, and though there is a cash book in which the actual realizations are shown, there is no interest ledger, and he then states his conclusion thus:

Clearly therefore the assessee has not computed his profits at all, and no particular method of accounting can be said to be regularly employed by him. The Income Tax Officer had therefore to make the computation of profit upon such basis and in such manner as the Income Tax Officer may determine and he decided to adopt the accrued basis which was also followed in previous years without objection on the part of the assessee.

The Assistant Commissioner then negatived the contention on behalf of the assessee that the proviso to Section 13 of the Act did not entitle the Income Tax officer to compute the profits on the accrual basis, the basis of which contention was that the accrued interest not actually received is not "income, profits, or gains" within the meaning of the Income Tax Act. What he failed to observe was that the Income Tax Officer had not proceeded under the proviso. In the result he maintained the computation of income and held it as assessable subject to the deductions mentioned.

It was in consequence of the rejection of the contention mentioned that the application was, as already stated, made u/s 66(2), to refer the question whether the Income Tax Officer was entitled to regard interest unrealised as taxable income. The argument on behalf of the assessee was that as the assessee does not, as the Assistant Commissioner found, employ any regular method of accountancy that can be accepted by the department (and the accrual basis is such a method) for computing the profits of his money-lending for purposes of Income Tax (this is a paraphrase of "no, particular method of accounting can be said to be regularly employed by him"), the substantive portion of Section 13 which is:

Income, profits and gains shall be computed, for the purposes of Sections 10, 11 and 12 in accordance with the method of accounting regularly employed by the assessee

does not apply and so the proviso to that section which is:

Provided that, if no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income Tax Officer, the income, profits and gains cannot properly be deducted therefrom, then the computation shall be made upon such basis and in such manner as the Income Tax Officer may determine,

must apply if anything does, and the assessee''s profits cannot, under the terms of the proviso itself, be computed on the accrual basis.

The point is now stated as being that even though in an assessment under the substantive portion of Section 13 the accrued basis may be adopted where the assessee has himself treated the accrued interest as income of the year under assessment, still as accrued interest is only notional income, the computation under the proviso to Section 13 must be of actual and not of notional income. In short the Income Tax Officer, it is contended, took the accrued (and unrealised) interest to be income, profits and gains of the year, whereas, it is contended, it is not so in law unless the assessee has so treated it in his accounts.

The Commissioner of Income Tax (as it happened, the same officer who was the Assistant Commissioner, had become the Commissioner) being of opinion that the question of law, as formulated by the assessee, did not cover all the facts of the case, substituted the question quoted above and referred it for decision purporting to do so u/s 6.6(2).

Actually the question referred may be expanded as follows:

Whether in the circumstances of the case the assessee is liable to Income Tax for 1931-32 on profits and gains from money lending of 1930-31 on the aggregate of (a) the amount of Interest accrued in 1930-31 when no interest has been realised: and (b) the amount of interest realised in 1930-31 less the amount thereof previously assessed to Income Tax.

The above statement of the facts expands what the Commissioner of Income Tax has said by the application of his annexures A and B and the other papers.

In the statement of the case he then goes on to affirm that as a matter of fact the assessee has been assessed neither on strictly cash basis nor on accrual basis." Computation of income in the year under assessment had, he points out, been made on the same lines as had been adopted at the instance of the assessee himself in previous years: for certain reasons (which are set out but which are irrelevant) he had in 1931-32 claimed assessment of the cash basis under deduction of interest included in the cash realisation of the year where that interest had already been taxed on the accrual basis in the previous years. The Commissioner had in fact come to realise the inapplicability of some of the observations in the appellate judgment in which the computation of profit by the Income Tax Officer had been affirmed on a ground different from that on which it had been made. What he means appears to be that whatever the theory applied, in fact computation had been on the same lines as in previous years, as is indicated above, to wit on the method of accounting (not a pure mercantile or a pure cash method of accounting but a mixture of these methods) which the assessee himself regularly employed, and not under the proviso to Section 13: such are "the circumstances of the case," and the observations, obiter or even erroneous in the course of the appellate decision do not, it is implied alter the fact that the assessment is under the substantive part of Section 13.

Then comes para. 6 in which, apart from the affirmation above-mentioned, he gives his own opinion on the case in which the High Court is consulted. It is that in fact the computation of the assessee''s profits and gains has, as always hitherto, been made under the substantive portion of Section 13, that is, in accordance with the method of accounting regularly employed by him. He bases this opinion on the following: the assessee had shown no ground for discarding his previous method of accounting; no doubt the appellate finding that no regular (particular) system of accounting has been followed by the assessee, is right in the sense that the assessee''s books do not furnish a basis for an inference that either of the two well-known methods is followed, but it is not necessary that the method of accounting regularly followed be purely cash or purely mercantile, that is to say, it may be a mixture of the two systems and in fact the system which the assessee has actually adopted for computation of profits, (to wit, the mixed system shown in the returns A and B is a method of accountancy within the meaning of Section 13, and it is on that method that the computation of profit was made in previous years and in the year in controversy. His point is that in spite of observations in the appellate decision the computation has actually been made under the substantive part of Section 13. Finally he argues that even if (contrary to his view on the facts as stated by him) it is the proviso that is applicable to the case, the assessment is nevertheless valid as being made on a basis and in a manner such as the Income Tax Officer is authorised to determine, which, it is implied, may be the accrual basis (with necessary modification); there is apparently no question that in the circumstances of this assessee, as disclosed by himself and his accountant, the profit of the year may safely be computed, as it has always been by himself, as equal to the full interest (less remission shown which has accrued within the year.)

Thus the assessee''s contention is that the legitimacy of the principles of computation applied by the assessee is a question of law and that the accrued interest debt duo to him cannot be taxed as profits unless he treats it as such, while the case for the Commissioner is that what has been held liable to Income Tax is not the unrealised accrued interest but the profit of the business computed on the assessee''s own method of computation, though it happens to be of the same amount (subject to the assessee''s remissions and the deductions mentioned) as the accrued interest. But the case stated implies that the assessee has treated the accrued interest as received by him (so that in the eye of the law it is a receipt) and subject to deductions which are not in controversy) as profits of his business during the year. It would thus appear that the assessee''s point is not here in controversy since in spite of the requisition of the assessee u/s 66(2), the reference of the Commissioner cannot be said to include it; the reference definitely states the case as one in which a method of accounting, though perhaps not a normal one, has been regularly employed by the assessee himself from which moreover the profit of the business can properly be and has been deduced, and in such circumstances the proviso to Section 13 does not come in at all. The function of the High Court is to decide not the question set out in the application u/s 66(2), but questions of law raised by the case stated, of which the question whether under the proviso to Section 13 the computation of profit can legally be on the basis of the accrued interest (with or without modification) is here not one.

Manifestly what happened is this. On considering the assessee''s application u/s 66(2), the Commissioner found himself, as already indicated, in disagreement with his order as Assistant Commissioner where he had held in error of fact that the Income Tax Officer had applied the proviso to Section 13; two courses must have seemed open, either to review that order u/s 33 or to refer the larger question so that there might be tested the validity of the assessment whether under the substantive part of Section 13 or under the proviso thereto; if however he passed an order u/s 33 substituting reasons of his own for those of the Assistant Commissioner there was, until the first proviso to Section 66(2), was inserted by Act 18 of 1933, no provision for a reference u/s 66(2), against his order; (though that proviso came into operation on 11th September, the correction slip did not arrive until after the requisition had been considered); and thus the reference made on 13th October 1933, though nominally u/s 66(2), is actually one which would more appropriately be made u/s 66(1), since though the case stated accepts the order u/s 31 in so far as that order dismissed the appeal it rejects the grounds on which that order is made, and accepts the basis on which the Income Tax Officer computed the profit assessable (with modification in detail bringing it within the previous mixed cash and accrual basis): in fact the case stated is that the resultant computation of profit for the purpose of Section 10 is made on the method of accounting regularly employed by the assessee which though no doubt a mixed system, is one from which his profits can properly be and have been deduced.

I am accordingly constrained to the view that on the statement of the case referred for opinion it must be held that the computation of profit for assessment to Income Tax has, as it stands, been genuinely made under the substantive part of Section 13, that is to say, on the method of accounting regularly employed by the assessee, and that accordingly no point of law arises thereon for decision u/s 66(5). A reference back to the Commissioner u/s 66(4) has not been suggested and it would probably not be helpful at this stage. I shall deal briefly with two incidental contentions for the assessee. The first of these is that "in the circumstances of the case" the assessee in fact employs no method of accounting within the meaning of Section 13 so that a computation of profit thereon is not possible. But though it may be unscientific, a method of accounting is certainly, regularly employed by him, which, moreover, he has himself utilised for over fifteen years to ascertain from it the sums on which he was in his own view liable to Income Tax as profit of his business. The second contention is that the mere fact that hitherto the assessee has permitted himself to be assessed on sums, to wit, unrealised interest, which are really debts due to him and not profits of his business, does not involve a continuance of the method of accounting under which that was done, with a consequent continuance of unwarranted taxation. That would be so, but it is not the position here. What has to be ascertained is the ''profits and gains'' of his business as a whole--how much it has improved in the year and that is exactly what has been done.

The assessee has indicated that in his view the accrued interest is a good asset at its face value and the computation of improvement has here been made on his own method of accounting in which he takes his unrealised interest as profit of the business. I agree with the view of Agarwala, J., in this regard and particularly that the decision in St. Lucia Usines & Estates Co., Ltd. v. Colonial Treasurer of St. Lucia (1924) AC 508, and the argument founded thereon are by no means favourable to the assessee in the circumstances of this case. It is not necessary to express an opinion on the argument of Mr. Manohar Lal as to the proviso to Section 13 though it is attractive. His first claim, which, as indicated, is that it does not apply, is good on the case stated, but as a last line of defence he was prepared to maintain that if the substantive part of Section 13 is held inapplicable, and there is no method of accounting regularly employed by the assessee on which computation can be made or from which profits and gains can properly be deduced, the assessing authority is nevertheless entitled to utilise as the best rough and ready way available, the method of accounting employed, even though ex hypothesi, the "profits and gains cannot properly be deduced therefrom." The reference in the form in which it has been made, I would answer in the affirmative. It is not implied that a reference is not possible on future materials in which the question originally submitted by the assessee might not properly arise for decision u/s 66(5). As the reference has not been made in a satisfactory manner, with resultant trouble to all concerned, I would direct the parties to bear their own costs.