Judgment

GROVER, J.:- This is an appeal by special leave from the judgment of the Calcutta High Court in an Income-tax Reference.

2. The assessee who is the appellant is a public limited company doing the business of jute and manufacturing of jute goods. The method of accounting followed by the assessee is the mercantile system. During the assessment year 1955-56 (the previous year ended on 31st December, 1954), the assessee claimed a deduction of Rs,1,49,776/- on account of sales tax determined to be payable by the sales tax authorities on the sales made by the assessee during the aforesaid previous year. The sequence of dates may be mentioned. The income tax return was filed on 13th January,1956. The demand notice was served by the sales tax authorities on the 21st November, 1957. On 9th November, 1959, the assessee filed a revised return claiming the aforesaid deduction. The assessee had taken the order by which the demand for such tax had been created to the higher departmental authorities, as it was contesting its liability to the extent that had been determined. The Income Tax Officer, however, completed the assessment on 11th March, 1960 before any final decision was given in the proceedings relating to the assessment of sales tax. According to the Income Tax Officer, the assessee was not entitled to claim the deduction of the aforesaid amount of sales tax inasmuch as it had denied its liability to pay that amount and had made no provisions in its books with regard to the payment of that amount. The Appellate Assistant Commissioner confirmed the order of the Income-tax Officer. The Appellate Tribunal dismissed the appeal of the assessee. The following question of law was referred by the Tribunal for the opinion of the High Court:-

"Whether on the facts and in the circumstances of the case, amount of Rs. 1,49,776/- which was claimed by the assessee as a deduction on account of sales tax was deductible as a business expense?"

3. The High Court was of the opinion that unpaid and disputed sales tax liability could not form the basis of a claim for deduction for the purposes of income tax. The reasoning of the High Court mainly was that for the purpose of claiming a deduction under S. 10 (2) (xv) of the Income Tax Act, 1922 (hereinafter called the Act), mere legal liability was not enough. There had to be an expenditure in the first place and it must be laid out or expended wholly and exclusively for the purpose of such business. The High Court further held that unpaid and disputed sales tax could not be validly deducted in the computation of business income even under S. 10 (1) of the Act.

4. It has been submitted on behalf of the assessee that sales tax paid or unpaid would be admissible deduction under S. 10 (2) (xv) as well as under S. 10 (1). It is pointed out that if the method of accounting adopted by the assessee is cash system, it would qualify for deduction only in the year in which it has been actually paid. If the method of accounting is mercantile system then the deduction will be permissible in the year to which the liability relates irrespective of the point of time when the liability has actually been discharged. Section 10 (5) provides that in sub-section (2) "paid" means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the section. The argument proceeds that in order, therefore, that sales tax may qualify for deduction under S, 10 (2) (xv), it has to be in the nature of an expenditure which has either been actually paid during the year of accuunt or for the payment of which, the liability has been incurred in the accounting year, according as the method of accounting followed by the assessee is cash system or mercantile system. It is indisputable that the amount of sales tax paid or payable by the assessee is an expenditure within the meaning of S. 10 (2) (xv). The amount in question was thus a kind of expenditure about which ther