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1991 Supreme(Online)(Ker) 40
KERALA HIGH COURT
A, J
CIT v. Kerala State Drugs And Pharmaceuticals Ltd.
Income Tax Reference Case No.1234/1986
For the Appellants/Petitioners: Mr. X
For the Respondents: Mr. Y
Only real income, not hypothetical claims, is taxable under the mercantile accounting system.
Headnote:(A) Income Tax Act - Sections 4 and 5 - Mercantile system of accounting - Accrued income - Claim for excess receivable amount not constituting income as it was only a tentative amount, not finalized by the Government - Mere claims not recognized as income - Appeal dismissed. (Paras 4, 12, 18)
(B) The Court concluded that the claim made by the assessee for an excess amount was properly excluded from taxable income, as it did not represent a real income accrued but merely a hypothetical claim subject to government approval.
Facts of the case:
The respondent, a public sector undertaking, engaged in manufacturing pharmaceuticals, sought exclusion of an unaccepted claim of Rs.4,186,349 from the profit and loss account, which the Government had declined.
Findings of Court:
The Tribunal affirmed the Commissioner of Income Tax’s decision deeming the claim not to constitute accrued income, aligning with principles of the mercantile accounting system.
Issues: Whether the amount claimed by the assessee constitutes real income under the mercantile system of accounting.
Ratio Decidendi: The court reaffirmed that merely making a claim does not constitute accrued income unless it can be realized, echoing established principles concerning real income and accounting methods.
Result: The question referred was answered in favour of the assessee and against the Revenue.
| Table of Content |
|---|
| 1. nature of claims in relation to income. (Para 1 , 2 , 4) |
| 2. mercantile system's impact on taxation. (Para 6 , 17) |
| 3. exclusion of unrecognized receipts from taxable income. (Para 8 , 12 , 18) |
1 At the instance of the Revenue the following question has been referred to this Court for decision:
"Whether, on the facts and in the circumstances of the case and considering the mercantile system of accounting followed by the assessee and also considering the reopening of accounts is impermissible under Indian Law, the Tribunal is right in holding
i) the amount credited as the price of medicine supplied to Government does not represent accrued income or income received?
ii) entries made in accounts represent only mere claims?
2. Respondent assessee is a public sector undertaking of the Government of Kerala and the subsidiary of the Kerala State industrial Enterprises Ltd. It is engaged in the manufacture and sale of pharmaceutical products. We are concerned with the assessment year 1978-79 for which the corresponding previous year ended on 31-3-1978.
3. The entire productions of the assessee are supplied to the Health Services Department of Kerala Government. The Government had been sanctioning ad hoc advances to be adjusted later against the supplies. Some difficulties arose in following this practice and the Director of Health Services pointed out to the Government that adjustment of advances could not be made because the prices of the items have to be fixed by the Government of India. Further advance could not be made to the assessee company and that created a grave financial situation for the assessee. The Director of Health Services therefore suggested" to the Government that the advances already paid may be adjusted on the basis of the tentative price approved by the firm and further advances may be sanctioned so as to enable them to continue further production. An indemnity bond was executed by the Chairman of the company to the effect that if the price structure fixed by the Government is lower than the rate fixed by the firm, the excess payment will be adjusted against future supplies. If the price fixed was lower, claims could be preferred for the balance amount. This proposal was agreed to by the Government.
4. During the accounting year under consideration the assessee preferred a claim for Rs.4186349/- as excess amount receivable over and above the price tentatively agreed for the products supplied. The claim was not accepted by the Government and the Joint Secretary of the Industries Department turned down the claim. The amount had been shown in the Profit & Loss Account as amount receivable and the original return has been filed by the assessee on this basis. In the course of proceedings under S.144B the company filed a revised return claiming exclusion of this amount from the total receipts. By that time the Government had already turned down the assessee's claim. The
Income Tax Officer was not willing to accept the assessee's claim for exclusion. According to him the assessee was following the mercantile system of accounting and credit once taken cannot be excluded on a reconsideration of finalised accounts. On appeal the Commissioner of Income Tax (Appeals) held that the claim was unilateral and a mere claim cannot have the characteristics of income. According to him the amount claimed had not become the income of the assessee at any point of time and he therefore held that this amount should be deleted. On further appeal before the Income Tax Appellate Tribunal, that appellate authority came to the conclusion that the price of the products supplied was fixed only tentatively and was subject to ultimate fixation by the Government of India. The Tribunal observed that the price initially charged did not represent the correct price of the product supplied and a mere claim made cannot be equated with the incurring of liability or a receipt. Relying on the decision of the Supreme Court in M/s. Shoorji
