1960-VIL-54-ALH-DT

Equivalent Citation: [1961] 42 ITR 446 (Allahabad)

HIGH COURT OF ALLAHABAD

IT MISC. NO. 386 OF 1952

Dated: 23.09.1960

GAPPUMAL KANHIYALAL

COMMISSIONER OF INCOME-TAX

Bench

B. UPADHYA AND R. N. GURTU, JJ.

JUDGMENT

Gurtu,

The following question has been referred to us under section 66(1) of the Indian Income-tax Act :

"Whether on the facts and circumstances of this case, the Tribunal was justified in disallowing the expenditure of Rs 9,076 spent by the assessee in a period preceding the accounting year but written off in the account books in the accounting year relevant for the assessment year ?"

The question arises, according to the statement of the case submitted to us, in the following way. It appears that the assessee had advanced a certain sum of money on the basis of a mortgage deed which he put into suit on July 16, 1932, and in which he obtained a decree from the subordinate judge's court. Upon appeal, the appeal was allowed and the suit was dismissed on the ground that the transferors had no right to transfer the property. At that time the amount of Rs 24,794 stood to the debit of the account of the mortgagor debtor.

This was made up as follows :

Principal amount	Rs 14,500-0-0
Expenses	Rs 2,995-4-0
Interest as determined and allowed by the court	Rs 7,298-12-0
Total	Rs 24,794-0-0

In the accounting year 1938-39, relevant for the assessment year 1940-41, this amount of Rs 24,794 was written off as a bad debt and the claim of bad debt was admitted by the Department. Thus at the end of the said accounting year the mortgagor debtor's account was closed down. The assessee appealed to the Privy Council and expenses totalling Rs 9,098 were incurred in prosecuting the Privy Council appeal between 1939 and 1943 and these amounts were debited to the accounts of the said mortgagor debtor. When the appeal in the Privy Council failed, this amount of Rs 9,098 was credited to the account of the said debtor and written off in the revenue account. The assessee claimed to deduct this amount as expenditure in the accounting year ending on May 17, 1945, relevant to the assessment year 1946-47, the year under our consideration. It was found by the taxing authorities that the assessee spent only an amount of Rs 21-6-0 on May 17, 1945, during the accounting year under assessment and the rest of the expenses were spent in the preceding years and its claim was disallowed. The assessee claims that this sum of Rs 9,098 was a business expense of his money-lending business in the year in question according to his system of accounts and as such was admissible as a business deduction under section 10(2)(xv) of the Act in the accounting year. Hence this reference.

It seems to be admitted, or at least impliedly admitted, in the Tribunal's judgment and in the statement of the case, that the assessee in his money-lending business kept a mixed method of accounting and that whereas he credited the interest account only upon the receipt of interest, where a suit was instituted the entire accrued interest was creidted with a corresponding debit to the debtor's account, and that with respect to litigation expenses in general the practice was to debit litigation expenses to the debtor's account and to write off so much of those expenses which remained irrecoverable only at the time when the litigation came to a finality. The Tribunal, however, held that whatever might be the system of accounting adopted by the assessee he could claim an allowance in respect of expenditure only in the accounting year in which it was incurred. The assessee contended before the Appellate Tribunal, and contends here, that he should be allowed all the expenditure incurred in the previous years in the accounting year in question. He says that by virtue of section 13 of the Income-tax Act the system of accounting as adopted by him entitles him to such deduction in the year in question. The contention is that even previously in regard to the litigation expenses of this very suit he was allowed to claim the expenditure incurred in the previous year in which the High Court dismissed his suit even though the expenses had been incurred earlier.

On the other hand, it was contended before us that according to the assessee's system of accounts no debt remained outstanding after the entries made in the accounting year 1938-39 when the entire principal amount, expenses and interest were written off and that therefore the expenses now sought to be deducted could not be said to be expenses incurred for the protection of the debt created by the mortgage deed and that the expenses were not connected with any business of the assessee. It is further contended that expenses could only have been allowed in the year in which they were incurred.

It is true that the entire amount pertaining to this mortgage debt and including the expenses incurred up to that date was treated as a business loss in the year 1938-39 and written off and that in one view of the matter there was no further interest to protect under the mortgage deed. On the other hand, the fact remains that the matter had been taken to the Privy Council and in case of reversal of the decree of the High Court the mortgage amount together with interest could be recovered and also at least such part of the costs which would have been allowed for all stages of the litigation.

No doubt strictly speaking expenses cannot be deducted only as expenditure. But the view that the assessee seems to have taken is that for the purposes of accounting it was best to go on debiting the mortgagor debtor with not only accrued and accruing interest but also with expenses incurred in the litigation and to adjust against the amounts so debited such sums as were later recovered as a result of the decrees passed. The advantage to the assessee of this method of accounting was that at any point of time he could know how much money he had spent in respect of the particular litigation and so the method of debiting the expenses to the mortgage account was adopted. There can be no doubt that no fault was found earlier with this system of accounting by the revenue and that in a sense expenditure of earlier years was allowed to be deducted in the assessment year 1939-40 when the loss was allowed to be written off, for the loss included an amount debited in respect of prior years as expenditure incurred. The essence of the matter therefore is that the assessee in the hope that some part of the expenditure incurred by him from year to year in connection with the litigation would be recovered from the mortgagor, entered the expenditure as a debit against the mortgagor and when hope of recovery was lost wrote it off as a bad debt. His books treated the matter of expenditure as if it was a question of a debt due by the mortgagor. In essence, however, it was merely putting off the claiming of deduction on account of expenditure incurred and postponing his right to claim a deduction to a future date when the position would become clearer. The assessee says this is the system and it has already been accepted previously and there is no reason why it should not be accepted now.

The answer given to the contention of the assessee is that expenses could only be claimed in the accounting year when they were incurred. Several cases were cited to us. It was contended that deductions can be permitted in respect of only those expenses (and losses) which are incurred in the relevant accounting year. Reliance for this proposition was and may be placed upon the cases of Commissioner of Income-tax v. Basant Rai Takhat Singh [1933] 1 ITR 197, Mackenzie v. Arnold [1952] 33 Tax Cas. 363, In re Chouthmal Golapchand [1938] 6 ITR 733 , Commissioner of Income-tax v. Mathuradas Mannalal [1942] 10 ITR 95, and Mulchand Hiralal v. Commissioner of Income-tax [1938] 6 ITR 151 . In Commissioner of Income-tax v. Chitnavis [1932] 2 Comp. Cas. 464 Lord Russell said as follows :

"You may not, when setting out to ascertain the profits and gains of one year, deduct a loss which had in fact been incurred before the commencement of that year. If you did, you would not arrive at the true profits and gains of the year. For the purpose of computing yearly profits and gains, each year is a separate self-contained period of time, in regard to which profits earned or losses sustained before its commencement are irrelevant." (p 470)

Therefore the general proposition is true that expenses must be claimed as incurred in the relevant accounting year. But the question still remains as to whether in view of the hybrid system of accounting maintained by this assessee he could claim to deduct expenditure incurred in previous years in the assessment year in question.

Now income-tax has to be paid by an assessee under section 10(1) of the Income-tax Act in respect of the profits and gains of business, profession or vocation. Express provision is not made under that section for deduction of expenditure, but commercial profits and gains cannot be worked out without deduction being made in respect of expenditure incurred. Section 10(2) also specifies and makes provision for certain statutory deductions and these deductions have also to be made in computing the profits of a business. When we come to section 13 of the Income-tax Act we find that income, profits and gains have to be computed for the purposes of section 10(1) in accordance with the method of accounting regularly employed by the assessee. There is a proviso to that section which says 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 deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax Officer may determine. It seems therefore to follow that if profits are to be computed in accordance with the method of accounting regularly employed by the assessee, then it is to the method of accounting that one must look. And if the method of accounting regularly employed is a method whereby litigation expenditure is, so to say, kept in a suspense account and is brought into the accounts only for the purpose of being claimed as expenditure when the fate of the litigation is clear and nothing can be recovered out of the sum expended then it ought not to matter whether the expenditure which has been kept in the suspense account was actually incurred in earlier years. If according to the regularly employed method of accounting the expenditure is treated as having been incurred in the accounting year, then it should matter little whether the expenditure was actually incurred in years earlier. Of course this does not mean that an assessee would be entitled to the benefits of his accounting system if that were brought into existence for the particular purpose of backing his claim only in the particular year. But if a method of accounting is regularly employed, then the assessee ought to get the advantage and suffer the disadvantage of that system of accounting, provided the accounting system is regularly maintained, and even though it may happen that in a particular year the revenue may gain but in another year the assessee may gain.

The decision given in Commissioner of Income-tax v. Maharajadhi-raja of Darbhanga [1933] 1 ITR 94, was relied upon. In that case a hybrid system of book-keeping had been employed. The assessee, the Maharajadhiraja of Darbhanga, entered into money-lending transactions and kept a deposit register in which payments made by the debtors were recorded but without any allocation between principal and interest. Subsequently, if and when allocation was made, an entry in respect of the interest portion of such payments was made in the interest ledger as well as in the interest account of the general ledger. This allocation was made, not necessarily in the year in which the money was actually received by the assessee, but sometimes in the following year and sometimes several years later. In the relevant assessment year the Income-tax Officer took first the amount which was allocated to interest and credited in the interest register in the previous year and which had not borne tax; he next examined the deposit register and in the case of sums there shown as received in the previous year but from which no allocation had been shown in the interest account, he himself calculated the proportion of each receipt which represented interest and added the result to the figure obtained from the interest register. The Privy Council upheld the assessment.

They observed:

"Their Lordships see nothing contrary to principle in the computation of an assessee's total income for a particular year as consisting in part of actual receipts in that year and in part of sums carried by the assessee to income account in that year out of the receipts of previous years which have been held in suspense and no part of which has been previously returned as income."

Having regard to the Privy Council case what can be done in the case of income should also be allowed to be done in the case of expenditure, provided of course that the method of accounting adopted by the assessee adopts a regular method as evidenced by his account books.

It would seem that the cases to which reference was made before us and to some of which we have referred were not cases where the point was directly raised as to what would be the position having regard to section 13 of the Income-tax Act if a hybrid system of accounting was maintained by the assessee, and expenditure, so to say, was held in suspense, by this method of debiting it to the debtor's account and then crediting it.

In National Petroleum Co. v. Commissioner of Income-tax [1945] 13 ITR 336, no doubt the court observed that they were not really concerned with the method according to which the assessee keeps his books of account or what view he took of the particular payment in the case. It is however difficult to ignore the effect of section 13 of the Income-tax Act.

It would therefore appear that the assessee would be entitled to deduct the expenses in question, even though they were expenses of previous years, because for the purposes of calculation of income-tax they could be considered to be expenses incurred in the accounting year on the basis of the regularly employed method of the assessee's accounting on the basis of which income, profits and gains are required to be computed under section 13 of the Income-tax Act. The answer to the question raised must therefore be in the negative.