Income Tax Appellate Tribunal - Madras
Income-Tax Officer vs Servall Engg. Works (P.) Ltd. on 29 August, 1990
Equivalent citations: [1990]35ITD482(MAD)
ORDER
S. Kannan, Accountant Member
1. This departmental appeal is directed against the order dated 30-9-1986 of the CIT (Appeals), Coimbatore, relating to the assessment year 1983-84.
2. The assessee-company is engaged in the business of supplying, erecting and commissioning paper mills on turn-key basis. During the year of account relevant to the assessment year 1983-84 now before us, the assessee supplied paper manufacturing machinery, inter alia, to the following three clients under three different contracts all of which contained guarantee clauses:
(i) Shree Warana SSK Ltd. (Warana for short);
(ii) Shree Dutta SSSK Ltd. (Dutta for short); and
(iii) M/s Konark Paper and Industries Ltd. (Konark for short).
In the course of the assessment proceedings, the ITO found that the assessee had made a provision of Rs. 6,86,172 towards, what according to the assessee, was the guarantee fund relating to the three contracts. The said sum was calculated at the rate of 5% on the total value (including taxes etc.) of the contracts as detailed below :
Name of the Contract price 5% of contract price.
buyer
Warana Rs. 53,66,720 Rs. 2,68,336
Dutta Rs. 53,66,720 Rs. 2,68,336
Konark Rs. 29,90,000 Rs. 1,49,500
_____________
Rs. 6,86,172
_____________
The sum was straightaway deducted from sales turnover and shown as a liability in the balance sheet. The assessee's case before the ITO was that the guarantee-fund retained by the buyers did not accrue to it and hence the sum in question was rightly deducted from the aggregate contract price and shown as a liability.
3. On an examination of the contracts in question, the ITO found that in the Dutta contract there was no provision enabling the buyer to withhold 5% of the contract value towards guarantee fund, as alleged by the assessee. All that the contract stipulated was that the last instalment of 5% would be released "against Seller's Bank Guarantee for performance". And the last instalment was in fact released on the assessee's providing a bank guarantee as stipulated in the contract.
The Konark contract also did not contain any provision enabling the buyer to retain any guarantee fund. And the entire contract price was in fact received by the assessee.
As respects the Warana contract, the ITO could not come to any conclusion, one way or the other, because the relevant contract was not made available to him by the assessee.
4. In view of the foregoing, therefore, the ITO held that, the assessee having received the entire sale proceeds and nothing having been retained by the buyers towards guarantee fund, the sum of Rs. 6,86,172 could not be regarded as a provision. At best it was a contingent liability and hence the assessee was not entitled to a revenue deduction in respect of the said sum. He, therefore, added back the said sum of Rs. 6,86,172 to the income returned by the assessee.
5. The assessee's case before the CIT(A) was as follows :
(i) Under the guarantee clause of the contracts, the assessee was liable to give guarantee, the liability extending over the stipulated guarantee period.
(ii) The money value of the quarantee was quantified at the reasonable rate of 5% of the contract price.
(iii) Bank guarantee was also given for this purpose.
(iv) Money was thus blocked with the bank, instead of with the buyers. This meant that income to the extent of Rs. 6,86,172 did not accrue to the assessee during the relevant year of account. It accrued only on the expiry of the guarantee period. And since the said period expired during the subsequent year(s) of account, the accrual of income to the extent of the said sum of Rs. 6,86,172 took place only in the subsequent year(s) of account.
(v) Also, there was a legally enforceable liability against the assessee to the extent of Rs. 6,86,172.
(vi) The assessee was therefore justified in reducing the aggregate contract price by Rs. 6,86,172 and in exhibiting the said sum as a liability in the balance sheet In this regard reliance was placed on the Bombay case of CIT v. Nadiad Electric Supply Co. Ltd. [1971] 80 ITR 650.
6. The CIT(A) approached the matter from two angles, namely, (0 the concept of real income and (if) the existence of a legally enforceable claim.
7. According to him, the substantive clauses of the contracts would show that "the appellant had only a contingent right to demand payment to the extent of 5% of the contract value and in the circumstances, no debt can be said to have accrued and consequently no amount may be credited in the books of the assessee, even in mercantile system of accounting". Again, "therendering of services under the above contracts does not bring into existence a right to enforce payment from the three customers to the extent of 5% of the contract value, unless otherwise the conditions spelt out in the warrantee clause are satisfied. Since this warrantee clause contains two crucial periods, income in real terms to the extent of 5% of the contract value could be said to accrue or arise only after the expiry of such periods and only after proper performance of the contracts by the assessee. The presence or absence of entries in the account looks is not conclusive to prove accrual of income especially in those cases where income accrues under contract or agreement for specific services to be rendered". In other words, no real income accrued to the assessee.
8. In this regard he referred to and relied upon the following reported cases :
CIT v. Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC), Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC), Vishnu Agencies (P.) Ltd. v. CIT [1963] 48 ITR 444 (Bom.), CIT v. Naskarpara Jute Mills Co. Ltd. [1983] 141 ITR 384 (Cal.), E.D. Sassoon & Co. Ltd. v. CIT [1954] 26 ITR 27 (SC) and Tribunal's decisionin in Shrimpel 13 ITD 148.
9. The other line taken by the CIT(A) was that there existed during the relevant year of account a liability which could be legally enforced against the assessee. According to him, "the very fact that the appellant had executed a bank guarantee clearly indicates that there was a substantial liability to the extent of 5% of the contract value completely enforceable at law by the parties". The CIT(A) sought support in this regard from Section 126 of the Contract Act, which deals with "Contract of guarantee".
10. In view of the foregoing, therefore, the CIT(A) held that the assessee was entitled to succeed in principle. However, of the three buyers, only Warana and Datta enforced the bank guarantee clause of the contracts; the third buyer Konark did not. "Since no bank guarantee was executed in favour of Konark Paper & Industries Ltd., the entire income had accrued (to the assessee) on this particular contract in the relevant assessment year". The CIT(A), therefore, confirmed the addition to the extent of Rs. 1,49,500 and deleted the balance of Rs. 5,36,672.
11. It is in these circumstances that the department is now before us. [To make the picture complete, we may add that admittedly the assessee has not filed any appeal against the impugned order of the CIT(A)].
12. Shri Tilakchand, the learned departmental representative, took us through the facts and circumstances of the case and vehemently contended that the CIT(A) was not justified in deleting the sum of Rs. 5,36,672. He drew our attention to the fact that the sale of the machinery was complete and that during the relevant year of account no claim towards performance guarantee was made by the two buyers in question. According to Shri Tilakchand, the assessee would become liable to pay the guaranteed amount only if the machinery in question did not function properly or there were any defects in them. This would clearly show that the liability is one that is uncertain, that is to say, one that may or may not arise. The liability is, therefore, a contingent liability.
13. Shri Tilkchand then contended that 5% of the value of the contract was not withheld by the buyers. The contracted amount was fully paid. The assessee gave a bank guarantee only and it is a matter of record that no claim was made during the relevant year of account by the buyers in respect of the said guarantee.
14. Continuing his argument, Shri Tilakchand contended that none of the cases referred to or relied upon by the CIT(A) is relevant As a matter of fact, the Supreme Court decision in the case of Morvi Industries Ltd. (supra) supports the department's case. In the case before us, not only the right to the income had accrued, but also the income was received in full by the assessee. In the circumstances, therefore, contended by Shri Tilakchand, the Supreme Court decision in the case of Punjab Distilling Industries Ltd. v. CIT [1959] 35 ITR 519 is squarely applicable to the case before us.
15. In view of the foregoing, therefore, contended Shri Tilakchand, the department is entitled to succeed.
16. On his part, Shri Vijayaraghavan, the learned counsel for the assessee, strongly supported the impugned order of the CIT(A) on this issue. His arguments may be summarised as follows:
(i) Unless there is a right to receive it, income cannot be said to have accrued or arisen. In the case before us, the assessee was contractually bound to guarantee the performance of the machinery. Therefore, the right to receive 5% of the contract value arose only after the guarantee period was over. Thus, the case before us is not one of postponement of the receipt of income that had accrued earlier it is one where the accrual of income itself was postponed. In this regard, he referred to and relied upon the following cases :
(i) Supreme Court decision in the case of CIT v. Hindustan Mousing & Land Development Trust Ltd. [1986] 161 ITR 524/27 Taxman 458, and
(ii) Special Bench decision of the Pune Bench of the Tribunal in, Shri Someshwar Sahakari Sakhar Karkhana Ltd. v. ITO [1985] 11 ITD 335.
(ii) The quantification of the guarantee amount at 5% of the total value of the contract is reasonable.
(iii) The assessee's liability under the guarantee clause of the contracts was a legally enforceable liability and hence the provision made in respect of the guarantee money is revenue deductible. In this connection, he referred to and relied upon the following reported cases:
(i) Supreme Court decision in Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1; and
(ii) Special Bench decision of the Pune Bench of the Tribunal in Shri Someshwar Sahakari Sakhar Karkhana Ltd.'s case (supra).
(iv) The provision of a bank guarantee is no different from the retention of the stipulated sum by the buyers. In cases where bank guarantees are given, money is blocked with the bank, just as money is blocked with the buyers if the contracts allow them to retain the stipulated amount. The contract money thus retained is not income see Patna High Court decision in CIT v. ChanchaniBros. (Contractors) (P.) Ltd. [1986] 161 ITR 418 and the Calcutta High Court decision in CIT v. Simplex Concrete Piles (India) (P.) Ltd. [1989] 179 ITR 8/45 Taxman 370. The same ratio is equally applicable to bank guarantee also.
(v) In any event, the assessee is entitled to its claim Under Section 37(1) of the IT Act. In this regard, he relied on the following decisions:
(i) Decision of the Delhi Bench 'E' of the Tribunal in Qantas Airways Ltd. v. ITO; and
(ii) Decision of the Pune Bench of the Tribunal in ITO v. Wanson (India) Ltd. [1985] 5 ITD 102.
17. In reply, Shri Tilakchand vehemently contended that this is a case of contingent liability and hence the assessee is not entitled to revenue deduction in respect of the provision made. The cases referred to and relied upon by the assessee's counsel cannot avail the assessee, because they turned on different sets of facts.
18. We have looked into the facts of the case. We have considered the rival submissions. We may at the outset notice certain facts that are material for the resolution of the issues before us.
19. In this case, we are concerned with two contracts the Warana contract dated July 17,1981 and the Dutta contract dated August 7, 1981. Clause 7 of the Warana contract, which deals with the guarantee which the assessee had undertaken to provide, reads as follows :
7. Guarantee :
(a) All the machinery and equipment will conform to the specifications, material and workmanship given in the Appendix 'A'. Any fabricated/manufactured equipment found defective during the period of one year from the date of commissioning 18 months from the date of despatch, shall be replaced or repaired by the Sellers free of charge, should such defect be due to either faulty design, workmanship or use of defective materials.
(b) The total production of paper will be minimum of 20 tons per day of saleable 50 gsm., of cream wove variety.
The Dutta contract also contains a guarantee clause which reads as follows :
7. Guarantee :
A. All the machinery and equipment will conform to the specifications, material and workmanship given in the offer. Any fabricated/manufactured equipment found defective during the period of one year from the date of commissioning/18 months from the date of despatch shall be replaced or repaired by the Sellers free of charge should such defect be due to either faulty design, workmanship or use of defective material.
B. The total production of paper will be minimum of 20 Tons per day of 50 gsm.
20. Then we have the clause relating to the terms of payment. Clause 4 of the Warana contract reads as follows :
4. Terms of payment:
The Purchasers shall pay the aforesaid contract price of the Paper Machine in the following manner:
(a) 40% of the contract price as per Clause 3 when signing the agreement but on the Seller's furnishing bank guarantee for the advance amount.
(b) 55% against documents covering despatch of machineries against letter of Credit for pro rata payments against part deliveries, the Letter of Credit to be opened by the purchasers within 30 days from the date of signing the agreement.
(c) 5% against Seller's Bank Guarantee for performance.
Similar provisions are contained in Clause 4 of the Dutta contract which reads as follows:
4. Terms of payment:
The Purchasers shall pay the aforesaid Contract Price of the Paper Machine in the following manner:
(a) 40% when signing the agreement but on the Seller's furnishing bank guarantee for the advance amount as in Clause 3 above.
(b) 55% aga nst documents covering despatch of machineries against Irrevocable Letter of Credit for pro rata payments against part deliveries, the Letter of Credit to be opened by the Purchasers within 30 days from the date of signing the Agreement.
(c) 5% against Seller's Bank guarantee for performance.
21. It would be seen from the above that the final instalment of the purchase consideration was payable on the assessee's giving a bank guarantee for the stipulated amount. And it is common ground not only that the assessee did give a bank guarantee, but also that, on the furnishing by the assessee of such a guarantee, the respective buyers released the final instalment of the purchase price.
22. This brings us on to the bank guarantee furnished by the assessee. In respect of both the contracts, the bank guarantee was given by Indian Overseas Bank and the terms of the guarantee are couched in identical terms. After reciting the factum of the assessee's having given the buyers a guarantee for performance on the terms and conditions contained in the relevant clause of the contract, the Letter of Guarantee goes on to detail the bank's liability in this regard in the following terms:
1. We, Indian Overseas Bank guarantee that the Machinery and equipment (to be) supplied by the Supplier shall conform to the specifications, material and workmanship given in the appendix A of the Agreement and any fabricated/manufactured equipments found defective during the period of one year from the date of commissioning/18 months from the date of supply, whichever is earlier, shall be replaced or repaired by the Company at free of charge, should such defect be due to either faulty design, workmanship or use of defective materials.
2. Further the Bank Guarantees to the Karkhana that if the Supplier fails to carry out the above mentioned obligations within a reasonable time from the date of receipt of notice for rectification/repair/replacement it undertakes to indemnify and keep the Karkhana indemnified and pay on first demand, without demur to the extent of the proportionate value of the particular defective material or part.
3. For the determination of guarantee period of 18 months the count starts from the date of delivery of the last equipment or 12 months from the date of commissioning, whichever is earlier.
4. Notwithstanding anything contained hereinbefore our total liability under this Guarantee is restricted to Rs. 2,68,336 (Rupees two lakhs, sixty eight thousand three hundred and thirty six only) and it shall remain in force until twenty fourth day of July, one thousand nine hundred and eighty four or 12 months from the date of commissioning, whichever is earlier. Unless the suit or action to enforce a claim under this Guarantee is filed against us on or before twenty fourth day of July, one thousand nine hundred and eighty four, all your rights under the said guarantee shall be forfeited and we shall be deemed relieved and discharged from all liabilities thereunder. (Emphasis supplied)
23. A combined reading of (i) the clauses relating to the guarantee to be provided by the assessee, (ii) the clauses relating to the terms of payment and (Hi) the stipulations contained in the Letters of Guarantee bring into sharp focus the following :
(i) The guarantee given by the assessee to the buyers under the relevant contracts relates to (a) specifications, material and workmanship, (b) manufacturing defects found in the machinery and (c) the minimum out-turn of the machinery.
(ii) The guarantee is for a stipulated period, after the expiry of which the guarantee clauses ceased to be operative.
(iii) The release by the buyers of the final instalment of the contract price of the machinery was conditional upon the assessee's providing a bank guarantee as stipulated in the contracts. Admittedly, the assessee furnished sucha guarantee and the buyers released the final instalment.
(iv) The terms and conditions of the Letters of Guarantee given by the Indian Overseas Bank are in consonance with those contained in the relevant clauses of the contract. Thus, the Letters of Guarantee combines themselves to the defects minimum performance during the stipulated period only. Beyond the stipulated period, however, the bank guarantee will not be operative.
(v) The question of the bank's honouring the letter of guarantee is conditional on the assessee's failing refusing to honour the stipulations contained in the guarantee clauses of the contracts.
(vi) Even here, the bank's liability will be limited to the proportionate value of the particular defective material or part'.
24. One more material fact needs to be noticed and that relates to the manner in which the assessee has exhibited in its books of account the sale consideration received from the two buyers. The assessee did not credit to the Profit and Loss A/c the aggregate sale consideration in full it deducted from the aggregate sale consideration the guarantee money calculated at the rate of 5% of the contract price and credited the remainder to the Profit and Loss Account. The guarantee money was exhibited in the balance sheet under the head 'Liabilities'.
25. It is in these circumstances that the issue, namely, whether the assessee was justified in not crediting the guarantee money to the Profit & Loss Account, has had its genesis.
26. The admitted position is that in respect of the two contracts under consideration the assessee had furnished necessary bank guarantee and it received the final instalment of the contract price. In other words, the assessee had received, in full, the contract price attributable to both the contracts. Even so, the assessee contends that the sum of Rs. 5,36,672 (being the guarantee money attributable to the two contracts in question) is not exigible to tax in the assessment for the assessment year 1983-84, which is before us.
27. As we see it, the cardinal fact of this case is that the assessee had received in full the contracted price for the machineries supplied by it to the two parties. Now, under the scheme of the IT Act, 1961, the ambit of taxation varies with the factor of residence in the previous year. In respect of residents and the assessee is a resident - the charge is on
(i) Income received or deemed to be received in India in the year of account, the date or place of its accrual being immaterial [Section5(1)(a)];
(ii) Income which accrues or arises or is deemed to accrue or arise in India during the accounting year, the date or place of its receipt being immaterial [Section 5(1 )(b)], and
(iii) Income which accrues or arises outside India during the accounting year, even if it is not received in or brought into India [Section 5(1)(c)].
28. Secondly, it is well settled that whenever the right to receive money in the course of trading transactions accrues or arises or the money is realised, the profit or the income embedded in the receipt also arises or accrues or is received - See Raja Mohan Raja Bahadur v. CIT [1967] 66 ITR 378 (SC). For a fact, even when the sale consideration is received not in money but in money's worth, that is to say, even in cases of exchange the above principle applies. It may here be highlighted that, in the said case, the Supreme Court quoted with approval the following observations of Lord Trayner in Californian Copper Syndicate v. Harris :
A profit is realised when the seller gets the price he has bargained for. No doubt here the price took the form of fully paid shares in another company, but, if there can be no realised profit, except when that is paid in cash, the shares were realisable and could have been turned into cash, if the appellants had been pleased to do so. I cannot think that income-tax is due or not according to the manner in which the person making the profit pleases to deal with it.
29. In the case before us, the assessee had received the sale consideration in full. Hence the profit embedded in the sale consideration was simultaneously realised or received by the assessee. With the result, Section 5(1)(a) of the Act will get activated to bring to charge on receipt basis, the entire profit arising out of the two transactions. In other words, there is no warrant for leaving out of reckoning the sum of Rs. 5,36,672.
30. Yet, Shri Vijayaraghavan vehemently contends to the contrary and, in this regard, invites us to accept the following propositions:
(i) The assessee is contractually obligated to give guarantee to the buyers on the terms and conditions contained in the contract. The value of the guarantee was also quantified on a reasonable basis. The contractual liability of the assessee in this regard was given shape and substance in the form of the bank guarantee given to the buyers. And since the guarantee was to be in operation during the stipulated period, till the stipulated period was over, the assessee was fastened with a liability to pay the guarantee money and hence the sum in question was rightly exhibited in the balance-sheet as a liability. Consequently, this is a case where the assessee has rightly created a provision in this regard and consequently, the sum is revenue deductible. :
(ii) Having regard to the legal consequences of the guarantee clauses and the bank -guarantee provided by the assessee to the buyers it must be held that the right to receive the guarantee money arose only after the stipulated period came to a close. In other words, this is a case where the accrual of income itself was postponed to a later date and hence the sum in question is not exigible to tax. The right to receive the said sum crystallised only in the subsequent year (s) account and hence the sum in question could be taxed only in the subsequent assessment year (s).
(iii) The buyers could easily have retained the guarantee money till the expiry of the guarantee period. In that event also, the right to receive the guarantee money would have been postponed to a later date. In the case before us, instead of the buyers retaining the guarantee money the sum in question was blocked with the bank through the instrumentality of bank guarantees. It should, therefore, follow that the sum in question" is not exigible to tax in the assessment for the assessment year 1983-84.
(iv) In any event, the assessee is entitled to a revenue deduction in respect of the sum in question under Section 37(1) of the IT Act, 1961.
31. We may now deal with the aforesaid propositions of the assessee's counsel.
32. The first proposition is, essentially, that the assessee has created a provision in respect of the guarantee money and the amount provided for is, therefore revenue deductible.
33. The expression "provision" has not been defined in the Act. However, in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, the Supreme Court had occasion to consider, inter alia, the connotations and denotations of the term 'provision'. As demonstrated by the Supreme Court, provision is a retention of a sum for the purposes of providing for depreciation, renewals or diminution in the value of assets, or for providing for any known liability, of which the amount cannot be determined with substantial accuracy. Unlike a reserve, which is a stand-by created out of profits of the business to meet contingencies which are unknown and which cannot be foretold on the basis of knowledge of current facts, a provision is a charge against profit and it is created to meet liabilities which are known and enforceable. To be entitled to be called a provision, it is enough that the liability in question is known and enforceable; it is not necessary that the liability must be capable of being quantified at the time when a provision therefor is made.
34. Central to the concept of a known, present, enforceable liability is the concept of debt owed'. The expression 'debt owed' came up for consideration by the Supreme Court in the case of Kesoramln dustries & Cotton Mills Ltd. v. CWT [1966] 59 ITR 767. While examining the matter, the Supreme Court quoted with approval the following:
(i)...a debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation, debitum in praesenti, solvendum in future" (per Lindley L.J. in Webb v. Stenton).
(ii) "But the distinction must be borne in mind between the case where there is an existing debt, payment whereof is deferred and a case where both the debt and its payment rest in the future. In the former case there is an attachable debt; in the latter case there is not. If, for instance, a sum of money is payable on the happening of a contingency, there is no deot owing or accruing. But the mere fact that the amount is not ascertained does not show that there is no debt".
(iii) "Standing alone, the word 'debt' is as applicable to a sum of money which has been promised at a future day as to a sum now due and payable. If we wish to distinguish between the two, we say of the former that it is a debt owing and of the latter that it is a debt due. In other words, debts are of two kinds solvendum in praesenti and solvendum in futuro ... A sum of money which is certainly and in all events payable is a debt, without regard to the fact whether it be payable now or at a future time. A sum payable upon a contingency, however, is not a debt, or does not become a debt, until the contingency has happened" (per Supreme Court of California in People v. Arguello).
35. The Supreme Court summarised the legal position as follows :
To summarize : A debt is a present obligation to pay an ascertainable sum of money, whether the amount is payable in praesenti or in futuro : debitum in praesenti, solvendum in futuro. But a sum payable upon a contingency does not become a debt until the said contingency has happened. A liability to pay income-tax is a present liability though it becomes payable after it is quantified in accordance with ascertainable data. There is a perfected debt at any rate on the last day of the accounting year and not a contingent liability. The rate is always easily ascertain- able. If the Finance Act is passed, it is the rate fixed by that Act; if the Finance Bill pending before Parliament or the rate in force in the preceding year, whichever is more favourable to the assessee. All the ingredients of a "debt" are present. It is a present liability of an ascertainable amount.
36. Again, in the recent case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 the Supreme Court, on a review of the reported cases on the subject, observed (at page 598 of the Report) as follows:
...Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which was deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure. (See in this connection, the observations of this court in Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66. A distinction is often made between an actual liability in praesenti and a liability de futuro, which for the time being is only contingent. The former is deductible but not the latter.
37. The question that arises for consideration in this case is whether the guarantee money can be properly be regarded as a debt in praesenti, solvendum in futuro. The answer is : No. It is but a contingent liability.
38. The assessee has no doubt given certain guarantees to the buyers on the terms and conditions contained in the contract. The assessee has also given a bank guarantee in that regard. But, a debt properly so called does not arise out of these circumstances. The arising or accrual of the guarantee-related debt depends upon many contingencies. Thus, the defects mentioned in the guarantee clause may or may not arise within the guarantee period. Should they arise, the assessee may, on its own, proceed to make good the deficiency, without calling upon the bank to step into the picture. Again, it may not. In the latter event, the bank will come into the picture. Even here, the amount that the bank will pay the buyers under the Letter of Guarantee will depend upon the nature of the defects. This is because, as already pointed out, the bank's liability under the Letter of Guarantee is limited to "proportionate value of the particular defective material or part". There is also the contingency that having regard to the nature of the defect the buyer may choose not to enforce the bank guarantee.
39. The foregoing analysis will show the liability in question is nothing but a contingent liability and hence the sum provided for in that regard is not revenue deductible.
40. The matter can be looked up from another angle also. Bank guarantee is nothing but a contract for guarantee and the provisions of Section 126 of the Contract Act, therefore, apply to such a guarantee. And it will be ex facie clear from the provisions of the Section that the performance of the promise by the surety is contingent upon the default on the part of principal debtor. In other words, eve a in law, the liability arising out of a contract of guarantee is a contingent liability.
41. It may here be mentioned, in parenthesis, that having stated the correct legal position to the effect that a contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default, the CIT(A) missed the significant point that the liability is contingent on the third person's committing a default. Instead, he focussed his attention on the term "liability" and went on to observe : "The very fact that the bank guarantee has been executed by the appellant shows that there was an existing liability to the extent of 5% of the contract value or to put it in other words, income to the extent of 5% of the contract value had not accrued in real terms to the appellant at least in the case of two contracts of Warana and Detta where specific guarantees had been executed." Here again, he was in error on two counts. First, he failed to see that there are liabilities & liabilities and that only those liabilities relating to 'debt owed' are revenue deductible and not what are merely contingent liabilities.
42. Secondly, he got his lines crossed when he held that the existence of a liability meant that real income had not accrued to the assessee. As will be demonstrated presently, "provision" and "real income" operate in different fields.
43. In view of the foregoing, therefore, we reject the first proposition canvassed by Shri Vijayaraghavan.
44. Shri Vijayaraghavan's second proposition is that, by reason of the contractual obligation to provide guarantee to the buyers, the assessee's right to receive the guarantee money is postponed till after the expiry of the guarantee period. Implicit in this proposition is that what is exigible to tax is the real income of the assessee and that the guarantee money is not the real income of the assessee.
45. A preliminary remark or two may be made. Shri Vijayaraghavan's first proposition, namely, that the provision relating to the guarantee sum is revenue deductible can be understood only on the basis that the entire income had accrued to the assessee and was also received by the assessee and yet there was the subsisting enforceable liability in respect of which a revenue deductible provision was made. His second proposition, interestingly, proceeds on the diametrically opposite basis that income had not accrued at all. As already pointed out, in the case before us the contract price and therefore the income or profit embedded in it was received in full by the assessee in the relevant year of account itself; and is taxable on receipt basis. It should, therefore, follow that, on first principles, the second proposition, based as it is on the concept of accrual, is to be rejected.
46. On authority also, the concept of real income is not applicable to the case before us. In the case of State Bank of Travancore v. CIT [1986] 158 ITR 102, the Supreme Court had occasion to examine the concept of real income and held that the concept of real income must be applied with extreme caution and that it should not be extended to areas in which it has no application. After noticing various cases [including some of those relied upon by the CIT(A) and the learned counsel for the assessee] in which the concept of real income was discussed, the Supreme Court observed : "It may be reiterated that in some limited fields where something which, in the reality of the situation, prevents the accrual of the income, then the notion of real income, i.e., making income accrued in the real sense of the term, can be brought to play, but the notion of real income...cannot be brought into play where the income has accrued....The Supreme Court observed that the concept of real income cannot be so used as to make accrued income non-income on the mere ipse dixit of the assessee. The Supreme Court further held that where the Act applies, the concept of real income should not be so read as to defeat the provisions of the Act
47. It will be clear from the foregoing that the concept of real income is applicable only in the context of accrual of income In the case before us, the assessee had received in full the contract price together with the income embedded therein during the relevant accounting year itself. Since under Section 5(1)(a) of the Act, an item of income becomes exigible to tax the moment it is received, it is not necessary to go into the question of accrual.
48. In view of the foregoing, we reject the second proposition..
49. The third proposition is, basically, that if regard be had to the substance of the transactions, it would be seen that the guarantee money in questioa is not exigible to tax in the assessment for the assessment year 1983-84. We are unable to agree. As far back as in 1940, in Bank of Chettinad Ltd. v. CIT [1940] 8 ITR 522 (PC). Sir Lancelot Sanderson observed:
Their Lordships think it necessary once more to protest against the suggestion that in revenue cases "the substance of the matter" may be regarded as distinguished from the strict legal position. In Inland Revenue Commissioners v. Duke of Westminster (1936 AC 1) disapproval of this doctrine was expressed in the opinions of Lord Tomlin and Lord Russell of Killowen. A passage from the opinion of Lord Russell of Killowen at page 24 may usefully be cited. It is as follows : "I confess that I view with disfavour the doctrine that in taxation cases the subject is to be taxed if in accordance with a Court's view of what it considers the substance of the transaction, the Court thinks that the case falls within the contemplation or spirit of the statute. The subject is not taxable by inference or by analogy, but only by the plain words of a statute applicable to the facts and circumstances of his case.
50. In the case of CIT v. B.M. Kharwar [1969] 72 ITR 603, the Supreme Court of India had occasion to deal with the suggestion that in revenue cases 'the substance of the matter' must be considered. The Supreme Court quoted with approval the following observations of Lord Russell of Killowen in Duke of Westminster v. IRC [1935] 19 TC 490 (HL).
...I view with disfavour the doctrine that in taxation cases the subject is to be taxed if, in accordance with a court's view of what it considers the substance of the transaction, the court thinks that the case falls within the contemplation of the spirit of the statute... If... the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine.
The Supreme Court held that the taxing authorities are not entitled in determining whether a receipt is liable to be taxed to "ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as "the substance of the matter".
51. In the case before us, there are two sets of transactions each having different legal consequences. The first set comprises the two contracts for supply of machinery entered into by the assessee with the two buyers concerned. Under these contracts, the assessee had received the contract price in full in the relevant year of account itself. These contracts never contemplated the buyers' retaining a part of the contract price so as to create a guarantee fund. All that these contracts stipulated was that the final instalment of the contract price would be released on the assessee's furnishing a bank guarantee. And it is a matter of record that, on furnishing such a guarantee, the assessee received the last instalment of the contract price.
52. The second set comprises the Letters of Guarantee issued by the Indian Overseas bank. The legal effect of the Letters of Guarantee is that, in the event of the assessee's failing to honour the terms and conditions of the guarantee clauses during the guarantee period, the bank will make the necessary payments to the buyers. And, as pointed out earlier, even here, the bank's liability is restricted to "proportionate value of the particular defective material or part". May be the assessee had blocked certain funds with the bank in connection with the guarantee given by the bank. Even so, the money blocked with the bank cannot be deemed to be guarantee fund retained by the buyers.
53. There is yet another reason why the third proposition of Shri Vijayaraghavan must fail. In cases where one of the parties to the contract is authorized by the terms and conditions of the contract to retain a part of the money payable by it to the other party to the contract and to release it after the expiry of a stipulated period, what happens is that, by reason of such retention, the right to receive the income embedded in the guarantee fund retained is postponed. For a fact, in cases such as Janatha Contract Co. v. CIT [1976] 105 ITR 627 (Ker.), Chanchani Bros. Construction (P.) Ltd.'s case (supra) and Simplex Concrete Piles India (P.) Ltd.'s case (supra) it has been held that where there is a stipulation postponing the time for payment of the whole or part of the balance until after the expiration of the stipulated period, the payment of the money retained would not have become due to the contractor. Since the payment of the money retained by one of the parties to the contract does not become due till after the stipulated period, the accrual of the income or profit embedded therein is also consequently postponed. It was in this view of the matter that it had been held in those cases that till is paid the retained money would not enter into the computation of the contractor's taxable income.
54. The money blocked by the assessee with the bank in connection with the guarantee given by the bank stands on a different footing altogether. What is blocked with the bank is mere cash; and not trading receipts in which income is embedded. It should, therefore, follow that the money or cash blocked with the bank cannot be equated to the guarantee fund retained in the cases referred to supra.
55. We, therefore, reject this proposition also.
56. The final proposition of Shri Vijayaraghavan is that, in any event, the assessee is entitled to a revenue deduction in respect of the guarantee money Under Section 37( 1) of the IT Act, 1961. We fail to see the rationale behind this argument. In cases where a claim for revenue deduction is made on the basis of a provision made as respects a legally enforceable (and not a mere contingent) liability, the matter is always examined in the context of Section 37(1) and even Section 28 of the Act. We have held that the provision in respect of the sum of Rs. 5,36,672 relates to a contingent liability and is hence not revenue deductible. If the sum is not revenue deductible, it cannot be allowed either Under Section 37(1) or even Under Section 28 of the Act. Hence, we reject the fourth proposition also.
57. In view of the foregoing, therefore, we hold that the CIT(Appeals) was not justified in allowing the assessee's claim for revenue deduction in respect of the sum of Rs. 5,36,672. We, therefore, set aside the order of the CIT(A) on this issue and restore that of the assessing officer.
58. In the result, the departmental appeal is allowed.