Income Tax Appellate Tribunal - Mumbai
Deputy Commissioner Of Income-Tax vs Parikh Petro Chemicals Agencies (P.) ... on 17 August, 2000
Equivalent citations: [2002]81ITD18(MUM)
ORDER
R.V. Easwar, Judicial Member
1. In this appeal by the department, the following grounds have been taken :
(1) On the facts and in the circumstances of the case and in law the learned CIT(A) erred, failed to appreciate the facts that:-
(i) the assessee had been consistently following the accounting system of showing the receipts as also expenses on cash basis in the past years,
(ii) it changed the accounting system during the assessment year under consideration in respect of expenses only and claimed expenses on mercantile basis whereas the receipts were shown on the old basis only,
(iii) on the basis of departure from past practice it claimed expenses of Rs. 12,82,313 for the period from 1-8-1988 to 31-3-1989 on mercantile basis without showing corresponding receipts on mercantile basis for the same period, and thereby erred in not disallowing the claim for said expenses of Rs. 12,82,313 while deleting the addition of Rs. 98,14,543 made by the Assessing Officer towards receipts on mercantile basis.
(2) On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in deleting the disallowance of Rs. 11,410 being subscription and membership fee clubs on behalf of Directors which is their personal liability and not related to the business of the assessee.
2. The brief facts loading up to the filing of the appeal may be noticed. The assessee is a company engaged in the business of providing consultancy services. The assessment year concerned is 1989-90, for which the previous year consisted of a period from 1-8-1987 to 31-3-1989. On 14-2-1979, the assessee had entered into an agreement for providing consultancy services with V/o Sojuzne fleexport (hereinafter called SNE), Moscow. As per the agreement, the assessee is to provide the following services to the SNE:
(a) To effect activities hereunder subject to SNE confirmation and in full conformity with instructions given by SNE.
(b) To submit to SNE regularly systematic and full report on the market situation and trend of sales effected and prices obtained by competitors, terms of payment and all other management information regarding crude oil and petroleum products. The management services as specified herein shall be rendered by Consultant and Agency by visiting Moscow from time to time.
(c) At the request of SNE to settle and deal with all claims and differences arising out of the abovementioned contract.
(d) To organise from time to time meeting between the representatives of SNE and IOC as well as with the representatives of shipowners to review and discuss the deliveries of products and other matters concerning problems related to it.
3. While completing the assessment, the Assessing Officer noticed that the assessee was maintaining accounts on cash basis up to the assessment year 1988-89. For the assessment year 1989-90, which is the year under appeal, the Assessing Officer noticed that the assessee was debiting the expenses on accrual basis but the consultancy charges or commission were shown only on the receipt of credit notes from the bank. According to him, this was not correct and the assessee should have also shown the consultancy charges on the basis of bills submitted, consistent with the mercantile system of accounting which it had chosen to follow for the assessment year under appeal. He noted that the assessee had shown receipt of consultancy charges at Rs. 98,14,344 from SNE in its return for the assessment year 1990-91 on the basis of the advice dated 13-4-1989 of the Hong Kong Shanghai Bank of Bombay. In his opinion, it was clear that this amount belonged to the period 1-8-1987 to 31-3-1989. He, therefore, proposed to increase the income for the year under appeal by the aforesaid amount and invited the assessee's objections.
4. By letter dated 8-2-1991, it was explained by the assessee that the cash system of accounting was given up and the mercantile system was adopted only because of the changes made" in the Companies Act, that the accounting of income was done on the basis of the receipt of the actual amount which was being continued because of the peculiar nature of the consultancy business, in respect of which it is impossible for the assessee to determine the basis on which the income is accrued and also considering the fact that the assessee has to accept the payment made by the Government of Russia, which effects payment only on their satisfaction and after fulfilment of all the obligations under the terms of the agreement. It was, therefore, submitted that it is not correct to say that the commission of Rs. 98,14,543 received in April 1989 accrued prior to 31-3-1989.
5. The assessee filed another letter on 13-2-1991 to which a letter dated 11-2-1991 written by SNE to the assessee-company was enclosed. This letter is as under :
We confirm that payment for the amount of Rs. 94,35,655.95 was made to you during the period 1-8-1987 to 31-3-1989 as under :
19-10-1987 Rs. 77,77,479.22
26-12-1987 Rs. 11,69,321.87
25-12-1987 Rs. 4,88,853.83
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Rs. 94,35,655.95
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No further amount other than paid above was due to you on 31st March, 1989.
We may clarify that no amount becomes due to you unless our agency calculates service charges payable to you and the same is approved by our Finance Department and the Bank for Foreign Economic Affairs of the USSR as per USSR State laws of foreign remittances.
As regards your enquiry regarding payment of Rs. 93,14,344 paid during the month of April 1989 we have to inform you that the said amount has been paid in respect of your consultancy service and in accordance with and as per approval by our Finance Department and appropriate authenticity given during April 1989.
It was pointed out that the commission accrued only when the certificate from the bank was received by the assessee confirming the telegraphic transfer from the Bank of Foreign Trade of USSR by TT No. 301 4ES, dated 11-4-1989 and therefore the amount was rightly offered for tax in the assessment year 1990-91 and not in the assessment year under appeal.
6. On 21-3-1991, the assessee filed another letter dated 20-3-1991 with the Assessing Officer raising the following four contentions :
(1) The income becomes due on fulfilment of conditions as per agreement dated 14-2-1979.
(2) Payment of the service charges shall be effected against presentation of a credit note issued in favour of consultant and agent to the Bank for foreign trade of the USSR Moscow.
(3) The commission is accounted for on accrual basis on the basis of the credit note issued by USSR Government Agency which accidentally coincides with the receipt, which gives the erroneous impression that the commission is accounted on cash basis.
(4) That no amount becomes due to the assessee the Russian Agency calculates service charges payable to the assessee and the same is approved by the Finance Department and by the Bank for Foreign Economic Affairs of the USSR as per USSR State laws of foreign remittances.
7. The Assessing Officer was not convinced by the assessee's explanation. According to him, the assessee changed the system of accounting from cash to mercantile w.e.f. 1-8-1987 and under the mercantile system of accounting, just as all the expenses can be deducted on accrual or as soon as the liability arose, all income is also taxable as soon as the assessee gets the right to receive the same. In his opinion, briefly stated, the assessee has received the commission of Rs. 98,14,543 on 11-4-1989 and this would not have been possible unless the right to receive the said amount had accrued to the assessee in the year ended 31-3-1989. He further held that the assessee cannot have the expenses debited on mercantile basis but the income credited only on receipt basis. He therefore assessed the consultancy services commission of Rs. 98,14,543 in the year under appeal.
8. The assessee appealed to the CIT(A). The CIT(A) examined the terms of the agreement between the assessee and SNE. According to him, Clause (iiv) was important. It stated that the payment for services rendered by the assessee to be made as full compensation for all services to be rendered by the consultant agent (i.e. the assessee) to SNE in connection with the execution or the agreement, SNE agrees to pay to the assessee service charges at the rate of 0.15% of the total FOB value of the petroleum products supplied from USSR to India as per contract entered into in December 1978 and already paid by IOC. The clause further states that in case the amount received by SNE from IOC on which service charges have been paid to the assessee is reduced by payment of any claims of IOC, SNE has the right to reduce the service charges accordingly. Importantly, the clause says that the payment of the service charges shall be effected against presentation of a credit note issued in favour of the assessee to the bank for foreign trade of the USSR, Moscow. After examining the relevant agreements and the various letters written by the assessee to the Assessing Officer, the CIT(A) came to the conclusion that there was no change in the method of accounting of income as such, but because of the amendment to the Companies Act, the accounting of the expenditure is done on accrual basis while the income continues to be accounted for on the same basis as before viz., the accrual basis. In this connection, he relied on a note attached to the balance sheet which clearly stated that the consultancy charges for services rendered accrues to the company only on the presentation of the credit notes from the foreign principals and hence such charges will be accounted on the receipt of the credit note. Relying on this note as well as the terms of the agreement and the correspondence exchanged between the assessee and the Assessing Officer, the CIT(A) came to the conclusion that the commission or consultancy charges accrued to the assessee only on the presentation of the credit notes and such presentation took place on 11-4-1989, which fell in the accounting year relevant to the assessment year 1990-91 and not in the assessment year 1989-90 and therefore the amount of Rs. 98,14,543 cannot be assessed in this year. He accordingly deleted the same.
9. The revenue is in appeal before us. It is pointed out on its behalf that undisputedly the services were rendered by the assessee during the previous year relevant to the assessment year under appeal and therefore the commission had accrued or arisen to the assessee. Once the shipments were made, the assessee became entitled to the commission according to the ld. DR and the presentation of the credit notes is a procedural matter which did not affect the substantial question as to when the income accrued. According to the ld. DR, the credit notes are important only for the purposes of payment and not for deciding the entitlement of the assessee to the commission which has already fallen due once the services had been rendered. The credit notes and their presentation do not determine the time of accrual according to the ld. DR. Our attention was also drawn to paragraph 7 of the Accounting Standards-IX under the heading "rendering of services", wherein it has been opined by the Institute of Chartered Accountants of India that recognition of revenue must be proportionate to the rendering of the services. It is contended that in accordance with the standard, the assessee ought to have taken credit for the consultancy charges. In full since the entire services have been rendered during the relevant accounting year. With reference to the letter dated 11-2-1991 written by SNE to the assessee, which we have extracted earlier, the ld. DR contended that this letter cannot abrogate the terms of agreement of 1979. It was further contended that merely because the commission has been offered in the assessment year 1990-91, it cannot be said that it did not accrue or arise to the assessee in the year under appeal. Strong reliance was placed on the judgment of the Supreme Court in the case of CIT v .British Paints India Ltd. [ 1991] 188 ITR 44 to submit that the accrual of income cannot be postponed by the assessee to suit its purposes.
10. On the other hand, Mr.' Trivedi, the ld. counsel for the assessee pointed out that it is not correct to say that the commission accrued the moment the services were rendered. He submitted that there was a difference between the "earning" of the commission, which takes place once the services are rendered, and the "accrual" of the commission, which depends on various uncertainties and, only when those uncertainties are cleared and the credit note is presented to the assessee that the commission can be stated to have accrued or arisen to the assessee. He pointed out further that the terms of the agreement themselves provided for reduction of the service charges if the IOC reduced the payment to SNE. He submitted that the assessee was not in the practice of issuing debit notes in which case it may perhaps be possible to say that the assessee itself considers the commission to have accrued on the issue of the debit notes. The presentation of the credit notes is the only point of accrual on the facts of the present case and on a proper consideration of the terms of the agreement. It is further pointed out that the assessee has not taken credit for the commission even in the accounts and this is only consistent with its claim that the commission did not accrue in the year of accounting. Mr. Trivedi further pointed out that the taxing of the commission in the assessment year 1990-91 is more beneficial to the revenue because of the change in the rates of tax and therefore there was no motive on the part of the assessee to postpone the point of accrual for obtaining any benefit in terms of tax.
11. In her reply, the ld. DR, reiterated the principle laid down in the Accounting Standards. She also submitted that the uncertainties of the kind contemplated by the agreement were not adequate to prevent the accrual of the commission in favour of the assessee. She further pointed out that the assessee had not even attempted to make an estimate of the probable commission which it would receive. As regards the claim that the commission accrued only on the presentation of the credit notes, she submitted that a very important right such as the right of accrual, cannot depend or be made to be depend on uncertainties such as bureaucratic delays. With reference to the claim of the ld. counsel for the assessee that the assessee did not even take credit for the commission in the accounts consistent with the system of accounting followed by it, the ld. DR submitted that accounting entries were not decisive of the question of accrual.
12. We have carefully considered the rival contentions. The crux of the matter is the determination of the point of time when the consultancy charges can be said to have accrued to the assessee. The departments case is that as soon as the assessee had rendered the services, in accordance with the agreement, the commission had accrued and since the services had been rendered during the relevant accounting year, the commission ought to be taken to have accrued during the said period. There is a difference between the word 'accrual' and the word 'earned'. In E.D. Sassoon & Co. Ltd. v. CIT [1954] 26 ITR 27 (SC), it has been held by the Supreme Court that the "accrual" and the earning of the income are two different concepts. A person may be stated to have "earned" his income in the sense that he has contributed to its production by rendering services and the parenthood of the income can be traced to him. But in order that the income may be said to have accrued to him an additional element is necessary in the sense that he must have created a debt in his favour. The rendering of services or the other activities indulged in should have been effected to bring into existence a right to enforce payment from a third party. "Earning" in the sense of rendering of services or doing something which results in income without his right to enforce payment thereof, will not bring about an accrual or arisal of the income. This difference is important particularly in relation to service contracts, such as we find in the present case since the person rendering the services will not be entitled in law to any remuneration till the entire services are performed, and in some cases, till after a lapse of a further time after the completion of the services. We have before us a case of the later type. It may be true that the assessee-company had rendered services during the relevant previous year to SNE and had thereby 'earned' the remuneration in the form of commission or consultancy charges. But the question whether such income became a enforceable debt against the SNE during the same period is a matter which is quite different and has to be ascertained on a perusal of the terms of the agreement. As pointed out on behalf of the assessee and as per Clause (iv) of the agreement, the assessee is entitled to consultancy charges at the rate of 0.15% of the total FOB value of the petroleum products supplied from USSR to India as per the contract dated 22-12-1978 and already paid for by IOC. The clause further provides that in case the amount received by SNE from IOC on which service charges are payable to the assessee is reduced by payment by SNE on any claims of IOC, SNE has the right to reduce the service charges accordingly. The clause further provides that the payment of the service charges shall be effected against presentation of a credit note issued in favour of the assessee by SNE to the bank for foreign trade of the USSR at Moscow. The information relating to the despatches of the petroleum products to various points in India, the quantities despatched, the price, freight and such other information are all available with the SNE and the assessee-company is not aware of any of these details. The calculation of the service charges are thus dependent upon several factors and therefore it is that it has been provided in the agreement that the payment will be effected only on presentation of the credit note. The assessee, as we have been informed by the ld. counsel, is not in the habit of issuing any debit notes for the commission in view of certain restrictions contained in the Foreign Exchange Regulation Act, 1973. Thus, it is only on the presentation of the credit note that the assessee obtains a right to enforce the payment of the commission and not at any anterior point of time. The CIT(A) has also found that the credit note prepared by SNE must be approved by the Ministry of Finance and Foreign Trade of the Russian Government and the Central Banking authority of that country as per the terms of the contract. Only after these formalities are gone through that the credit note is presented to the Central Banking authority of USSR for making payment to the assessee-company. The letter dated 11-2-1991 written by SNE to the assessee, a copy of which was filed before the Assessing Officer, as enclosure to the assessee's letter dated 13-2-1991 clarifies that no amount becomes due to the assessee unless the Russian agency calculates service charges payable to the assessee and the same is approved by the Finance Department and the Bank for Foreign Economic Affairs of the USSR as per the laws of the USSR. It has further been clarified in the letter that the commission of Rs. 98,14,543 became due and payable only in April 1989 and was accordingly transferred on 11-4-1989. The bank's advice is dated 13-4-1989. Therefore, notwithstanding the fact that the services might have been rendered by the assessee-company during the relevant previous year, the right to obtain payment of the commission accrued or arose to the assessee only on presentation of the credit note which took place only after 31-3-1989.
13. There was some discussion as to whether the assessee had followed the mercantile system of accounting for expenses and cash system for income. This discussion arose because of the allegation of the Assessing Officer in his letter dated 4-2-1991. In response thereto, it was clarified by the assessee by letter dated 8-2-1991 that even in respect of income, the assessee was following only the mercantile method and it was submitted that it is not correct to say that the commission received in April 1989 accrued prior to 31-3-1989. Any doubt in this regard was set at rest by the assessee's letter dated 20-3-1991 which we have extracted in the earlier part of our order.
14. For the above reasons, we hold that the CIT(A) was right in his view that consistent with the method of accounting followed by the assessee, viz., the mercantile system, the commission income of Rs. 98,14,543 accrued to the assessee only on 11-4-1989 and was therefore not taxable in the assessment year under appeal. The order of the CIT(A) is confirmed and the ground is rejected.
15. We may clarify that ground No. 1 relating to this issue has not been properly framed and therefore the following revised ground was filed by petition dated 21-7-2000 :
On the facts and is the circumstances of the case and in law, the ld. CIT(A) has erred in deleting the addition of Rs. 98,14,543 made on account of consultancy service commission which accrued during the year.
The amendment of the ground is allowed. But, as we have stated earlier, the ground is decided against the revenue.
16. The second ground is that the CIT(A) erred in deleting the disallowance of Rs. 11,410 being subscription and membership fee of clubs paid by the company on behalf of the directors. It is stated that the payment has no relation to the assessee's business. This contention however cannot be accepted in view of the judgment of the Hon'ble Bombay High Court in Otis Elevator Co. (India) Ltd. v. CIT [1992] 195 ITR 6821. Respectfully following the said judgment, we decide the ground against the revenue.
17. In the result, the appeal is dismissed.