R.R. Rastogi, J.
1. The Income-tax Appellate Tribunal, Allahabad Bench, has referred the following questions of law under Section 256(1) of the I.T. Act, 1961, for the opinion of this court :
' (1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sum of Rs. 71,000, representing the surplus of damages received during the previous year representing the loss of commission that the assessee would have earned under the agreement if it was implemented, was a revenue receipt taxable under the Income-tax Act, 1961 ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the aforesaid amount of Rs. 71,000 was taxable as the income of the assessee for assessment year 1970-71 ?'
2. The brief facts are these : The assessee, a partnership firm, had entered into an agreement with M/s. Gaya Cotton & Jute Mills Ltd. (hereinafter referred to as ' the Jute Mills ') on February 1, 1957. By means of that agreement the Jute Mills appointed the assessee as the sole selling agent of pieces of all sorts and yarn manufactured by them. The assessee was to advance a loan of Rs. 1,50,000 to the Jute Mills to enable them to restart and run the spinning section and waste-cotton plant to its full capacity. There was a provision for a further advance of Rs. 50,000 by the assessee and it was to receive commission on all sales. The agreement was for a period of three years commencing from February 1, 1957. In pursuance of that agreement, the assessee did advance, a loan of Rs. 1,50,000 but it appears that soon after some disputes arose between the parties. The matter was referred to an arbitrator who gave his award on October 13, 1958. By means of that award the Jute Mills were to pay to the assessee the following amounts :
(1) Credit notes in respectof commission due on the sale of goods up to 31-8-1958
(2) Damages suffered up to31-8-58 for not working the shifts as per clause 13
(3) Loan advance
3. There was a provision for interest at 6 per cent, on loan and damages.That award was made a rule of the court by an order dated September 3,1959. An appeal was preferred against that order before the High Court of Patna where a compromise was arrived at between the parties and it wasagreed that in case the jute mills paid a sum of Rs. 2,44,000 to the assessee in addition to the amount of Rs. 1,00,000 already paid, the decree which had been passed in pursuance of the award would stand fully satisfied.This amount was to be paid in instalments. There again arose some dispute between the parties on the question of costs and the matter went tothe Supreme Court where some modification was ultimately made andadmittedly the assessee received, on various dates, a total sum ofRs. 3,46,477-50.
The assesse allocated that sum as under:
for loan ;
for interest already taxed ;
unpaid credit notes forcommission already taxed ;and
compensation for agency.
4. The sum of Rs. 29,400 was assessed on accrual basis in the assessments for 1959-60 to 1963-64 and the sum of Rs. 25,822.33 was also assessed on the same basis in assessment years 1959-60 and 1960-61. The sum of Rs. 29,243.13 was shown as profits and assessed in the assessment year 1964-65. The litigation expenses amounted to Rs. 41,001. The remaining amount of Rs. 71,010 was brought to tax by the ITO in the assessment for 1970-71. It may be noted that this amount was out of the sum awarded as compensation for agency.
5. In its appeal before the AAC, the assessee contended that this amount represented compensation for termination of the agency agreement which was in the nature of capital receipt and was not liable to tax. In the alternative, it was submitted that since the assessee maintained its accounts onmercantile basis and this income accrued to the assessee in the earlieryears, therefore, it could not be taxed in the year under consideration.The AAC accepted both these submissions and deleted the addition ofRs. 71,010 from the assessee's assessment. The department filed an appealagainst that order before the Income-tax Appellate Tribunal. The Tribunal has disagreed with the view taken by the AAC on both the pointsstated above. According to the Tribunal, damages were paid to the assessee by way of commission which it would have earned in case the agreement had been implemented and, therefore, it was a revenue receipt. Asfor the other question, the view taken is that interest on the loan ofRs. 1,50,000 had not been returned by the assessee on accrual basis, thoughit had been brought to tax on that basis. Thus the system followed by theassessee for interest was not mercantile. Further, the receipts as per awardhad been returned by the assessee on cash basis and, therefore, this amountof Rs. 71,010 on that basis was rightly taxed in the year under consideration.
6. So far as the facts of the case are concerned, there is no dispute and they have been narrated in detail above. The first question to which we would like to address ourselves is whether the amount in dispute could be assessed in the year under consideration. This can be done if it is taken that in respect of commission the assessee follows cash system of accounting. If, on the other hand, it follows mercantile system, then this amount cannot be taxed in this year because, admittedly, it related to the period prior to the termination of the agreement, which as noted above, took place on August 31, 1958.
7. It was submitted before us on behalf of the assessee by Shri R.K. Gulati that, admittedly, the assessee follows the mercantile system of accounting. The assessee can have one system for one source of income and another for another source of income. There is no dispute that as for commission the assessee was following mercantile system and this basis could not be changed by the department.
8. We find that there is sufficient force in the contention urged on behalf of the assessee. Section 145 of the Act provides for methods of accounting. Sub-section (1) of this section is as under :
' (1) Income chargeable under the head 'Profits and gains of business or profession' or ' Income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee :
Provided that in any case where the accounts are correct and complete to the satisfaction of the Income-tax Officer but the method employed is such that, in the opinion of the Income-tax Officer, the income 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.'
9. There are two main methods of accounting, viz., cash system and the, mercantile system. According to the cash basis a record is kept of actual receipts and actual payments, entries being made only when money is actually collected or disbursed, and if the profits of the business are accounted for in this way the tax is payable on the difference between the receipts and the disbursements for the period in question. In the case of mercantile accounting system net profit or net loss is calculated after taking into consideration all the income and all the expenditure relating to the period, whether such income has actually been received or whether such expenditure had actually been paid or not. In the case of an assessee, who is following a method of accounting regularly, income is to be computed in accordance with such method. The department having adopted one basis of assessment cannot switch over to another basis. In Rattan Chand Dhawan v. CIT , the assessee had given a loan in 1944 of Rs. 55,000 on a mortgage. No interest was received. He did not maintain any accounts. In the assessment years 1959-60, 1960-61 and 1961-62, interest accruing on the mortgage was assessed to income-tax on accrual basis. Under a court's decree the mortgage money was recovered and the total amount of interest realised some to Rs. 40,529 and this amount was brought to tax in the year of receipt, that is, 1962-63. On a reference it was held by the Punjab and Haryana High Court that the interest having been assessed on accrual basis in three earlier years it was not open to the department to assess tax on receipt basis in 1962-63. The rule laid down in Jug Sah Muni Lal Sah's case : 7ITR522(Patna) was held applicable and it was observed that the existence of the mortgage was discovered by the ITO in the year 1959-60. At that time, two courses were open to him. He could have waited till the interest was received and then brought it to tax or he could have proceeded to assess the interest on accrual basis which he did in that and the two subsequent assessment years. It was also open to him to reopen the previous assessment if those were within limitation and to tax the interest that had accrued. Having failed to do that he could not, in order to cover his own default, switch over to receipt basis and bring the interest to tax in the year of receipt.
10. In CIT v. Chuni Lal V. Mehta and Sons Pot. Ltd. : 82ITR54(SC) the assessee was the managing agent of a company. On the termination of the managing agency pursuant to a resolution of the board of directors the assessee filed a suit for recovery of compensation. That suit was decreed and the assessee received the amount in December, 1955, and credited it in its profit and loss account for the year 1955. The question was whether the amount accrued to the assessee, which had maintained its accounts on the mercantile system on April 3, 1951, or whether it was liable to pay tax on the amount under Section 10(5A) of the Indian I.T. Act, 1922, in the assessment year 1956-57. On a reference, the view taken by the High Court was that the amount accrued to the assessee on April 23, 1951, and that that amount was not taxable but the interest thereon was taxable under Section 10(5A) in the assessment year 1956-57. On appeal, the Supreme Court affirmed that view. It also held that the fact that the assessee had included the receipt in question in its profit and loss account in 1955 was wholly an immaterial circumstance. The method of maintaining the accounts was one thing and the actual entries in the accounts maintained was another thing. What was relevant was the method of accounting and not the actual entries. It would be seen that the facts of the present case are almost the same as the facts in Chuni Lal V. Mehta's case : 82ITR54(SC) and that decision applies on all fours. It cannot be disputed that this compensation related to the period up to August 31, 1958, and on accrual basis could be assessed in the years to which it related and not in the year of its receipt.
11. There is another decision of the Supreme Court relevant to the question under consideration and it is in the case of Chidambaram Mulraj and Co. P. Ltd. v. CIT : 102ITR7(SC) . There also compensation for premature termination of the managing agency was held liable to assessment on accrual basis which system of accounting the assessee had been regularly adopting.
12. There is also the decision of the Andhra Pradesh High Court to the same effect and it is in the case of J.R. Kimtee and Sons v. CIT : 115ITR190(AP) .
13. We are not impressed with the argument made by the learned counsel for the department that in case the assessee was following accrual basis for commission income, it should have returned the commission income as mentioned in column No. 1 of the award. A copy of that award is annex. 'C' in the paper book and the figures are given at page 16. In column No. 1 the figures represent commission on production and in column No. 2 balance of credit and debit notes has been mentioned and column No. 3 contains the difference of the first two columns, that is, the net amount of compensation to which the assessee was entitled. Thus, the total amount was for the period from April, 1957, to the end of August, 1958, there being no dispute that unpaid credit notes for commission had been assessed on accrual basis. In other words, in regard to this source of income the assessee was following mercantile basis and the same was accepted by the department also. That being so, when subsequently the entire amount was received, the department could not have taxed it in the year of receipt. If the asseseee had not returned its commission income correctly on accrual basis, the remedy lay elsewhere. For all these reasons, therefore, we do not agree with the view taken by the Income-tax Appellate Tribunal and, in our opinion, the disputed amount could not be assessed in the year of its receipt.
14. Coming to question No. 1, it was only a faint effort made on behalf of the assessee to urge that the disputed receipt was of capital nature. We do not think that there can be any doubt that this amount of damages was paid to the assessee for commission which it would have received if the Jute Mills had worked according to the agreement. It was not a case of premature termination of the managing agency business but it was a case of breach of contract between the assessee and the Jute Mills and under Section 28(ii) of the Act it was clearly a revenue receipt liable to tax.
15. Our answer to question No. 1 is in the affirmative, in favour of the department and against the assessee, while our answer to question No. 2 is in the negative, in favour of the assessee and against the department. Since question No. 2 represents the main controversy involved in the case, the assessee would get Rs. 200 as costs.