BRIJLAL GUPTA J. - This is a reference under section 66 of the Income-tax Act. Three questions have been referred to this court for opinion :
'(1) Whether, on the facts and in the circumstances of the case, proceedings undertaken by the income-tax authorities under section 34 of the Income-tax Act are valid in law
(2) Whether the receipt of Encumbered Estate Bonds during the previous year 1947-48 amounted to receipt of cash during that previous year and not during the previous year 1948-49, when the bonds were in fact sold at less than their face value ?'
(3) Whether, in the circumstances of the case, the mere receipt of the Encumbered Estate Bonds was tantamount to receipt of income assessable in the year 1948-49
The assessment year in question is 1948-49 relevant to the accounting period the financial year ending March 31, 1948. The facts giving rise to the reference are that the assessee which is a Hindu undivided family carries on a money-lending business. In the course of that business it advanced a sum of Rs. 2,58,000 during the years 1919-1926 to Sri Nizar Ahmed Khan, a Taluqdar. In due course a suit had to be filed for realisation of the debt and it was fought up to the Privy Council. Ultimately a decree was passed in favour of the assessee. Thereafter the debtor made an application under the U. P. Encumbered Estates Act and in due course a decree was passed by the special judge under section 14 of that Act and finally a sum of Rs. 5,00,992 was received by the assessee in full satisfaction.
The receipt of the amount was partly in cash, viz., Rs. 1,54,692, and partly in the form of Encumbered Estate Bonds of the face value of Rs. 3,46,300. The cash was appropriated towards the principal amount in the year 1946 and we are no longer concerned with it. The cash was not sufficient to wipe out the principal and, therefore, the amount of the bonds included part of the principal, the entire interest and costs of the litigation. The bonds received by the assessee on February 26, 1948 which date fell within the accounting period relevant to the assessment year in question. The assessee credited the amount of the bonds to the account of the debtor and debited it to the encumbered estate bonds account and squared up the account on March 31, 1948, which was the last date of the accounting period.
The assessees system of accounting with regard to interest income was the cash system. It maintained two interest accounts, one called the interest 'accrued' account and the other the interest 'realised' account. The assessee split up the amount of the bonds into two amounts, one of Rs. 2,22,097-9-11 and the other of Rs. 1,24,202-6-1. It debited the amount of the bonds to the debtors account by the last of the above amount and credited the same to the interest 'accrued' account and not to the interest 'realised' account. In the return which it subsequently filed for the assessment year in question it did not include the sum of Rs. 1,24,202-6-1 as its interest income of the year. In the course of the examination of its books for assessment purposes, the Income-tax Officer signed the particular ledger account in which the receipt of the bonds was entered and also put tick marks against the entry of Rs. 1,24,202-6-1 in the interest 'accrued' account. He completed the assessment without including this amount as the assessees interest income of the year. With regard to the assessees interest 'accrued' account the Income-tax Officer made a note to the following effect 'a scrutiny of the interest 'accrued' account is called for in greater detail. This account is allied to the account of Nizar Ahmad Khan, Taluqdar of Mohana Estate, District Sultanpur. It is a matter of pity that during the last year and half, there have been five deaths in the assessees family and whenever an attempt was made to fix a date for further scrutiny of accounts, it was learnt that members of the assessee family together with the staff were pre-occupied otherwise.'
The assessment was completed by order dated January 23, 1951.
During the next accounting period the assessee sold the bonds for a sum of Rs. 3,21,600 and out of the sale proceeds showed the amount which it considered to be its interest income in its return of income for the assessment year 1949-50. In the course of proceedings for this year the Income-tax Officer who was different from the officer who had completed the assessment for the date when by sale they were converted into cash in the succeeding accounting period. Accordingly, he took the view that interest income in the loan account of Sri Nizar Ahmed Khan had escaped assessment in the assessment year in question. Thereupon, after taking the sanction of the Commissioner of Income-tax, he issued a notice dated January 29, 1953, to the assessee under section 34. In the course of proceedings initiated by this notice he made a careful and detailed scrutiny of the interest 'accrued' account of the assessee which his predecessor could not do on account of deaths in the assessees family but about which he had left a note on the file.
The result of the scrutiny was entirely unfavorable to the assessee and during the course of the scrutiny it was admitted by the assessee that the amount of Rs. 1,24,202-6-1 shown by it in the interest 'accrued' account was not correct and the amount included in the decree on account of interest was Rs. 1,59,687-13-8. The on the admission of the assessee himself the entry in regard to interest amounted to a suppression of interest himself the entry in regard to interest amounted to a suppression of interest income to the extent of over Rs. 35,000. The Income-tax Officer did not, however, accept even the increased interest income as correct and in the course of further investigation observed :
'The assessee was not prepared to give out correct information and disclose the amount of interest actually received by him, and............... the assessee has always on one plea or another avoided the production of correct information and......... he promised to produce ledgers for the earlier years as well, which he never did as usual.'
With regard to the accounts maintained by the assessee the Income-tax Officer from a study of the past records of the assessee observed as follows :
'Uptil the assessment year 1935-36 account were never produced, or those produced were incomplete, so much so, that a number of items of interest were always found omitted from the statements filed by the assessee. In the assessment year 1930-31, it was mentioned that even the interest amounting to Rs. 12,080 received by him in cash on 2nd January, 1921, from this very debtor, Shri Nizar Ahmad Khan of Mohana Estate, was not shown in the books produced before the then Income-tax Officer, and a good number of assessments were also completed under section 23(4) for non-production of accounts in compliance with notice under section 22(4). In an appeal for the assessment year 1935-36, the Appellate Assistant Commissioner of Income-tax, Benares, ordered the assessee to recast his accounts which was done, and the accounts were prepared on the cash system of accounting. Only the interest actually realised was shown. It is therefore clear that for the period earlier to this assessment year, there was no reliable record regarding the amount of expenditure incurred in this case, i.e., the case of Shri Nizar Ahmed Khan of Mohana Estate, and there is no proof to show that these expenses were not claimed by the assessee in the relevant assessment years and allowed. As the accounts have been maintained on cash basis, and considered as such, the natural presumption will be that the expenses incurred by him in any case during these years must have been deducted from the taxable income, and allowed to the assessee.'
After careful and detailed scrutiny of the accounts of the assessee, the Income-tax Officer completed the assessment under section 34 by order dated January 25, 1954, and included in this assessment a sum of Rs. 2,02,168 and not merely the sum of Rs. 1,24,202-6-1 as the interest income of the assessee for the assessment year 1948-49 in the loan account of Sri Nizar Ahmed Khan. The Income-tax Officer was also not satisfied that the amount claimed by the assessee as litigation expenses was the correct amount and allowed a deduction of Rs. 50,000 only by estimate. The Income-tax Officer also observed that action under section 28(1)(c) was being taken against the assessee separately. The Income-tax Officer relying on the decision of this court in Commissioner of Income-tax v. Maheshwari Saran Singh overruled the contention of the assessee that the interest income was received not when the bonds were received but only when the bonds were subsequently converted into cash.
Against the order of the Income-tax Officer the assessee went up in appeal before the Appellate Assistant Commissioner. It was argued by the assessee before that officer that the Income-tax Officer who made the original assessment must be taken to have recorded a judicial finding on the basis of facts which were all before him that the interest income was not assessable when the bonds were received but only when the bonds were converted into cash. As such what the successor of that officer did in proceedings under section 34 was merely to correct the view taken by his predecessor and proceedings under section 34 could not be initiated on this basis and were, therefore, invalid. The other point taken before the Appellate Assistant Commissioner was that the assessees system of accounting being on a cash basis interest income was received only when the bonds were converted into cash and not earlier when only bonds had been received. Both the grounds were overruled by the Appellate Assistant Commissioner. He held that it was settled law that receipt of encumbered estate bonds constituted actual receipt of income even if the method of accounting followed was the cash basis and there was clear omission by the assessee to include interest income constituted by the receipt of these bonds in his return and as such the Income-tax Officer was justified in reopening the assessment under section 34(1)(a). He also held that the receipt of bonds was not merely the substitution of the debt against Nizar Ahmed Khan by debt against the State Government but was receipt of income. In the matter of quantum the Appellate Assistant Commissioner gave some relief to the assessee by allowing him a further sum of Rs. 19,177 on account of litigation expenses.
Against the decision of the Appellate Assistant Commissioner the assessee went up in further appeal to the Income-tax Appellate Tribunal where the same arguments were repeated. The Tribunal overruled the contentions of the assessee but reduced the interest income further to a sum of Rs. 1,60,991. The Tribunal held that the receipt of the bonds was receipt of income. This income did escape assessment in the original assessment. In the return filed by the assessee in that assessment this income was not included. Thus there was a failure on the part of the assessee to disclose all material facts and the provisions of section 34(1)(a) were attracted. It went on to hold that the mere fact that the Income-tax Officer had signed a particular ledger account did not necessarily mean that he had applied his mind to the question whether the receipt of the bonds was income, or that he had at all formed any opinion about it. On the other hand it appeared from the note left by the Income-tax Officer that he could not himself complete the scrutiny of the 'accrued' interest account but that he desired that this should be done before the question of the taxability of interest income could be finally decided. From this reference by the Tribunal to the note of the Income-tax Officer it appears that the view of the Tribunal was that all necessary facts for the taxability of interest income in the year in question were not known to the Income-tax Officer who made the original assessment and, therefore, no final opinion could have been expressed on the question by that officer until further and detailed scrutiny was made. As such that officer could not be hale to have formed or expressed any opinion about the taxability of the amount and when his successor brought the amount to tax under section 34 he could not be said to have merely taken a different view from the view taken by his predecessor. According to the Tribunal the predecessor had not taken any view at all and as such there could be no question of any change of opinion by the successor. The Tribunal concluded by observing that the information in consequence of which the Income-tax Officer initiated proceedings under section 34 was that the interest which was constructively received by the assessee during the relevant accounting year had escaped assessment. The reason for escarpment was not very material. The escapement of income might very well be due to mistake or error or negligence of the Income-tax Officer. That, however, would not invalidate the assessment under section 34.
Thereafter the assessee required the Tribunal to state a case to this court and the case has been stated.
So far as the third question referred to this court for opinion is concerned that is concluded by the decision of the court in Commissioner of Income-tax v. Maheshwari Saran Singh. It has not been argued before us by the learned counsel for the assessee that case was wrongly decided or that it requires further consideration. It appears to me settled law that income may not be received merely in cash but may be received in kind. If what is received in kind is transferable and, therefore, convertible into cash the receipt of it is tantamount to receipt of cash. Another way in which the question can be considered is that where in liquidation of a debt not cash but something in kind has been received the receipt amounts to settlement of the debt and if the creditor chose to retain the thing received then it is considered that nationally after receipt of cash in lieu of the debt the creditor has invested in laying it out or in spending it over thing received. It is not necessary to deal with this matter further.
What the assessee has argued is that its system of accounting being the cash system and not the mercantile system, until the assessee could not be held to have received any income which could be subjected to tax. This argument seems to be based upon a misconception of the true nature of the cash system of keeping accounts. That system does not require that the receipts and the disbursements should be in cash alone and may not be in kind. All that it implies is that there should be an actual receipt or an actual disbursement. It is not sufficient that a right to receive something may have arisen or that a liability to give or pay something may have been incurred. Where such is the case, the system of accounting is called the mercantile system. In the cash basis of accounting there may be no actual receipt in money at all. It may only be a constructive receipt. It may also be a receipt in kind. It may be a receipt by adjustment or settlement of accounts. It would nevertheless be a cash basis of accounting.
In our case the bonds were transferable and represented moneys worth. They were accepted by the assessee in settlement of the debt. After receiving them the assessee did not keep the loan account still outstanding but squared it up its account books. In the circumstances the interest included in the bonds was properly the receipt of interest income of the assessee on the date on which the assessee received the bonds. The third question referred to this court must, therefore, be answered in the affirmative and against the assessee.
In the view of this answer the second question must also be answered in the affirmative and against the assessee. The bonds having been received on February 26, 1948, amounted to the receipt of cash in the previous year 1947-48 and not during the next previous year 1948-49 when the bonds were sold and actually converted into cash. The fact that the bonds were sold in the succeeding previous year at less than their face value does not give rise to any question which can be argued in this reference. It does not appear from any of the orders which have been dealt with in considerable detail above that the assessee at any time raised the point that if at all the interest income was assessable in the assessment year relevant to the previous year 1947-48 in which the amount represented by the sale proceeds which was less than the face value of the bonds, should be assessed. It is, therefore, not possible to say that such a question arises out of the appellate order of the Tribunal which only we have jurisdiction to decide. In all the calculations which were submitted by the assessee appears during the scrutiny and investigation into the accounts the assessee appears to have based the calculations on the face value of the bonds, and not on their sale proceeds. If the assessee had raised any such question an investigation might have been made as to what was the market value of the bonds on February 26, 1948, when they were received and whether or not it was the same as their face value. These questions of fact remained uninvestigated on account of the omission of the assessee to raise the question at the material time. It is not necessary to pursue this matter further.
Now only the first question remain to be considered, namely, whether the proceedings taken by the income-tax authorities under section 34 were valid. The materials relevant for the purpose of answering this question may be summarised as follows :
The assessee had not shown the interest income in the interest receipt account. The assessee had not included the interest income in its return for the assessment year in question. The Income-tax Officer who made the original assessment knew that bonds had been received in settlement of the debt. He also knew of the entry of Rs. 1,24,202-6-1 in the interest 'accrued' account. During the subsequent investigation it was admitted that the interest income was at least Rs. 1,59,687-13-6. The entry was, therefore, wrong. The Income-tax Officer did not scrutinise or investigate the question of the correctness of the entry as according to him before this could be done further scrutiny was necessary and this he did not do. The entry occurred in the interest 'accrued' account which was misleading as an entry regarding accrual would be relevant only in mercantile system of accounting, and would be irrelevant and misleading in receipt or cash basis of accounting. On these facts it seems to be clear that the assessment under section 34 would be covered by sub-section (a) of section 34(1). That was the view of the Appellate Assistant Commissioner and the Tribunal also justified it under that sub-section (b) of section 34(1) also. The Tribunal recorded the finding of fact that there was omission or failure on the part of the assessee to disclose fully and truly all material facts necessary for his assessment in the year in question. On the facts stated above it is not possible to say that there was no material in support of this findings of fact. It follows that the order under section 34 made by successor Income-tax Officer was valid and first question must also be answered in the affirmative and against the assessee.
In this view it is not necessary to consider whether the assessment under section 34 can be justified under sub-section (b) of that sub-section (1), also. As, however, the point has been argued it may be dealt with. It might be conceded that the orders of the authorities below are confused on this point. Merely because an income has escaped assessment, it cannot be held that section 34 will at once become applicable to it. Action under sub-section (b) of section 34(1) can be taken only where there is not omission on the part of an assessee to file a return under section 22 or where there is no omission or failure on his part to disclose fully and truly all material facts. It follows that in this case on the finding that there was omission or failure on the part of the assessee to include the amount of interest income in its return and to disclose fully and truly all material facts necessary for its assessment, the application of sub-section (b) was excluded. Even if this fact is ignored and it is assumed that there was no omission or failure on the part of the assessee in regard to those two matters then action under sub-section (b) can be taken if the Income-tax Officer 'in consequence of information in his possession has reason to believe that income chargeable to income-tax has escaped assessment.' The question at once arises what was the information in the possession of the successor Income-tax Officer in consequence of which he formed the belief that income had escaped assessment. The findings recorded by the Tribunal are that mere knowledge of the receipt of the bonds and of the entry of amount in the interest 'accrued' account could not lead to the conclusion that the Income-tax Officer had applied his mind to the taxability of the amount or that he had consciously and deliberately come to the conclusion that the amount or that he had entry was not taxable. There was no evidence that the question of the taxability of the amount arose or was considered and decided in favour of the assessee by the Income-tax Officer. On the other hand what appears to have happened is that in view of the facts that the assessees method of interest 'accrued' account the Income-tax Officer was misled into assuming, if he allowed his mind to come into play at all that no question of its taxability could arise. There was of course the further fact which has already been stated that the amount was not included by the assessee in its return. There is column in the return form, viz., Section D of Part 1 of the return, where all receipt have to be included irrespective of the fact whether they are assessable or not. There is no evidence that the assessee included this amount in that part of the return. Thus, even though the Income-tax Officer may have glanced at the entry and signed it mechanically, in the view of the Tribunal it did not amount to the Income-tax Officer bringing to bear upon that entry conscious mind for consideration of the question whether the amount was taxable or not. The Tribunal, therefore, held and it appears in the circumstances that it rightly held that it could not be said that the Income-tax Officer made any finding that the amount was not taxable. It, therefore, negatived the argument of the assessee that when the successor Income-tax Officer brought the interest income to tax under section 34 what he did was by a mere change of opinion. For a change of opinion the forming of an opinion prior to its change is a necessary postulate. On the findings of the Tribunal there was no previous opinion on the question formed at all. It follows that there could be no change of any opinion. One further fact may now be stated. The original assessment was made on March, 21, 1951. The ruling in Commissioner of Income-tax v. Maheshwari Saran Singh was given only in October, 1950. It was published in the Income Tax Reports only in 1951. There is no evidence that this ruling had been published before the completion of the assessment on March 21, 1951. There is also no evidence that the Income-tax Officer was aware of this ruling. It looks highly unlikely that is he was aware of this ruling then on precisely the same point he would have omitted to apply the ruling the taxability of a very large amount of interest income and would have allowed that income to escape assessment. On all these materials it appears to be clear that the Income-tax Officer was entirely oblivious to the question of the taxability of the amount entered in the 'accrued' interest account. The successor Income-tax Officer issued notice under section 34 on January 29, 1953. By that time this ruling must have become very well known to all officers of the department. The assessment proceedings in the succeeding year were before him. In the course of those assessment proceedings part of the sale proceeds of the bonds representing interest income was offered for tax. The question of taxability of the interest and of the year in which it should be taxed arose directly before him. In view of the state of the law as contained in the ruling he formed the opinion that the interest income had escaped assessment in the preceding year. It follows that the condition in section 34(1)(b) was fully satisfied, viz., that now there was before him information as to the true state of the law contained in the ruling. In consequence of that information by reference to the facts of the case he came to the conclusion that income had escaped assessment. The order under section 34 could, therefore, be justified under section 34(1)(b) also. It only remains to say that the notice under section 34 having been issued on January 29, 1953, and the assessment under that section having been completed within one year thereof, viz., on January 25, 1954, the assessment was made within the limitation prescribed under section 34(3).
For the reasons stated above all the three question referred to this court must be answered in the affirmative and against the assessee. The reference should be returned to the Income-tax Appellate Tribunal with this answer under the seal of the court and signature of the Registrar. The department should get its costs fixed at Rs. 200.
DESAI C.J. - For the reasons stated in my judgment in Income-tax Reference No. 9 of 1959, I agree that all the question be answered in the affirmative.