1. This appeal by the department relates to the assessment year 1975-76 for which the accounting year ended on 30-6-1974. The assessee is a firm carrying on business in marine products. The ITC Ltd. was the exclusive customer of the assessee. The assessee used to sell marine products to the ITC Ltd. and those products were ultimately exported.
The assessee used to get the marine products packed in the cartons belonging to the ITC Ltd. and get certificates about the good condition of the products from the Export Inspection Agency, which was a Government authority. The assessee used to receive nearly 90 per cent of the price of the products by way of advances from the ITC Ltd. before the above operations were carried on. These products were then used to be shipped to foreign purchasers indicated by the ITC Ltd. Subsequently, the assessee used to receive the balance of the price.
2. In the relevant accounting year, the turnover disclosed in the books of account of the assessee was Rs. 1,49,358 and the net profit as per the profit and loss account was Rs. 26,32,406. However, in its return, the assessee disclosed a loss. The reasons for filing the return for loss were mentioned by the assessee in its letter dated 19-6-1976 to the ITO. It was stated in the said letter that an amount of Rs. 27,70,943 included in the total sales shown in the books of account represented disputed claims against the ITC Ltd. The details of the said amount were as under:1. Difference in exchange rates in respect of frog legsshipments from 21-9-1973 to 29-3-1974.
7,45,379.923. Sale of marine products awaiting the Export Inspection ____________Agency certificate of FOB value 10,39,610.70 ____________ The assessee further stated in that letter that the ITC Ltd. had filed a civil suit in the Bombay High Court claiming refund of the advances and repudiating the assertion of the assessee about the sale of Rs. 27,70,943. Consequently, according to the assessee, the said amount represented contingent claim during the pendency of the said suit and, as such, the assessee was not liable to pay any tax in respect of the said amount.
3. The ITO observed that the products of the above amount had been packed by the assessee in the cartons belonging to the ITC Ltd. and that the asseesee had also obtained certificate of good condition of these products from the Export Inspection Agency and, as such, according to the method employed by the assessee in all such transactions, the sale in favour of the ITC Ltd. had been completed with the result that profits arising out of the said sale had accrued to the assessee. Mere fact that the ITC Ltd. had filed a suit against the assessee would not entitle the assessee to treat the sale of the said amounts entered in the account books as not to have taken place at all. The sales in question could not be considered as contingent sales.
The ITO emphasised the fact that in the counterclaim, made by the assessee in the suit filed by the ITC Ltd., the assessee had categorically asserted that the property as well as the ownership in the goods in question had vested with the ITC Ltd., taking into consideration these facts, the ITO declined to deduct the said amount from the total sales shown in the books of account. He computed the income according to the book results making variations on some other points with which we are not concerned.
4. The contention of the assessee before the Commissioner (Appeals) was that it was the regular practice on the part of the assessee to take credit for the sale to the ITC Ltd. in their books of account only after the relevant marine products had actually been shipped on behalf of the ITC Ltd. and intimation had been received from the ITO of the fact that all export documents had been negotiated by the banks. It was only with respect to the three transactions amounting to Rs. 27,70,943 that the assessee departed from the said regular practice in view of the dispute with the ITC Ltd. and made entries about the said sale on 31-5-1974 although the products had not been shipped. If the normal practice of recording sales which had been regularly followed prior to 31-5-1974 had been adopted, the entries for sale of the above amount would not have been made. Consequently, the mere fact that the entries regarding the said amounts have been made would not mean that the sale had in fact taken place and income from those sales had in fact accrued.
5. The learned Commissioner (Appeals) examined the account books of the assessee and afforded a reasonable opportunity of being heard to the ITO. The ITO contended before the Commissioner (Appeals) that the assessee had not explained either to the ITO at the time of asseesment or to the IAC Ltd. at the time of making objections under Section 144B of the Income-tax Act, 1961 ('the Act'), as to how the entries dated 31-5-1974 regarding the amount could not have been made if the regular method regarding making of entries against sale which had been followed prior to 31-5-1974 had been adopted and as such the assessee should not be allowed to raise such point. The Commissioner (Appeals) rejected the said contention of the ITO. He examined the books of account and he was satisfied that the assessee had been making entries against sale after the products had been shipped and intimation had been received from the ITC Ltd. and that there had been departure from this practice while making entries dated 31-5-1974 regarding the above amount.
6. Before the Commissioner (Appeals), an affidavit dated 20-2-1981 of Shri N.P. Kambli, one of the partners of the assessee-firm, was filed.
In that affidavit, it was stated that marine products in question had been handed over by the assessee to the court receiver in pursuance of the direction of the High Court in the suit filed by the ITC Ltd. against the assessee. It was further mentioned therein that the assessee would offer those sale proceeds for taxation under Section 41(1) of the Act, when received from the High Court. There was a prayer to allow deduction of the above amount of Rs. 27,70,943 from the net profits. The Commissioner (Appeals) considered this affidavit and observed as follows: ...It is held that the appellant-firm is entitled to relief of Rs. 27,70,943 less the value of the closing stock as represented by sale proceeds thereof deposited with the court receiver. The appellant would furnish the figure to the ITO directly and it is open to the ITO, to verify the correctness of the same at the time of giving effect to this order.
7. It would be seen from the above order that the Commissioner (Appeals) directed the ITO to value the closing stock represented by the disputed marine products as on the last date of the relevant accounting year 30-6-1974 at the figure at which the said goods had been sold by the court receiver on some subsequent date. The department has now come in appeal before us.
8. We may mention at the outset that there is some confusion in the assessment order as well as in the appellate order about the details of the disputed amount of Rs. 27,70,943. At some places in these orders it has been assumed as if this whole amount represents the disputed sale.
This is not correct. We have already given the details of Rs. 27,70,943 in paragraph No. 2 above. From those details, it is clear that the said amount of Rs. 27,70,943 consists of three items, the first of which is of Rs. 7,45,379.92. The amount is not in respect of disputed sale. This amount represents additional sum, which according to the assessee, the assessee is entitled to receive from the ITC Ltd. on account of difference in exchange rates in respect of shipments which had taken place between 21-9-1973 and 29-3-1974. It is the balance amount of Rs. 20,25,562.74, which represents the disputed sale. We shall deal with these two items separately.
9. Before we deal with the contentions raised by the parties, it is necessary to refer to the agreement between the assessee and the ITC Ltd., which took place on 1-12-1971. The copy of the said agreement has been filed by the assessee. In clause 2 of the agreement, it is mentioned that the ITC Ltd. was an exporter of marine products and had agreed to purchase from the assessee marine products for the purpose of export only and the assessee had agreed to sell the marine products for the said purpose and to ship such marine products to the ITC Ltd.'s customers in foreign countries on the ITC Ltd.'s behalf only. Under clause 3 of the agreement, the assessee had to ensure that the marine products to be supplied were of the first class quality fit for export to countries abroad to the ITC Ltd.'s satisfaction. Under clause 4 of the agreement, the assessee was required on the ITC Ltd.'s behalf to ship the marine products purchased by the ITC Ltd. under the agreement to the ITC Ltd.'s customers abroad and in that connection to comply with all the necessary formalities relating to export of marine products by the ITC Ltd. including actual shipping of the marine products and other letters of credit from the foreign customers in the ITC Ltd.'s favour. Under clause 5 of the agreement, the ITC Ltd. was to pay 90 per cent of the price of the stock of marine products packed in the cartons by the assessee and stored in the assessee's cold storage at Bombay. The balance of the price of 10 per cent was payable by the ITC Ltd. at the time the marine products were exported and the assessee handed over to the ITC Ltd., the shipping and other documents including the bill of lading and the letter of credit in favour of ITC Ltd. There was an important stipulation in clause 6 of the agreement, which was to the effect that from the advance of 90 per cent of the price which had been made till the time when the sale was completed by placing the marine products with the shippers for export abroad and handing over the documents to the ITC Ltd., all the marine products owned by the assessee including the packaging material would be hypothecated in favour of the ITC Ltd. by the assessee. It was further mentioned therein that all the marine products in the assessee's cold storage would be insured by the assessee against loss, destruction or damage and if the marine products hypothecated to the ITC Ltd. were lost, damaged or destroyed, the money payable under the insurance policy would be reimbursed to the ITC Ltd. to the extent of the amount hypothecated.
10. The first contention raised by the learned departmental representative was that the sale was completed when the assessee packed the marine products in the cartons and obtained the certificate of good quality from the Export Inspection Agency. The fact that the property in goods passed to the ITC Ltd. at that stage was, according to the learned departmental representative, confirmed by the conduct of the assessee in making entries dated 31-5-1974 crediting the amount (of Rs. 20,25,562.74) to the sale. This fact was further confirmed by the conduct of the assessee in asserting in the counterclaim made before the High Court and in the correspondence with the ITC Ltd. to the effect that the sale in favour of the ITC Ltd. had been completed on 31-5-1974 and that the property in goods had passed to the ITC Ltd., the learned departmental representative took us through the plaint filed by the ITC Ltd. in the Bombay High Court and the written statement containing the counterclaim filed by the assessee in reply to the ITC Ltd's claim. It was submitted that the above amount (of Rs. 20,25,562.74) represented the sale made by the assessee to the ITC Ltd., and, as such, the said sale had to be taken into account in computing the profits. According to the learned departmental representative, the assessee could claim deduction as bad debt if the assessee was unable to recover the amount due to the assessee from the ITC Ltd. on account of those sales and if the assessee was required to refund the advances received by the assessee from the ITC Ltd. 11. We are unable to accept this contention. The entries in the books of account are not decisive in determining the rights and liabilities of the parties in particular transactions. The rights and liabilities of the parties are to be determined on the basis of the agreement prevailing between the parties. Consequently, the crucial document would be the agreement, dated 1-12-1971. We have already reproduced the main conditions agreed upon by the parties. As already indicated, the condition in clause 6 clinches the issue. It is specifically mentioned therein as under: It is expressly agreed and understood that from the time the advance of 90 per cent of the price is made and until the sale is completed by the supplier placing the marine products with the shippers for export: abroad. and handing over the documents to the ITC Ltd. in terms of this agreement, all the marine products owned by the supplier including the packaging material thereof shall be hypothecated in favour of the ITC Ltd. by the supplier.
From this clause, it is clear that the sale was completed only at the time when the assessee placed the marine products with the shippers for export abroad and handed over the documents to the ITC Ltd. and not before that stage. The very fact that from the time of making advances to the time of placing the marine products with the shippers, the assessee was required to hypothecate the products in favour of the ITC Ltd., indicated that the ownership in the goods continued to vest in the assessee till the time of shipment of the goods and handing over the documents to the ITC Ltd. in the present case, the documents filed by the assessee indicated that the assessee had hypothecated the products in question in favour of the ITC Ltd. and had not shipped the products and had not handed over the shipping documents to the ITC Ltd. Consequently, it cannot be said that the property in those products had vested in the ITC Ltd. The property in those products continued to vest in the assessee. There is further stipulation in clause 6 to the effect that the assessee was bound to store the products at the assessee's cold storage prior to shipment and that the assessee was bound to get those products insured against loss, destruction or damage in assessee's own name after those products had been hypothecated to the ITC Ltd. and was bound to reimburse to the ITC Ltd. in respect of the money received under the insurance policy to the extent of the amount hypothecated. This clause further supported the conclusion that the property in the products did not vest in the ITC Ltd. prior to the shipment of the products and handing over the documents to the ITC Ltd. and that the property in those products continued to vest in the assessee.
12. In view of the above position, as it emerged from the agreement between the parties, the fact that the assessee made entries on 31-5-1974 regarding sale prior to the shipments of the products and the fact that the assessee asserted that the property in the products had vested in the ITC Ltd. in correspondence as well as in the counterclaim would be wholly immaterial. On the basis of the said conduct of the assessee, no finding that the sale was completed could be recorded particularly when under the terms of the agreement, the sale could not have been completed before the products had been shipped and the documents had been handed over to the ITC Ltd. Considering all the circumstances, and after paying due regard to the submissions made on behalf of the department, we confirm the finding of the Commissioner (Appeals) to the effect that the above amount (of Rs. 20,25,562.74) did not represent the complete sale in favour of the ITC Ltd. Consequently, the entry dated 31-5-1974 regarding this amount consisting of two items was erroneous and the assessee was entitled to deduct this amount from the total sale shown in the books of account.
13. Before parting with this topic, we may mention that the learned departmental representative had argued that the learned Commissioner (Appeals) should not have allowed the assessee to explain the past methods of making entries regarding the sale when the assessee had not taken that stand before the ITO and before the IAC. It is not necessary for us to consider this contention. We have relied on the terms of agreement between the parties which are decisive in the matter and from those terms, it is obvious to us that as far as the above amount (of Rs. 20,25,562.74) was concerned, the sale in favour of the ITC Ltd. had not been completed and that the property in the goods had not passed in favour of the ITC Ltd. and that the property in goods remained with the assessee.
14. There is another reason for deducting the said amount from the total sale. For that reason is that the above amount represents mere claim of the assessee that the sale to that extent in favour of the ITC Ltd. had taken place. That claim of the assessee was denied by the ITC Ltd. and the ITC Ltd. had filed a suit in August 1974 repudiating the said claim. Consequently, the said claim was a disputed claim. Much could be said on both sides as far as this claim was concerned. In these circumstances, it cannot be said that the income arising out of the alleged sale of Rs. 20,25,562.74 had really accrued to the assessee. It is well established that even under the mercantile system of accounting no income can be taxed unless it accrued. The learned Counsel for the assessee has cited several decisions on this point and they are: CIT v. Nadiad Electric Supply Co. Ltd.  80 ITR 650 (Bom.), Dhrangadhra Chemical Works Ltd. v. CIT  106 ITR 473 (Bom.), Vishnu Agencies (P.) Ltd. v. CIT  48 ITR 444 (Bom.) and Feros Shah v. ITC  1 ITR 219 (PC).
It is not necessary for us to discuss these decisions because the legal principle involved is well established. For this reason also the assessee was entitled to exclude the said amount of Rs. 20,25,562.74 from the total sales.
15. It cannot be gainsaid that if the sale to the extent of Rs. 20,25,562.74 is excluded from the total sales, the value of the goods in question would have to be added in the value of closing stock. This is because the goods in question continued to be the property of the assessee on the last day of the accounting year (30-6-1974). We are of the opinion that the learned Commissioner (Appeals) should not have based the decision regarding the value of the goods to be included in the closing stock on the affidavit of one of the partners of the assessee-firm filed before him. The learned Commissioner (Appeals) should have directed the ITO to determine the value of those goods to be included in the closing stock according to the method of accounting regularly followed by the assessee. The value to be included would be either the cost or market value as on 30-6-1974, whichever is lower.
For determining the market value as on 30-6-1974, the ITO cannot ignore the fact that on 31-5-1974, the assessee had made an entry about the sale of those products thereby indicating that on that date those products were in excellent condition. The assessee had also obtained a certificate from the Government agency about these products being in good condition. The ITO also cannot ignore the fact that under the agreement, the assessee was required to store those products in the cold storage and to insure those products against the loss, damage or destruction. The ITO may take into account the subsequent events also, namely, about the handing over of the products to the receiver.
However, the ITO would not be bound to determine the value of the closing stock solely on the basis of what had happened subsequently. He has to take into account all the surrounding circumstances and to determine the value to be included in the closing stock as on 30-6-1974. We, therefore, modify the direction of the Commissioner (Appeals) on this point. We hereby direct that the ITO shall include the value of the products as on 30-6-1974 in the closing stock and the value to be included would be that determined by the ITO in accordance with the method of accounting regularly followed by the assessee and after taking into account all the surrounding circumstances mentioned above including those that may be brought to his notice by the assessee.
16. Now we come to the first item comprised in the total amount of Rs. 27,70,943, that item is of Rs. 7,45,380. As already stated, it represents the difference in the exchange rates in respect of frog legs shipments made between 21-9-1973 to 29-3-1974. The products in question have already been exported and the sale price has already been credited. This is an additional amount which the assessee claims that the assessee is entitled to receive from the ITC Ltd. because of the difference in the exchange rates. The assessee has not yet received this amount. There is no clause in the agreement between the parties under which this amount is payable. The assessee is claiming this amount on the basis of the past practice. The ITC Ltd. has in clear terms repudiated the claim of the assessee in respect of this amount in reply to the counterclaim in the litigation between the parties. Thus, this amount represents a disputed claim. The amount has not been received and there is merely a claim of the assessee, which is denied by the ITC Ltd. In these circumstances, mere fact that the assessee made an entry regarding this amount would not lead to an inference that this amount represented additional sale price receivable by the assessee from the ITC Ltd. For the reasons already given, we hold that this amount should be excluded from the total sales for computing the profits. We confirm the order of the Commissioner (Appeals) regarding this item on the above grounds.
17. Before parting with this appeal, we may point out that the learned departmental representative had brought to our notice the fact that there were some instances prior to 31-5-1974, when sale was credited prior to the shipment of goods and handing over of the documents to the ITC Ltd. These instances were pointed out in the statement of shipments filed by the assessee. We have not based our decision on the past practice of the assessee. We have relied on the agreement between the parties. As already stated by us, entries in the account books are not conclusive evidence of the rights and liabilities of the parties in respect of the transactions in question although they may constitute one of the pieces of evidence particularly in those cases where there is no agreement in writing which governed the impugned transactions. In the present case, there is an agreement in writing which governs the transactions with which we are concerned and, as such, the legal question as to whether the property in goods passed to the purchaser at a particular point of time shall have to be decided on the basis of interpretation of the terms of the agreement and not on the basis of unilateral entries made by the assessee in the books of account. In this view of the matter, we find it unnecessary to record any finding on the question whether the assessee had adopted a uniform practice of crediting the sale only after the shipment and handing over of the documents to the ITC Ltd. and not prior to that stage because nothing would turn on that finding in view of the express terms of the agreement.