Leila Sheth, J.
1. The assessed is a registered firm dealing in the wholesale business of 'art' silk. During the assessment year 1970-71, the assessed purchased goods worth Rs. 86,002 from M/s. G.R. Co., Chandni Chowk, Delhi. The assessed paid for these purchases partly in cash and partly by issuing crossed cheques. The cash payments were as follow :
Rs.1. 15-4-1969 4,5002. 21-7-1969 6,5003. 11-3-1969 4,5004. 26-8-1969 5,5005. 18-11 1969 4,000-----------24,500
2. Section 40A(3) of the I.T. Act (to be referred to in short as 'the Act') was introduced in respect of which payment was made of a sum exceeding Rs.2,5000 otherwise than by a crossed cheque or a crossed bank draft. It was made applicable from April 1, 1969. However, certain exceptions were specified in rule 6DD of the I.T. Rules, 1962.
3. Before the ITO the assessed stated that the abovementioned cash payments should be treated as payments towards the old credit balance of Rs. 75,684 which was outstanding on April 1, 1969. But the ITO observed that the copy of the accounts of M/s. G.R. Co., Chandni Chowk, Delhi, revalued that payments amounting to Rs. 72,500 had been received by crossed cheques and cash by July 9, 1969. Thus, relying on the principles of accountancy, be adjusted the old balance in chronological order and, after deducting the payment of Rs. 72,500 from Rs. 75,684. held that there was a balance of Rs. 3,184. This amount was again chronologically adjusted against the first payment made thereafter on July 21, 1969. The said payment of Rs. 6,500 was made in cash. Subtracting the amount of Rs. 21,316 was to be disallowed in terms of s. 40A(3) of the Act.
4. On appeal by the assessed, the AAC affirmed the order of the ITO.
5. On further appeal the learned Accountant Member of the Income-tax Appellate Tribunal noted that it was not disputed that the sum of Rs. 75,684 was due from the assessed to M/s. G.R. Co., Chandni Chowk, Delhi, for purchases made prior to April 1, 1969. He observed that this sum had become a loan due from the assessed to said M/s. G.R. Co. He also noticed that the Finance Ministry issued a press note on May 2, 1969, with a view to clarifying the provisions pertaining to payment of sums exceeding Rs. 2,500 (s. 40A(3)). The said note provided that the said provisions applied to payments made on or after April 1, 1969. Further payments made under contracts entered into before April 1, 1969, would be excluded from the purview of s. 40A(3), if required by the contract to be paid in cash. He also noticed that the advancing of a loan or repayment of the principal amount of the loan did not constitute an expenditure deductible in computing the taxable income; but the interest payment of amounts exceeding Rs. 2,500 at a time were required to be made by crossed bank cheques or drafts as interest is a deductible expenditure.
6. The said Member, after considering the circumstances of the case, accepted the assessed's contention that the amount of Rs. 75,684 due on April 1, 1969, was a loan and repayment thereof did not constitute 'expenditure'. He also accepted the further contention of the assessed that the ITO was not justified in cash related to the subsequent about transactions of purchases made during the year, especially as s. 40A(3) was a new section and an understanding already reached with the creditor about the mode of payment could not be disregarded. The genuineness of the payments and the identity of the payee not being in doubt, it was not necessary to adjust the amounts paid in the same order in which the liability was incurred, especially as most of the payments were by cheques and just a few, not involving large amounts, were in cash. As such he deleted the addition of Rs. 21,316 made by the authorities below.
7. The learned Judicial Member agreed with the conclusion of the Accountant Member. In doing so, however, he did not agree with the entire reasoning and observed that no exceptional circumstances had been brought out to indicate why the payments were made in cash rather than by crossed cheques; nor was he of the view that the amount due had become a loan. But he was of the view that 'expenditure' under s. 40A(3) had 'reference to expenses incurred by an assessed in the course of carrying on his trading activity'. Such expenses were distinct from the payment of price for merchandise in which the assessed was trading; this price not being deductible from the gross profits but the profits being determined after taking into account the purchase price and the price at which the assessed disposed of the merchandise. Though he noticed that rule 6DD envisaged payment of price to be also by crossed cheque he felt that the rules were clarificatory of the main section and could not go beyond the scope of the main provision.
8. The Commissioner being aggrieved moved the Income-tax Appellate Tribunal to state a case and refer for our opinion a question of law. As the Tribunal was of the view that a question of law did arise out of its order it referred the following question for our consideration :
'Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that the payment of Rs. 21,316 made by the assessed to various creditors are not covered under the head 'Expenditure' under section 40A(3) of the Income-tax Act, 1961, and thus deleting the addition of Rs. 21,316 made by the Income-tax Officer under section 40A(3) of the Income-tax Act, 1969 ?'
9. In order to appreciate the point in issue it is necessary to examine the relevant provisions. Section 40A(3) reads as follow :
'Where the assessed incurs any expenditure in respect of which payment is made, after such date (not being later than the March 31, 1969, as may be specified in this behalf by the Central Government by notification in the Official Gazette, in a sum exceeding two thousand five hundred rupees otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, such expenditure shall not be allowed as a deduction :
Provided that where an allowance has been made in the assessment for any year not being an assessment year commencing prior to the April 1, 1969, in respect of any liability incurred by the assessed for any expenditure and subsequently during any previous year the assessed makes any payment in respect thereof in a sum exceeding two thousand five hundred rupees otherwise than by a crossed bank draft, the allowance originally made shall be deemed to have been wrongly made and the Income-tax Officer may recompute the total income of the assessed for the previous year in which such liability was incurred and make the necessary amendment, and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of that section being reckoned from the end of the assessment year next following the previous year in which the payment was no so mad :
Provided further that no disallowance under this sub-section shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, in such cases, and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, consideration of business expenditure and other relevant factors.'
10. Rule 6DD prescribes the cases and circumstances in which payment in a sum exceeding Rs. 2,500 may be made otherwise than by a crossed cheque drawn on a bank or a crossed bank draft. The relevant provisions are as under :
'6DD. Cases and circumstances in which payment in a sum exceeding two thousand five hundred rupees may be made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft. - No disallowance under sub-section (3) of section 40A shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft in the cases and circumstances specified hereunder, named :-....
(e) where the payment is made by way of adjustment against the amount of any liability incurred by the payee for any goods supplied or services rendered by the assessed to such payee;....
(j) in any other case, where the assessed satisfies the Income-tax Officer that the payment could not be made by a crossed cheque drawn on a bank or a crossed bank draft -
(1) due to exceptional or unavoidable circumstances, or
(2) because payment in the manner aforesaid was not practicable, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement thereof, and also furnished evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.'
10. Two points were in issue before u : (1) the scope of the word 'expenditure' in s. 40A(3); and (2) the aspect of appropriation of payments towards amounts due.
11. Counsel for the revenue wanted us to hold that expenditure as referred to in s. 40A(3) is not confined to such expenditure as can be claimed as a deduction under s. 37 but includes payments for purchase of stock. He contends that the word 'expenditure' is a word of wide import and relied on various decision of the Allahabad and Punjab & Haryana High Courts to support this contention. These are U.P. Hardware Store v. CIT : 104ITR664(All) , Ratan Udyog v. ITO : 109ITR1(All) , CIT v. Grewal Group of Industries .
12. Counsel for the assessed, however, wanted us to hold, as had been done by the learned Judicial Member, that the word 'expenditure' under s. 40A(3) had reference only to expenses incurred by the assessed in the course of carrying on his trading activity; and that this was distinct from the payment made for the purchase price of stock-in-trade or raw materials. Learned counsel submitted that there was a clear distinction between business expenditure and business or trading loss. Relying on a decision of the Supreme Court in CIT v. S. C. Kothari : 82ITR794(SC) , it was contended that monies spent for purchase of stock-in-trade is investment and not expenditure; as such the monies spent in the present case for purchase of art silk was an investment and not expenditure and outside the purview of s. 40A(3). This was further supported by indicating the difference between s. 40A(2) which deals specifically with expenditure pertaining to goods, service or facilities whereas s. 40A(3) does not so provide. Also r. 6DD(e) specifically excludes from the ambit of s. 40A(3) payments made by way of adjustment against amounts of any liability incurred by the payee for any goods supplied or services rendered by the assessed to such payee. As a result it was submitted that the meaning to be attributed to the word 'expenditure' in the present context is what is permissible under s. 10(2)(xv) of the 1922 Act, or s. 37 of the 1961 Act. The case of Escorts (Agents) P. Ltd. v. CIT : 80ITR61(Delhi) has been relied on for this proposition.
13. The question as to the scope of the word 'expenditure' in sub-s. (3) of s. 40A raise an interesting issue. However, in view of the decision that we are going to take with regard to the second point urged before us, we feel that it is not necessary to decide this wider question and it can be determined in a more appropriate case.
14. Coming then to the question of appropriation of payments to the amounts due, it is necessary to examine ss. 59, 60 and 61 of the Indian Contract Act, 1872. The question posed is whether the first item on the debit side of the account has to be discharged or reduced by the first item on the credit side, i.e., chronologically Mr. Wadhera, for the revenue, relying on the rule in Clayton's case  1 Mer. 572, and s. 61 of the Indian Contract Act, so contended.
15. Section 61 provides that where neither party makes any appropriation the payment shall be applied in discharge of the debts in order of time. The point to be noticed is that this section comes into operation when a debtor from whom distinct debts are due makes a payment but neither he nor the creditor makes any apportionment. According to s. 60 of the Indian Contract Act, if the debtor or the circumstances do not indicate the appropriation, the creditor is entitled to do so. This right only terminates when the creditor has made an appropriation and communicated it to the debtor. But it is only when neither party has manifested his intention concerning the application of payment that appropriation has to be made in accordance with the provision of s. 61 and the court in doing so has to reach an equitable result. In the case of a running account, the normal assumption is that the payment is towards the earlier items in the account.
16. However, s. 59 provides that where a debtor owing several distinct debts to one person, makes a payment, to him, either with, express intimation, or under circumstances implying that the payment is to be applied to the discharge of some particular debt, the payment, if accepted, must be applied accordingly. It is, thereforee, clear that a debtor is entitled to make payment towards any debt. Thus, appropriation is a matter firstly for the debtor; failing him the creditor; and only thereafter does the rule of order of time as provided in s. 61 come into play.
17. However, it is clear that the above are not strict or automatic rules of thumb applicable in all circumstances; they have been laid down to govern situation in the absence of anything in the circumstances to show the attitudes of the contracting parties whose mutual rights against each other will depend on the manner of the adjustments intended by the one or the other. But where the parties are silent or unaffected, can the revenue step into the shoes of the creditor or otherwise intervene or intermeddle in such a contractual field to say that the payments should be adjusted in a particular manner We think not.
18. In Smith v. Law Guarantee and Trust Society Ltd.  2 Ch 569 , a debenture trust deed executed by a company provided that the trustees should appropriate the proceeds of the realisation of the securities firstly towards interest and then towards interest and then towards principal. The company made default and in the proceedings to enforce the securities and carry the provisions of the deed into execution, orders were made from time to time. Initially under these orders payments were made to the debenture-holders by way of interest but subsequent orders of payment to the debenture-holders were for payment towards principal and interest generally and it was common ground that if all the payments made to the debenture-holders were attributed to principal that would be insufficient to discharge the full amount due. The Inland Revenue intervened to claim that all the payments made on account generally ought to be attributed to interest in the first place and that tax ought to be deducted there from. Byrne J. decided that the provisions in the trust deed for payment of interest in the first place was inserted for the benefit of the debenture-holders, and could be waived by them in the absence of opposition by the debtors; that, as between themselves and the trustees, the debenture-holders must elect whether they would take the money as principal or interest, without prejudice to the question whether in their hands it would be treated differently. This was substantially affirmed by the Court of Appeal. Romer L.J. pointed out that, when the Crown raised a question in this regard, the debenture-holders were entitled to sa : 'This estate is insolvent; it is to our interest now to have these sums appropriated, if they have not been already appropriated to capital and we ask the court to do this'.
19. The above principal was applied by the Privy Council in CIT v. Maharajadhiraja Kameshwar Singh of Darbhanga  1 ITR 94 . Lord Macmillan observed at pp. 108, 10 :
'Moreover, if the question were one ... between debtor and creditor the assessed might up to the last moment appropriate the (sum) to capital account ... and there is authority for the proposition that in a question with the revenue the taxpayer is entitled to appropriate payments as between capital and interest in the manner least disadvantageous to himself : Smith v. Law Guarantee and Trust Society Ltd.  2 Ch 569 . Their Lordships have also not omitted to bear in mind the provisions of ss. 60 and 61 of the Indian Contract Act, though these were not relied on in argument as applicable to the case.'
20.The Madras High Court applied this rule in Chidambaram Chettiar v. CIT  62 ITR 774. It is sufficient to extract the headnote at p.77 :
'Between a creditor and debtor, in the absence of the debtor expressing preference it may be presumed that the creditor has appropriated an open payment by the debtor towards outstanding interest and then only to the principal. Under the Chetty system of accounting, which is a combination of mercantile and cash system of accounting, the practice is to credit part -payment by debtors first towards principal and the balance, if any, towards interest. But this rule of appropriation has no application where it is a question between an assessed and the revenue, and the taxpayer is entitled to appropriate open payments as between capital and interest in the manner least disadvantageous to himself.'
21. The decision was partly reversed by the Supreme Court (vide CIT v. Chidambaram Chettiar : 80ITR467(SC) , but the applicability of the principal was not doubted. On the contrary, the Supreme Court approved Lord Macmillan's dictum. It was held, however, that the High Court had erred in drawing there from a rule that, in the absence of appropriation by the parties, any payment should be appropriated towards principal. It was pointed out that whereas in the case before the Privy Council, it was advantageous for the assessed to have the payment adjusted against principal, in the case before them it was decidedly advantageous for him to appropriate it towards interest and that was also what he did.
22. Applying the above principal, that the assessed is entitled to appropriate payments in the manner least disadvantageous to himself, to the present case, we think that the assessed is entitled to say that the cash payments may be treated as having been made in payment of purchases, effected prior to April 1, 1969, and this, it would appear to us, is the assessed's attitude and approach. Though the assessed may not have expressed itself explicitly with regard to the appropriation, it is clear that this was its intention. This can be gathered from, inter alia, its written reply dated August 24, 1971, filed before the ITO. It has specifically stated therein that these cash payments should be adjusted against the old credit balance of Rs. 75,684 and the payments by way of cheques be treated as having been made for the purchases made during the year under consideration. The ITO treated the written reply as untenable. He held that it disregarded the principles of accountancy which required adjustment chronologically. However, he failed to appreciate that the assessed was entitled to have the payments applied to the discharge of a particular debt for the reasons discussed above.
23. For the reasons outlined above, we are in agreement with the conclusion of the learned Accountant Member of the Tribunal that in the circumstances of the case, the cash payments must be deemed to have been adjusted against the earlier sums due to M/s. G.R. Co. on April 1, 1969.
24. As already noted, we do not propose to answer the first part of the question which deals with whether the amount spent for purchases constitutes 'expenditure', but we answer the second part by saying that the Tribunal was right in deleting the addition made by the ITO. As the assessed has succeeded, it will be entitled to costs. Counsel's fee Rs. 350.