1. The question referred to us for the assessment year 1964-65 is in the following terms :
'Whether, on the facts and in the circumstances of the case, and having regard to the principles of law and accountancy, the amount of Rs. 38,139 representing sales tax liabilities could be allowed as deductible expenses in the computation of income, profits and gains for the accounting year relevant to the assessment year 1964-65 ?'
2. The question has arisen in somewhat unusual circumstances. The assessed is an individual dealing in knitting wool : formerly he was a partner in a firm known as Gokal Chand Rattan Chand, but even as an individual he was carrying on business under the same name. The firm was dissolved on March 31, 1956, and then the assessed took over all assets and liabilities as shown by a dissolution deed dated June 8, 1956. The firm during its existence incurred sales tax liability amounting to Rs. 10,670 for the period April 1, 1953, to March 31, 1956. There was subsequently sales tax liability also on the individual business amounting to Rs. 27,469. Although the point is not explained in the statement of case, it seems there was some doubt as to whether sales tax was payable or not. In any event, a demand notice was issued on February 25, 1964, by which the sales tax authorities determined the liability of both the firm and the individual as Rs. 38,139 (Rs. 10,670 plus Rs. 27,469). This was for the periods 1953-54 to 1958-59. After receipt of the demand, entries were made in the accounts and deduction was claimed in the assessment year 1964-65. The manner in which the various authorities treated this deduction differed.
3. The ITO disallowed the deduction on the ground that the assessed claimed that the sales were not made at Bombay, but the sales tax authorities had raised the demand. He noted that the matter was still under dispute and not finally settled and also, that no documents had been produced nor orders from the authorities relating to the demand.
4. On appeal, the AAC was shown the documents and he held that the liability arose during the accounting period and, hence, was to be allowed. In other words, he allowed the deduction without any discussion in the order.
5. The Department appealed to the Income-tax Appellate Tribunal where different views were taken by the Accountant Member and the Judicial Member. The Accountant Member was of the view that the AAC was right, but the Judicial Member was of the view that the case was governed by the Supreme Court's decision in Kedarnath Jute Mfg. Co. Ltd. v. CIT : 82ITR363(SC) , and hence the liability did not relate to the assessment year in which the demand was raised but to those years in which the liability arose.
6. The matter was referred to a third member, who agreed with the Accountant Member. Now, the reference is before us in which it is contended that the view of the Judicial Member was correct.
7. Before proceeding with the case further, it may be mentioned that the third member analysed the judgment of the Supreme Court in Kedarnath Jute Mfg. Co.'s case : 82ITR363(SC) and also based his decision on a different point altogether. It was observed that the assessed could keep his accounts on the mercantile system or on cash basis or adopt a hybrid system of accounting. In this case, it was held that the sales tax liability had been recorded by the assessed on the basis of the demand notice and as this was the first occasion on which sales tax liability had been placed in the accounts, the year of accountancy adopted by the assessed allowed him to do so, but he could not later change the method. It may at once be said that the method of accountancy adopted by assessed cannot be varied particularly, as the assessed in this case was contesting the liability to pay the sales tax on the ground that no sales tax was payable at Bombay. We asked learned counsel for the assessed as to what was the point involved in the sales tax case. We were informed that the knitting wool in question was imported from abroad and than sold to another party and the question was as to whether the situs of the sale was at Bombay or elsewhere, i.e., the question was whether the liability arose at Bombay or not. He was not sure, but he seemed to think that the liability was still being contested.
8. Taking the question relating to Kedarnath Jute Mfg. Co.'s case : 82ITR363(SC) , we may mention that the assessed in question was following the mercantile system of accounting. Sales tax liability to the extent of Rs. 1,49,776 arose on account of sales tax determined to be payable for the calendar year 1954 relevant to the assessment year 1955-56. No claim for deduction for the said amount was raised by the assessed, but after the amount had been determined, the assessed filed a revised return and claimed the deduction. The case, thereforee, was that there was no entry in the account books and also no claim, but after the amount had been determined the assessed filed a revised return. The Calcutta High Court had held that unpaid and disputed sales tax liability could not form a basis of a claim for deduction for the purpose of Income-tax.
9. The Supreme Court held as follows (p. 367) :
'We are wholly unable to appreciate the suggestion that if an assessed under some misapprehension or mistake fails to make an entry in the books of account and although, under the law, a deduction must be allowed by the Income-tax Officer, the assessed will lose the right of claiming or will be debarred from being allowed that deduction. Whether the is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessed might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter. The assessed who was maintaining accounts on the mercantile system was fully justified in claiming deduction of the sum of Rs. 1,49,776 being the amount of sales tax which it was liable under the law to pay during the relevant accounting year.'
10. This is an authority for the proposition that even without an entry in the accounts, the claim can be raised in the relevant assessment year. But, what happens if the liability is not determined till much later In the present case, the demand was raised in February, 1964, but related to the period 1953-54 to 1958-59. Obviously, the assessed could not claim the deduction on the basis that it arose at a much earlier date. Perforce, the claim could only be raised after it had been determined as the assessment for all those years would be over long ago.
11. We are of the view that a liability which is settled before the assessment is over can be appropriated to the relevant year in accordance with the Supreme Court's judgment, but if the liability is raised, say, ten years later as appears to be the case here, then it cannot be appropriated to that year and has to be claimed at a later date or not at all.
12. The mercantile system of accounting visualises entries being made in the account books and claims being made in respect thereof when the income has either accrued or is receivable and similarly an expense has to be entered when the obligation arises or the liability to pay arises. The entries are made in anticipation of actual payments. In this case, on the facts, as the assessed was denying the liability to be taxed at Bombay, no entries could be made. If the demand had been raised in the period shortly after the year ended and before the assessment was completed, then on the basis of Kedarnath Jute Mfg. Co's case : 82ITR363(SC) , a revised return could have been filed and the deduction could have been allowed. But, if there is neither an entry nor a demand, it is difficult to visualise how the deduction could be claimed earlier than the actual demand.
13. We agree with the majority decision of the Tribunal that in such a case the entry could be made only when the demand was raised and not earlier and the principles settled by the Supreme Court in Kedarnath Jute Mfg. Co's case : 82ITR363(SC) , would also not be applicable because the demand was raised in 1964, whereas the assessment years were 1953-54 to 19958-59. So, there was no occasion or possibility of filing a revised return.
14. The question referred to us has been set out earlier and we note that it refers to principles of law and accountancy. The word 'accountancy' occurring in the question is very appropriate. We have to visualise what the assessed should do in the circumstances of the case where the liability is contested for several years and the demand is raised many years later. This situation can occur in many cases that come to mind, especially in a case where the validity of the tax or the validity of the demand is strongly contested for various reasons. In such a case, it often happens that the settlement of the liability takes place long afterwards and cannot possibly be raised earlier.
15. Learned counsel urged that the assessed should have put the demand several years earlier as the liability to pay sales tax arose with each sale. Of course, the liability arises at the time of each sale, but where the assessed takes the view that no liability arises and he cannot even quantify the liability, it is difficult to see how an entry can be made earlier. In any case, this is a matter for the assessed to deal with in his own way. It seems to us that it was open to the assessed to make the entry either on the basis of an accrual of liability or on the basis of the demand raised by the Department. Inasmuch as the third member of the Tribunal has noted that the entry made by the assessed was on the basis of the demand and no different system had been previously followed by the assessed, we think this is a case which can be easily decided on coming to the view that the assessed had adopted a hybrid system of accounting which was open to him and hence, on the principles of accountancy adopted by the assessed, the amount was a deductible expense for the assessment year 1964-65.
16. For the reasons stated above, we think that the decision in Kedarnath Jute Mfg. Co.'s case : 82ITR363(SC) , aforementioned, is limited to those cases in which the demand is raised by the sales tax department before the assessment has actually been completed, as no revised return can be filed after the assessment is over. Certainly, we do not see how in this case a revised return could have been filed because the demand was raised about five years after the last assessment year in question.
17. We may note also that in this very case the ITO himself was of the view that the deduction could not be allowed because it was premature inasmuch as the matter was still under contest and he passed the order in February, 1969. In fact, the ITO was of the view that the claim to deduction was premature. According to the Judicial Member, it was belated. These two totally opposing views on the same question reveal the difficulties involved by adopting a purely mercantile accountancy method to a disputed amount. Of course, if the matter is settled, it can be claimed in the relevant assessment year in which the liability arose, but if it is not settled, it can only be raised later.
18. Thus, both on account of the hybrid accountancy method adopted by the assessed and on the ground that the determination of the liability was not earlier than 1964, we are of the view that the question referred to us has to be answered in the affirmative, in favor of the assessed and against the Department. We leave the parties to bear their own costs.