1. The following question has been referred to us by the Income-tax Appellate Tribunal under s. 256(1) of the I.T. Act, 1961, for the assessment year 1967-68 :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right that no deduction of Rs. 36,916 was permissible from the total income towards the possible sales tax which might be levied on the assessed subsequently ?'
2. It will at once become apparent that the answer to the question has to be in accordance with the facts and circumstances of the case which, in fact, change the meaning of the question. In case, the assessed was keeping accounts on a cash basis and the sales tax had not been quantified, the answer to the question would obviously have been that the Tribunal was right. So, before answering the question, it is necessary to note the actual facts of the case.
3. The sales tax in question was payable under the U.P. Sales Tax Act. The assessment year being 1967-68, an amount of Rs. 36,916 had been provided by making entries in the account as sales tax payable for that year. No doubt, this sales tax had not been paid in fact to the authorities during the year but it was payable because the assessed was not contesting the fact that the amount was due.
4. The ITO disallowed the amount on the footing that the amount had not been paid. However, on appeal the AAC allowed the same in the light of the judgment of the Supreme Court in Kedarnath Jute Mfg. Co. Ltd., v. CIT : 82ITR363(SC) . He also found that in two subsequent years 1968-69 and 1969-70, the ITO had not even added back the amount.
5. When the Department's appeal was heard by the Tribunal, it came to the conclusion that there were the observations in the judgments of the Supreme Court, viz., Chowringhee Sales Bureau P. Ltd. v. CIT : 87ITR542(SC) and Sinclair Murray and Co. P. Ltd. v. CIT : 97ITR615(SC) , to the effect that sales tax collections were trading receipts in the hands of the trader and could be deducted as and when paid to the Government. From this, the Tribunal deduced that the entry could only be made after a demand had been made by the sales tax authorities and the amount was actually paid to the State Government concerned.
6. The question as to when an entry is to be made under the mercantile system of accounting was not examined in the two judgments of the Supreme Court. Of course, it is observed that the deduction is to be allowed at the time the amounts is paid to the State Government. But, when the mercantile system of accounting is followed, an amount which is payable is shown as already paid an amount which is receivable is shown as already received. This is the feature of the mercantile system of accounting. Hence, the assessed while following the mercantile system would show the amount as the already paid though not paid, and in the case of receipts would show the same as having been received though not yet received. This system of accounting has the effect of appropriating the credits and debts to the right year even if the actual receipts and payments may be at a different point of time. There is nothing which the assessed did which appears to be inconsistent with these two judgments of the Supreme Court.
7. It was urged by the learned counsel for the Department that what the Supreme Court meant was actual payment. But, that would mean that the assessed would be forced in this case to maintain the accounts on a cash basis as opposed to mercantile basis, and that would be contrary to the accounting system being used by the assessed. We, thereforee, think that there is nothing particularly wrong in the assessed claiming the amount as having been paid though not paid by following the mercantile system of accounting.
8. It may also be observed that Kedarnath Jute Mfg. Co. Ltd.'s case : 82ITR363(SC) , had allowed the deduction to be made even though no entry was made in the accounts by holding that the assessed could not, by making any mistake, change the year for which the liability had arisen. In that case, the assessed did not make an entry regarding the liability, nor was the deduction claimed in the return filed before the income-tax authorities. Before the income-tax could be decided by the ITO, the sales tax authorities had raised the demand and, thereforee, a revised return was filed including the sales tax which had not been included in the return nor in the accounts, as a deduction, and the Supreme Court held that the amount was to be allowed as a deduction and the Supreme Court held that the amounts was to be allowed as a deduction because it was appropriated to this particular year, i.e., the accounting year in question. In a similar manner, if the present assessed had not even made an entry but the amount of sales tax had been crystallised, a possible deduction might have been claimed in the return or in a revised return. We do not see any way in which the amounts could be appropriated to another year expect in a case where the demand was contested and could not be included in this particular year.
9. In Chowringhee Sales Bureau P. Ltd., v. CIT : 110ITR385(Cal) , the Calcutta High Court has also had an opportunity to examined the question whether deduction could be made on the mercantile system before the amount had been paid to the sales tax authorities and it has been held that in the mercantile system, this deduction can be allowed. So the question whether an entry can be made at a particular time or not depends not only on whether the amount is paid but also on the system of accounting maintained by the assessed.
10. We have recently had an opportunity to examined this matter in another case, Addl. CIT v. Rattan Chand Kapoor : 149ITR1(Delhi) . In that case, the sales tax liability was being contested by the assessed for a number of years. The demand was raised several years later and when raised was claimed as deduction. The case of the Department was that the amount could only be claimed in the appropriate year, i.e., in the year in which the liability to pay tax arose, and not in the year in which the demand was raised or the amount was actually paid. It will be seen that this plea is just the reverse of the present position.
11. We observed in that case that if the demand was treated as payable by the assessed, he could make the entry and claim the deduction in the year in which the liability arose, i.e., during the period when the sales took place. If the liability was contested, but unsuccessfully, the deduction could be made claimed by the assessed even by a revised return as held in Kedarnath Jute .'s case : 82ITR363(SC) . If the liability arose afterwards, and there was no earlier year to which it could be appropriated, because the income-tax cases were closed, then the assessed perforce had to make the entry and claim the deduction at the time the demand was raised, i.e., when the actual accrual had taken place. Another reason supporting this line, as mentioned in that judgment, was that a hybrid system of accounting could be adopted for this situation.
12. From these cases, it would appear that the normal method is to claim the amount in the year in which the liability arises, i.e., the year in which the sales take place. The liability did arise in the year in which the assessed made the entry in this case, though the actual quantification and the final demand for the same might be postponed to another year. If there is a variation in the amount now entered by the assessed, as a result of the acutal demand, then an adjustment in the accounts would be made at that time but the primary liability would be appropriated to the present year; the entry was rightly made and, thereforee, the deduction has to be allowed.
13. In the circumstances, we would answer the question referred to us in the negative, in favor of the assessed and against the Department. We also note that the question has to be read in the light of the facts particularly the fact that the assessed was using the mercantile system of accounting and in subsequent years this amount was allowed to be deductible without any objection by the Department. The parties are left to bear their own costs.