Leila Seth, J.
(1) The assessed is a registered firm dealing in the wholesale business of 'art' silk. During the assessment year 1970-71, relevant previous year being the financial year 1969-70, 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 follows :
1. 15-4-1969 Rs. 4,500.00 2. 21-7-1969 Rs. 6,500.00 3. 11-3-1969 Rs. 4,500.00 4. 26-8-1969 Rs. 5,000.00 5. 18-11-1969 Rs. 4,000.00 Rs. 24,500.00
(2) Section 40A(3) of the Income-tax Act (to be referred to in short as 'the Act') was introduced in 1969. It provided for disallowance of any expenditure in respect of which payment was made of a sum exceeding Rs. 2,500.00 otherwise than by a crossed cheque or a crossed bank draft. It was made applicable from 1st April, 1969. However, certain exceptions were specified in rule 600 of the Income-tax Rules, 1962.
(3) Before the Income-tax Officer the assessed stated that the abovementioned cash payments should be treated as payments towards the old credit balance of Rs. 75,684.00 which was outstanding on 1st April, 1969. But the Income-tax Officer observed, that the copy of the accounts of M/s. G.R. Co. Chandni Chowk, Delhi revealed that payments amounting to Rs. 72,500.00 had been received by crossed cheques and cash by 9th July, 1969. Thus, relying on the principles of accountancy he adjusted the old balance in chronological order and after deducting the payment of Rs. 72,500.00 from Rs. 75,684.00 held that there was a balance of Rs. 3,184.00 . This amount was again chronologically adjusted against the first payment made thereafter on 21st July, 1969. The said payment of Rs. 6,500.00 was made in cash. Subtracting the amount of Rs. 3,184.00 from the total cash payment of Rs. 24,500.00 he held that the sum of Rs. 21,316.00 was to be disallowed in terms of section 40A(3) of the Act.
(4) On appeal by the assessed the Appellate Assistant Commissioner affirmed the order of the Income-tax Officer.
(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. 75,6841/ was due from the assessed to M/s. G.R. Co., Chandni Chock, Delhi for purchases made prior to 1st April, 1969. He observed that this sum had become a loan due from the assessed to the said M/s. G.R. Co. He also noticed that the Finance Ministry issued a press note on 2nd May, 1969 with a view to clarifying the provisions pertaining to payments of sums exceeding Rs. 2,500.00 (section 40A(3). The said note provided that the said provisions applied to payments made on or after 1st April, 1969. Further that payments made under contracts entered into before 1st April, 1969 would be excluded from the preview of section 40A(3), if required by the contract to be paid in cash. He also noticed that 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 interest payments of amounts exceeding Rs. 2,500.00 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. 75,684.00 due on 1st April, 1969 was a loan and repayment thereof did not constitute 'expenditure'. He also accepted the further contention of the assessed that the Income-tax Officer was not justified in considering that payments by cheques covered the earlier transactions while payments in cash related to subsequent transactions of purchases made during the year especially as section 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. 21,316.00 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 or unavoidable circumstance had been brought out to indicate why the payments were made in cash rather than by crossed cheques; nor was he of the opinion that the amount due had become a loan. But he was of the view that 'expenditure' under section 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 is 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 assesses disposed of the merchandise. Though he noticed that rule 600 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 :
'WHETHERon the facts and 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, 1961 ?'
(9) In order to appreciate the point in issue it is necessary to examine the relevant provisions. Section 40A(3) reads as follows :
'WHEREthe assessed incurs any expenditure in respect of which payment is made, after such date (not being later than the 31st day of March, 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 1st day of April, 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 cheque drawn on a bank: or 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 so made : 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 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, considerations of business expediency and other relevant factors.'
(10) Rule 600 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 :
'600,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, namely : (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 by 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 furnishes evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.'
Two points were in issue before us :
(1)the scope of the word 'expenditure' in section 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 section 40A(3) is not confined to such expenditure as can be claimed as a deduction under section 37 but includes payments for purchase of stock. He contends that the word 'expenditure' is a ward of wide import and relied on various decisions of the Allahabad and Punjab & Haryana High Court to support this contention. These are U.P. Hardware Store v. Commis. of Income-tax U.P. : 104ITR664(All) , Ratan Udyog v. Income-tax Officer, Kanpur and another : 109ITR1(All) , Commissioner of Income-tax v. M/s. Grewal Group of Industries, 1977 C TR 117, and Commissioner of Income-tax, Patiala v. Avtar Singh and Sons .
(12) Counsel for the assessed, however, wanted us to hold, as had been done by the learned Judicial Member, that the word 'expenditure' under section 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 is a clear distinction between business expenditure and business or trading loss. Relying on a decision of the Supreme Court in Commissioner of Income-tax, Gujarat 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 an expenditure and outside the purview of section 40A(3). This was further supported by indicating the difference between section 40A(2) which deals specifically with expenditure pertaining to goods, services or facilities whereas section 40A(3) does not so provide. Also rule 60(8) specifically excludes from the ambit of section 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 section 10 (2) (xv) of the 1922 Act or section 37 of the 1961 Act. The case of Escorts (Agents) P. Ltd. v. Commissioner of Income-tax, Delhi : 80ITR61(Delhi) has been relied on for this proposition.
(13) The question as to the scope of the word 'expenditure' in sub-section (3) of section 40A(3) raises 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. Coming then to the question of appropriation of payments to the amounts due, it is necessary to examine sections 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, 1814 All E.R.I and Section 61 of the Indian Contract Act, so contended.
(14) 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 section 68 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 an intention concerning the application of payment that appropriation has to be made in accordance with the provisions of section 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.
(15) However, section 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 that exists and the creditor has to appropriate the money towards that 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 section 61 come into play.
(16) 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 situations 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 uneffected, 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.
(17) In Smith v. Law Guarantee and Trust Society Ltd., (1904) 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 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 I 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 say: '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'.
(18) The above principle was applied by the Privy Council in an early Dharbanga case (Commissioner of Income-tax v. Maharajadhiraj Kameshwar Singh of Dharbhanga, (1933) 1 I.T.R. 94, Lord Macmillan observed (at pp. 108-9):
'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 tax-payer 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. : 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.'
The Madras High Court applied this rule in Chidambaram Chettiar v. Commissioner of Income-tax, (1960) 62 I.T.R. 774. It is sufficient to extract the head note at page 775:
'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 systems of accounting, the practice is to credit part-payment by debtors first towards principal and the balances, 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.'
The decision was partly reversed by the Supreme Court: (vide Commissioner of Income-tax v. Chidambaram Chettiar : 80ITR467(SC) but the applicability of the principle was not doubted. On the contrary, the Supreme Court approved Lord Mecmillan'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.
(19) Applying the above principle, that the assessed is entitled to appropriate payments in the manner least disadvantageous to himself, to the present case, we think the assessed is entitled to say that the cash payments may be treated as having; been made in payment of purchases effected prior to 1st April, 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 writen reply dated 24th August, 1971 filed before the Income-tax Officer. 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 by treated as having been made for the purchases made during the year under consideration. The Income-tax Officer 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.
(20) 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 1st April, 1969.
(21) 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 Income-tax Officer. As the assessed has succeeded, it will be entitled to costs: Counsel's fee Rs 350.