1. Since both these matters arise out of one and the same case, We will dispose of both of them by this common judgment. In the income-tax reference the following question has been referred to us -
'Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the remuneration forgone by the assessee was not income liable to tax is erroneous in law.'
2. This question has been referred to us at the instance of the revenue.
3. Along with the question which has actually been referred to us, the revenue also waited the following two questions to be referred to us :
'(1) Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the assessee had explained the sources of Rs. 38,000 is based on no material on record and is perverse in law
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in reducing the income of the assessee from Rs. 58,000 to Rs. 10,200 ?'
4. At the time of making the reference, the Tribunal found that a question of law did arise so far as the question which has been actually referreed to us is concerned but the remaining two questions were not referred to the High Court because the Tribunal felt that those two questions merely pertained to questions of fact and appreciation of evidence and there was no question of law. Thereafter, the Commissioner of Income-tax, Gujarat II, has filed the income-tax application requesting that the two questions which were not referred by the Tribunal should also be considered or a statement of the case should be called for from the Tribunal regarding these two questions.
5. The facts leading to this reference are as follows. The assessment year under consideration is assessment year 1963-64. The assessee is an individual and the previous year, that is, the accounting period, is the calendar year 1962. Prior to January 1, 1962, the assessee was carrying on his own business as an individual and the business was of manufacture and sale of chemicals. With effect from January 1, 1962, the business of the assessee was transferred to a private limited company, namely, Accollete Chemicals private Limited. The assessee was appointed a director of the company on remuneration of Rs. 400 per month. It appears that in 1962 the company incurred heavy losses and by its resolution dated March 18,1963, the board of directors of the company accepted the suggestion of the assessee in his capacity as a director of the company that the directors should waive their right of remuneration for the year 1962 looking to the heavy losses suffered by the company. Consequent to this resolution the assessee waived his right of remuneration of sum of Rs. 4,800 which had become due to him for the calendar year 1962, that being the relevant previous year for assessment year 1963-64. The Income-tax Officer assessed the remuneration of Rs. 4,800 as part of the income of the assessee in spite of the waiver on the part of the directors as regards their remuneration. When the matter was taken in appeal, the Appellate Assistant Commissioner who decided the matter ex parte because the assessee did not remain present in spite of several opportunities given to him, the decision of the Income-tax Officer was upheld as regards this amount of remuneration aggregating to Rs. 4,800. The assessee took the matter in further appeal before the Income-tax Appellate Tribunal and when the matter was finally decided by the Tribunal, the contention of the assessee was accepted because the Tribunal come to the conclusion that the assessee having forgone the remuneration due to him, the question of assessing the same in his hands did not arise and the Tribunal, accordingly, deleted the amount of Rs. 4,800 and thereafter the question regarding the remuneration forgone by the assessee came to be referred to us at the instance of the revenue.
6. As regards the other two questions the facts giving rise to those question are that in 1962 the assessee in his individual capacity, reduced his liabilities in the aggregate sum of Rs. 1,05,892. Out of this total amount it was found that the assessee had withdrawn a sum of Rs. 57,140 during the calendar year 1962 and to that extent he had been able to explain his reduction of liabilities. The amount of Rs. 48,752, the balance, was not explained according to the Income-tax Officer and that was treated as income in his hands. Over and above this amount of Rs. 48,752 it was found by the Income-tax Officer that no amount had been withdrawn by the assessee for his household expenses in the year of account and an amount of about Rs. 5,000 was added and ultimately the Income-tax Officer came to the conclusion that Rs. 53,200 should be added as the income of the assessee taking it as a round figure. When the matter was taken in appeal before the Appellate Assistant Commissioner and ultimately the matter was decided ex parte though on merits, the Appellate Assistant Commissioner upheld the conclusion of Before the Tribunal the explanation given on behalf of the assessee was that in the calendar year 1961 he had withdrawn a sum of Rs. 59,409 and kept the amount with him and from that amount he had utilised an amount of Rs. 4,500 to Rs. 4,700 for the purpose of his household expenses and the balance amount was utilised for the purpose of liquidating his liabilities in the calendar year 1962. Particulars as regards the date of withdrawal and the amount withdrawn were supplied by the assessee before the Income-tax Officer but he had not led evidence in support of this explanation and the Income-tax Officer held that the explanation of the assessee was not supported by any evidence. Consequently, he came to the conclusion that the sum of Rs. 52,200 should be treated as income from undisclosed sources. The Tribunal held that as regards the discharge of the liabilities of the value of Rs. 58,752 in the statement which the assessee had given before the Income-tax Officer on February 24, 1968, the assessee had given particulars of the withdrawals for a sum of Rs. 43,112 only even though in the preamble of the explanation, the assessee had stated that the withdrawals were of Rs. 59,409. No particulars of the difference between Rs. 59,409 and Rs. 43,112 having been giving by the assessee, the Tribunal came to the conclusion that it could not be held that the withdrawals of that amount were duly explained by the assessee. The Tribunal held that the assessee had explained the source of the repayment of the liabilities of the value of Rs. 38,000 only and hence the assessee was liable to pay tax on the unexplained income of Rs. 10,200 only and the Tribunal treated that amount of Rs. 10,200 as income from undisclosed sources. It is in the light of these facts that the two other questions which the revenue wants to be referred to the High Court were suggested before the Tribunal but were turned down by the Tribunal. The first of these two questions which has not been referred to us is regarding the sum of Rs. 38,000 having been explained by the assessee and the second question is about the reduction of the amount from Rs. 58,000 to Rs. 10,200. It may be explained that the Tribunal having given the benefit of the waiver in the sum of Rs. 4,800 and Rs. 38,000 as having been treated as properly explained by the assessee, the balance of Rs. 10,200 from the aggregate of Rs. 58,000 was held to be the find amount which, according to the Tribunal, would be brought to tax and that is the subject-matter of the second question.
7. As regards the two questions which have not been referred to us by the Tribunal, it must be observed that the whole thing turns upon appreciation of facts. The Tribunal found that the assessee had given particulars of the withdrawals both as regards dates and amounts and the Tribunal found that explanation satisfactory. It cannot be said that there was no evidence before the Tribunal to come to the conclusion that the amount of Rs. 38,000 has been properly explained by the assessee. Under these circumstances the Tribunal was right in holding that question No.(1) which was not referred to us, namely, regarding Rs. 38,000 was a pure question of fact and that no question of law had arisen regarding this amount of Rs. 38,000.
8. As regards the second question which has not been referred to us, once it is found that the question as regards the amount of Rs. 38,000 is purely question of fact and not of law, the consequential question regarding the reduction of the income from Rs. 58,000 to Rs. 10,200 was also purely a consequential question of fact. Of course, if we come to the conclusion that the amount of Rs. 4,800 could not be deducted, then that amount will be added back at the appropriate stage but that depends upon a consideration of a pure question of law. We, therefore, come to the conclusion that Income-tax Application No. 2 of 1975 should be rejected with no order as to costs.
9. As regards the main question which is referred to us it must be borne in mind that this amount of Rs. 4,800 was on the basis of remuneration to be paid to the assessee as a director and the remuneration was on the basis of salary being paid by the company to the director for regularly working for the company. This amount was to be received by the assessee as an employee of the company and would be liable to be brought to tax under the head of 'Salary' under the Income-tax Act 1961. Under section 15 of the Income-tax Act, 1961, it has been provided - 'The following income shall be chargeable to income-tax under the head 'Salaries' -
(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not.'
10. By sub-section (c) of section 15 it is provided -
'any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.'
11. The Explanation to section 15 provided :
'For the removal of doubts, it is hereby declared that where any salary paid in advance is included in the total income of any person for any previous year it shall not be included again in the total income of the person when the salary becomes due.'
12. The provisions of section 15(a) and the Explanation emphasise that the salary is to be treated as income when it become due and even if it is not paid to him, it is chargeable to income-tax under the head 'salaries' if it fell due in the relevant previous year. By virtue of the Explanation to section 15, if however the amount has been received in advance and the amount received is included in the total income of the previous year in which the amount was received, then it is not to be included again in the total income of the previous year in the course of which the salary became due. Unlike incomes falling under other heads of income, as regards salaries, the principle under section 15 is that the income becomes chargeable to tax with reference to the previous year in which it fell due, not on the basis of actual receipt but on the basis of the amount becoming due. The Supreme Court in various decision has considered the question of income when the accounts are maintained on mercantile basis as distinguished from actual receipt basis and has held that what has to be looked at is the substance of the transaction and the real character of the whole course of conduct and not merely the accrual part of it. But Mr. Kaji for the revenue is right when he contends that those general observations cannot help the particular assessee in respect of income under the head 'Salaries'.
13. We find reference to the real income principle in H. M. Kashiparekh & Co., Ltd. v. Commissioner of Income-tax. The assessee was a limited company and it maintained its accounts accounts on the mercantile system. It was the managing agent of a paper mill company. Under the managing agence agreement it was under a duty to forgo up to one-third of its commission where the profits of the managed company were not sufficient to pay a dividend of 6 per cent. For the accounting year ending March 31, 1950, the assessee earned a commission of Rs. 1,17,644, but as a result of resolutions passed by the managed company and the assessee-company, the assessee gave up a sum of Rs. 97,000 in December, 1950. The Appellate Tribunal held that the maximum amount the assessee was bound to forgo was only Rs. 39,215 and included the balance of the amount forgone, viz., Rs. 57,785, in the taxable income of the assessee. The Tribunal at the same time held that the sum of Rs. 57,785 was given up for reasons of commercial expediency. On these facts the Bombay High Court held that it was the real income of the assessee-company for the accounting year that was liable to tax and that the real income could not be arrived at without taking into account the amount forgone by the assessee. In ascertaining the real income the fact that the assessee followed the mercantile system of accounting did not have any bearing. The accrual of the commission, the making of the accounts, the legal obligation to give up part of the commission, and the forgoing of the commission at the time of the making of the accounts were not disjointed facts : there was a dovetailing about them which could not be ignored. The real uncome of the assessee was Rs. 27,644 and the amount of Rs. 97,000 forgone by the assessee could not be included in the real income of the assessee for the accounting year. The High Court observed :
'The principle of real income is not to be subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect of managing agency commission is made, agreed to or given on grounds of commercial expediency, simply because it takes place some time after the close of an accounting year. In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinnaire aspect of it. It will lay greater emphasis on the business aspect of the matter viewed as a whole when that can be done without disregarding statutory language.'
14. The High Court observed in that case that surrender of commission had been made bona find and as a matter of commercial expediency and at an early point of time when accounts were made up. As observed earlier, the High Court found that there was a dovetailing about the aspect of giving up of the commission which could not be ignored.
15. The decision of the Supreme Court in Commissioner of Income-tax v. Shoorji Vallabhdas & Co., is on the same lines as the decision in H. M. Kashiparekh & Co., Ltd.'s case. The Supreme Court there pointed out that income-tax is a levy on income. Though the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt, yet the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a 'hypothetical income', which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstance, have been made in the books of account. This was not a case of a gift by the assessee to the managed companies of a portion of income which had already accrued, but an agreement to receive a lesser remuneration than what had been agreed upon. The assessee had, in fact, received only the lesser amount in spite of the entries in the account books, and this lesser amount alone was taxable.
16. The decisions of the Supreme Court in Commissioner of Income-tax v. Harivallabhadas Kalidas & Company and Commissioner of Income-tax v. Chamanlal Mangaldas & Company also turn on the same principles as the decision in Commissioner of Income-tax v. Shoorji Vallabhdas & Co It was found in Commissioner of Income-tax v. Harivallabhadas Kalidas & Co., that the managing agent's commission did not accrue as and when the sale took place and it could not be held, therefore, that as a result of their agreeing to the modification of the agreement, the managing agents had voluntarily relinquished a portion of their commission. On the other hand, under the original agreement the managing agents were entitled to receive commission only at the end of the year and before then the agreement was varied modifying its terms as from the beginning of the accounting year, and the amount could not, therefore, be treated as the income of the managing agents. In Commissioner of Income-tax v. Chamanlal Mangaldas & Co., the Supreme Court held that the clause in regard to commission had to be read as one integrated whole and so read it meant that the right of the managing agents to receive the commission or its accrual was at the end of the accounting year when all the sales were and could be added up and the accounts were made up. The amount which alone accrued or which they were entitled to received was the lesser sum and not what would have been payable had there been no modification of the agreement. The agreement was one integrated and indivisible whole and that the managing agent;s commission was only determinable and accrued when the year was over. It was then found, as a matter of fact, in that particular case, that the agreement to take amount of commission was before the accounts of the relevant accounting year were made up.
17. As against these decisions in Commissioner of Income-tax v. Shoorji Vallabhdas & Co., Commissioner of Income-tax v. Harivallabhadas Kalidas & Co. and Commissioner of Income-tax v. Chamanlal Mangaldas & Co., there is a decision of the Supreme Court in Morvi Industries Ltd. v. Commissioner of Income-tax. In that case the assessee was the managing agents of its subsidiary company and was maintaining its accounts on the mercantile system. It was entitled to receive an office allowance of Rs. 1,000 per month, a commission of 121/2 per cent. of the net profits of the managed company and an additional commission of 11/2 per cent. on all purchases of cotton and sales of cloth and yarn. In the two accounting years, the total amounts including the office allowance which the assessee was entitled to receive came to Rs. 50,719 and Rs. 13,963 for the two years of account. Under the particular clause of the managing agency agreement the commission was due to the assessee on December 31, 1954, and December 31, 1955, respectively. By resolutions of its board of directors dated April 4, 1955, and June 19, 1956 (that is after the commission had become due but before it had become payable) the assessee relinquished its commission on sales and office allc vance because the managed company had been suffering heavy losses in the past years. On these facts the Supreme Court held that the commission had become due to the assessee on December 31, 1954, and December 31, 1955, and the fact that payment was deferred till after the accounts had been passed in the meetings of the managed company, did not affect the accrual of the income. Since the amounts of income for the two years were given up unilaterally by the assessee after they had accrued to it, it could not escape liability to tax on those amounts. It was observed by the Supreme court :
'Income accrues when it becomes due. The postponement of the date of payment does not affect the accrual of income. The fact that the amount of income is not subsequently received by the assessee would not also detract from or efface the accrual of the income. Although non-receipt may, in appropriate eases, be valid ground for claiming deductions.' It was also observed :
'The mercantile system of accounting differs substantially from the case system of book-keeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits, whereas under the mercantile system, credit entries are mad in respect of amounts due immediately they become legally due and before they are actually received. Similarly, the expenditure items for which legal liability has been incurred are immediately debited even before the amounts in question are actually disbursed. Where accounts are kept on the mercantile basis, the profits or gains are credited though they are not actually realised, and the entries thus made really show mothing more than an accrual or arising of the said profits at the material time.'
18. No decision of the Supreme Court dealing specifically with the case of 'salaries' has been pointed out to us and all the decisions which we have referred to above were in the context of income taxable under the head 'income from business' in the hands of the assessee concerned. It was in this contest that the question of considering whether the amount waived by the assessee concerned was a taxable expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922, also has been considered in some other cases. The position as regards income falling under the head 'salaries' is altogether different from the income falling under the head 'income from business' because what can be deducted from the commercial point of view under the present section 28 and old section 10(1) is not available in the case of 'salaries' and the approach of the courts has always been that so far as income falling under the head 'income from business' is concerned, to consider it from the commercial point of view as to ascertain whether the particular income would be income or profits from the commercial point of view. We, however, find that there is one decision of the Madras High Court directly dealing with the question of 'salaries'. That is the case of K. R. Kothandaraman v. Commissioner of Income-tax. In that case the assessee was appointed as the managing director of a company for a period of five year from the date of its incorporation under an agreement which provided, 'the company shall pay to the managing director (the assessee) in respect of each year of account of the company........a monthly remuneration of Rs. 1,250 plus commission at the rate of five per cent. on the net profits made by the company'. The commission was to become due and be paid to him yearly and he was to be entitled to draw the same immediately after the annual accounts of the company of each year were made up and the accounts were laid before the company in general meeting, subject to the provision that the assessee would be entitled to draw his minimum remuneration in monthly instalments of Rs. 1,250. For the accounting year ended December 31, 1959, the company credited to the assessee a remuneration of Rs. 1,250 every month, but on December 31, 1959, the company debited the assessee with a sum of Rs. 15,000 which represented the salary for the whole year in pursuance of a resolution of the board of directors dated May 9, 1960, to the effecd : 'In view of the company not making any profit, the company decides to stop payment of remuneration of Rs. 15,000 per annum to the managing director (the assessee) for the year 1959.' In respect of the assessment year 1960-61, the assessee claimed that he was not entitled to remuneration for the whole year of 1959, by virtue of the resolution and that the credit entries made month after month did not entitle him to remuneration in the circumstances. This contention was rejected and the sum of Rs. 11,250 credited to the assessee's account for the nine months from April to December 1950 was brought to tax. On these facts the Madras High Court held that the terms of the agreement and the functions assigned to the assessee and the reservation to the board of directors of the right of superintendence, direction and control showed that the relationship between the company and the assessee was that of employer and employee, and the monthly remuneration credited to the assessee for the nine months in question was 'salary'. It was held that even if the resolution of the board of directors was to be read as having the effect of denying the salary during the period the period of nine months to the assessee or if it is to be taken that the assessee had waived the accrued remuneration, such denial, withdrawal or waiver occuured subsequent to the assessment year, and it would, therefore, be totally ineffective in the computation of the income for the assessment year which would be liable to tax under section 7. The Madras High Court quoted from its earlier decision in Kothari Mehta & Co., (P.) Ltd. v. Commissioner of Income-tax :
'If after the accrual of the income, according to the terms terms of the managing agency agreement, the managing agents purported to give up any part of that income, that cannot be regarded as affecting the terms of the agreement whereunder such income had accrued to it.' In K. R. Kothandaraman's case as also in the case of Kothari Mehta & Co. (p.) Ltd'.s case the Madras High Court held that the waiver operated only as a disposal of the income.
19. It is true, as has been urged by Mr. Shah on behalf of the assessee, that in Commissioner of Income-tax v. Birla Gwalior (p.) Ltd., the supreme court has approved the decision of the Bombay High Court in H. M. Kashiparekh & Co. Ltd. v. Commissioner of Incame-tax and has distinguished its own decision in Morvi Industries Ltd. v. Commissioner of Income-tax but there again the question was considered from the point of view of real income and from the point of view of commercial expediency and expenditure was allowed as revenue expenditure under section 10(2)(xv) of the Act of 1922. The following passage from the earlier decision of the Supreme court in Commissioner of Income-tax v. Shoorji Vallabhdas & Co., was cited and relied upon by the Supreme Court in Commissioner of Income-tax v. Birla Gwalior (p.) Ltd. :
'Income-tax is a levy on income. Though the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt, Yet the substance of the matter is the income. If income does result at all, there cannot be a tax, even though in book-keeping an entry is made about a 'hypothetical income, which does not materialise. Where income has in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even thought given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account.'
20. Now, this passage from Shoorji Vallabhdas & Co.'s case is in the context of income falling under the head 'Profits and gains of business or profession' and not under the head 'Salaries'. This distinction between income chargeable to tax as 'Salary' and income chargeable to tax as 'Profits and gains of business or profession' is material and what has been said in general terms in the context of income falling under the head 'Profits and gains of business or profession' cannot apply in the context of income falling under the head 'Salaries'.
21. Under these circumstances we have come to the conclusion that the writing off or waiver on the part of the assessee after the income from 'Salaries' had become due to him cannot amount to anything more than disposal of income. The concept of 'real income' in a case like the present one where the income falls under the head 'salaries' cannot help the assessee and his waiver cannot amount to anything more than the disposal of the income already received by the assessee. It is disposal of real income that has been brought about. Under these circumstances we must hold that the Tribunal had erred in law in coming to the conclusion that the remuneration of Rs. 4,800 waived or forgone by the assessee was not income liable to tax. We therefore, answer the question referred to us in the affirmative and against the assessee, that is, in favour of the revenue.
22. Before we part with this case we may point out that the legislature has provided that salary becomes taxable when it becomes due, that is, on the accrual basis and whether you call it 'accrual basis' or to use the language of the relevant section of the Income-tax Act, 1961, say 'when the amount of salary becomes due', the principle is the same. It is because of these special provisions of the Income-tax Act, 1961, section 15, that we have come to the conclusion in the instant case that the assessee is liable to pay tax on the amount of salary that became due to him even though subsequently he waived his right to receive the remuneration. However, it appears to us that it is the very basis of the principle of a particular amount being considered as income on the basis of accrual that if at any subsequent point of time it is found that that amount is not deemed to have been received on the basis of accrual or has not in fact been received and the right to receive that amount has been given up because of circumstances of the particular case, then in the year in which this right to receive the money has been waived or given up or agreed to be given up is the period during which an appropriate relief must be given by way of deduction to the assessee concerned because if that were not to be done, the very basic principle of accrual is violated. That principle is that though not received on the basis of accrual, it is due to be received and the tax is payable and has to be paid on that basis. If subsequently it becomes clear that that amount is not to be received though accrued earlier and is not going to be received at all, it is in the fitness of things that corresponding deduction for the amount waived or written off should be given to the assessee in the year of account in which such amount is written off or waived or debited. It is on this basis that in the system of mercantile account keeping, bad debts are written off and deductions are allowed on the basis of bad debts being written off in the year in which the debt is written off by the assessee concerned. It is true, as Mr. Kaji has urged before us, that so far as 'salaries' are concerned, the income chargeable under the head 'salaries' shall be computed after making the deductions set out in section 16 and the deduction of the type that we are pointing out is not contemplated by the actual words of section 16. But what we are pointing out goes to the very root of the notion of 'income' and before anything can be considered 'income', this principle which follows from the basic approach of 'income accrued' being considered on the same footing as income received must be accepted. It is for the authorities concerned to consider whether in the year in which the assessee agreed to waive his right to receive the amount of Rs. 4,800 he would be entitled to the deduction of this amount on the ground that that which had accrued was in fact not received by him. We are conscious that we cannot issue any directions to the income-tax authorities in this connection but we thought it our duty to explain the legal position as we see it.
23. Under these circumstances Income-tax Application No. 2 of 1975 is rejected with no order as to costs. The question referred to us in Income-tax Reference No. 43 of 1974 is answered in the affirmative and against the assessee. There will be no order as to costs in the special facts of this case.