MASUD J. - This reference under section 66(1) of the Income-tax Act, 1922, arises under the following circumstance :
The assessee is a Private Ltd. Co. incorporated in India and is a 100% subsidiary of Imperial Chemical Industries Ltd., London, which holds the entire share capital of the assessee. The assessment years are 1949-50, 1950-51, 1951-52 and 1952-53 and the corresponding accounting years ended on 30th September, 1948, 1949, 1950 and 1951 respectively. The assessee, among other things, acts as selling agents for a large variety of goods. Another complete subsidiary of Imperial Chemical Industries Ltd., London, aforesaid is the Imperial Chemical Industries (Exports) Ltd., Glasgow, which is hereinafter described as 'I. C. I. (Exports) Ltd.' This last company had four agents in India, (1) M/s. Gillanders Arbuthnot & Co., Calcutta, (2) Best & Co. Ltd., Madras, (3) Anglo-Thai Co. Ltd., Bombay, and (4) Shaw Wallace & Co. for their Products. As a result of confabulations in 1974, which effect from April 1, 1948, these selling agencies were terminated and the assessee was appointed as sole agent in their places. The I. C. I. (Exports) Ltd. agreed to pay compensation to the ex-selling agents at the rate of 2/5ths, 2/5ths and 1 and 2/5ths of the normal rate of commission payable by the principals for the three years from April 1, 1948. In pursuance of this arrangement the compensation was paid to the ex-selling agents through the assessees accounts. The method by which the compensation payable to the former agents was shown as paid in the books of accounts of the assessee is as follow :
The total compensation payable to the ex-selling agents was spread over three years and assuming the turnover was constant over the said three years, the commission payable to the assessee would be 4/15ths of the commission at the normal rates. Under the aforesaid arrangement the ex-agents were entitled to get 2/5ths of the normal rate of commission in the first years, 2/5ths in the second year and 7/5ths in the third year which would amount to payment of 11/5ths of the normal commission in three years. Accordingly, the ex-agents were shown to have been paid (II/5/3) = 11/15ths of the normal rate of commission every year. Further, in the companys profit and loss account each year as evidence the assessees books of accounts, the latter in the first stance credited the full commission account and debited I. C. I. (Exports) Ltd. with the amount equivalent to commission at the normal rates on sales effected during the year. The proportion that would be payable as compensation, namely, 11/15th, was then transferred each year from the commission account to a special reserve account so that the funds retained might be accumulated and paid to the former agents from time to time. In the assessments for the assessment years 1949-50, 1950-51, 1951-52 and 1952-53 the assessee showed a certain amount of commission as having been earned on the selling agency for I. C. I. (Exports) Ltd. with footnotes added that the amounts were arrived at after deduction of the compensation paid to the outgoing agents. The Income-tax Officer held that the payments of 11/15ths of the normal rate of commission payable to the former agents amounting to Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 for the assessment years 1949-50 to 1952-53, respectively, were not admissible deductions against the assessees profits and accordingly disallowed the amounts. He, therefore, held that the assessee was entitled to the normal commission and that the aforesaid payment to the ex-selling agents were to be viewed as appropriation of profits. The assessee appealed to the Appellate Assistant Commissioner and the Appellate Tribunal, but the said appeals were dismissed. On these facts the following question of law has been referred to this cour :
'Whether the inclusion by the Income-tax Officer of Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 in the assessment for the years 1949-50, 1950-51, 1951-52 and 1952-53 for the relevant accounting years ending the 30th September, 1948, 1949, 1950, and 1951, respectively, in the computation of the total income of the assessee in justified and correc ?'
Mr. Meyer, learned counsel for the assessee, has submitted that according to the terms of the agreement between the assessee and the I. C. I. (Exports) Ltd., the commission receivable by the assessee-company was to be the difference between the commission calculated at the usual rates and the commission payable to the outgoing agents, or, in other words, the income or actual profit or gain of the assessee is only the differential sum and not the entire amount of commission calculated at the usual rates. He has, therefore, stated that the said sums of Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 paid to the ex-agents as compensation cannot be included in the computation of the total income of the assessee. Secondly, Mr. Meyer has urged that, in any event, having regard to the agreement between the assessee and I. C. I. (Exports) Ltd., the amount payable as compensation to the ex-agents has been diverted from the assessees income by an overriding title, i.e., the agreement between the assessee and the I. C. I. (Exports) Ltd. to the effect that the amount equivalent to normal rates of compensation would not be receivable by the assessee. Alternatively, Mr. Meyer has argued that the amount paid as compensation to the ex-agents by the assessee in terms of the arrangement between the assessee and I. C. I. (Exports) Ltd. is an expenditure admissible as a deduction under section 10(2)(xv) of the Income-tax Act, 1922.
Mr. Balai Pal, learned counsel for the Commissioner of Income-tax, has with great force asked us to confirm the order of the Appellate Tribunal on the following ground :
(a) The payment of compensation to the ex-agents was entirely the liability of the I. C. I. (Exports) Ltd. and the assessee has no legal obligation to pay proportionate amount of compensation in the four assessment years.
(b) The payment of compensation by the assessee-company was made entirely for the purpose of business of the foreign principal, namely, I. C. I. (Exports) Ltd., and, accordingly, the expenditure on the part of the assessee have nothing to do with the assessees business.
(c) The assessee-company was only chosen as the agent of its foreign principal for the purpose of the said payments to the ex-agents. These payments were, therefore, not made by the assessee in the character of a trader but in the character of an agent of its principal. Further, such a payment, if it was to be deductible either under section 10(1) or under section 10(2)(xv) must spring directly from the carrying out of the assessees own business or must be incidental to such carrying out. In the present case, even on the terms as they emerged from the arrangement on record and on the basis of the book entries, the full normal commission was earned by the assessee as from the annual sales. The payment of the compensation to the ex-agents had no direct relation to the carrying on of the selling agency business of the assessee nor was even incidental to the said carrying on. The payment was thus an appropriation or application of income already earned by the assessee. The deductions which the assessee had claimed were not permissible in law, inasmush as the payments of compensation to the former agents were not only capital expenditure, but also expenditure not incurred for the assessees business.
(d) Lastly, no deduction for payments of the said compensation was permissible under section 10(2)(xv) inasmuch as the sums paid by the assessee to the ex-agents were paid for acquisition of a capital assets.
Before we consider the sums of money paid by the assessee as compensation to the ex-agents, it is necessary to consider the circumstances under which such payments were made. The first document which is material for the purpose is the letter dated 11th March, 1947, from Imperial Chemical Industries (Exports) Ltd., Glasgow, to Gillanders Arbuthnot and Co., annexure 'F' to the statement of case, which indicates the terms and conditions of the transfer under which the assessee become the sole agent of I. C. I. (Exports) Ltd. in place of the former agents. The terms as proposed in the said letter may be stated as follow :
'1. For the first three post-transfer years we shall pay you 2/5ths of the commission accruing on annual sales in the territory of your agency taken over by Imperial Chemical Industries (India) Ltd., such commission rates formally paid to you.
2. In the third post-transfer year we shall pay you, in addition a sum equivalent to the full commission on sales for that year effected by Imperial Chemical Industries (India) Ltd. In your territory calculated at the same rates.
3. Payment will be made you after the end of each year as soon as the amount due is ascertained.'
The second important document is an affidavit of Mr. W. A. Bell, a director of I. C. I. (India) Private Ltd., being annexure 'A' to the statement of case, sworn on 30th September, 1957, the material portions of which may be stated as belo :
(2) Imperial Chemical Industries (Exports) Ltd., Nobel branch, Glasgow, the principals, had notified to the outgoing agents in March, 1974, that their agencies would be terminated as from the 1st April, 1948, and intimation of the same was also given to I. C. I. (India)........................
(4) Mr. John Weston Donaldson was then the director-in-charge of the Nobel Branch of Imperial Chemical Industries (Exports) Ltd. and it was agreed between us that from April, 1951, onwards the commission that would be payable to I. C. I. (India) would be the same as was being allowed to the outgoing agents on the various items of explosives and accessories. For the interval, however, between 1st April, 1948, and 1st April, 1951, during which years the outgoing agents had to be paid their compensation as agreed upon I. C. I. (Indias) commission would on an overall basis be the difference between the normal rates of commission which would be allowed after 1st April, 1951, and the sums of compensation payable to the outgoing agents during the three years.
(5) During the talks Mr. Donaldson desired that I. C. I. (India) should out of the sale proceeds accruing to I. C. I. (Exports) Ltd. during the three years 1948-49, 1949-50 and 1950-51 pay to the outgoing agents for and on behalf of the I. C. I. (Exports) the sums which the I. C. I. (Exports) had agreed to pay to the outgoing agents.
'In pursuance of the aforesaid arrangement I directed payment of same to the outgoing agents for the years 1948-49, 1949-50 and 1950-51 calculated in terms of the agreement between I. C. I. (Exports) Ltd. and the former.
As in the final years I. C. I. (India) Ltd. were to pay a sum greater than the commission, I directed the creation of a new account headed Explosives, Ex-agents Compensation Reserve A/c so as to provide for an accumulation of funds during the first two years wherewith to pay the increased compensation during the third years.'
The next important document is the affidavit of Mr. J. W. Donaldson, being annexure 'B' to the statement of case sworn on the 17th September, 1957, which has reiterated the facts mentioned in the said affidavit of Mr. W. F. Bell. The only other document which substantiated the arrangement pay compensation to the ex-agents on the aforesaid terms is the letter of Messrs. Lovelock and Lewis, a well-known firm of chartered accountants, dated the 3rd January, 1958, addressed to the assessee, being annexure 'D' to the statement of case which, inter alia, sets out the method of accounting to the statement of case which, inter alia, sets out the method of accounting necessary for implementation of the said arrangement. Both the counsel for the assessee and for the Commissioner of Income-tax founded their arguments on the legal effect of the aforesaid documents.
Mr. Meyers main contention before us is that, on a construction of the aforesaid documents, the assessees only income in respect of this transaction with I. C. I. (Exports) Ltd. is the specific sum representing the difference between the normal rates of commission which would be allowed after April 1, 1951, and the sums of compensation payable to the outgoing agents during the three years commencing from April 1, 1948, and ending on March 31, 1951. The agreement between the I. C. I. (Exports) Ltd. and the assessee provides that the assessee for the first three years will be entitled to receive only a reduced rate of commission which works out as 4/15ths of the usual rate of commission during the first three years. The real bargain between the parties is that the assessees income will be smaller but a definite figure for the first three years only. Mr. Meyer has stated that the assessee would be liable to pay tax on actual profits and gains of the business carried on by the assessee which would be 4/15ths of the usual rate of commission. Mr. Meyer has first made an endeavour to support this argument by inducting the real income theory, but subsequently he has submitted that, apart from the real income theory, the assessees liability is only limited to the actual profits and gains of his business under section 10(1) of the Act. Mr. Meyer has, therefore, concluded that 11/15ths of the normal commission payable by the assessee to the former ex-agents can never be the profits or gains of the assessees business inasmuch as the said compensation amounting to Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,248 and Rs. 4,00,052 have neither accrued nor reached the assessee at any stage.
The arguments of Mr. Balai Pal on the four grounds mentioned above are more or less interdependent and accordingly it is convenient to discuss them together. He has submitted that the said four sums of money representing compensation for termination of the four agencies should be included in the total income of the assessee. He has referred to paragraph 12 of the order of the Income-tax Officer and paragraphs 3, 5 and 8 of the Appellate Assistant Commissioners order to contend that the assessee has made payments to the former agents out of its own funds and on behalf of a foreign principal, namely, I. C. I. (Exports) Ltd. According to him assessee has made payment as an agents and, as such, such payments have been made not in respect of the business carried on by him. Mr. Pal has further urged that the aforesaid letter of M/s. Lovelock & Lewis and the entries in the assessees books of account show that the full rate of commission has accrued to the assessee as profits or gains of its business and the subsequent payments were merely appropriation or application of its profits and gains for the benefit of the ex-agents. He has also argued that real income presupposes a hypothetical sum out of which a deduction is made to arrive at the real income. Real income, according to him, is arrived at by permissible deductions from the apparent income. In the instant case, the deduction claimed by the assessee is not permissible in law as the payment has not been made in conducting or in running the assessees business. He has laid stress on the fact that in arriving at the real income no deduction is permissible unless it is justifiable on commercial principles or on the basis on the provisions of the relevant taxing statute provided there is no prohibition, express or implied, in the same Act against such deduction. The assessee has already earned the full commission as entered in its books of account and the compensation has only been paid for acquiring a capital asset. The deduction claimed by the assessee in respect of the said four amount representing compensation cannot be allowed inasmuch as it is not only a capital expenditure but also it has not been incurred for the assessees own business. Capital expenditure can never be allowed as a deduction because it has been expressly prohibited under section 10(2)(xv). Capital expenditure cannot be supported as a deduction on commercial principles also. He has referred to paragraph 17 of the Tribunals order where the assesseess business as commission agent and for selling the goods of the principals has been held by the Tribunal as stock-in-trade of assessee and has submitted that this finding is not a finding of fact, but is a misdirection in law and a wrong approach. Selling agencies can never be stock-in-trade of a business unless it is established on evidence that the assessees business is that of acquiring and selling agencies. The Tribunal has come to the finding that the commission agency is a stock-in-trade without finding that the assessees business was buying and selling commission agencies. This conclusion, according to Mr. Pal, is wholly wrong.
Relying on Henderson v. Meade-King Robinson & Co. Ltd., Commissioner of Income-tax v. H. Hirjee and Commissioner of Income-tax v. Motiram Nandram, the Tribunals finding that the commission agency was the assessees stock-in-trade, Mr. Pal argued, is an erroneous conclusion of law. We may add here that Mr. Meyer referred to Girdhardas & Co. Ltd. v. Commissioner of Income-tax and strongly objected to this point being agitated by Mr. Pal at this stage. Mr. Pal has, however, urged that the question raised in this reference is wide in its scope and the finding arrived at is only a wrong approach to law and not a finding of fact.
The first case referred to by Mr. Pal is Badridas Daga v. Commissioner of Income-tax. In that case the appellant carried on business as moneylender, dealer in shares and bullion and commission agent, through an agent who held a power of attorney which conferred on him large powers of management including authority to operate on bank account sums aggregating to Rs. 2,30,636 and applied them in satisfaction of his personal debts incurred in speculative transactions. On being informed of the true state of affairs the appellant cancelled the power of attorney and called upon the agent to pay the amounts withdrawn. The appellant later filed a suit against the agent for recovery of the amount but could recover only an amount of Rs. 28,000 and wrote off the sum of Rs. 2,02,442 as irrecoverable. The question was whether this amount was an admissible deduction in computing the profits of the assessees business for the purpose of income-tax. Venkatarama Aiyar J., in coming to the conclusion that the loss sustained by the assessee as a result of misappropriation by the agent was one which was incidental to the carrying on of business and should, therefore, be deducted in computing the profits under section 10(1) of the Act, has stated at pages 15-1 :
'The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established then the deduction must be allowed provided, of course, there is no prohibition against it, express or implied, in the Act..... At the same time it should be emphasised that the loss for which a deduction could be made under section 10(1) must be one that springs directly from the carrying on of the business and is incidental to it and not any loss sustained by the assessee, even if it has some connection with his business.'
Thus, profits and gains which are liable to be taxed under section 10(1) are what are understood to be such under ordinary commercial principles. Further, it is a question turning on the facts of each case whether an expenditure can be said to arise out of the carrying on of the business and to be incidental to it.
The next case cited by Mr. Pal was Commissioner of Income-tax v. Abdullabhai Abdulkadar, the facts of which may be stated as follow : The assessee-firm which carried on business as commission agents supplied goods from India to a non-resident principal who on its part sent cotton to the assessee and others for selling in India. The income-tax authorities treated the assessee as the agent of the non-resident principal under section 43 of the Income-tax Act and assessed it in respect of the tax payable by the non-resident. The assessee had to pay in all Rs. 3,78,491 which after adjustment against the amounts payable to the non-resident left a debit balance of Rs. 3,20,162. In the year of account the assessee wrote off the amount which it was unable to recover, and claimed it as a bad debt and a trading loss. Kapoor J., following Badridas Daga v. Commissioner of Income-tax, came to the conclusion that the loss which the assessee had incurred was not in its own business, but the liability arose because of the business of another person and that could not be a permissible deduction within the meaning of section 10(1) of the Act. It should be remembered that in this case the liability was imposed upon the assessee-firm because it was treated as an agent within the meaning of section 42(1) of the Act and the liability was imposed because of the deeming provision in sub-section (2) of section 42. The solution to each case, according to Kapoor J., would depend on the question whether the liability could be described as a business debt arising out of the assessees business on the facts of each case.
Mr. Pal then drew our attention to Commissioner of Income-tax v. Malayalam Plantations Ltd., the material facts of which may be briefly stated. The assessee is a resident company incorporated outside India. Most of its shareholders are in the United Kingdom. During the accounting period certain payments were made towards estate duty on the death of some shareholders who were not domiciled in India. The assessee debited the said amounts to revenue in its accounts in ascertaining the profits and gains of its business for the accounting year. Subba Rao J., in holding that the estate duty paid by the assessee was not a permissible deduction under section 10(2)(xv) of the Act, has stated at page 15 :
'The expression for the purpose of the business is wider in scope than the expression for the purpose of earning profits. Its range is wid : it may take in not only the day-to-day running of the business but also the rationalization of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business. It cannot include sums spent by the assessee as agent of a third party, whether the origin of the agency is voluntary or statutory; in that event, he pays the amount of behalf of another and for a purpose unconnected with the business.'
The facts in this case are clearly distinguishable. The payment of estate duty by the assessee-company on the death of its foreign shareholders cannot be a responsibility of the assessee-firm and, in any event, such payment does not directly or indirectly ensure to the benefit of the assessees business in any manner.
Mr. Pal also referred to Haji Aziz and Abdul Shakoor Brothers v. Commissioner of Income-tax, where the Supreme Court held that no expense which was paid by way of penalty for a breach of the law even though it might involve no personal liability, could be said to be an amount wholly and exclusively laid for the purpose of the business of the assessee within the meaning of section 10(2)(xv) of the Income-tax Act and that the fine paid by the assessee was not a permissible deduction under that section. Kapoor J., after a review of numerous decisions, made it clear by stating at page 35 :
'If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader.'
Thus, the arguments of Mr. Meyer and Mr. Pal show that their respective approaches to the question in this reference are entirely different. We may now discuss which approach, on the facts of this case, is justifiable in law. Section 10(1) of the Income-tax Act, 1922, reads as follow :
'10. Business. - (1) The tax shall be payable by an assessee under the head profits and gains of any business, profession or vocation in respect of the profits or gains of any business, profession or vocation carried on by him.'
The doctrine of real income has often been inducted on the strength of the words of this section. The words 'profits and gains' in respect of a business should be understood in the commercial sense. It is true that the commercial sense may not always correspond to the principles of taxability and very often the doctrine of accrual of income or profits or subsequent application of profits create difficult situations on the facts and circumstances of a case. To say that tax is leviable only on the actual income is to over-simplify the matter. At the same time to examine every case of profits and gains from an academical and doctrinaire approach would lead to complicated consequences in the commercial world. The scheme of the section shows that section 10(1) is the charging section under which profits and gains of business, profession or vocation can be taxed. Section 10(2) provides certain contingencies whereby the profits or gains can be computed after making certain allowances. But before section 10(2) is attracted there must be profits or gains of the business. If there are no profits or gains, the question of reduction or deduction of profits or gains by certain allowances would not arise. It is settled law that the allowances set out in section 10(2) are not exhaustive; to illustrate, the Indian Income-tax (Amendment) Act (VII of 1939) for the first time introduced section 10(2)(xi) by which bad and doubtful debts were included as one of the allowances. But even before the said amendment, in determining the profits or gains of the business under section 10(1), bad and doubtful debts have been exclude : Commissioner of Income-tax v. Chitnavis. This case explains that the tax is leviable on the actual profits and gains of the assessee, apart from the provisions of section 10(2). Thus, in assessing the profits or gains of a business the profits that reach the assessee must be taken into consideration. Section 10(1) stands on an independent footing. The profits and gains on which the tax is leviable under section 10(1) might in certain cases accrue to the assessee and the assessee for some reason or other might appropriate or apply such profits to the accounts of other persons. In such a case the actual physical income which the assessee would get could only be derived after such appropriation or application. But section 10(1) does not contemplate the taxability of such actual income because in such a case the profits or gains have reached the assessee, but the assessee has at its option voluntarily appropriated the profits in favour of other persons in connection with his business. In such a case the appropriation or application of profits takes place after the profits or gains reach the assessee and, as such, the income that has accrued to the assessee prior to such appropriation would be taxable. But there may be cases where the accrual of profits and gains have not taken place at all, because the assessee has not seen the colour of the money or it may be that the profits and gains have not reached the assessee on account of initial diversion of the profits under an overriding title. In the last two cases the tax is leviable only on the actual money or the real profits or gains that have reached the assessee.
The following decisions may be cited in support of the aforesaid legal principle :
The first case which may be referred to is Calcutta Co. Ltd. v. Commissioner of Income-tax the facts of which may be stated as follow :
The appellant bought lands and sold them in plots fit for building purposes undertaking to develop them by laying out roads, providing a drainage system and installing lights, etc. When the plots were sold the purchaser paid only a portion of the purchase price and undertook to pay the balance in instalments. The appellant in its turn undertook to carry out the developments within six months. In the relevant accounting year the appellant actually received in cash only a sum of Rs. 29,392 towards sale price of lands, but in accordance with the mercantile system of accounts adopted by it, it credited in its accounts the sum of Rs. 43,692 representing the full sale price of lands. At the same time] it also debited an estimated sum of Rs. 24,809 as expenditure for the developments it had undertaken to carry out, even though no part of that amount was actually spent. The department disallowed the expenditure. Bhagwati J., while holding that the sum of Rs. 24,809 was an allowable deduction in arriving at the profits and gains of the business of the assessee under section 10(1) of the Act, stated at page :
'Apart, however, from the question whether section 10(2)(xv) of the Income-tax Act would apply to the facts of the present case the case is, in our opinion, well within the purview of section 10(1) of the Income-tax Act. The appellant here is being assessed in respect of the profits and gains of its business and the profits and gains of the business cannot be determined unless and until the expenses or the obligations which have been incurred are set off against the receipts. The expression profits and gains has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purposes of earning the receipts is deducted therefrom -whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date.'
Bhagwati J. in the said judgment has quoted Lord Herschell in Russell v. Town and County Bank Ltd :
'The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to me to be the meaning of the word profits in relation to any trade or business. Unless and until you have ascertained that there is such a balance, nothing exists to which the name profits can properly be applied.'
Similarly, Lord Herschells and Lord Chancellor Halsburys opinions in Gresham Life Assurance Society v. Styles were quoted by hi :
'When we speak of the profits and gains of a trader we mean that which he had made by his trading. Whether there be such a thing as profit or gain can only be ascertained by setting against the receipts, the expenditure or obligations to which they have given rise... The thing to be taxed is the amount of profits or gains. The word profits, I think, is to be understood in its natural and proper sense - in a sense which no commercial man would misunderstand.'
Bhagwati J. also relied on Commissioner of Income-tax v. Chitnavis, where the Privy Council at page 296 has observe :
'Although the Act nowhere in terms authorises the deduction of bad debts of a business, such a deduction is necessarily allowable. What are chargeable to income-tax in respect of a business are the profits and gains of a year; and in assessing the amount of the profits and gains of a year, account must necessarily be taken of all losses incurred, otherwise you would not arrive at the true profits and gains.'
Further, Bhagwati J. quoted the observations of Venkatarama Aiyar J. in Badridas Daga v. Commissioner of Income-ta :
'It is to be noted that while section 10(1) imposes a charge on the profits or gains of a trade, it does not provide how those profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions, but it is well-settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable under section 10(1)... The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trade principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act.'
The next case which may be relied on is Commissioner of Income-tax v. Shoorji Vallabhdas & Co., where Hidayatullah J. has observe :
'Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, namely, the accrual of the income or its receipt; but the substance of the matter is the income. If the 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 circumstances, have been made in the books of account... A mere booking -keeping entry cannot be income, unless income has actually resulted...'
The next case which may be referred to is Commissioner of Income-tax v. Chamanlal Mangaldas & Co., where Kapoor J. has, at page 14, state :
'No doubt in this case the amounts of commission were credited every six months which only means that as an interim arrangement the accounts of all sales were made up at the end of six months also. But this would not affect the construction of the clause containing the terms for payment of commission nor the reduction made therein as a result of the modified arrangement. The amount which would arise or accrue and which the managing agent would have the right to receive cannot be affected by the manner in which the entry was made.'
Our attention has also been drawn to Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax, where Lord Macmillan, at page 200, has state :
'But their Lordships do not agree with the learned Chief Justice in his rejection of the view that the sums paid by the appellant to his step-mother were not income of the appellant at all. This, in their Lordships opinion is the true view of the matter. When the Act by section 3 subjects to charge all income of an individual, it is what reaches the individual as income which it is intended to charge.'
We may not discuss how far these principles would apply to the facts and circumstances of this case. The letter of I. C. I. (Exports) Ltd. dated 11th March, 1943, the affidavits of Mr. W. A. Bell and Mr. J. W. Donaldson and the letter of M/s. Lovelock & Lewis establish to the effect that the assessee is entitled to receive for the period between 1st April, 1948, and 31st March, 1951, as commission a specific amount representing the difference between normal rates of commission and the compensation payable to the former agents during this period. The said agreement provides that the compensation for termination of the agencies payable to the former agents is two-fifths of the compensation at normal rates for the first two years and one and two-fifths of commission at normal rates in the third and final year. Thus the assessees actual profits during the assessment years amount to a definite figure which is calculated on the basis of such reduced rate of commission. The Tribunal at paragraph 13 of its order has state :
'The conclusion that can be drawn is that there was no agreement or if there was one it was not acted upon.'
This conclusion cannot be described as a finding of fact; it is an erroneous conclusion in law. The Tribunal has referred to the said two affidavits of Mr. W. A. Bell and Mr. J. W. Donaldson which have set out the terms of the agreement. Far from disbelieving those affidavits, the Tribunal has opined that they have been sworn in by men of great standing in the business world and that it would be difficult to brush them aside.
Mr. Pals argument is based either upon expenditure or upon deduction permissible in law. He has taken it for granted that in order to have actual profits or gains of a business under section 10(1) there must be an apparent income and a deduction permissible in law. This approach may be relevant in a case where the doctrine of real income is made applicable to the facts and circumstances of a case. In the instant case, it is not necessary to apply the concept of real income. The taxability of the assessee should be determined in strict compliance of the terms of the said agreement. Under this agreement full rate of commission which were being paid to the former agents before 1st April, 1948, would be payable to the assessee after 1st April, 1951, and between 1st April, 1948, and 31st March, 1951, the assessees income on the basis of the system of accounting advised by Messrs. Lovelock and Lewis was four-fifteenths of the commission each year. Thus during the relevant assessment years the former agents received eleven-fifteenths of the commission and the balance four-fifteenths only reached the assessee company each year. Thus the eleven-fifteenths of the commission received by the former agents, therefore, could not be held to be part of the income of the assessee. The assessee-company is obliged to accept a lesser commission for the first three years under the said arrangement, inasmuch as they not only were appointed the sole agent of I. C. I. (Exports) Ltd. in place of the former agents but also they under the said arrangement would become entitled to the full commission three years after the agreement came into force. Therefore, it cannot be denied that for the first three years the income on which tax would be leviable is the specific sum which represents four-fifteenths of the normal rate of commission payable by the I. C. I. (Exports) Ltd. The assessee cannot be held liable for the sums of money paid as compensation to the former agents because the said four sums amounting to Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 were neither due and payable to the assessee under the said arrangement nor they ever accrued to the assessee as its income. It is true that the entries in the books of account of the assessee have not been maintained in strict compliance with the terms of the agreement. It is also true that the entries might give an impression that the full commission was first credited to the assessee company and, thereafter, the compensation amounts had been debited to the foreign principals account. But it is obvious that on account of the peculiar nature of the terms of the contract, namely, payment of commission to the extent of two-fifths, two-fifths and seven-fifths in three years, the particular system of accounting has been maintained by the assessee. But these entries by themselves could not lead to the conclusion that there was no agreement at all or that it was not acted upon. The system or method of book-keeping cannot override the true and substantial character of a transaction. The form of accounting is only a means to an end, the end being the implementation of rights and liabilities arising out of the stipulation and, as such, the book entries unless they lead to the opposite conclusion should not be the decisive factor. The book entries may be quite regular from the point of view of accountancy but in view of the fact that the assessees claim has its foundation in and flows from the said agreement, we are of opinion that in strict compliance with the stipulated terms the book entries should have been maintained by showing the actual receipt of commission by the assessee-company after adjusting against the compensation paid to the former agents at the rate of two-fifths and two-fifths in the first two years and seven-fifths in the third year. In the premises, we accept the contention of Mr. Meyer and, applying the principles of law laid down by the Supreme Court in Calcutta Co. Ltd. v. Commissioner of Income-tax, Commissioner of Income-tax v. Shoorji Vallabhdas & Co. Ltd. and Commissioner of Income-tax v. Chamanlal Mangaldas & Co., we are of opinion that the sums paid by the assessee as compensation to the ex-agents in the facts and circumstances of the case cannot be included in the total income of the assessee under section 10(1) of the Income-tax Act, 1922.
Both Mr. Meyer and Mr. Pal have argued alternatively on other points as set out above. But as we have accepted the first contention of Mr. Meyer, namely, that the assessee is liable to pay tax on the difference between the commission calculated at the usual rates and the compensation payable to the outgoing agents on the ground that such difference is the actual profits or gains of the assessee and that the compensation paid to the former agents cannot be included in the total income of the assessee, it is not necessary for us to decide on those alternative arguments which the learned counsel for the assessee and for the Commissioner of Income-tax have urged.
For the reasons stated above, the question raised in this reference should be answered in the negative and the inclusion by the Income-tax Officer of Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 in the assessment for the years 1949-50, 1950-51, 1951-52 and 1952-53 for the relevant accounting year ending 30th September, 1948, 1949, 1950, and 1951, respectively, in the computation of the total income of the assessee is not justified. We may, however, add that the assessees income during the first three years should be ascertained strictly in terms of the agreement between I. C. I. (Exports) Ltd. and its former agents and not in accordance with the book entries as maintained by the assessee-company under the advice of Messrs. Lovelock and Lewis. The respondent shall pay the costs of this reference to the appellant.
S. P. MITRA J. - I agree.
Question answered in the negative.