P L D 1966 (W (PLP)

3. The brief facts of the case are that Messrs Abbasi Textile Mills Public Limited appointed the assessee Messrs Ali and Roberts Bahawalpur Limited as their managing agents by an agreement dated the 26th of February 1947. The method of accounting, of both the companies was mercantile with the accounting year ending on the 31st of March each year. The assessee-company was originally assessed for the assessment year 1954-55 by the order of the Income-tax Officer dated the 4th of December 1954, and the determination resulted in a loss of Rs. 3,

131. In the next assessment year 1955-56, the assessee declared a loss of Rs. 64,546 for the year ending 31st March 1955. The credit side of profits and loss account included an item of Rs. 1,08,693 on account of managing agency commission received from the managed company. In the succeeding assess ment year 1956-57, the profits and loss account for the period ending 31st March 1956, showed a loss of Rs. 23,276 and on the credit side the account included an item of Rs. 15,960 on account of managing agency commission.

4. While the assessments for the years 1955-56, 1956-57 were pending, the Income-tax Officer dealt with the assessment of the managed company for the assessment year 1954-55 and found that the managed company had debited a commission of Rs. 1,08,693 on account of managing agency commission in its accounts for the year ending 31st March 1954. Since this amount was not shown on the credit side by the managing company in the assessment year 1954-55, the Income-tax-Officer- made a reassessment under section 34 against the managing agents. Similarly the amount of commission of Rs. 15,960 was assessed by the Income-tax Officer, in the assessment year 1955-56. In this way, the Income-tax Officer excluded the sum of Rs. 1,08,693 from that assessment year and Rs. 15,960 from the income of 1956-5 7 and included it in the income for the charge year 1955-56. As a result of these adjustments the assessment of the managing company for the commission received from the managed company was taxed during 1954-55 and 1955-56 respectively instead of 1955-56 and 1956-57.

5. The assessee filed an appeal and the Appellate Assistant Commissioner agreed with the contention of the assessee and directed the Income-tax Officer to assess the amount of commission in the year in which it was shown by the assessee in its books. Aggrieved by this order, the Income-tax Commissioner went in appeal to the Tribunal for the assessment for all the three years and the Tribunal held that the managing agency commission accrued to the assessee in the year in which it was debited in the accounts of the managed company. In arriving at this conclusion the learned members of the Tribunal relied on Commissioner of Income-tax, Madras v. K. R. M. T. T. Thingaraja Chetty & Co. ((1953) 24 1 T R 525). The present reference has been made on the above stated questions of law.

6. Learned counsel for the assessee has argued that the assessee has shown the income in the following year according to the method of accounting followed by him according to rules the amount receivable as commission could not be made unless the accounts of the managed company had been closed for making necessary adjustments and net profits of the managed company had been worked out. It was stated that the accounts of the managing company were not audited till six months after the conclusion of the accounting period and in some cases the accounting was not even completed in a year or more. In these circumstances it was urged that it was impossible for the managing agents to receive during the accounting period, the profits, which were not yet determined. According to the learned counsel, the assessment to tax from commission in the hands of the managing agents must follow the ultimate determination of the net profits in the hands of the managed company.

7. For the purposes of coming to a correct conclusion we have perused the agreement of managing agency which was concluded between the assessee and Abbasi Textile Mills. A cursory glance of various stipulations of the agreement makes out that the managing agents in fact controlled the entire affairs of the managed company. The general management of the business of the company was in the hands of the managing agents who had power and authority on behalf of the company to do all things usually necessary, or desirable in the management or the affairs of the company or for the purposes of the transactions and management of the affairs and business of the company. This of course was subject to the supervision of the Board of Directors of the company but the assessee was also reported on that Board. We have gone through the agreement because it was referred to by the Tribunal in its order under reference and we find that factually the control of Messrs Abbasi Textile Mills was in the hands of the managing agents and whatever might be the reason for their not crediting the commission in their books of account for the relevant charge year, it cannot be argued with any force that the managing agents were not in the knowledge of the income which was accruing in their favour as commission on the sales, etc., of the managed company.

8. The argument of the learned counsel for the assessee, that it was a non-descript system of accounting which was followed by his client, is of no avail to him, because the year which ended on the 31st of March 1954, was the first year when the commission was debited to the accounts of the managing agents and credit accrued in the following year in their books of accounts. Therefore, it cannot be maintained that the particular method of accounting was followed regularly by the assessee. It was contended that there was an understanding between the managing agents and the managed company as to the mariner of accounting for the commission but there is no evidence on record to substantiate this argument nor the contents of the agreements of managing agency, which we have read thoroughly, disclose any such agreement between the parties. The mere fact that the managing agents were not paid any commission in the previous year by the managed company make no difference as the system of accounting followed by them was "mercantile". Actual receipt of income being immaterial we have to look in which year the amount in question accrued. It is contended that the profits shown as having been debited by the managed company in their books of account against the managing agency are a mere right to receive and, therefore, they do not accrue until and unless they are actually computed. The calculation of the profits after the 31st of March or any other later date cannot be said to suspend the accrual of the profits to the managing agents. Had there been a provision in the agreement of the Agency that the Commission was to be paid after the accounts had been computed on the part of the managed company at the end of the year or at any other time, the position would have been different and it could have been argued with some force that since the commission was not payable till the end of a definite period no income had accrued. But in this case no such conditions exist. On the contrary the fact that in the account books of the managed company a credit was made in favour of the assessee during the relevant account year fixes the period during which the income in question had accrued.

9. Learned counsel concedes that the formula applied by Al, the Tribunal would have been applicable in case his clients were R keeping cash system of accountancy, but it was not applicable, because the mercantile system was in practice by both the companies. It is, therefore, necessary to explain the two methods of accountancy maintained by the business community which are kept for the income, profits and gains of a business on the cash basis and the mercantile basis. According to the former a record is kept of actual receipts and actual payments, entry is being made only when money is actually collected or disbursed, and if the profits of the business are accounted for in this way, the tax is payable on the difference between the receipts and the disbursements for the period in question. The mercantile system is also known as the book profit system of accountancy or the double entry book-keeping system. Under this system profit and loss account is maintained and at the end of financial year the assets and liabilities are valued and entered in the accounts and the difference between the two is the profit upon which the tax is paid. Under this system the net profit or loss is calculated after taking into accounts all the income and all the expenditures relating to the period whether such income has been actually received or not and whether such expenditure has been actually paid or not. In fact the profit computed under this system is the profit actually earned though not necessarily realised in cash. What distinguishes mercantile system with the cash system is that it brings into credit what is due immediately and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. Keeping in view this distinction of the two systems of accountancy the argument of the learned counsel looses its force and in fact goes against him. The assessee was required to have credited the commission in its books of accounts when it became legally due never mind when it was computed or paid. This business liability had definitely accrued to Messrs Abbasi Textile Mills, in the accounting year in which it was debited against the managing agents and they claimed deductions on the payments made by them towards the commission agency, therefore, it could not be said that the income has not accrued to the assessee during the relevant assessment years. On the other hand, if the accounts were kept on cash basis or in other words on receipt basis, allowance had to be given in the year of disbursement irrespective of the question when the liability to pay the same arose.

10. Having explained the two methods of accountancy, it is necessary to quote in this judgment, certain provisions of the Income-tax Act of 1922, relevant to the question of determining the liability of a tax-payer on the income which has accrued or has arisen to him in a previous year. The charging section 3 is in the following words :- "(3) Where any Act of Parliament enacts that income-tax shall be charged for any year at any rate or rates tax at that rate or those rates shall be charged for that year in accordance with, and subject to-the provisions of, this Act in respect of the total income of the previous year or the previous years, as the case may be of every individual . . . ." The definition of total income given in section 2 (15) is "2 (15) "total income" means total amount of income; profits and gains referred to in subsection (1) of section 4 computed in the manner laid down in this Act, etc." and now we come to subsection (1) of section 4 which is the pivot of the subject "4 (1). Subject to the provisions of this Act, the total income of any previous year of any person includes all income, profits and gains from whatever sources derived which- (a) are received or deemed to be received in Pakistan in such year by or on behalf of such person; or (b) if such person is resident in Pakistan during such year, (i) accrue or arise or are deemed to accrue or arise to him in Pakistan during such year."

11. The Oxford English Dictionary defines "accrue" as to fall as a natural growth or increment; to come as an accession or advantage. The word "arise" has been defined "as to spring up, to come into existence". The two words seem to be synonymous and the difference only lies in their application to the facts of a particular case more appropriately than the other. As pointed out by Fry L. J., in Colquhoun v. Brooks ((1889) 14 A C 493) that both the wards are used in contra-distinction to the word `receive' and indicate a right to receive. In this context it will also be necessary to explain the meaning of the term `income' also. The ordinary meaning given in Oxford Dictionary is "that which comes in periodical produce of one's work, business, lands, other investments (considered in reference to its amount and commonly expressed in terms of money, annual or periodical receipts accruing to a person or corporation". This definition clearly denotes the idea of receipts, actual or constructive. The intention of the law maker is to make the income taxable when it is paid or received either actually or constructively. So far as receiving of income is concerned, there can be no plainer meaning than the word "receiving" itself. The receipt of incomes refers to the first B occasion, when the recipient gets the money under his own control. But the Act lays down for taxing purposes three occa sions; (i) when the income is received, (ii) when the income is deemed to have been received, and, (iii) when the income accrues or arises. When income is deemed to have accrued or received in Pakistan, the only meaning possible is that whereas it is not in reality so, the Statute requires it to be treated as it were, and the phrase "statutory receipt" might be conveniently employed to cover income which is deemed to be received. It, therefore, cannot be construed to be deemed to have been received by the volition of the assessee. Profits are not deemed to be received merely by reason of an entry in accounts under the, mercantile system and there is consensus of judicial dicta on the subject, that the words deemed to be received refer to the cases set out in the Statutes itself, Commissioner of Income-tax, v. Bombay Trust Corporation (4 T C 312 P sC) and Kasher Narain Singh v. Commissioner of Income-tax ((1947) I T R 311,319 (FC)).

12. The words "accrue" and "arise" represent a state anterior to a point of time when the income is in fact received. "The meaning of the words arising or accruing as used in re lation to only profits or gains, is frequently of importance in deter mining the year in which amounts paid to recipient are income for the purposes of income-tax". There is an important distinction between debts due to a trading income and unpaid in a particular year or period and other income which is not a trading receipt. Trading debts due but not yet paid must be included in arriving at the balance of profits or gains. With regard, however, to other income, there must be something coming in; but once there is income, the fact that it was not, by reason of some particular circumstances, received by the person entitled in the year in which it became due is immaterial. Income can be held to have "accrued" only when the assessee acquired a right to receive it (Halsbury's Laws of England, para. 189). For instance damages claimed on account of breach of contract would accrue only when the suit is decreed or the claim is admitted by the defendant and not when merely a claim is made.

13. In Back (Inspector of Taxes) v. Whitlock ((1932) 1 K B 747), in which the assessee who had previously been resident abroad, came to England on April 7, 1927, two days after the financial 'year had begun, the Commissioner decided that the respondent became chargeable to income-tax and that the assessment for the income-tax year 1928-29 should accordingly have been made on the full amount of income arising during that year. Rowlatt, J., observed "here I simply have to consider the, question whether this income first arose c4thin the year preceding the year of assessment. It does not matter that the respondent's residence first begins preceding the year of assessment. Para. (a) of subsection (1) of section 28 of the Finance Act of 1926, refers to the profits of the trade or profession which was set up or commenced with the year preceding the year of assessment and para. (b) refers .to income first arising in the year of assessment. In Fry v. Burma Corporation ((1930) A C 321), it was held with reference to trade that "if the trade were the same it did not matter when the trade swam into the purview of Income-tax Act. How can I avoid applying the same reasoning to words which are really and parallel as they can be having regard to the different subject with which they deal? I cannot regard this income of the present respondent as first arising when the possessor of it swam into the purview of Income-tax Act". In this case the assessee was the resident of Strait Settlements for many years where he was in receipt of income arising from stock, shares and rents. On his return to England he continued to receive such income. It was held that his income did not first arise on April 7, 1927, to have his income-tax for the Financial year 1928-29 computed on the income of that year.

14. In Spence v. Commissioner of Inland Revenue (24 T C 1941-42 311) the appellant entered into a contract to sell shares in 1931, the transfer of shares, being completed in 1933. In 1939, the appellant successfully having pleaded fraud, obtained a decree and the contract was reduced, the shares were retransferred to the appellant, and the purchaser was ordered to pay a lump sum being a difference between the purchase price which was repayable by the appellant with interest together with a proportion of a loss suffered by the purchaser arising out of his possession of the shares, and a sum representing the dividend by the purchaser while the shares stood in his name for the purposes of super-tax for the years 1936-37 to 1938-39, amounts equal to the dividends received in those years by the purchaser of the shares were included in the total income of the appellant. On appeal it was contended that the assessee had not received the dividend but had received money in lump sum under the decree of the Court. The Special Commissioner decided that the effect of the decree was to revest the title to the shares and to the dividends in the appellant. On a reference to the Court of Sessions as the Court of Exchequer in Scotland, it was held that the amount of the dividend was appropriately included in the appellant's assessment. Lord President (Normand) observed, "In my opinion, what he received was the dividends and not a surrogatum of the dividends. It was not compensation for loss of the dividends nor was it damages for loss of the dividends. It was just the dividends which, one may say, Mr. Crawford received and held for the person whom he had defrauded. "Lord Fleming in a separate judgment remarked." I am however, quite unable to understand the grounds upon which it can be said that the nature of the sums comprised in the set-off can alter the character of the payments which fell to be made by Crawford to the Appellant. If there had been any set-off, these payments would have been of an income character, and the fact that there was set-off does not appear to me to alter their character." The third Judge, Lord Moncrieff, while concurring with Lord President, observed, "that if due regard be had to the substance of the transaction, the Appellant must be deemed to have received, although in a single deferred payment and in an equivalent form, nothing other than the dividends which, had the transfer not been completed, he would have drawn in the form of dividends. That appears to me to be, although in the form of a single payment, a payment representing income and not capital". It; therefore, follows that what has in fact "accrued" or "arisen" as an income to an assessee in a previous year has to be C included in his total income for that year and not in the year m which he chooses to include it for the purposes of his assessment.

15. Learned counsel for the assessee relied on Kanpur Tannery Limited v. The Commissioner of Income-tax (A I R 1958 All. 612), but the facts of that authority are quite different from the facts of the present case. In that case the assessee was required to pay war risk insurance premium in a particular year and on his failure to do so, he was fined and subsequently the amount was paid by him. The question which fell for determination was, whether the assessee was entitled to charge the amount of premia in the year in which it was paid or it should have been accounted for in the year for which it was due. Relying on the language of section 10 (2) (iv) of the Income-tax Act, it was held, "that what was meant by the word paid in that section was what has actually been paid or incurred and the assessee, was, therefore, entitled to claim the payment of the insurance premia as a legitimate deduction in -the year of account in question". In the present case what has to be determined is whether income had in fact "accrued" or "arisen" to the assessee as distinct from "received" in the relevant charge year. The old principle that for' income-tax purposes "receivability" without "receipt" is nothing, had no application to the cases under the Income-tax Act, because section 4 expressly provides to bring to charge not only the income which has been actually received or deemed to have been received but also the income which has accrued or arisen.

16. As already explained above, the mercantile system of accounting treats profits or gains as arising at the date of the transaction notwithstanding that they are not received or deemed E to be received and under that system, book profits are assessed and are liable to tax. In this case it has not been contended that although a debit entry was made against the managing agents in -the account books of the managed company, the amount was not received by the agents or not paid by the managed company. What has been argued by the learned counsel for the assessee is that it was his system of accounting that the commission earned by him from the managed company in a relevant charge year were credited in the succeeding year, despite the fact that he was maintaining mercantile system of accounting. Income, profits and gains accrue when they first come into existence, when the Statute requires that income, profits and gains should accrue, arise or be received in the previous year. All that can be taxed in a given year are the profits and gains which are not only received but have also arisen or accrued in the "previous year", and it follows from that, that the tax in such a case can be on the accruals and not on the actual receipt. The commission was duly credited to the account of the agents in the relevant charge years in which it was shown against their names in the books of accounts of the managed company and in the absence of any evidence 'to the contrary the Tribunal rightly considered it as income which had accrued or arisen to the assessee in the years under consideration.

17. Our answer, therefore, to the question, referred to us, is in the affirmative but in view of the complicated question of law involved, we refrain from burdening the assessee with the costs of these proceedings. S. Q. Reference answered in affirmative.