Case Note & Summary
The dispute arose in a reference under Section 66(1) of the Income Tax Act, 1922 concerning the assessment year 1959-60. The appellant, a public limited company incorporated in 1924 under the Companies Act, 1913, derived income from tea grown on its estate and followed the mercantile system of accounting. Its managing agents, Harrisons and Crosfield Limited, had been managing the company from the beginning under an oral arrangement with commission and secretarial remuneration. After the Companies Act, 1956 came into force, the company and its managing agents decided to enter into a fresh managing agency agreement in conformity with the new statutory requirements. The proposed agreement provided for reappointment of the managing agents for ten years on a remuneration of 5 per cent commission on net profits computed under Sections 349 to 351 of the Companies Act, 1956, with a minimum of Rs. 12,000 per annum, effective from April 1, 1956. The agreement was sent to the Central Government for approval on August 3, 1957, as required by Section 326. By letter dated September 2, 1957, the Central Government approved the appointment with retrospective effect from April 1, 1956. The company subsequently passed a resolution at an extraordinary general meeting on October 4, 1957, formally reappointing the managing agents. For the accounting periods, the company had credited managing agency remuneration in its books even before approval, but for income-tax purposes it added back these sums in the earlier assessment years. For the assessment year 1959-60, the company claimed deduction of Rs. 97,188, representing managing agency remuneration and expenses for the period April 1, 1956 to June 30, 1957, on the ground that the liability became payable only when the Central Government approved the agreement. The Income-tax Officer disallowed the claim, holding that approval was necessary only for actual payment and that the assessee should have ascertained the liability for each year and claimed it on mercantile basis. The Appellate Assistant Commissioner and the Income-tax Appellate Tribunal affirmed. The Madras High Court, on reference, answered against the assessee, reasoning that the approval later obtained gave legal effect to the debit entries retrospectively from April 1, 1956. The Supreme Court allowed the appeal. The Court held that the High Court and lower authorities erred by emphasizing the mercantile system without recognizing that even under that system a deduction cannot be claimed until the liability has accrued. Section 326 of the Companies Act, 1956 contains an absolute prohibition against appointment or reappointment of a managing agent before approval of the Central Government is obtained; therefore the assessee could not assume approval would be granted. The liability to pay remuneration accrued only on September 2, 1957, when approval was conveyed. Although the Government gave retrospective effect from April 1, 1956, that did not mean the liability arose from any date prior to the approval. The Court concluded that the sum of Rs. 97,188 was deductible in the assessment year 1959-60.
Headnote
A) Income Tax - Deductibility of Expenditure - Accrual of Liability - Income Tax Act, 1922 - The assessee followed the mercantile system of accounting but claimed deduction of managing agency remuneration only in the assessment year when Central Government approval was received; the High Court rejected the claim, treating retrospective approval as creating liability from the earlier date. The Supreme Court held that even under the mercantile system, deduction cannot be claimed until liability accrues; the liability did not accrue before approval under Section 326 of the Companies Act, 1956. Held that the assessee was entitled to claim deduction in assessment year 1959-60 for the sum of Rs. 97,188 (Paras not available). B) Company Law - Managing Agency Appointment - Central Government Approval - Companies Act, 1956, Section 326 - Section 326 contains an absolute prohibition against appointment or reappointment of a managing agent before the approval of the Central Government is obtained. The Court held that the liability to pay managing agency remuneration accrued only on September 2, 1957, when approval was conveyed, even though the approval was given retrospective effect from April 1, 1956; the liability could not have arisen from any date prior to the approval. Held that the High Court erred in answering the reference against the assessee (Paras not available).
Issue of Consideration
Whether the sum of Rs. 97,188 representing Managing Agency remuneration for period 1-4-1956 to 30-6-1957 was deductible in computation of income of previous year ending on 30th June 1958, relevant for assessment year 1959-60.
Final Decision
The Supreme Court allowed the appeal. The High Court erred in answering the question against the assessee. The liability to pay managing agency remuneration accrued only upon Central Government approval dated September 2, 1957, and not from any earlier date. The sum of Rs.97,188 was deductible in the assessment year 1959-60.
Law Points
- Mercantile system of accounting does not permit deduction until liability accrues
- Section 326 Companies Act
- 1956 contains absolute prohibition against appointment without Central Government approval
- Liability for managing agency remuneration accrues only on date of approval
- not retrospectively from effective date specified by Government
- Deduction claimed in year of accrual is proper.
