Holding

For a taxpayer using mercantile accounting, the liability to pay sales tax accrues at the time of the taxable sale, not when a demand notice is issued, so the deduction must be claimed in the year of the sale (1962‑63) and not in 1971‑72.

Summary

Kalinga Tubes Ltd., a steel tube manufacturer, was assessed for central sales tax for the year 1962-63. The Sales Tax Officer demanded Rs 11,02,698 in 1966, which the Sales Tax Tribunal reduced to Rs 2,22,161 in 1970. The assessee claimed this amount as a deduction under Section 37 of the Income‑Tax Act in the assessment year 1971-72, arguing that the liability became determinable only then. The Income‑Tax Officer disallowed the claim, stating that under the mercantile system of accounting the liability accrued at the time of sale (1962-63). The appellate Commissioner allowed the deduction, the Tribunal reversed, and the High Court again allowed it, holding that the liability accrued when the fresh demand notice was issued. The Supreme Court held that for a taxpayer following mercantile accounting, the liability to pay sales tax accrues at the time of the taxable sale, not when a demand notice is served, and therefore the deduction could not be claimed in 1971-72. The Court set aside the High Court decision and answered the referred question negatively in favour of the revenue.

Issues considered

When does a liability to pay central sales tax accrue for a taxpayer following the mercantile system of accounting for purposes of deduction under Section 37 of the Income‑Tax Act?
Can the assessee claim a deduction for a sales‑tax liability in an assessment year different from the year in which the liability accrued?

Legislation cited

Central Sales Tax Act, 1956
Income Tax Act, 1961s. 256(1), s. 37

Subjects

sales taxcentral sales taxmercantile accountingaccrual of liabilitydeduction under Section 37assessment yearIncome Tax TribunalHigh CourtSupreme Court

Judgment

COMMISSIONER OF INCOME-TAX, ORISSA A
v.
MIS. KALINGA TUBES LTD.

JANUARY 8, 1996

[B.P. JEEVAN REDDY AND S.B. MAJMUDAR. JJ.] B

Cei1trai Sales Tax Act. 1956 :

Sales Tt.v.:-Assessee-Follo\VillR 1nerca11t;/e sysfe1n of accnunting-
Liability to pay tax--Held arises when the assess~e nuule the sale.
c
Income Tax Act, 1961 : Sectio11 37.

Assessee 's sale's tax liabili(v arisinR duri11s: the previous year relevant to
assessment year 1962-63-Tax de!ennined by Sales Tax Officer in a subsequent
year-Tax denuuul reduced by Tribunal during previous .vear relevant to
a~·.\·essn1ent year 1971-72-Held assessee \Vas not entitled to clairn deduction
D
(~fthe said an1nunt in assessn1ent .vear 1971-72.

The rospondent-Company was engagt!d in the manufacture and sales
of steel tubes and was liable lo pay sales lax under the Central sales Tax
Act, 1956. In respect of assessment year 1962-63 the Sales Tax Officer E
completed the assessment on 31st March, 1996 and demand additional tax
of Rs. 11,02,698. This amount was reduced to Rs. 2,21,161 by the Tribunal
in second appeal. The respondent-assessee claimed deduction of the said
amount as business expenditure in respect of the assessment for the previous
year 1970-71 since according to it the sales-tax liability was of the assessment
year 1971-72. The Income-tax Officer disallowed the said deduction in the F
relevant assessment year on the ground that the assessee was following
mercantile system of accounting and hence the liability lo pay sales tax
accrued to it prior to the said year. The appellate Commissioner allowed
the said deduction holding that as the said liability became determinate and
known only during that assessment year, it could he ~llowed for that G
assessment year.

The Iucomc-Tax Tribunal reversed the finding of the Appellate
Commissioner and held that the said sales tax liability was not admissible
as deduction during the relevant assessment year. The High Court held that
the liability to pay sales tax can be said to have initially accrued when the H
197
198 SUPREME COURT REPORTS (1996] 1 S.C.R.
A sales were effected but till the liability had ceased, it shall be treated to have
continued to accrue and that when pursuant to the Tribunal's order a fresh
demand notice was served by the Sales Tax Officer on the assessee, the
liability on the assessee can be said to have accrued on receipt of such
demand notice and, therefore, the assessee could claim the deduction under
Section 37 of the Income Tax Act during the assessment year 1971-72 even
B
though the liability was of the assessment year 1962-63.

In appeal to this Court it was contended for the revenue that (i) the
decision of the High Court was erroneous; (ii) as the assessee was following
mercantile system of accounting the liability to pay the central sales tax
C accrued to the respondent:assessee, the moment the sales, which were
subject to sales tax, were made; and (iii) the liability could not cease to be
a liability because the assessee had taken proceedings before higher
authorities for getting it reduced or wiped out so long as the contention of
the assessee did not prevail.

D Allowing the appeal preferred by Revenue and setting aside the
decision of the High Court, this Court

HELD : 1. The decision of the High Court is not sustainable at all.
When the assessee is following mercantile system of accounting, in case of
sales tax payable by the assessee, the liability to pay sales tax would accrue
E the moment the dealer made sales, which are subject to sales tax. At that
stage the obligation to pay the tax arises. Raising of dispute in this connection
before the higher authorities would be irrelevant. [202-A, 203-E]

2. In the present case, the liability to pay central sales tax arose or
accrued on the basis of mercantile system of accounting followed by the
F
assessee, during the previous relevant year 1962-63. It is a fact that the
assessment forthat year was completed by the Sales Tax Officer on 31.3.1966.
However, in mercantile system of accounting, liability to pay the quantified
sales tax dues as per order of Sales Tax Officer can be said to have accrued
to the assessee for the relevant assessment year 1962-63. It is true that the
G assessee challenged the same and ultimately got the liability to pay the sales
tax for the assessment year 1962-63, reduced in second appeal before the
Sales Tax Tribunal on 28.5.1970 to Rs. 2,22,161. But that would not affect
the accrual of liability to pay sales tax on the basis of mercantile system of
accounting. It is obvious that in no case, the assessee who was following
H mercantile system of accounting could\ have claimed deduction for payment
COMMR. OF LT v. KALINGA TUBES LTD. [MAJMUDAR, J.] 199
of central sales tax dues for assessment year 1962-63 in the assessment year A
1971-72. The High Court erred in coming to the conclusion that because
fresh demand notice was given by the Sales-Tax Officer Pursuant to the
decision of the Sales-Tax Tribunal the amount covered by the demand
notice could be claimed by way of deduction on accrual basis during the
assessment year 1971-72 or that such liability could be treated to have
B
accrued in that year. [203-F-G, 204-C]

3. Even if it is held that the order of the Sales Tax Officer had merged
in the order of Sales Tax Tribunal that would not have any impact on the
decision as to when the liability to pay sales tax had accrued to the assessee
on mercantile system of accounting and in which relevant assessment year C
the claim for deduction under Section 37 of the Income Tax Act could have
been made by the assessee. [204-E]

Kedarnath Jute Mant(facturing Co. Ltd. v. Co1nmissioner of Income-Tax
(Central) Calcutta, [1971] 82 ITR 363, applied.

illcome Tax Q(ficer, Kolar a11dA11r. v. SefihU Bichiah Setty, [1964] 7 SCR
D
148 and State bank ofTravancore v. The Co1nmissioner of Income-Tax, Kerala,
AIR (1986) SC 757, held inapplicable.

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1396 of 1996.

From the Judgment and Order dated 13.5.87 of the Orissa High Court in E
S.J.C. No. 52 of 1980.

S.N. Tcrdol and B. Pathasarthy for the Appellant.

Ms. Indra Jaising and Ms. Vijay Lakshmi Menon for the Respondent.
F
The Judgment of the Court was delivered by

S.B. MAJMUDAR, J. Leave granted.

By consent of learned Advocates of both the sides the appeal is finally
heard and is being disposed of by this judgment. The appellant Commissioner
of Income Tax, has brought in challenge the judgment and order dated 13th
G
May, 1987 passed by the High Court of Orissa at Cuttack answering the referred
question under Section 256(1) of the Income-tax Act, 1961 against the Revenue
and in favour of the assessee. It is the contention of the income-tax authorities
that the question should be answered against the assessee. A few relevant facts
centering round the question in controversy deserve to be noted at this stage. H
200 SUPREME COURT REPORTS [1996] l S.C.R.
The relevant assessment year is 1971-72. The respondent-assessee is a
''
limited company which manufactures and sells $lee! tubes in the State ofOrissa.
During the previous year relevant to assessment year 1962-63, the assessee was
liable to pay sales tax urrder the Central Sales Tax Act. The Sales Tax Officer
Completed the assessment in respect of assessment year 1962-63 on 31st
March, 1966 and demanded an additional amount of Rs. 11,02,698. The assessee
B
unsuccessfully carried the matter in appeal and then filed second appeal before
the Sales Tax Tribunal. The Tribunal by its order dated 28th May, 1970 reduced
the additional demand of sales tax to Rs. 2,22, 16 I. On the basis of the aforesaid
order of the Tribunal, the respondent-assessee claimed deduction of the said
amount as business expenditure in respect of the assessment for the previous
C year 1910- 71 since according to the assessee the sales-tax liability was of the
assessment year 1971-72.

The Income-tax Officer disallowed the said deduction in the relevant
assessment year, as according to the Income-tax Officer the assessee was
following mercantile system of accounting and hence the liability to pay sales
D tax accrued to it prior to the said year. On appeal, the appellate Commissioner
allowed the said deduction holding that as the said liability became determinate
and known only during that assessment year, it would be allowable for that
assessn1ent year.

The Income-Tax Tribunal reversed the finding of the Appellate
E Commissioner holding that the said sales tax liability was not admissible as
deduction during the relevant assessment year. For that conclusion the Tribunal
relied upon the decision of this Court in the case of Kedamath Jute Mcm4acturing
Company Limited v. Commissioner ~ffncome-tax (Central), Calcutta, (1971)
82 !TR 363. The assessee got the following question referred under Section 256
F (I) of the Income-tax Act for the opinion of the High Court :

"Whether on the facts and in the circumstances of the case, the
assessee is entitled to deduction of Rs. 2,22, 161 towards the sales-tax
liability for the assessment year 1971-72"

G The High Court after hearing both the sides answered the question in the
affirmative in favour of the assessee and against the Revenue, as noted earlier.
It is this answer of the High Court that is challenged on behalf of the Revenue
by the appellate Commissioner of the Income-Tax.

Learned counsel for the appellant submitted that the High Court has
H misunderstood and misapplied the ratio of decision of this Court in Kedamath
\-
COMMR. OF I.T. v. KALINGA TUBES LTD. [MAJMUDAR, J.] 201
Jute Mani~facturing Co. Ltd. (supra) That once it is nol in dispute that the A
aJsessee was following mercantile system of accountiag, the liability to pay the
central sales tax ac~rued to the respondent-assessee, the mo1nent the sales,
which are subject lo sales tax, are made. That liability would not cease to be a
liability because the assessee had taken proceedings before higher authorities
for getting it reduced or wiped out so long as the contention of the assessee did
B
not prevail. Further, the fact that the assessee had failed to debit the liability in
its books of accounts did not debar him from claiming the sum as deduction.
The eligibility for getting .deduction depends on the provisions of the law and
not on tlie view which the assessee might take of his rights.

The High Court, on the other band, took the view in the light of the very C
same decision in Kedar Nath Jute Mant{facturing Co. L!<L (supra) that the
liability to pay sales tax can be said to have initially accrued when the sales
were effected but till the liability had ceased, it shall be treated to have
continued to accrue and thol when pursuant to the Tribunal's order a fresh
demand notice was served by the Sales Tax Officer on the assessee, the liability
of the assessee can be said to have accrued on receipt of such demand notice D
and, therefore, the assessee can claim the deduction under Section 37 of the
Income Tax Act during the assessment year 1971-72 even though the liability
was of the assessment year 1962-63. It was submitted by the learned counsel
for the appellant that the aforesaid view of the High Court was erroneous. That
the High Court had misread and misapplied the ratio of the decision of this E
Court in Kedarnath Jute Man~faclllring Co. Ltd. (supra). On the other hand,
learned counsel for the respondent-assessee submitted relying on the decision
of this Court in Income Tax Officer, Kolar and Another v. Seghu Buchiah Setty,
[1964] 7 SCR 148 that the order of the Sales Tax Officer merged in the order
of the ultimate appellate authority, namely, the Sales Tax Tribunal and it is only
thereafter that the liability to pay sales tax could be said to have crystalized F
against the assessee or could be said to have accrued to the assessee. She also
submitted relying on the decision of this Court in the case of State Bank nf
· Travancore v. The Commissioner of Income-tax, Kera/a, AIR ( 1986) SC 757
that when entries are made in the books of accounts maintained as per mercantile
system of accounting, it i,s on the accrual of the real income that entries became G
-,. effective. According to the learned counsel for the respondent it is only on the
issuance of the fresh demand notice by the S.ales Tax Officer pursuant to the
order of the Sales Tax Tribunal that the liability to pay sales tax could be said
to have accrued to the assessee and that happened in the previous year relevant
to the concerned assessment year 1971-72. The High Court therefore had
rightly answered the question in favour of the assessee. H
I

-I

202 SUPREME COURT REPORTS [1996] 1 S.C.R.
A Having given our anxious consideration to the rival contentions, we find
that the decision of the High Court is not sustainable at all. The question is
squarely covered by the decision of this Court in Kedomath Jute Manufocturing
Co. Ltd. (supra). In that case, the assessee followed mercantile system of
accounting. During the relevant assessment year the assessee claimed deduction
of Rs. 1,49,776 being the amount of sales tax which it was liable under the law
B to pay during lhe relevant account.ing year. The income tax return was filed on
13tl1 January, I956. The demand notice was served by the sales tax authorities
on 21st November. 1957. On 9th November, 1959, the assessee filed a revised
return claiming the aforesaid deduction. The assessee had challenged the order
by which the demand for such tax had been raised, before higher authorities,
c as it was contesting its liability to the extent it had been determined. The
Income Tax Officer completed the assessment on 11th March, 1960 before any
final decision was given to the proceedings relating to the assessment of sales
tax. According to the Income Tax Officer, the assessee was not entitled to claim
the deduction of the aforesaid amount of sales tax inasmuch as it had denied its
liability to pay that amount, The Appellate Assistant Commissioner confirmed
D the order of the Income Tax Officer. The Income Tax Officer's aforesaid order
was confirmed in the hierarchy of proceedings upto the Tribunal and also
before the High Court in reference proceci!ings. The aforesaid view of the High
Court was upturned by this Court in the decision of Kedarnath Jute
Man4acturing. Co. Ltd. (supra) wherein this Court made following pertinent
E observations :

"Now under all sales tax laws including the statute with which we are
cencerned, the moment a dealer makes either purchases or sales which
are subject to taxation, the obligation to p·ay the tax arises and taxability
is attracted. Although that liability cannot ·be enforced till the
F quantification is affected by assessment proceedings, the liabiltty for
payment of tax is independent of the assessment. It is significant that
in the present case, the liability had even been quantified and a
demand had been created in the sufn of Rs. ~,49,776 by means of the
notice dated 21st November, 1957, during the pendency of tl)e
assessment proceedings before the Income Tax Officer and before the
G
finalisation of the assessment. It is not possible to comprehend how ~he
liability would cease to be one because the assess~ had taken
proceedings before higher authorities for getting it reduced or wiped
out so long as the contention of the assessee did not prevail with regard
to the quantum of liability etc. An asse~see who follows the mercantile
H system of accounting is entitled to deduct from the profits and gains
//

\
COMMR. OF LT." KAL!NGA TUBES LTD. [MAJMUDAR, J.] 203
of the business such liability which had accrued during the period for A
which the profits and gains were being computed. It can again not be
'' disputed that the liability to payment of sales-tax had accrued during
the year of assessment even though it had to be discharged at a future
date. In Pope The King Match Factory v. Co1nmissio11ero.flncome-tax,
~- a demand for excise duty was served on the assessee and though he
B
was objecting to it and seeking to get the order of the Collector of
Excise reversed, he debited that amount in his accounts on the last day
of his accounting year and claimed that amount as a deductible allow-
ance on the ground that he was keeping his accounts on the mercantile
basis. The Madras High Court had no difficulty in holding that the
assessee had incurred an enforceable legal liability on and from the c
date on which he received the Collector's demand for payment and
that his endeavour to .get out of that liability by preferring appeals
could not in any way detract from or retard the efficacy of the liability
which had ~een imposed upon him by the competent excise authority.
In our judgment, the above decision lays down the law correctly." D
The aforesaid decision, therefore, squarely lays down the legal proposi-
tion that when the assessee is following mercantile system of accounting, in
case of sales tax payable by the assessee, the liability to pay sales tax would
accrue the moment the dealer made sales, which are subject to sales tax. At that
stage the obligation to pay the tax arises. Raising of dispute in this connection E
before the higher authorities would be irrelevant. In the present case, the
liability to pay the central sales tax arose or accrued on the basis of mercantile
system of accounting followed by the assessee, during the previous relevant
.• - year 1962-63. It is a fact that the assessment for that year was completed by the
Sales Tax Officer on 31.3.1966. However, in mercantile system of accounting,
F
liability to pay the quantified sales tax dues as per ~rder of Sales Tax Officer
can be said to have accrued to the assessee for the relevant assessment year
1962-63. It is true that the assesse,e challenged the same and ultimately got the
liability to pay the sales tax for the assessment year 1962-63, reduced in second
appeal before the Sales Tax Tribunal on 28.5.1970 to Rs. 2,22,161. But that
would not affect the accrual of liability to pay sales tax on the basis of G
... -,. mercantile system of accounting. It was submitted by the learned counsel for
the respondent - assessee that if such entire deduction of Rs. ll,02,698 was
sought for by the assessee during the assessment year 1962-63. and ultimately
as held by the Tribunal the liability was reduced to Rs. 2,22,161 an incongruous
situation would have arisen. Such a contention cannot be countenanced for the H
204 SUPREME COURT REPORTS [1996] l S.C.R.
A simple reason that if ultimately the lax liability is reduced and if in retrospect
it was found !ha! during the relevant assessment year !he assessee had claimed
a large amount of deduction by way of business expenditure the difference of
the amount wrongly claimed and allowed in earlier relevant assessment year
could always be added back in the assessment of the relevant subsequent
.~

assessment year. It is obvious that in no case, the assessee who was following
B mercantile system of accounting could have claimed deduction for payment of
central sales tax dues for assessment year.1962-63 in the assessment year 1971-
72. It is difficult to appreciate how the High Court persuaded itself to come to
the conclusion that because fresh demand notice was given by the Sales-tax
Officer l'Ursuant to the decision of the Sales-tax Tribunal the amount covered
C by the demand notice could be claimed by way of deduction on accrual basis
during the assessment year 1971-72 or that such liability could be treated to
have accrued in that year. This finding of the High Court runs counter to the
ratio of the decision of this Court in Kedarnath Jute Man~facturing Co. Ltd.
(supra). Reliance placed by the learned counsel of the respondent. on the
D decision of this Court in Income Tax Officer, Kolar and Anr., [1964] 7 SCR 148
is also of no avail as even if it is held that the order of the Sales Tax Officer had
merged in the order of Sales Tax Tribunal that would not have any impact on
the decision as to when the liability to pay sales tax had accrued to the assessee
on mercantile system of accounting and in which relevant assessment year the
claim for deduction under Section 37 of the Income Tax Act could have been
E made by the assessee. Similarly, decision of this court in State Bank o/Travancore
(supra) is also of no avail to the assessee. The question with which we are
concerned in the present case is not covered by ratio of the sci.id decision and
on the contrary it is squarely covered by ratio of the decision in Kedar Nath Jute
Man4acturing Co. Ltd. (supra).
.F In the result, this appeal succeeds and is allowed. The answer given by
r
the High Court is set aside. The referred question is answered in the negative
in favour of the Revenue and againsi the assessee. There will be no order as to
costs.

G T.N.A. Appeal allowed.
,-
,