Holding

The enhanced charges represented only hypothetical income and did not constitute real income accrued to the assessee, therefore they were not taxable.

Summary

Godhra Electricity Co. Ltd., a licensee under the Electricity Act, raised electricity rates but could not recover the increased charges because of protracted consumer litigation, a government advisory to maintain status quo, and a takeover of its undertaking under the Defence of India Rules. The Income Tax Officer had added the uncollected enhanced charges to the company's taxable income for assessment years 1969-70 to 1972-73, but the Appellate Assistant Commissioner deleted those additions, holding they represented only hypothetical income. The Tribunal affirmed this view, and the Gujarat High Court reversed it, holding the company had a legal right to recover the charges. The Supreme Court examined whether income under the mercantile system must be real, not merely accrued on paper, and considered the effect of the advisory letter and the takeover. It held that the enhanced charges were not real income and could not be taxed, affirming the Tribunal’s decision and setting aside the High Court judgment. The appeal was allowed.

Issues considered

Whether amounts representing enhanced electricity charges, uncollected due to litigation and government advisory, constitute real income accrued for tax purposes under the mercantile system of accounting.
Whether hypothetical income can be taxed under the Income Tax Act, 1961.
Whether the letter from the Under Secretary to the Government of Gujarat and the subsequent consumer suits affect the accrual of income.
Whether the takeover of the undertaking under the Defence of India Rules, 1971, impacts the right to recover the enhanced charges and thus taxability.
Whether the additions made by the Income Tax Officer for the assessment years 1969-70 to 1972-73 are taxable.

Legislation cited

Subjects

mercantile accountinghypothetical incomereal incomeincome taxenhanced electricity chargesaccrual of incomeDefence of India Rulestaxabilityassessment yearsIndian Electricity ActElectricity (Supply) Act

Judgment

-~
\

GODHRA ELECTRICITY CO. LTD., AHMEDABAD A
v.
COMMISSIONER OF INCOME TAX, GUJARAT-II,
AHMED ABAD

APRIL 3, 1997
B
(S.C. AGRAWAL AND G.B. PATTANAIK, JJ.]

Income tax Act, 1961:

Income Ta~Ays 1969-70 to 1972-73-Accmal of income-Mercantile C
System of Accounting-Assessee, a licensee under the Electricity Act,
generated and supplied electricity-Cliarges for supply were enhanced but due
to pendency of litigation in various courts against increase in charges, assessee
unable to recover the same-Litigation ultimately ended infavour of assessee
but immediately thereafter State Govemment suggested to the assessee to D
maintain status quo for the rates for six months-Be/ore the expiry of the said
six months, consumers again challenged the right of the assessee to recover
the enhanced charges-Recovery was stayed and the consumers suit
decreed-During the pendency of the said consumers' suit the assessee-com-
pany was taken over by State Govemment under Defence of India Rules and
subsequently tran:.je"ed to State Electricity Board-Held:Accmal must be real E
income and not hypothetical income-Jn such circumstances, even though
assessee followed the mercantile :.ystem of accounting and had made ent1ies
in the books regarding enhanced charges, no real income had accmed to it
and the enllies represented only hypothetical income-Hence, not includible
in the total income of the assessee-Electlicity Act, 1910-Electricity (Supply) F
Act, 1948-Defence of India Rules, 1971. Income Tax-Mercantile System of
Accounting-Accrual of income-Real or hypothetical-Test to dete1~
mine-Held: Probability or improbability of realisation had to be considered
in a realistic manne~In the circumstances of the case, there was no accmal
of real income.
G
The appellant-assessee was a licensee under the Electricity Act, 1910
generating and supplying electricity. The assessee enhanced the charges
for supply of electricity but due to pendency of litigation in various courts
against the increase in charges, it was unable to recover the same. The
litigation ultimately ended in favour of the assessee but immediately H
539
/
,P.-
I

540 SUPREME COURT REPORTS [1997] 3 S.C.R.

A thereafter the Under Secretary to the State Government made a suggestion
the assessee to maintain status quo for the rates for six months. Before
the expiry of the said period of six months, the consumers again challenged
the right of the assessee to recover the enhanced changes. The recovery
was stayed and ultimately the consumer's suit decreed. During the penden-
cy of the said suit, the assessee-company was taken over by the State
B
Government under the Defence of India Rules, 1971 and subsequently
transferred to the State Electricity Board. The assessee was following the
mercantile system of accounting and had made entries in the books
regarding enhanced charges for the supply made to the consumers.

C For the assessment years 1969-70 to 1972-73 the Income Tax Oflicer
(ITO) included the enhanced charges, though not recovered from the
consumers, in the taxable income of the assessee. The said addition made
by the ITO was, however, deleted by the Appellate Assistant Commissioner.
The Income Tax Appellate Tribunal held that the enhanced charges rep-
resented only hypothetical income and did not represent the income, which
D had really accrued to the assessee during the relevant previous years, and
hence the enhanced ~h'lrges were not liable to be included in the taxable
income of the assessee. The High Court allowed the appeal filed by the
Revenue. Hence this appeal.

E Allowing the appeal, this Court

HELD : 1.1. Under the Income Tax Act, 1961 income charged to tax is
the income that is received or is deemed to be received in India in the
previous year relevant to the year fur which assessment is made or on the
income that accrue or arises or is deemed to accrue or arise in India during
F such year. The computation of such income is to be made in accordance with
the method of accounting regularly employed by the assessee. It may be
either the cash system where entries are made on the basis of actual outgo-
ing or disbursements or it may be the mercantile system where entries are
made on accrual basis, i.e., accrual of the right to receive payment and the
G accrual of the liability to disburse or pay. This principle is applicable
irrespective of the fact whether the accounts are maintained on cash system
or under the merc.antile system. If the accounts are maintained under the
mercantile system what has to be seen is whether income can be said to have
really accrued to the assessee-company. [550-D-E, HJ

H CIT v. Slzooiji Vallabhdas and Co., (1962) 46 ITR 144; CIT v. Bir/a
GODHRAELECTRICITYCO.LTD. v. C.I.T. 541
rr.1;
_ ,_-.ior (P) Ltd., "(1973) 89 ITR 266 and Poona Electric Supply Co. Ltd. v. A
-:::n; (1965) 57 ITR 521, relied on.
'i_-..

H.M. Kashiparekh & Co. Ltd. v. CIT (1960) 39 ITR 706 (Born.),
approved.

M01vi Industries Ltd. v. CIT (1971) 82 ITR 835, referred to. B
1.2. Even though the assessee-company was following the mercantile
system of accounting and had made entries in the books regarding en·
hanced charges for the supply made to the consumers, no real income had
accrued to the asessee-company in respect of those enhanced charges.
After the decision was taken by the assessee-company to enhance the C
charges it was not able to realise the enhanced charges on account of
pendency of the earlier representative suits of the consumers followed by
the letter of the Under Secretary to 'the State Government. [553-A, El

State Bank of Trav:mcore v. CIT, (1986) 158 ITR 102, relied on. D
2. It is true that the letter addressed by the Under Secretary to the
State Government, to the assessee-company had no legally binding effect
but one has to look at things from a practical point of view. The assessee-
company, being a licensee, could not ignore the directior. of the State
Government which was couched in the form of an advice, whereby the E
assessee-company was asked to maintain the status quo for at least six
months and not to take steps to recover the dues towards enhanced
charged from the consumers during this period. Before the expiry of the
period of six months the subsequent suit had been filed by the consumers
and during the pendency of the said suit the undertaking of the assessee-
company was taken over by the State Government under the Defence of
F
India Rules, 1971 and subsequently it was transferred to the State
Electricity Board and, as a result, the assessee-company was not in a
position to take steps to recover the enhanced charges. [553-G-H, 554-A-B)

RB. Jodha Mal Kuthiala v. CIT., (1971) 82 ITR 570, relied on. G

Jindas Oil Mill & Ors. v. Godhra Electricity Co., [1969) 3 SCR 836,
referred to.

3. The question whether there was real accrual of income to the
assessee-company in respect of the enhanced charges for supply of H
542 SUPREME COURT REPORTS (1997] 3 S.C.R.

A electricity has to be considered by taking the probability or improbability
of realisation in a realistic manner. If the matter is considered in this light, ·
it is not possible to hold that there was real accrual of income to the
assessee-company in respect of the enhanced charges for supply of
electricity which were added by the Income Tax Officer while passing the
B assessment orders in respect of the assessment years under consideration.
The Appellate Assistant Commissioner was right in deleting the said
addition made by the Income Tax Officer and the Tribunal had rightly held
that the claim at the increased rates as made by the assessee-company on
the basis of which necessary entries were made represented only hypotheti-
cal income and the impugned amounts as brought to tax by the Income
C Tax Officer did not represent the income which had really accrued to the
assessee-company during the relevant previous years. [554-F-H]

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 5638-
5640 of 1983.

D From the Judgment and Decree dated 24/25.2.82 of the Gujarat High
Court in I.T.R. Nos. 288175, 73178 and 171of1978.

S. Ganesh, U.A. Rana, Rajiv Tyagi and Subramaniam for the Appel-
!ant.
E
Ms. Laxmi Iyengar, C. Radha Krishnan and B.K. Prasad for the
Respondent.

The Judgment of the Court was delivered by

F S.C. AGRAWAL, J. : These appeals, by certificate granted under
Section 261 of the Income Tax Act, 1961 (hereinafter referred to as 'the
Act'), have been filed by the Godhra Electricity Co. Limited,
(hereinafter referred to as 'the asessee-company') against the judgment
of the Gujarat High Court dated February 24-25, 1982 in Income Tax
G References Nos. 288 of 1975, 73 of 1978 and 171 of 1978. Income Tax
Reference No. 288 of 1975 related to tlie assessment year 1969-70, while
Income Tax Reference No. 73 of 1978 related to the assessment years
1970-71 and 1971-72 and Income Tax Reference No. 171 of 1978 related
to assessment year 1972-73.

H On November 19, 1922 the then Government of Bombay granted
GODHRAELECTRICITYCO. LTD. v. C.I.T. [S.C.AGRAWAL,J.] 543

a licence under the Indian Electricity Act, 1910 to Lady Sulochana Chinub- A
hai & Company authorising it to generate and supply electricity to the
consumers in Godhra area. The assessee-company is the successor of
the said licensee. On the recommendations of a Rating Committee
constituted under Section 57 (2) of the Electricity (Supply) Act, 1948
the State Government had fixed the charges for supply of electricity and B
motive power by the asscssee-Company wit_h effect from February 1,
1952. After the amendment of the Electricity (Supply) Act, 1948 in 1956
the assesee-company increased the charges for motive power from
January 1, 1963 to 35 np. per unit with a maximum of Rs. 7 per month
for every installation and a few months thereafter on June 22, 1963 the C
assessee-company increased the rates for electricity supplied for lights
and fans to 70 np. per unit with a minimum of Rs. 5 of every installation
with effect from July l, 1963. This unilateral increase in the rates for
supply of motive power as well as electricity for lights and fans led to
the institution of two representative suits by the consumers (Civil Suits D
Nos 152 of 1963 and 50 of 1964) in the court of Civil Judge (Senior
Division) at Godhra wherein the right of the assessee-company to
unilaterally increase the charges in respect of motive power and lights
and fans was challenged. The said suits were decided by the trial court
in favour of the consumers and the decree of the trial court was affirmed
in appeal by the Assistant Judge, Panchmahals at Godhra. The second E
appeals filed by the assessee-company were dismissed by the learned
single Judge of the Gujarat High Court on April 11, 1966 but the Letters
Patent Appeals (L.P. As. Nos. 42 and 43 of 1966) filed by the assessee-
com pany against the said judgment of the learned single Judge were.
allowed by the Division Bench of the High Court by judgment dated F
December 3, 1968 and both the representative suits filed by the con-
sumers were dismissed. It was held that under the Electricity (Supply)
Act, 1948, as amended in 1956, the assessee-company was entitled to
enhance the charges unilaterally subject to the conditions prescribed in
the Sixth Schedule to the said Act. The said judgment of the Division G
Bench 0f the Gujarat High Court was affirmed by this Court by judg-
ment dated Febrnary 26, 1969 in Jindas Oil Mill Ors. v. Godhra Electricity
Co., (1969] 3 SCR 836. During the pendency of this litigation in the
various courts the assessee-company was not able to realise the en-
hanced charges from the consumers. After the decision of this Court on H
544 SUPREME COURT REPORTS [1997) 3 S.C.R.

A February 26, 1969 some of the citizens of Godhra met the Minister of
Industries, Mines and Power, Government of Gujarat, with a view to .
persuading him to intervene and restrict the assessee-company from
recovering the enhanced rates from the consumers. Thereafter the Under
Secretary to the Government of Gujarat in the Industries, Mines and Power
B Department, addressed a letter dated March 19, 1969 to the Assessee-com-
pany suggesting that the company may be advised to maintain the status
quo for the rates to the consumers are concerned and abo to continue the
existing street light agreement for at least six months. The Chief Electrical
Inspector was requested to go through the accounts of the assessee-com-
C pany for year to year and report to the Government the actual position
about the reasonable return earned by the assessee-company. On May 16,
1969 some of the consumers filed another representative suit (Suit No. 118
of 1969) against the assessee-company in the court of Civil Judge (Junior
Division) at Godhra challenging the right of the assessee-company to
D recover the consumption charges at the enhanced rates. In the said suit it
was claimed that the decision of this Court was only of academic interest
as, in April 1965, the assessee-company began to purchase in bulk electrical
energy at 10 paise per unit from the Gujarat Electricity Board and it had
to work merely as distributing agency and had to collect the charges and
not generate electrical energy and that the assessee-company would earn
E more profits even if it supplied electricity at 31 paise per unit to the
consumers of motive power and that it would earn a reasonable return even
on the basis of the existing rates. An interim injunction was granted by the ...
trial court in that suit. A written statement was filed by the assessee-com-
pany contesting the said suit but when the suit came up for hearing no
F evidence was led to controvert the evidence produced on behalf, of the
consumers since at that point of time the undertaking of the assessee-com-
pany was under the management of the Collector of Godhra and he did
not give any instructions to the lawyer appearing on behalf of the assessee-
company with the result that the said lawyer reported no instructions. The
G said suit was decreed in favour of the consumers by the Civil Judge by his
judgment dated June 20, 1974 and a declaration was granted to the effect
that the assessee-company shall not recover the charges exceeding 31 np.
per unit for lights and fans and 20 np. per unit for motive power. The
interim injunction which had been granted against dis-connection or dis-
H continuance of the supply was made absolute on the same terms on which
GODHRA ELECTRICITY CO. LTD. v. C.I.T. [S.C. AGRAWAL, J .] 545

it was initially granted. During the course of hearing before the High A
Court it was stated by the learned Advocate General appearing for the
assessee-company that an appeal was in fact filed against the said judg-
ment but the plaintiffs by their application dated July 27, 1979 sought
permission of the court to withdraw the suit with liberty to file a fresh suit
on the same cause of action, if and when necessary and the trial Judge by B
order of even date permitted the plaintiffs to withdraw the suit and
granted them the liberty sought. While the said suit was pending before
::e trial court the Gujarat State Electricity Board, in exercise of power
conferred on it by Section 6 (1) of the Indian Electricity Act, 1910 read
with clause (2) of the terms of the licence, sought to exercise its option C
to purchase the electrical undertaking of the assessee-company by issuing
a notice dated November 8, 1971. The assessee-company filed a Writ
P;:tition (Special Civil Application No. 1752 of 1972) in the Gujarat High
Court challenging tile validity of the said notice. During the Pendency of
the said Writ petition the Government of Gujarat issued an order under D
Rule 115 (2) of the Defence of India Rules, 1971 taking over the manage-
ment of the w iertaking of the assessee-company with effect from Novem-
ber 19, 1972 and the Collector of Godhra was authorised by the said order
to take over the management of the undertaking of the assesee-company.
The said Writ Petition was ultimately dismissed by the High Court by its E
judgment dated October 16-17 of 1973. In the appeal filed by the asses-
see-company against the said judgment in this Court an interim order was
passed directing the Collector of Godhra to hand over the undertaking to
the Gujarat State Electricity Board and in accordance· ~ith the said
direction the Government of Gujarat on December 20, 1973 instructed the
Collector of Godhra to hand over the management of the undertaking to F
the Gujarat State Electricity Board which was done on the next day and
thereafter the notification issued under Rule 115 (2) of the Defence of
Indian Rules, 1971 was cancelled on May 4, 1974.

Upto assessment year 1963-64 the assessee-company was assessed on G
the basis of the accounts maintained according to the mercantile system.
For the subsequent assessment years, i.e., from 1964-65 to 1967-68, the
assessee-company deducted a total amount of Rs. 10,87,828 from the total
earnings in respect of sale of electrical energy on the ground that the said
amount was not actually recovered by it from the consumers since the H
546 SUPREME COURT REPORTS [1997] 3 s. C.R.

A consumers had filed a suit against the assessee-company and had obtained
interim belief in that behalf. The particulars of the deduction made for the
aforesaid four assessment year were as under :

Asseement year Amount Deducted
1964-65 Rs. 2, 59,777
B
1965-66 Rs. 3,16,953
1966-67 Rs. 3,89,761
1967-68 Rs. 1,21,337

C The aforesaid disputed amounts were shown by the assessee-com-
pany on the liability side in the balance sheet under the head "Disputed
increase in rates charged to customers (consumer), carried forward pend-
ing settlement of disputes in the District Court". In the assessment year
1968-69 there was an adjustment of the claim amounting to Rs. 3,54, 152
D due to settlement of dispute with the railway authorities and the disputed
balance stood reduced to Rs. 7,33,676. While making the assessment for
the assessment year 1969-70 the Income Tax Officer included the said
amount of Rs. 7,33,676 on the ground that the suit filed against the
assessee-company by the consumers was decided in favour of the assessee-
company by this Court during the accounting years 1968-69 and the asses-
E see-company has the legal right to recover the said amount and on the basis
of the accountancy followed by the assessee-company the amount of Rs.
7,33,676 will have to be taxed as the income that has accrued to the
assessee-company on account of the decision of this Court in the assess-
ment year 1969-70. The said addition made by the Income Tax Officer was,
p however, deleted by the Appellate Assistant Commissioner, on appeal, on
the view that no legally enforceable claim had accrued to the assessee-com-
pany during the previous year by which it could recover the arrears of the
earlier years for enhanced charges/rates in respect of motive power and
electricity for lights and fans from the consumers. The Income Tax Appel-
late Tribunal (hereinafter referred to as 'the Tribunal'), on further appeal,
G held that the question of fixing a reasonable return was still an open issue
since it was a subject matter of further litigation wherein as a result of the
decision of Civil Judge, Junior Division, Godhra the assessee-company was
restrained from recovering the charges more than the 31 paise per unit for
lights and fans and 20 paise per unit for motive power from the customers
H and that the right to receive the increased rates had not crystallized.
GODHRAELECTRICITYCO. LTD. v. C.l.T. [S.C.AGRAWAL,J.] 547

According to the Tribunal the claim at the increased rates as made by the A
assessee-company and on the basis of which necessary entries were made
in the books, represented only hypothetical income and the impugned
amount as brought to tax by the Income Tax Officer did not represent the
income which had accrued to the assessee-company during the relevant
previous year. On an application by the Revenue the Tribunal referred B
following question of law for the opinion of the Gujarat High Court :

"Whether the Tribunal was right in law in holding that the amount
of Rs. 7,33,676 which had accrued to the assesse during the
previous year, and which was brought to tax by the Income Tax
Officer did not represent the income and, therefore, could not be C
included in computation of the total income of the assessee."

On the basis of the said reference Income Tax Reference No. 288 of
1975 was registered in the High Court.

Similarly in respect of asse~· .1ent years 1970-71 and 1971-72 the D
Income Tax Officer included the sums of Rs. 2,63,465 and Rs. 2,98,077
respectively as income that had accrued to the assessee-company in those
years and was taxable. The said addition was deleted by the Appellate
Assistant Commissioner on appeal by the assessee-company and the said
decision was upheld by the Tribunal. On application moved by the E
Revenue the following question of law was referred to the High Court for
its opinion :

"Whether, the Tribunal was right in law in holding that the amount
of Rs. 2,63,465 for assessment year 1970-71 and Rs. 2,98,077 for
F
assessment year 1971-72 which had accrued to the assessee during
the previous year and which was brought to tax by the Income Tax
Officer did not represent the income of the assessee and therefore
not liable to be included in computation of the total income of the
assessee?"
G
On the basis the said reference, Income Tax Reference No. 73 of
1978 was registered in the High Court.

For the assessment year 1972-73 the Income Tax Officer included a
sum of Rs. 3,17,741 as income that had accrued and was taxable in the H
548 SUPREME COURT REPORTS [1997) 3 S.C.R.

A hands of the assessee-company which addition was deleted by the Appel-
late Assistant Commissioner and the said order of the Appellate Assistant
Commissioner W'dS upheld by the Tribunal. The following question were
referred by the Tribunal to the High Court for opinion :-

"l. Whether, the Income Tax Appellate Tribunal was right in
B holding that the amount of Rs. 3,17, 741 which had accrued to the
assessee during the previous year, and which was brought to tax
by the Income Tax Officer did not represent the income and
therefore it could not be included in the computation of the total
income of the assessee?
c
2. Whether, on the facts and in the circumstances of the case, the
receipt of Rs. 3,17,741 could be subjected to tax in the assessment
year in question as the income of the assessee?"

On the basis the said reference, Income Tax Reference No. 171 of
D 1978 was registered in the High Court.

All the three references were disposed of by the High Court by a
common judgment dated February 24-25, 1982. The High Court has held
that the assessee-company was following the mercantile system of account-
£ ing and that even under this system in order to visit the assessee-company
with the obligation to pay tax the profit must become actually due no
matter when it is received and that income cannot be said to have accrued
to an assessee-company if it is based on a mere claim not backed by any
legal or contractual right to receive the amount al a subsequent date. The
High Court has held that in the mercantile system of accounting it is the
F
real income, as distinguished from a hypothetical income, which can be
brought lo tax. In view of the decision of the Division Bench of the High
Court allowing the Letters Patent Appeal~ of the assessee-company, which
judgment was affirmed by this Court on February 26, 1969, the High Court
has held that the assessee-company had a legal right to recover the con-
G sumption charge al the enhanced rate from the consumers. As regards the
letter from the Under Secretary to the Government of Gujarat, Industries,
Mines and power Department, dated March 19,1969 the High Court has
observed:

H "We do not know if this letter was a directive to the assessee under
··- ----l

GODHRAELECTRICITYCO. LTD. v. C.I.T. [S.C.AGRAWAL,J.j 549

any provision of law but in any case it was in the form of a A
suggestion which, if accepted, enured for a period of six months
only. Therefore, the contention of the learned Advocate General
that income could not be said to have accrued to' the assessee in
view of this letter received by the assessee within a few days after
the Supreme Court dismissed the appeals filed by the consumers, B
does not appeal to us. In any case, the request made by the State
Government was to maintain the status quo for a period of six
months only. That letter did not take away the right of the assessee
to recover consumption charges at the enhanced rates from its
consumers."
c
As regards the representative suit (Suit No. 118 of 1969) which was
filed by the consumers in the court of Civil Judge (Junior Division) at
Godhra, the High Court has observed that "the said suit concerned the
recovery of enhanced charges for the period subsequent to 31st March,
1969 and not prior thereto". The High Court rejected the contention urged D
on behalf of the assessee-company that no real income had accrued to the
assessee-company in the facts and circumstances of this case since the
assessee-company was legally entitled to recover the consumption charges
from the consumers at the enhanced rates and at no point of time had the
assessee-company forgone or given up its right to recover the enhanced E
rates from its consumers. On that view of the matter, the High Court
answered the questions mentioned above against the assessee-company and

- in favour of the Revenue. By order dated January 15, 1983 the High Court
granted certificate of fitness to appeal to this Court against the said
judgment. Hence these appeals.
F
Shri S. Ganesh, the learned counsel appearing for the assessee-
company, has submitted that in the facts and circumstances of this case it
must be held that no real income had accrued to the assessee-company on
account of enhanced charges for electricity since the assessee-company was
not able to recover the said enhanced charges from the consumers in view G
of the protracted litigation during the period from 1963 to 1969 and
thereafter on account of the letter from the Under Secretary to the
Government of Gujarat dated March 19, 1969 asking the assessee-company
not to charge the enhanced rates for at least six months and the subsequent
suit (Suit No. 118 of 1969) filed by the consumers in 1969 and the taking H
550 SUPREME COURT REPORTS [1997) 3 S.C.R.

A over of the management of the assessee-company by the Collector, Godhra
in pursuance of the Order passed under Rule 115(2) of the Defence of
India Rules, 1971. It has been urged that though the assessee-company was
following the mercantile system of accounting but in the mercantile system
also tax can be imposed only if there is real income and income tax cannot
B be imposed on hypothetical income. The learned counsel has placed
reliance on the decisions of this Court in Commissioner of Income Tax,
Bombay City-I v. Messrs. Shoorji Vallabhdas and Co., (1962) 46 ITR 144;
Commissioner of Income Tax, West Bengal-II v. Bir/a Gwalior (P) Ltd.,
(1973) 89 ITR 266; Poona Electric Supply Co. Ltd. v. Commissioner of
Income Tax, Bombay City-I, (1965) 57 ITR 521, R.B. Jodha Mal Kuthiala
c v. Commissioner of Income Tax, Punjab, (1971) 82 ITR 570 and State Bank
ofTranvancore v. Commissioner of Income Tax, Kera/a, (1986) 158 ITR 102.

Under the Act income charged to tax is the income that is received
or is deemed to be received in India in the previous year relevant to the
D year for which assessment is made or on the income that accrues or arises
or is deemed to accrue or arise in India during such year. The computation
of such income is to be made in accordance with the method or accounting
regularly employed by the assessee. It may be either the cash system where
entries are made on the basis of actual receipts and actual outgoings or
E disbursements or it may be the mercantile system where entries are made
on accrual basis, i.e., accrual of the right to receive payment and the
accrual of the liability to disburse or pay. In Commissioner of Income Tax,
Bombay City- Iv. Messrs. Shoorji Vallabhdas and Co. (supra), it has been
laid down:

F "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, viz., the accrual of the income or its receipt, but the
substance of the matter is the income. If income does not result
at all, there cannot be a tax, even though in book-keeping," an entry
is made about a hypothetical income, which does not materialise."
G [p. 148)

This principle is applicable whether the accounts are maintained on
cash system or under the mercantile system. If the accounts are maintained
under the mercantile system what has to be seen is whether income can be
H said to have really accrued to the assessee-company. In H. W. Kashiparekh
GODHRAELECTRICITYCO. LID. v. C.I.T. [S.C.AGRAWAL,J.] 551

& Co. Ltd. v. Commissioner of Income Tax, (1960) 39 IIR 706, the Bombay A
High Court had said :

"Even so, (the failure to prciduce account losses) we shall proceed
on the footing that the assessee-company having followed the
mercantile system of account, there must have been entries made
in its books in the accounting year in respect of the amount of B
commission. In our judgment, we would not be justified in attach-
ing any particular importance in this case to the fact that the
company followed mercantile system of accounting they would not
have any particular bearing in applying the principle of real income
in the facts of this case." c
The said view was approved by this Court in Commissioner of Income
Tax v. Bir/a Gwalior (P) Ltd. (supra) where the assessee maintained its
accounts on the mercantile system. In that case this Court, after referring
to the decision in M01vi Industries Ltd. v. Commissioner of Income Tax,
(1971) 82 IIR 835, which was also a case where the accounts were main- D
tained on mercantile system, had said;-

"Hence it is clear that this court in morvi Industries case did
emphasise the fact that the real question for decision was whether
the income had really accrued or not. It is not a hypothetical E
accrual of income that has got to be taken into consideration but
the real accrual of the income." [p. 273]

In Poona Electric Supply Co. Ltd. v. Commissioner of Income Tax,
Bombay City-I (supra) this Court had said;-
F
"Income tax is a tax on the real income, i.e., the profits arrived at
on commercial principles subject to the provisions of the Income
Tax Act."

In that case the Court has approved the following principle laid down G
by the Bombay High Court in H.M. Kashiparekh & Ltd. v. Commissioner
of Income Tax (supra) :

"The principle of real income is not to be so subordinated as to
amount virtually to a negation of it when a surrender or concession
or rebate in respect of managing agency commission is made, H·
552 SUPREME COURT REPORTS (1997) 3 S.C.R.

A agreed to or given on grounds of commercial expediency, simply
because it takes place some time after the close of an accounting
year. In examining any transaction and situation of this nature the
court would have more regard to the reality and speciality of the
situation rather than the purely theoretical or doctrinaire aspect
of it. It well lay greater emphasis on the business aspect of the
B matter viewed as a whole when that can be done without disregard-
ing statutory Language."

In State B(111k of Tranvacore v. Commissioner of Income Tax, Kera/a
(supra), after considering the various decisions of this Court, Sabyasachi
C Mukharji j. (as the Learned Chief Justice then was) has said:

"An acceptable formula of co-relating the notion of real income in
conjunction with the method of accounting for the purpose of the
computation of income for the purpose of taxation is difficult to evolve.
D Besides, any strait-jacket formula is bound to create problems in its
application to every situation, it must depend upon the facts and cir-
cumstances of each case. When and how does an income accrue and
what are the consequences that follow from accrual of income as well-
settled. The accrual must be real taking into account the actuality of the
situation. Whether an accrual has taken place or not must, in ap-
E propriate cases, be judged on the principles of real income theory. After
accrual, non-charging of tax on the same because of certain conduct
based on the ipse dixit of a particular assessee cannot be accepted. In
determining the question whether it is hypothetical income or whether
real income has materialised or not, various factor will have to be taken
p into account. It would be difficult and improper to extend the concept
of real income to all cases depending upon the ipse dixit of the assessee
which would then become a value judgment only. What has really
accrued to the assessee has to be found out and what has accrued must
be considered from the point of view of real income taking the prob-
ability or improbability of realisation in a realistic manner and dovetail-
G ing of these factors together but once the accrual takes place, on the
conduct of the parties subsequent to the year of closing an income which
has accrued cannot be made 'no income'." (p. 154)

If the matter is examined in the light of the aforementioned
H principles laid down by this Court, it must be held that even though the
GODHRA ELEC1RICITY CO. LTD. v. C.I.T. [S.C. AGRAWAL, J.] 553

assessee-company was following the mercantile system of accounting and A
had made entries in the books regarding enhanced charges for the supply
made to the consumers, no real income had accrued to the assessee-com-
pany in respect of those enhanced charges in view of the fact that soon
after the assessee-company decided to enhance the rates in 1963 repre-
sentative suit (Civil suits Nos. 152 of 1963 and 50 of 1964) were filed by B
the consumers which were decreed by the trial court and which decree was
affirmed by the appellate court and the learned single Judge of the High
Court and it is only on December 3, 1968 that the Letters Patent Appeals
filed by the assessee-company were allowed by the Division Bench of the
High Court and the said suit were dismissed. But appeals were filed against
the said judgment by the consumers in this Court and the same were C
dismissed by the judgment of this Court dated February 26, 1969. Shortly
thereafter, on March 19, 1969, the Under Secretary to the Government of
Gujarat wrote a letter advising the assessee-company to maintain the status
quo for the rates to the consumers for at least six months and the Chief
Electrical Inspector was directed to go through the accounts of the asses- D
see-company from year to year and to report to the Government about the
actual position about the reasonable returns earned by the assessee-com-
pany. On May 16, 1969 another representative suit (Suit No. 118 of 1969)
was filed by the consumers wherein interim injuction was granted by the
Court and which was finally decreed in favour of the consumers on June
23, 1974. It would thus appear that after the decision was taken by the E
assessee-company to enhance the charges it was not able to realise the
enhanced charges on account of pendency of the earlier representative
suits of the consumers followed by the letter of the Under Secretary to the
Government of Gujarat and the subsequent suit of the consumers and
during the pendency of the subsequent suit the management of the under- F
taking of the assessee-company was taken over by the Government of
Gujarat under the Defence of India Rules, 1971 and the undertaking was
subsequently transferred to the Gujarat State Electricity Board.

It is no doubt true that the letter addressed by the Under Secretary
to the Government of Gujarat to the assessee-company had no legally G
binding effect but one has to look at things from practical point of view.
[See : R.B. Jodha Mal Kutltiala v. Commissioner of Income Tax, Punjab
(supra)]. The assessee-company, being a licensee, could not ignore the
direction of the State Government which was couched in the form of an
advice, whereby the assessee-company was asked to maintain the status quo H
554 SUPREME COURT REPORTS [1997] 3 S.C.R.

A for at least six months and not to take steps to recover the dues towards
enhanced, charges from the consumers during this period. Before the
expiry of the period of six months the subsequent suit had been filed by
the consumers and during the pendency of the said suit the undertaking
of the assessee-company was taken over by the Government of Gujarat
under the Defence of India Rules, 1971 and subsequently it was trans-
B ferred to the Gujarat State Electricity Board and, as a result, the
assessee-company wa5 not in a position to take steps to recover the
enhanced charges.

The High Court has observed that the subsequent suit that was
C filed on May 16, 1969 related to recovery of enhanced charges for the
period subsequent to March 31, 1969 and not prior thereto. We have,
however, perused the judgment of the Joint Judge (Junior Division),
Godhra dated June 20, 1974 in the said suit which was annexed as
Annexure 'D' to the statement of the case. The said judgment does not
D show that the suit was confined to the period subsequent to March 31,
1969. On the other hands, it shows that the plaintiffs in that suit were
challenging the enhancement in charges made in 1963 and had sought
a declaration that the assessee-company was not entitled to recover
more than 31 paise per unit for light and fans and 20 paise per unit for
motive power anC: the trial court, while decreeing the said suit had given
E a declaration in these terms. The said declaration is not confined to the
period subsequent to March 31, 1969.

The question whether there was real accrual of income to the
assessee-company in respect of the enhanced charges for supply of
F electricity has to be considered by taking the probability or im-
probability of realisation in a realistic manner. If the matter is con-
sidered in this light, it is not possible to hold that there was real accrual
of income to the assessee-company in respect of the enhanced charges
for supply of electricity which were added by the Income Tax Officer
while passing the assessment orders in respect of the assessment years
G under consideration. The Appellate Assistant Commissioner was right
in deleting the said addition made by the Income Tax Officer and the
Tribunal had rightly held that the claim at the increased rates as made
by the assessee-company on the basis of which necessary entries were
made represented only hypothetical income and the impugned amounts
H as brought to tax by the Income Tax Officer did not represent the
--~

GODHRAELECTRICITY CO. LTD. v. C.I.T. [S.C.AGRAWAL,J.] 555

income which had really accrued to the assessee-company during the A
relevant previous years. The High Court, in our opinion, was in error in
upsetting the said view of the Tribunal.

In the result, the appeals are allowed, the impugned judgment of
the High Court is set aside and the questions referred by the Tribunal
for opinion are answered in favour of the assessee-company and against B
the Revenue. But in the circumstances, there will be no order as to costs.

v.s.s. Appeals allowed.