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Civil Reference No. 11 of 1966, decided on 21st December 1972.

, S. 4(1)(b)(i)‑Words "accrue" and "arise''‑Meaning‑B (assessee) appointed managing agents for a company V under a managing agency agreement‑L, under agreement, made entitled to receive Rs. 1,500 per month as office allowance and commission at rate of 10% on annual profits made by managed company‑Commission on annual profits could not be said to arise until end of year‑Office allowance, being monthly, could, however, be said to accrue to assessee as end of every month ‑ B passing resolutions (accepted by managed company V) foregoing its commission on annual profits as well as office allowance "with a view to stabilise" the managed company‑Held, no income on account of commission accrued to B at end of assessment year ; but office allowance accrued from month to month and this allowance could be treated as deductable expenditure only from date resolutions waiving such allowance passed.

B (a private company,) was appointed managing agents for a company V under a managing agency agreement. The agreement provided that B was entitled to receive Rs. 1,500 permensem as office allowance and commission at the rate of 10 can annual net profits made by the managed company. The office a lowance was payable every month whereas the commis sion on the net profits was payable at the end of the year. B, the managing agent passed resolutions foregoing its right to recover managing agency commission as well as the monthly office allowance for the year. The Income tax Officer held the managing agency commission as well as the office allowance of B as Incomes of B liable to tax.

Held: Under section 4(1)(b)(i) of the Income‑tax Act, 1922 the total income of any previous year of any person includes all incorrect profits and gauss from whatever source derived, which accrue or arise or are deemed to accrue or arise to him in Pakistan within such year. The words "accrue" and "arise" are used in contradistinction to the word "receive" and indicate a right to receive. Therefore, income must be held to accrue aw the date when a debt becomes due, that is, when the right to receive such income comes into existence.

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. It income does not result at all there cannot be a tax, even though in book‑keeping, as entry is made about a hypothe tical income, which does not materialise, where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable, where however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in tine books of account. Under the managing agency agreements, the managing agency commission was payable to the assessee only at the end of each relevant accounting year. Therefore, as far as managing agency commission was concerned, it could not be said to have accrued until the end of the account ing year in question. But for each such accounting year, the assessees passed a resolution foregoing the commission receiv able by them, which resolutions were accepted by the managed companies. Therefore, no income whatsoever resulted to the assessees with regard to these commissions which could not be said to have accrued due to them at all foe any of the accounting or the assessment years in dispute. As regards the question of office allowance, its waiver may he held justifiable, and accordingly deductable as expenditure under certain circumstances. One such circumstance is commercial expediency. But the office allowance accrued to the assessee from both the managed companies from month to month that is, at the end of every month. In the case of office allowance, therefore, the assessee's claim that this allowance should be treated as deductable expenditure was sustainable only from the date when resolution waiving such allowance was passed for each of the assessment years.

Colquroun v. Brooks (1888) 21 Q B D 52 ; E. D. Sasoon & CJ. Ltd. and others v. Commissioner of Income‑tax, Bombay City (1954) 26 I T R 27 ; Commissioner of Income‑tax, Bombay North. Kutch and Saurashtra, Ahmedabad v. Chatnanlal Mangaldas & Co. (1956) 29 I T R 987 ; Commissioner f Income‑tax, Bombay City I v. Shoorji Vallabhdas & Co. (1959) 361 T R 25 ; Douchty v. Commissioner of Taxes (1927) A C 336 ; Commis sioner of Income‑tax, Bombay Noah v. Chandulal Keskavlal & Co. (1960) 38 I T R 601 ; Tata Sons Ltd. v. Commissioner of Income‑tax, Bombay City (1950; 18 I T R 460 ; H. M. Kashi parakh & Co. Ltd. v. Commissioner of Income‑tax, Bombay North, Kutch and Saurashtra (1960) 39 I T R 706 and Commissioner of Income‑tax, Bombay City I v. Messrs Shoorji Vallabhdass & Co. (1962) 46 I T R 144 ref.

Ali Athar for Applicant.

S. A. Nusrat for Respondent.

Dates of bearing : 16th November 1971; 20th and 21st December 1972.

.‑The Income‑tax Appellate Tribunal (Karachi Bench) has referred, on the application of the Commis sioner of Income‑tax (Investigation), Karachi, the following question for the opinion of the High Court ;‑

"Whether on the facts and circumstances of the case managing agency commission and/or the office allowance from the two managed companies in the assessee accrued income liable to tax"

2. The question relates to the assessment years 1958‑5l, 1959‑60, 1960‑61 and 1961‑62. The relevant facts on which this question has arisen are these : The assessee, a private limited company, was appointed managing agents for Valika Textile Mills Limited and Valika Art Fabrics Limited under separate managing agency agreements. Under the managing agency agreement with Valika Textile Mills Limited, it was provided that the assessee will receive Rs. 1,5C0.00 per month as office allowance and commission at the rate of 10 per cent. on the annual net profits made by this managed company. The agreement with Valika Art Fabrics Limited made provision for payment to the assessee of Rs. 2,500.00 per month as office allowance and commission at the rate of 8 per cent. on the annual net profits of this managed Company. It is common ground that, while office allowance was payable every month, the commission on the annual net profits payable to the assessee by the two managed Companies was‑payable only at the end of the relevant account ing period. However, the assessee's Board of Directors passed resolutions for the relevant assessment years, as well as for earlier years, foregoing its right to recover the managing agency commis sion as well as the monthly office allowances from the managed Companies. It is also common ground that these resolutions were passed before the closure of each relevant accounting year. It is also not disputed that, in fact, for the assessment years fn question, the assessee did not receive, nor the managed Companies paid to the assessee, the managing agency commission or the monthly office allowance provided for in the managing agency agreements. Accordingly, the managing agency commission as well as the monthly office allowances were not disclosed by the assessee in its returns for these assessment years. But when assessment for the fourth assessment year came up before the Assessing Officer, he took the view that the managing agency commission and the monthly office allowance, being incomes of the assessee, had escaped assessment for the aforesaid assessment years, and accordingly he re‑opened cases for these years and brought the managing agency commission and the monthly office allowance for these three years and for the fourth assessment year to tax. Against these orders, the assessee went in appeals to the income‑tax Appellate Tribunal, which appeals were allowed by the Tribunal's order, dated 8th December 1964. Thereupon the question of law reproduced above was referred by the Tribunal to this Court at the ‑stance of the Commissioner of Income‑tax.

3. It has been stated above that the Tribunal found that, with regard to the each relevant accounting year, the assessee passed resolutions foregoing managing agency commission and office allowance before the closure of each year. It has also been found chat neither the amount of commission nor office allowance in dispute was ever entered in the assessee's books of account and further, the managed companies accepted the resolutions and did not pay to the assessee, nor made any credit in favour of the assessee for the managing agency commission and office allowance for these years. Further, the resolutions foregoing managing agency commission and the office allowance were passed to stabilize the managed companies as would appear from the following resolutions for each of the relevant years;---

The question of Managing Agents Commission and office allowance of Valika Textile Mills Ltd., Valika Woollen Mills Ltd. and Valika Art Fabrics Ltd. was discussed and considered. It was unanimously decided that with a view to stabilise the above‑named companies vii. Valika Textile Mills Ltd., and Valika Art Fabrics Ltd.. the company should forego their commission at 10 % and 8 % on the annual profits of M/s. Valika Textile Mills Ltd. and Valika Art Fabrics Ltd., respec tively and office allowance amounting to Rs. 30,000 (thirty thousand) from Valika Art Fabrics Ltd., Karachi for the year ending 31st March 1958.

The question of Managing Agency Commission and office allowance of M/s. Valika Textile Mills Ltd., Valika Woollen Mills Co. Ltd., and Valika Art Fabrics Ltd. was considered. It was unanimously decided that in order to serve best interest of M/s. Valika rextile Mills and Valika Art Fabrics Ltd., the company should not demand their 10 % and 8 % commission on net annual profits of the V. T. M. & V. Art Fabrics Ltd. respectively and also not demand office allowance amounting to Rs. 30,000 (Thirty thousand) from M/s. Valika Art Fabrics Ltd., for the year ending 31st March 1959.

The question of Managing Agents Commission on nets annual profits of M/s. Valika Textile Mills Ltd., Valika Woollen Mills Co. Ltd., and Valika Art Fabrics Ltd. and also of office allowance was discussed and considered. It was unanimously decided that looking to the interest of share holders, Company should not collect commission at 10 % and 8 % from M/s. Valika Textile Milts and M/s. Valika Art Fabrics Ltd. respectively for the year ending 31st March 1960, on the net annual profits of both the companies aforesaid.

The question of Managing Agency Commission and office allowance of M/s. Valika Textile Mills Ltd., Valika Woollen Mills Co. Ltd. and Valika Art Fabrics Ltd. was considered. It was unanimously decided that in order to stabillse more and more M/s. Valika Textile Mills and Valika Art Fabrics Ltd., the company should forego their commission at 10% and 8 % on the annual profits of both the companies for the year ending 31st March 1961. The Chairman was requested to inform M/s. Valika Textile Mills Ltd., and Valika Art Fabrics Ltd., Karachi accordingly."

4. It is in these circumstances that answer has to be given to the question referred to this Court by the Income‑tax Appel late Tribunal and this answer has to be given with reference to section 4(1) (b) (i) of the Income‑tax Act, 1922. Under this section, the total income of any previous year of any person includes all incomes, profits and gains from whatever source derived, which accrue or arise or are deemed to accrue or arise to him in Pakistan within such year. What is the meaning of "accrue" and "arise" Fry, L. J. stated in Colquroun v. Brooks ((1888) 21 Q B D 52) that these words are used in contradistinction to the word "receive" and indicate a right to receive. Therefore, income must be held to accrue at the date when a debt becomes due, that is when the right to receive such income comes into existence. Lengthy arguments were addressed to us on the question as to when income can be said to accrue or arise. The cases cited at the Bar were mainly from the Indian jurisdiction, and therefore, to deal effectively with the arguments of the learned Advocates before us, particularly Mr. S. A. Nusrat, who represents the Revenue, we have to refer to these cases. The first of these cases is the decision of the Indian Supreme Court in E. D. Sassoon & Company Ltd and others v. Commissioner of Income‑tax, Bombay City ((1954) 26 I T R 27). In this case, Sasaoons were the managing agents of a company and, as such, were entitled to receives commission of certain per cent. per annum on the annual net profits of the managed company which was to become due to them on the 31st of March of every year. On 1st December 1943, Sassoons assigned for consideration their managing agency and all their rights and benefits thereunder to another person, to whom the managed company paid the managing agency commission for the calendar year 1943. The question was whether, in the assessment year 1944‑45, the assignee was liable to pay tax on the accrual basis on the whole of the commission or whether the tax was payable by the assignee and the Sessions on proper apportionment being made between them of the amount received by the assignee. The majority of the Court held that the managing agency commission was not liable to such apportionment, but that the assignee was liable to pay tax on the whole commission, as the right to receive the commission would accrue to the managing agents only at the end of the calendar year which was a terminus a quo for the making up of the accounts and ascertaining the net profits earned by the company. This reasoning was set forth by the majority of the Court as follows :‑---

"What has however got to be determined is whether the income, profits or gains accrued to the assessee and in order that the same may accrue to him it is necessary that he must have acquired a right to receive the same or that a right to the income profits or gains has become vested in him though its valuation may be postponed or though its materialisation may depend on the contingency that the making up of the accounts would show income, profits or gains, the argument that the income, profits or gains are embedded in the sale proceeds as and when received by the company also does not help the transferees, because the managing agents have no share or interest in the sale proceeds received as such. They are not co‑sharers with the company and no part of the sale proceeds belongs to them. Nor is there any ground for saying that the company are the trustees for the business or any of the assets for the managing agents. The managing agents cannot there fore be said to have acquired a right to receive any commission unless and until the accounts are made up at the end of the year, the net profits ascertained and the amount of commis sion due by the company to the managing agents thus determined."

'This reasoning vas followed by the High Court of Bombay in Commissioner of Income‑tax, Bombay North, Kutch and Saurashtra Ahmedabad v. Chamanlal Mangaldas & Co. ((1956) 29 I T R 987) in which case the managed company passed a resolution fixing a remuneration for the managing agents at a lesser amount than that fixed in the agreement of managing agency, which resolution was accepted by the managing agents.

5. Even where the managing agency commission has accrued and been entered in tire books of account, it is open to the managing agents to accept lesser commission than that fixed in the agreement. This is what happened in a decision of the Bombay High Court in Commissioner of Income‑tax, Bombay City I v. Shoorji Vallabhdas & Co. ((1959) 36 I T R 25) in which the view taken in Doughty v. Commissioner of Taxes ((1927) A C 336) that Revenue is not entitled to take a mere book entry as conclusive evidence of the existence .of profits, was followed and it was held that the question whether the income accrued or not was not a mere matter of cogency of the entries made in the account books of the assessee but was essentially one of substance. It was found in this case that the agreement on the part of the assessee to receive 21 percent commission instead of 10 per cent. was a matter of business expediency, and that in cases of this kind what was to be con sidered was the real commission to which the managing agent, Shat is, the assessee became entitled in consequence of the agreement between them and the managed for )any. Consequently, commission only at the rate of 2 per cent. was held chargeable to income‑tax.

6. This question again came up before the Indian Supreme‑Court in Commissioner of Income‑tax Bombay, North v. Chandulal Keshavlal & Co. ((1960) 38 I T R 601). In this case, the managing agents became entitled to commission of Rs. 3,09,114.00 for the accounting year 19; 0, but, at the oral request of the managed company, agreed to accept only a sum of Rs. 1,00,000 in view of the unsatisfactory financial position of the managed company. The commission waived was allowed as business expenditure on the ground of commercial expediency. In holding this, the Court approved the Bombay decision in Tata Sons Ltd. v. Commissioner of Income‑tax, Bombay City ((1950) 18 I T 8460), where the managing agents made a voluntary payment to the managed company for payment of bonus to the employees, but which payment was held to be dedustable expenditure on the ground of commercial expediency.

7. There is another Bombay case, H. M. Kashiparekh & Co. Ltd. v. Commissioner of Income‑tax, Bombay, North Kutch and Saurashtra ((1960) 39 I T R 706). In this case, the managing agents earned the commission of Rs. 1,17,644.00 for the accounting year ending 31st March 1950. But, as a result of resolutions passer) by tree managed company and the managing agents, the latter gave up 'a sum of Rs. 97,000 in December 1950. This amount of Rs. 97,000.00 was held not chargeable to tax, and, in holding this, the Court proceeded on the reasoning that it was the real income of the assessee for the accounting year that was liable to tax, and that this real income could not be arrived at without taking into account the amount foregone by the assessee, tend that the principle of real income should not be applied in a way as to amount virtually to a negation of it when a surrender or concession or rebate in respect of managing agency commission its based on commercial expediency. The view taken in this case was approved by the Indian Supreme Court in appeal, the appel late decision being Commissioner of Income‑tax, Bombay City I v. Messrs Shoorji Vallahhdass & Co. ((1962) 46 I T R 144). It will be profitable to refer to the following observations of Hidayatullah, J. in this case :‑---

"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 sot materialise, where income has, in fact, been receive; and Is subsequently given up In such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where however, the Income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might in certain circumstances, have been made in the books of account."

8. Turning to the case before us, it has been found by the Income‑tax Appellate Tribunal that under the managing agency agreements, the managing agency commission was payable to the assessee only at the end of each relevant accounting year. There fore as far as managing agency commission is concerned it cannot be said to have accrued until the end of the accounting year in question. But for each such accounting year, the assessees passed a resolution foregoing the commission receivable by them, which resolutions were accepted by the managed companies 'therefore, no income whatsoever resulted to the assessees with regard to these commissions which cannot be said to have accrued due to them at all for any of the accounting or the assessment years in dispute before us. As regards the question of office allowance, its waiver may be held justifiable, sad accordingly deductable as expenditure under certain circum stances. One such circumstance is commercial expediency. We would refer again to two Indian cases. Commissioner of Income-tax, Bombay North v. Chandulal Keshavlal & Co. and Tata Sons Ltd. v. Commissioner of Income‑tax, Bombay City in support of this contention. But the office allowance accrued to the assessee from bath the managed companies from month to month, that is, at the end of every month. In the case of office allowance, therefore, the assessce's claim that this allowance should be treated as deductable expenditure is sustainable only from the date when resolution waiving such allowance was passed for each of the assessment years. This difficulty was brought to the notice of Mr. All Athar on the further hearing held on 20th December 1972. He then agreed that the office allowance for each of the assessment years may be treated as accrued income liable to tax. Accordingly we ourselves refrain from expressing any opinion whether in the case before us the assessee could make a valid claim that this allowance for the assessment years in question should be treated as deductable expenditure. We would rest our decision on this point on the concession made by Mr. Ali Athar. Consequently, cur answer to the question referred to the High Court by the Income‑tax Appellate Tribunal is that, for the assessment years under dispute, the managing agency commission from the two managed companies did not accrue as income liable to tax, but that office allowance for each of these years did accrue as income and is accordingly liable to tax.

K. B. A Reference answered.

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