Commissioner of Income Tax vs North Arcot District Co-operative Spinning Mills Ltd.

G. Ramanujam, J.—The assessee in this case is a co-operative society carrying on business in the manufacture of yarn. It imported from

Japan Blow Rooms and preparatory machine, etc., and the payment for these machines was to be made in instalments. The sixth instalment due by

the assessee to the foreign company, who supplied the machine, with interest fell due on 24-6-1968. However, the said payment with interest was

recorded in the books of account of the assessee in November 1968 after receipt of communication from the Director of Handlooms through

whom the transaction of import took place. The amount of interest paid on the sixth instalment was claimed as deduction in the assessment year

1970-71 based on the entry made in November 1968 in the books of account of the assessee. This deduction claimed by the assessee was

disallowed by the ITO on the ground that the assessee, haying followed the mercantile system of accounting and the interest on the sixth instalment

having become due on 24-6-1968 which fell within the accounting period relevant to the assessment year 1969-70, the deduction claimed cannot

be allowed in the assessment year 1970-71. The said disallowance was confirmed in appeal by the AAC. The assessee took the matter in appeal

to the Tribunal. The Tribunal found that the assessee has recorded the payment of interest in its books only after getting confirmation from the

Director of Handlooms and without reference to the actual date of accrual of liability for interest that this method of accounting had been accepted

as reflecting the true profits, by the revenue in the earlier years, that his claim for deduction of the interest payment had been allowed by the

revenue, accordingly, and that, therefore, it is not open to the revenue to contend that the method of accounting followed by the assessee is such

that it is difficult to arrive at the true profits only in the assessment year in question. In this view the Tribunal has held that as in the previous years,

the assessee''s claim for deduction of the interest payment on the sixth instalment should be allowed as in the previous years without reference to

the question as to whether the method of accounting followed is on mercantile basis or cash basis. One other question that arose before the

Tribunal was whether the assessee is entitled to claim development rebate at 53 percent in respect of the machinery used in the manufacture of

cotton yarn. The assessee''s claim was that since it is a manufacturer of cotton yarn which falls within entry 32 of the Fifth Schedule to the income

tax Act, 1961 (''the Act''), it is entitled to the development rebate at 35 percent as per section 33(1)(b) (B)(i) of the Act. The revenue resisted that

claim on the ground that since the assessee is not a manufacturer of textiles which is an item referred to in entry 32 of the Fifth Schedule but only a

manufacturer of cotton yarn, it is not entitled to the development rebate at 35 percent. The Tribunal, however, upheld the assessee''s claim for

development rebate at 35 percent on the basis that though the assessee is a manufacturer of cotton yarn, in view of the fact that in entry 32 of the

Fifth Schedule ''textiles'' has been referred as ''including cotton yarn'', the assessee should be taken to be a manufacturer of textiles for the purpose

of development rebate and this will enable the assessee to get the development rebate at 35 percent. Aggrieved against the decision of the

Tribunal, the revenue sought for and obtained a reference to this Court on the following two questions of law:

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in allowing a sum of Rs. 11,691 towards interest

claim in the assessment year 1970-71?

Whether, the Appellate Tribunal was right in allowing development rebate at 35 percent in respect of the machinery used in the manufacture of

yarn?

The second question does not present us any difficulty. Section 33(1)(b) (B)(i) (a) proceeds on the basis that in the case of machinery or plant,

installed for the purposes of business of construction, manufacture or production of any one or more of the articles or things specified in the list in

the Fifth Schedule, 35 percent of actual cost of the machinery or plant to the assessee, where it is installed before 1-4-1970, shall be the rate of

development rebate. Therefore, the primary question that arises is to find out whether the machinery has been used in the manufacture of any one

of the articles or things specified in the list in the Fifth Schedule. Entry 32 of the Fifth Schedule specifies the following articles or things:

Textiles (including those dyed, printed or otherwise processed) made wholly or mainly of cotton, including cotton yarn, hosiery and rope.

The said entry covers textiles made wholly or mainly of cotton, cotton yarn, hosiery and rope. The purpose of the Fifth Schedule is to specify

the articles or things which will be covered by section 33(1)(b) (B)(i). Entry 32 actually specifies textiles, cotton yarn, hosiery and rope. To restrict

the scope of the expression ''textiles'', it has been made clear that textiles made wholly or mainly of cotton alone will come under the operation of

the above provision in section 33. The expression ''including'' occurring before ''cotton yarn, hosiery and rope'' makes it clear that in addition to the

''textiles'' made wholly or mainly of cotton, cotton yarn, hosiery and rope are also special articles. The learned counsel appearing for the revenue

contends that the expression ''including'' will qualify ''cotton'' and not ''textiles''. We are not inclined to agree with the interpretation suggested by

him, for if that is the interpretation to be given, then hosiery and rope have to be taken as articles from which textiles are made. Hosiery and rope

are already manufactured articles and they cannot certainly be brought within the scope of the expression ''cotton''. Apart from the improbability in

accepting the mode of interpretation suggested by the learned counsel for the revenue, even the collocation of the words occurring in entry 32

suggests that the intention of the Legislature was to give the benefit of development rebate at 35 percent not only to the manufacturers of textiles

but also to the manufacturers of other articles such as cotton yarn, hosiery and rope. On this interpretation of entry 32, it should be taken to

specify, in addition to textiles, ''cotton yarn, hosiery and rope''. The assessee who is a manufacturer of cotton yarn should be taken to be a

manufacturer of an item specified in entry 32. The machinery and plant in respect of which development rebate has been claimed had, admittedly,

been used in the manufacture of cotton yarn, a specified item in entry 32. In a recent decision in CIT v. Premier Mills Ltd. [TC Nos. 74 and 75 of

1977] a Division Bench of this Court to which one of us was a party construed entry 32 of the Fifth Schedule, as a list specifying textiles, cotton

yarn, hosiery and rope, for the purpose of section 33 of the Act. The view we have taken is in accord with the view expressed in that case. In this

view, we are inclined to agree with the opinion expressed by the Tribunal that the assessee is entitled to claim development rebate at 35 percent u/s

33(1)(b) (B)(i) (a) read with entry 32 of the Fifth Schedule of the Act. Coming now to the first question, the contention of the learned counsel for

the revenue is as follows:

The assessee, admittedly, followed the mercantile system of accounting and not cash system and, therefore, the proper thing for the assessee

would have been to claim the deduction for the interest paid on the sixth instalment in the previous assessment year 1969-70 as the interest has

legally accrued even on 24-6-1968, which clearly fell within that assessment year. According to the revenue, the assessee cannot claim the

deduction for the interest paid on the sixth instalment in the assessment year 1970-71 taking advantage of the date of payment entered in the books

of account in November 1968 ignoring the date of accrual of liability which was in the previous assessment year. The Tribunal did not accept the

plea put forward by the revenue for the reason that in all the previous years, the interest payment had been recorded only in the accounting years

subsequent to the years in which the interest had accrued and that such method of accounting had been accepted and deductions have been

allowed in the subsequent years as claimed without raising any contention that the method of accounting followed by the assessee is one from

which the true profits of the assessee could not be clearly ascertained. The Tribunal held that if the assessee''s method of accounting, which it had

regularly adopted, had been accepted by the revenue as correctly representing the true profits, it is not open to the revenue to go back and call

upon the assessee to adopt either cash basis or mercantile basis of accounting. The question is whether the view taken by the Tribunal on this part

of the case is reasonable in the circumstances of the case. It is no doubt true on the facts of this case that the sixth instalment with the interest

accrued thereon fell due on 24-6 1968, that is within the assessment year 1969-70. However, the payment of the instalment and the interest was

recorded in the books of account in November 1968, which clearly fell within the assessment year 1970-71. It is based on the payment recorded

in November 1968 that deduction has been claimed in the assessment year 1970-71, as in the earlier years. The same method of accounting had

been followed by the assessee in the previous years. The revenue has not chosen to question the said recording of payment subsequent to the year

when the interest fell due. It is seen from the order of the Tribunal that the assessee has been regularly following this method and it has been

regularly accepted by the revenue as a method of accounting from which the true profits earned by the assesses could be ascertained. While the

same method of accounting regularly adopted by the assessee had been accepted by the revenue in the earlier years, it is unreasonable on the part

of the revenue now to say that the method of accounting adopted by the assessee is one from which the true profits of the assessee cannot be

clearly determined. We are not inclined to agree with the contentions of the learned counsel for the revenue that an assessee is to adopt either a

mercantile system of accounting or cash system and that it is not open to the assessee to adopt any other system of accounting. It is well

established that even apart from the two systems of accounting referred to above, there is a possibility of an assessee adopting a hybrid system of

accounting if it is possible to ascertain the true profits on the basis of such accounting. In this case, though the assessee has generally adopted the

mercantile system of accounting, so far as the transaction of import of plant and machinery from foreign sellers is concerned, it has been regularly

showing the payment of interest in the year in which the interest was actually paid and not in the year in which the interest legally fell due. Having

regard to the fact that it is not the case of the revenue that it is not possible to ascertain the true profits from the method of accounting regularly

followed by the assessee, the Tribunal is right in holding that it is not open to the revenue to go back on its stand taken in the earlier years and call

upon the assessee either to adopt cash system or mercantile system of accounting. In this view of the matter, we have to agree with the view of the

Tribunal in respect of both the questions.

The reference is, therefore, answered in the affirmative and against the revenue. The assessee will have its costs. Counsel''s fee Rs. 500.