2005 (2) TMI 81 - HC - Income Tax

Whether the hybrid method/system of accounting was permissible; if permissible, then could its consequences be avoided or ignored and the first proviso to section 145, as it stood for the respective previous years 1986-87, 1987-88 and 1988-89, invoked for the purpose of holding that the income could not be deduced from such mixed accounting system. - In the present case, it is clear that the income can be deduced under the system maintained and was, in fact, deduced both by the Assessing Officer and the learned Tribunal. Therefore, the proviso to section 145, as it stood for the respective previous years, could not be resorted to and applied for the purpose of interfering with the system of accounting maintained by the assessee, in the absence of any finding that the accounts maintained were inaccurate or incomplete and that it was not possible to deduce the income therefrom.

Issues Involved:
1. Permissibility of the hybrid method/system of accounting.
2. Applicability of the first proviso to section 145 of the Income-tax Act, 1961.
3. Accuracy and completeness of the hybrid system of accounting.
4. Authority of the Income-tax Department to intervene in the accounting method.
5. Impact of the hybrid system on the presentation of income.
6. Alleged tax avoidance through the hybrid system.
7. Interpretation and application of section 145 and its proviso.

Detailed Analysis:

1. Permissibility of the Hybrid Method/System of Accounting:

The primary issue was whether the hybrid method of accounting was permissible under the Income-tax Act, 1961, for the assessment years 1986-87, 1987-88, and 1988-89. The assessee maintained a mercantile system for outgoings and a cash system for receipts of interest from vehicle financing. Historically, this mixed system was accepted by the income-tax authorities. The court noted that prior to the amendment of section 145 in 1997, the hybrid system was permissible provided the accounts were complete and accurate.

2. Applicability of the First Proviso to Section 145:

The court examined whether the first proviso to section 145, as it stood before the amendment, could be invoked to reject the hybrid system of accounting. The proviso allowed the authorities to intervene if the income could not be deduced or if the method presented a distorted picture of the income. The court concluded that the proviso could only be applied if the accounts were not accurate or complete, or if the income could not be properly deduced from the accounts.

3. Accuracy and Completeness of the Hybrid System of Accounting:

The assessee argued that their hybrid system was accurate and complete. The court found that the hybrid system, which had been consistently followed over a long period, was accurate and complete. The income could be deduced from such a system, and the system had been recognized by the income-tax authorities in previous years.

4. Authority of the Income-tax Department to Intervene:

The Department contended that even if the accounts were accurate and complete, they could intervene if the method presented a distorted picture of the income. The court held that the authorities could not compel the assessee to switch to a different method if the hybrid system was regularly employed and recognized by law. The intervention was only justified if the income could not be properly deduced from the accounts.

5. Impact of the Hybrid System on the Presentation of Income:

The Tribunal had found that the hybrid system presented a distorted picture of the income because the income shown was less than what would have been shown under the mercantile system. The court disagreed, stating that once the hybrid system was accepted, its consequences could not be avoided or ignored. The shifting of income to another year under the hybrid system did not constitute a distorted picture as long as the income was taxable in the year it was received.

6. Alleged Tax Avoidance through the Hybrid System:

The Department argued that the hybrid system amounted to tax avoidance. The court dismissed this argument, stating that taxability depends on the earning of the income in a particular year, not on the rate of tax applicable in subsequent years. The court emphasized that the consequences of a permissible accounting method could not be a ground for holding it contrary to law.

7. Interpretation and Application of Section 145 and Its Proviso:

The court reiterated that section 145 allowed an assessee to compute income according to the method of accounting regularly employed. The authorities could not compel a change in the method unless the accounts were not accurate or complete, or the income could not be deduced. The court found that the hybrid system employed by the assessee was accurate, complete, and capable of deducing the income, thus the proviso to section 145 could not be applied.

Conclusion:

The court concluded that the hybrid system of accounting maintained by the assessee was permissible, accurate, and complete. The income could be deduced from such a system, and the income-tax authorities could not interfere with it. The appeals were allowed, and the order under appeal was modified in favor of the assessee. The court answered the respective questions in the negative, supporting the assessee's position. There was no order as to costs, and urgent xerox certified copies of the judgment were made available to the parties on usual terms.

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