2011 (2) TMI 52 - HC - Income Tax

Change in accounting polciy - (i) the assessee had been following hybrid system of accounting till the preceding assessment year i.e. assessment year 1988-89; (ii) the assessee had been accounting for income received from advertisement on cash basis which admittedly had been accepted by the revenue in the preceding years ending with assessment year 1988-1989; and (iii) the Tribunal has returned a finding of fact in favour of the assessee that the Assessing Officer s observation that because expenses against advertisement and publicity had been recorded on accrual basis while income from the said sources had been recorded on cash basis had created an imbalance was without merit. Tribunal was also persuaded to hold that this system of accounting had been accepted by the revenue as also the fact that the change in the system of accounting from a hybrid to a mercantile system was carried out by the assessee for bona fide reasons on account of the amendment carried out in the Companies Act. Where the Tribunal disagreed with the assessee was that having effected a change in the method of accounting and having recorded its income on the basis of mercantile system it could not go back to the cash system and hence proceeded to sustain the order of the Assessing Officer disallowing the deduction. Appeal is allowed

Summary

Issues Involved:
1. Disallowance of deduction claimed by the assessee for advertisement income accrued but not received in cash.
2. Consistency and acceptance of the hybrid system of accounting by the revenue.
3. Impact of the amendment in the Companies Act on the assessee's method of accounting.
4. Tribunal's findings on the method of accounting and its implications on the deduction claimed.

Issue-Wise Detailed Analysis:

1. Disallowance of Deduction Claimed by the Assessee:
The core issue revolves around the disallowance of Rs. 5,85,428 claimed by the assessee as a deduction for advertisement income accrued but not received in cash. The assessee argued that this deduction was justified because it followed a "cash" basis of accounting for income tax purposes. The authorities, however, disallowed this deduction, leading to the appeal.

2. Consistency and Acceptance of the Hybrid System of Accounting:
The assessee consistently followed a hybrid system of accounting, where income from advertisements and subscriptions was recorded on a cash basis, while other income was recorded on a mercantile basis. This hybrid system had been accepted by the revenue until the assessment year 1988-89. The Tribunal noted that the assessee had been following this system regularly and that it had been accepted by the revenue in previous years.

3. Impact of the Amendment in the Companies Act:
An amendment to section 209 of the Companies Act, 1956, mandated that accounts be maintained on an accrual basis. Consequently, the assessee prepared its accounts on a hybrid basis for part of the year and on an accrual basis for the remainder. The Tribunal acknowledged that the change to the mercantile system was bona fide and driven by the statutory requirement under the Companies Act. The Tribunal observed that the change was made for a legitimate reason and that the mercantile system was a recognized method of accounting.

4. Tribunal's Findings on the Method of Accounting and its Implications on the Deduction Claimed:
The Tribunal found that the assessee had been following a hybrid system of accounting consistently and that this method had been accepted by the revenue. However, the Tribunal concluded that once the assessee switched to the mercantile system due to the Companies Act amendment, it could not revert to the hybrid system for income tax purposes. This led to the disallowance of the deduction. The Tribunal's conclusion was deemed inconsistent with its earlier observations that the hybrid system was regularly employed and accepted by the revenue. The Tribunal did not agree with the Assessing Officer's view that the hybrid system created an imbalance in matching expenses to income.

Conclusion:
The High Court found that the Tribunal's final conclusion did not logically follow from its observations and findings. The Tribunal had accepted that the hybrid system was consistently followed and accepted by the revenue. The High Court held that the Tribunal erred in concluding that the assessee could not revert to the hybrid system for income tax purposes after switching to the mercantile system due to the Companies Act amendment. The High Court set aside the Tribunal's order, stating that the deduction claimed should have been allowed. The question of law was answered in favor of the assessee, and the appeal was allowed with costs following the result.