2010 (5) TMI 577 - AT - Income Tax

Addition of Rs. 11, 15, 482 - Methods of accounting - Rental income - Scrutiny - assessee was running a cold storage and revenue was recognized at the point of time of upliftment/exit of potato in good marketable condition - The storage rent did not become due prior to upliftment this method has been followed regularly and consistently right from the beginning of the business - assessee did not receive any advance rent and the rent was charged at the time of uplifting of the potatoes since inception and this method of accounting was followed consistently and if the method was to be changed then effect was to be given for the earlier year also - assessee can either adopt a cash system of accounting or mercantile system of accounting and the said method of accounting is to be followed regularly - assessee should have shown the proportionate rental income for the period January to March 2006 also in the assessment year under consideration since the assessee is following mercantile system of accounting the income for the period starting from 1-1-2006 to 31-3-2006 is to be accounted for on accrual basis for taxing the income in assessment year 2006-07 but the assessee is entitled to set-off of the income relating to the period 1-1-2005 to 31-3-2006 which had been received in the financial year 2005-06 and included in the taxable income considering that the mercantile system of accounting has been adopted by the assessee

Issues Involved:
1. Rejection of books of account and addition of Rs. 11,15,482 on account of rental income.
2. Application of Section 145(3) despite audited books.
3. Ignoring the method of accounting regularly employed by the assessee.
4. Applicability of Accounting Standards as per Section 145(2).
5. Timing of income accrual in cold storage business.
6. Basis and justification of the addition of Rs. 11,15,482.

Issue-wise Detailed Analysis:

1. Rejection of Books of Account and Addition of Rs. 11,15,482 on Account of Rental Income:
The assessee's books of account were rejected, and an addition of Rs. 11,15,482 was made on account of rental income. The Assessing Officer (AO) observed that the assessee had not credited the income corresponding to expenses incurred from January to March 2006, which was related to the loading and upkeeping of 49,577 bags of potatoes. The AO concluded that the assessee's method of accounting did not give a true picture of profits, leading to a suppressed profit scenario.

2. Application of Section 145(3) Despite Audited Books:
The AO applied Section 145(3) of the Income Tax Act, stating that the assessee's method of accounting did not allow for a correct or complete deduction of business profits. The assessee argued that their books, audited without adverse comments, had been consistently accepted by the department in previous years. However, the AO held that the method followed did not align with the mercantile system as claimed, leading to the rejection of books under Section 145(3).

3. Ignoring the Method of Accounting Regularly Employed by the Assessee:
The assessee contended that their method of accounting, consistently followed and accepted by the department in prior years, should not have been disregarded. The AO, however, maintained that the method did not accurately reflect the profit and gains of the business, as it mixed cash and mercantile systems, leading to an incorrect portrayal of income.

4. Applicability of Accounting Standards as per Section 145(2):
The AO referenced Accounting Standard AS-9, which mandates revenue recognition on a proportionate completion basis. The assessee argued that AS-9 was not notified by the Central Government for their business type and was not applicable to cold storage operations. The CIT(A) upheld the AO's view, emphasizing compliance with mandatory accounting standards prescribed by ICAI.

5. Timing of Income Accrual in Cold Storage Business:
The assessee claimed that income accrued at the time of unloading potatoes, not during storage. The AO disagreed, stating that expenses incurred from January to March 2006 should match the income for that period. The AO added Rs. 11,15,482 as proportionate rental income for 49,577 bags loaded during this period, aligning with the mercantile system's accrual basis.

6. Basis and Justification of the Addition of Rs. 11,15,482:
The AO's addition was based on the principle that expenses and corresponding income should be matched within the same accounting period. The CIT(A) confirmed this approach, citing the need to recast the profit and loss account to remove distortions. The Tribunal agreed with the AO's method but allowed a set-off for income already included in the previous year, resulting in a net addition of Rs. 1,96,830.

Conclusion:
The Tribunal upheld the AO's decision to apply Section 145(3) and add Rs. 11,15,482 to the assessee's income for the period January to March 2006. However, it directed a set-off for income already accounted for in the previous year, reducing the net addition to Rs. 1,96,830. The appeal was partly allowed, emphasizing the importance of accurately reflecting income and expenses within the same accounting period under the mercantile system.

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