2012 (12) TMI 134 - HC - Income Tax

Method of accounting Chit Fund Company - completed contract method - Commission income - discount and dividend Held that - Looked at from the angle of the subscriber, while there may be a certainty as to the dividend received every month for considering the same for assessment on accrual basis, as far as a company running the chit business is concerned, the dividend and the discount can properly be ascertained only at the completion of the transaction and not in the midway. Given the significant nature of the service yet to be performed in relation to the chit series, till the series come to an end, it is difficult to assess with any certainty, the amount that would be properly called as income for the purpose of assessment. Discount as defined under Section 2(g) of the Chit Funds Act, means the money set apart under the chit agreement to meet the expenses of running the chit or for distribution among the subscribers or for both. Dividend is the share of the subscriber in the amount of discount available for reasonable distribution among the subscribers at each instalment of the chit. Given the rights of the subscriber, when Section 21 provides for 5% chit amount to be given to the foreman, the same is stated therein as commission, remuneration or for meeting the expenses of running the chits. Thus, going by these provisions, when dividend to the foreman has to come only from out of the discount, we do not find any justifiable ground to agree with the Revenue that the assessee cannot claim completed contract method for income recognition. As far as the expenditure of the company is concerned, it is seen that the same related both to the administrative costs as well as to the advertisement costs. Taking note of the business of the assessee, we agree with the assessee's contention that the expenses cannot be viewed as relatable to the particular series alone, but as relating to the running of the business. Thus it has to be revenue expenditure to be considered in the year in which the same is incurred. Assessee is justified in following the mercantile system of accounting and adopting the completed contract method, to arrive at the real income. - Decided in favour of assessee

Summary

Issues Involved:
1. Accrual of taxable income for a chit company.
2. Applicability of Section 5 of the Income Tax Act, 1961, and Section 2 of the Chit Funds Act, 1982.
3. Tax exemption on dividends received by the appellant on grounds of mutuality.
4. Referral of the matter to a larger Bench by the ITAT.

Detailed Analysis:

1. Accrual of Taxable Income for a Chit Company:
The primary issue was whether taxable income for a chit company accrues only at the end of the chit period, justifying the completed contract method of accounting. The assessee argued that the income from the chit business should be recognized at the end of the chit period due to the uncertainties and responsibilities involved throughout the chit duration. The Revenue contended that the foreman's commission accrues monthly with each auction, making the proportionate completion method more appropriate.

The court, referencing the Supreme Court decision in Commissioner of Income Tax vs. Bilahari Investment P. Ltd., supported the assessee's use of the completed contract method. The judgment emphasized that revenue recognition should account for the significant responsibilities and uncertainties faced by the foreman, which are only determinable at the end of the chit period.

2. Applicability of Section 5 of the Income Tax Act, 1961, and Section 2 of the Chit Funds Act, 1982:
The assessee argued that under Section 5 of the Income Tax Act and Section 2 of the Chit Funds Act, commission cannot be taxed without accounting for the costs of services provided until the end of the chit period and bad debts. The court agreed with the assessee, noting that the income, including the foreman's commission and dividends, can only be accurately determined at the end of the chit period due to the ongoing obligations and risks.

3. Tax Exemption on Dividends Received by the Appellant on Grounds of Mutuality:
The assessee claimed that dividends received as a chit subscriber should be exempt from taxation based on the principle of mutuality. However, the court found no substantial arguments presented by the assessee on this matter and thus rejected the claim for tax exemption on mutuality grounds.

4. Referral of the Matter to a Larger Bench by the ITAT:
The assessee questioned whether the ITAT should have referred the matter to a larger Bench, given the favorable case law cited by the appellant. The court did not find it necessary to address this issue in detail, as the primary issues were resolved in favor of the assessee.

Conclusion:
The court concluded that the assessee is justified in following the mercantile system of accounting and adopting the completed contract method to determine real income. The order of the Income Tax Appellate Tribunal was set aside to the extent that it did not align with this conclusion. The court also upheld the Revenue's contention regarding the lack of mutuality for tax exemption on dividends. Thus, the Tax Case Appeals were partly allowed, with no costs awarded.