2008 (3) TMI 296 - HC - Income Tax

Assessee had changed the method of accounting from mercantile to cash which resulted in reduction of profits - assessee explained that he was acting as indenting agent/commission agent for textile mills and due to deterioration in the financial position of the textile mills the commission was not being received by the assessee the method of accounting had been changed from mercantile to cash bona fidely held that bona fide change should be accepted by Income Tax authorities

Summary

Issues Involved:

1. Change in method of accounting.
2. Impact of the change on income deduction.
3. Bona fide nature of the change.

Issue-wise Detailed Analysis:

1. Change in Method of Accounting:
The primary issue revolves around the change in the method of accounting from mercantile to cash basis adopted by the assessee for the assessment years 1984-85 and 1985-86. The Assessing Officer (AO) noted that this change resulted in a reduction of profits and called upon the assessee to justify why Rs.21,14,924 should not be added to taxable income. The assessee argued that the change was due to the financial deterioration of textile mills from which it was receiving commissions. However, the AO rejected this explanation, stating that the change was not for good and sufficient reasons and appeared to be aimed at reducing tax liability.

2. Impact of the Change on Income Deduction:
The AO and the Commissioner (Appeals) both held that the change in the method of accounting disabled the officer from properly deducing the income. For instance, the AO for the assessment year 1984-85 added Rs.21,14,924 to the income, and for 1985-86, added Rs.13 lakhs after estimating certain expenses on an accrual basis. The Tribunal upheld these findings, stating that the change at the fag end of the accounting year indicated it was an afterthought and not bona fide. They noted that the change in method disabled the AO from properly deducing the profits and gains of the business.

3. Bona Fide Nature of the Change:
The Tribunal and the Commissioner (Appeals) questioned the bona fide nature of the change, stating it was for convenience only and adopted half-heartedly. The Tribunal pointed out that the assessee had been following the mercantile system since inception and the switch to cash basis was motivated by delayed receipt of commission from two principal companies. The Tribunal also noted the close relationship between the directors of the assessee company and the principal companies, suggesting the change was not bona fide.

Court's Judgment:
The Court found that the Tribunal's findings were not supported by evidence and that the AO had not invoked the Proviso to section 145(1) of the Act, which allows the AO to compute income upon such basis if the method employed by the assessee does not permit proper deduction of income. The Court emphasized that merely because the change in the method of accounting results in reduced taxable income in a particular year, it cannot be assumed to be an attempt to deliberately reduce the tax burden. The Court also noted that the assessee had consistently followed the new method in subsequent years, which was not disputed by the authorities.

The Court concluded that the change in the method of accounting was bona fide and consistently followed, and the Tribunal's findings were without basis. The Court answered all three questions in favor of the assessee and against the revenue, allowing the appeal and disposing of the reference and tax appeal with no order as to costs.