2017 (5) TMI 841 - HC - Income Tax

Method of accounting - switch over from the mercantile to the cash system in the midst of the accounting year - whether the Tribunal was right in holding that the assessees could not adopt a cash system of accounting in respect of the commission received from MAL? - Held that - Under the second agreement, although the commission was fixed at 1.5 per cent. The receipt thereof may well have been the subject matter of controversy and uncertainty, inter alia, on account of clauses 11 and 13. The controversy and the disputes could lead to litigation which in turn would be resolved only after years. The assessees, therefore, would not at any given point of time know with any degree of certainty as to the amount that they would be entitled to during the financial year. The uncertainty of receiving the amount, the quantum of the amount and the time of receipt are crucial factors in the assessees decision as to which of the accounting systems ought to be followed. The assessee was, therefore, entitled to switch over from one system to the other.In these circumstances, the assessees were entitled to follow a different system of accounting in respect of their transactions under the new agreement although with the same party, namely, MAL. A switch over in the midst of an accounting year, especially in such cases, could lead to skewed results. An assessee could then avoid paying the correct advance tax by following the cash system at first and then justifying the non-payment or short payment by switching over to the mercantile system. Further, the assessee could do this, theoretically at least, more than once leaving the entire assessment in a state of uncertainty and confusion. This would considerably fragment an assessment year. Apart from placing a burden on the Assessing Officer and the other authorities under the Act in carrying out the assessment in terms of time and resources, it would pose considerable difficulties in carrying out the assessment. The authorities would understandably be far more reluctant to accept a switch over in the midst of the financial year. Their decision to refuse to accept the switch over in the midst of financial year ought not be interfered with lightly. A switch over in the midst of financial year ought to be permitted by the authorities only in exceptional cases where the same poses no difficulty whatsoever in computing income and the switch over is justified. The burden to establish the same must rest heavily upon the assessee who desires the switch over in the midst of the financial year. The reference to the first question, therefore, is answered in favour of the Revenue in so far as it relates to the assessees right to switch over from the mercantile to the cash system in the midst of the accounting year. - Decided in favour of the Revenue

Summary

Issues Involved:
1. Whether the Tribunal was right in holding that the applicant could not adopt the cash system of accounting in respect of commission from M/s. Majestic Auto Limited, which was a new source of income.
2. Whether the Tribunal was right in holding that the applicant was liable to interest under section 215 of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Adoption of Cash System of Accounting
- Background: The assessee, a registered firm, earned commission income from various companies and had an agreement with M/s. Majestic Auto Limited (MAL). Initially, the assessee used the mercantile system of accounting but switched to the cash system for commissions from MAL mid-year.
- Tribunal’s View: The Tribunal held that the assessee could not adopt the cash system for commission from MAL alone, as the source of income (four principals) was the same. The change was not justified as it was only applied to MAL.
- Court’s Analysis: The court noted that an assessee could switch accounting systems, including adopting a hybrid system, subject to the Income-tax Officer's discretion under section 145(1). However, the switch must be justified and not arbitrary. The court found that the two agreements with MAL (dated March 18, 1981, and October 1, 1983) were different in nature and scope, justifying a different accounting system. Despite this, the switch mid-year was problematic as it led to inconsistencies (expenses on accrual basis, income on receipt basis) and could result in tax evasion or confusion.
- Conclusion: The court upheld the Tribunal’s decision, allowing the switch in accounting systems but not mid-year. The assessee’s switch mid-year was not justified, and the Tribunal was correct in its decision.

Issue 2: Liability to Interest under Section 215
- Background: The assessee was held liable for interest under section 215 due to the change in accounting systems affecting the computation of advance tax.
- Court’s Analysis: The answer to this issue follows from the first. Since the switch mid-year was not permitted, the computation of advance tax based on the incorrect accounting method justified the imposition of interest under section 215.
- Conclusion: The court agreed with the Tribunal that the assessee was liable for interest under section 215 for the assessment year 1984-85.

Final Judgment:
- The reference was answered in favor of the Revenue. The assessee could not switch to the cash system mid-year, and the liability to interest under section 215 was upheld.