2017 (11) TMI 575 - HC - Income Tax

Consideration received on non-competition obligation - accrual of income - Method of accounting - Memorandum of Understanding cast an obligation upon the appellant not to compete with the business for a period of two years - Tribunal held that the provisions of section 145(1) are not applicable - Held that - As relying on decision of Gujarat High Court in Commissioner of Income Tax vs. Winner Business Link Pvt. Ltd. 2015 (1) TMI 829 - GUJARAT HIGH COURT no infirmity in the order passed by the Tribunal. The Tribunal has rightly considered that the method of accounting should be such from which the correct profit of each year can be deducted and that as per the method adopted by the Revenue, the profit in the year in which the card is issued would be more resulting in loss/less profit in the year in which the services will be rendered by the assesseee. We are of the opinion that when the services are rendered partially, revenue is to be shown proportionate to the degree of completion of the service and therefore the assessee was justified in spreading over the amount of membership fee and expenses.

Summary

Issues:
1. Interpretation of section 145(1) in relation to a non-compete agreement.
2. Treatment of income under the mercantile system of accounting.

Interpretation of section 145(1) in relation to a non-compete agreement:
The appellant challenged the Tribunal's decision allowing the department's appeal. The case involved a Doctor who entered into an agreement not to compete with a company for two years in exchange for ?1,00,00,000. The appellant argued that the provisions of section 145(1) should apply due to the non-compete obligation. The Tribunal's decision was based on the method of accounting and the accrual of income. The appellant relied on a decision from the Gujarat High Court regarding accounting methods for membership fees. The Tribunal correctly applied the accrual principle, spreading revenue and expenses over the membership period. The Hyderabad Bench's decision was cited to support the proper accounting method. The High Court emphasized the importance of matching revenue with expenses under the Mercantile System of Accounting.

Treatment of income under the mercantile system of accounting:
The High Court referred to the Central Government's Accounting Standard-1 to define "accrual." The Tribunal's decision was supported by various court judgments emphasizing the importance of matching revenue and expenses. The Bombay High Court's ruling highlighted the necessity of determining proper profits and adjusting accounting methods if needed. The Apex Court and Delhi High Court decisions reinforced the principle of income accrual for taxation purposes. The High Court concluded that the Tribunal erred in considering membership fees as income before services were resumed, stating that the fees should be treated as an advance until services were provided. The correct method of accounting should reflect the actual profit of each year, ensuring revenue is proportionate to service completion. Ultimately, the High Court upheld the Tribunal's decision, favoring the assessee and emphasizing the importance of proper accounting methods for accurate profit calculation.