2019 (3) TMI 1068 - HC - Income Tax

Appropriate method of income recognition in hire purchase transaction - Internal Rate Return (IRR) OR Equated Sum (ESM) - CBDT Circular dated 13.01.1998 - SOD method for book keeping - HELD THAT - The said questions are covered by a decision of this Court in the case of Commissioner of Income Tax Vs. Ashok Leyland Finance Ltd. 2012 (7) TMI 156 - MADRAS HIGH COURT admittedly, the Assessee has been following the same method of E.M.I for bifurcation of its income into Principal and interest component for all these years in question. The S.O.D method gives higher finance charges (interest) for the initial years and lower finance charges (interest) for the later years, i.e, the Sum of Digits is sum total of the number of years e.g. If the Hire Purchase Agreement is for 10 years, the SOD is 55 (1 2 3 4 5 6 7 8 9 10 55). Therefore, total financial charges for the first year would be 10/55, for the second year 9/55, for third year 8/55 and so forth which would clearly give higher financial charges for interest taxable in the first year. This SOD method even though adopted by the Assessee in its Book of Accounts on the basis of Guidelines issued by the Institute of Chartered Accountants of India was not adopted in the Returns of Income filed by it which consistently adopted EMI method for taxability of interest income all these years. Since, for the previous assessment years, this Court has already approved such bifurcation of income and has held that interest income (Finance charges) on consistently adopted basis of E.M.I. would be taxable in the hands of the Assessee, the mere change of Accounting method in its Book of Accounts on the basis of S.O.D. does not alter the position in the tax in the hands of the assessee. Since in the case of Ashok Leyland Finance Ltd., (supra) the Coordinate Bench of this Court has upheld the taxability with regard to interest income on EMI method, which has been consistently followed, there is no reason to take a different view in the matter for the present Assessment years, in this case. - Decided in favour of assessee.

Summary

Issues:
1. Appropriate method of income recognition in hire purchase transaction - IRR vs. ESM
2. Accrual of interest income under IRR method
3. Entitlement to maintain Book on IRR method while offering income on ESM method for tax purpose

Issue 1: Appropriate method of income recognition in hire purchase transaction - IRR vs. ESM

The Tribunal held that the Internal Rate Return (IRR) method is appropriate for income recognition in hire purchase transactions, contrary to the Equated Sum (ESM) method usually followed by the Appellant. The Tribunal emphasized that the character of the transaction as a hire purchase agreement necessitates following the treatment given under the agreement. The Madras High Court, citing a previous decision, agreed with the Tribunal's reasoning. The Court highlighted that the consistency in returning income based on EMI method, as accepted by the Revenue in previous years, did not result in income suppression. The Court upheld the Tribunal's decision, emphasizing that the method of income recognition should align with the nature of the transaction.

Issue 2: Accrual of interest income under IRR method

The Tribunal, supported by a Central Board of Direct Taxes Circular, allowed computing interest component based on the EMI Method. The Andhra Pradesh High Court discussed the Madras High Court's view, emphasizing the importance of reflecting bifurcation of EMIs into principal and interest components in hire purchase agreements. The Court illustrated the difference between indexing and mercantile systems of accounting, highlighting the impact on interest income accrual. It was concluded that interest income recognized on the basis of the Sum of Digits (SOD) system, as per the Assessee's books, represented the 'real income' accrued. The Court upheld the Revenue's computation of income from finance charges, emphasizing adherence to the chosen accounting method.

Issue 3: Entitlement to maintain Book on IRR method while offering income on ESM method for tax purpose

The Madras High Court differentiated a case where the terms of the agreement did not permit the Indexing System of accounting from the present case. It was emphasized that in the absence of a clear reflection of EMIs into principal and interest components, the Indexing system should be considered valid. The Court noted the Assessee's consistent use of the EMI method for tax purposes, despite employing the SOD method in its books. The Court relied on a previous decision to support taxability based on the EMI method. Consequently, the Assessee's appeal was allowed, affirming the use of the EMI method for tax assessment, in line with past practices.

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