1996 (8) TMI 140 - AT - Income Tax

Summary

Issues Involved:
1. Justification of additions on account of interest accrued to the assessee.
2. Change in the method of accounting from mercantile to a hybrid system.
3. Acceptance of the new accounting method by the income-tax authorities.

Issue-wise Detailed Analysis:

1. Justification of Additions on Account of Interest Accrued to the Assessee:
The core issue in these appeals was whether the departmental authorities were justified in making additions of Rs. 44,90,434 and Rs. 25,42,968 on account of interest accrued to the assessee. The assessee, a public limited company, had shifted its business focus to housing finance, leading to a substantial increase in housing loans. Due to delayed interest payments by borrowers, the company changed its accounting method from mercantile to a hybrid system, recognizing interest on a cash basis while maintaining accrual for other transactions. The Income-tax Officer (ITO) refused to accept this change, leading to the contested additions.

2. Change in the Method of Accounting from Mercantile to a Hybrid System:
The company passed a resolution on 12-11-1986 to change its accounting system from the mercantile system to a combined system, taking interest on loans only on a cash realization basis while maintaining accrual for other incomes and expenses. The application for this change was submitted to the ITO, highlighting difficulties in recovering interest and the substantial outstanding interest. Despite the ITO's refusal on 26-2-1987, the company proceeded with the change and reflected it in its accounts, resulting in lower reported income for the period.

3. Acceptance of the New Accounting Method by the Income-tax Authorities:
The ITO refused to compute the income on the new basis, citing reasons such as the company's historical use of the mercantile system, lack of a board resolution, and the impermissibility of changing the method for a specific income item. The CIT(A) upheld this view, stating that the hybrid system resulted in a lop-sided picture of the company's affairs. However, the Tribunal found that the assessee had regularly followed the new method in subsequent years and that the change was bona fide and necessary for a realistic presentation of financial statements. Citing various judicial precedents, the Tribunal concluded that the hybrid system was permissible if it was regularly followed and provided a true reflection of profits.

Conclusion:
The Tribunal allowed the appeals, directing the deletion of the additions of Rs. 44,90,434 and Rs. 25,42,968. It held that the assessee's hybrid system of accounting, which recognized interest income on a cash basis while maintaining accrual for expenses, was acceptable. The change was bona fide, regularly followed, and provided a realistic picture of the company's financial position. The Tribunal emphasized that the primary consideration was whether the new method was consistently applied and resulted in a true determination of profits, rather than the potential loss of revenue to the income-tax department.