2015 (11) TMI 122 - HC - Income Tax

Accrual of income - Additional Finance Charges (AFC) also known as Overdue Charges (ODC) - Taxation in the light of Section 145 - Held that - In the instant case, the Revenue is not in a position to show that due to the change of accounting method, the Revenue suffered loss. Admittedly, there is no finding to that effect in the assessment order. We also find that the change in method of accounting has not caused any loss to the Revenue, because AFC on receipt by the assessee-company has been offered to tax. Accordingly, we hold that the change of method of accounting of overdue charges from the mercantile basis to cash system insofar as AFC does not create any income, but the method of accounting only recognizes income. It would not be proper for the Department to contend that post amendment to Section 145 of the Income Tax Act, the change in the method of accounting adopted by the assessee should be re-looked. In the light of the decision of this court in the case of Annamalai Finance (2004 (10) TMI 51 - MADRAS High Court), we find no justification or good reason why we should reject the claim of the assessee. We have no hesitation to hold that collection and accrual of AFC happen simultaneously in the present case as and when received, as has been held by this Court. Hence, AFC cannot be treated as income on accrual basis. Following the decision of this Court reported in CIT V. Annamalai Finance Ltd 2004 (10) TMI 51 - MADRAS High Court and CIT V. Annamalai Finance Ltd.(2009 (11) TMI 11 - MADRAS HIGH COURT), we hold that the terms of the agreements, which enable the assessee to demand overdue charges (AFC) is only an enabling provision and the recovery of overdue charges is not certain and is taxable on cash receipt basis and not accrual basis. Deletion of additions made towards Additional Finance Charges, also known as Overdue charges confirmed - Decided in favour of assessee.

Issues Involved:
1. Taxation method for Additional Finance Charges (AFC) under Section 145 of the Income Tax Act.
2. Applicability of mercantile versus cash basis accounting for AFC.
3. Impact of amendments to Section 145 on the method of accounting for AFC.
4. Relevance of the concept of real income to AFC.
5. Distinguishing factors of previous judgments and their applicability to the present case.

Detailed Analysis:

1. Taxation Method for Additional Finance Charges (AFC) under Section 145 of the Income Tax Act:

The core issue in these appeals is the manner in which Additional Finance Charges (AFC), also known as Overdue Charges (ODC), should be taxed under Section 145 of the Income Tax Act, which prescribes the method of accounting.

2. Applicability of Mercantile Versus Cash Basis Accounting for AFC:

The assessee, engaged in hire purchase financing, leasing, and investments, followed a mercantile system of accounting for Equated Monthly Instalments (EMI) but accounted for AFC on a cash basis for income tax purposes. The Assessing Officer contended that since the assessee followed the mercantile system, AFC should also be accounted for on an accrual basis, leading to additions in the assessee's income.

The Commissioner of Income Tax (Appeals) deleted these additions, allowing the assessee to account for AFC on a cash basis, a decision upheld by the Tribunal. The Tribunal emphasized that there is no prohibition under the Income Tax Act against maintaining separate records for different purposes, referencing Section 115J, 115JA, and 115JB, which provide for special provisions in such situations.

3. Impact of Amendments to Section 145 on the Method of Accounting for AFC:

The Tribunal relied on the decision in Annamalai Finance Ltd. v. Additional CIT, which was upheld by the High Court, to conclude that the amendment to Section 145 did not affect the issue under consideration. The Tribunal held that AFC should be recognized as income only upon actual receipt, a stance that remained unchanged post-amendment.

Section 145, post-amendment, mandates that income should be computed in accordance with either the cash or mercantile system of accounting regularly employed by the assessee. The Tribunal found that the assessee's method of accounting for AFC on a cash basis did not violate this provision.

4. Relevance of the Concept of Real Income to AFC:

The Revenue argued that the concept of real income should not apply as there was no material evidence to show that AFC was impossible to realize. However, the Tribunal and the High Court found that AFC, being penal in nature and uncertain of recovery, did not accrue as income until actually received.

The High Court cited its earlier decision in Annamalai Finance Ltd., which held that overdue charges (AFC) should be recognized as income only when collected, due to the uncertainty of their realization. This principle was reaffirmed, emphasizing that AFC does not accrue with certainty and should be taxed on a cash receipt basis.

5. Distinguishing Factors of Previous Judgments and Their Applicability to the Present Case:

The Revenue's reliance on other judgments, such as Southern Technologies Ltd. v. Joint Commissioner of Income-tax and Commissioner of Income Tax & Anr. v. United Breweries Ltd., was found to be distinguishable. These cases dealt with bad debts and not the specific issue of AFC. The High Court noted that in the case of Southern Technologies, the Supreme Court dealt with the provision for Non-Performing Assets (NPA) under RBI directions, which did not constitute an expense for deduction under the Income Tax Act.

The High Court reiterated that the decision in Annamalai Finance Ltd., which allowed the change in accounting method for AFC from mercantile to cash basis, was applicable. The High Court found no reason to depart from this view, as the Revenue had not demonstrated any loss due to the change in accounting method.

Conclusion:

The High Court upheld the Tribunal's decision, affirming that AFC should be taxed on a cash receipt basis due to its uncertain nature. The Tribunal's reliance on the Annamalai Finance Ltd. case was deemed appropriate, and the Revenue's appeals were dismissed. The High Court emphasized that the method of accounting recognizes income but does not create it, and the change in accounting method for AFC did not cause any loss to the Revenue.

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