2020 (3) TMI 940 - AT - Income Tax

Rejection of books of account - Correct method of accounting - AO invoked the provisions of section 145(3) rejected the cash system of accounting and directed adoption of the accrual system of accounting - activities of the Assessee were not carried forward from one accounting year to the next and A.O. thus, held that the accounts should be in the nature of venture account and the correct profitability could be arrived at by following the accrual method of accounting only - whether correct profit/s of the assessee can be deduced or not from the books of account which the assessee has maintained on cash basis of accounting? - HELD THAT - As relying on own case 2019 (7) TMI 528 - ITAT DELHI cash method of accounting, which is followed by the assessee consistently and also for the impugned assessment year, cannot be rejected and the income of the assessee should not be computed on mercantile method of accounting. Accordingly, ground number 2 of the appeal of the assessee is allowed. Cash system of accounting of the Assessee and directed the assessee to follow the accrual system of accounting - The business of any company cannot be said to be defunct until and unless the company has been wound up or has surrendered the Certificate of Incorporation in accordance with law. The status of the assessee company as per the MCA website is, undisputedly, active till date. Therefore, the company cannot be considered as a defunct company. Since, the assessee company is active, it has to incur some expenditure to maintain its daily operations and accounts such as salary to staff, audit fees, legal and professional fees, rent, repairs and maintenance, bank charges, professional tax, interest on loan taken in earlier years, depreciation, etc. Such expenditure cannot be disallowed only on the ground that there was no business activity during the year especially in the case of companies. It is also seen that the AO has nowhere examined the expenses claimed by the assessee in the accrual system of accounting. He has not cared to discuss and examine any of the expenses claimed by the Assessee on accrual basis but has simply disallowed the said expenses and added back to the income of the assessee without carrying out the necessary enquiry and verification. In our considered view, it was the responsibility of the assessing officer to verify the expenditure individually head wise. Instead of doing so the AO assessed income on an overall basis and disallowed the entire expenditure. The A.O., to our mind, has grossly erred in understanding the concept of rejection of the books of the Assessee, the concept of adoption of a particular method of accounting and also the concept of disallowance of expenses. The action of the A.O. in rejecting the Cash system of accounting, as followed by the Assessee, and his subsequent computation of the income is grossly incorrect and is, therefore, rejected. - Decided in favor of assessee.

Issues Involved:
1. Rejection of the cash method of accounting.
2. Addition of ?5,72,17,800/- to the total income.
3. Allegation of no real business activity.
4. Computation of total income.
5. Charging of interest under section 234A and section 234B.
6. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Rejection of the Cash Method of Accounting:
The primary issue was the rejection of the cash method of accounting followed by the assessee. The Assessing Officer (AO) directed the adoption of the accrual method based on the previous assessment year’s proceedings. The AO and the Ld. Commissioner of Income Tax (Appeals) [CIT(A)] relied on the Disputes Resolution Panel (DRP) order for AY 2011-12, which had rejected the cash system of accounting. The assessee argued that this rejection was not independently discussed for the current year. The ITAT, in its order for AY 2011-12, had accepted the cash method of accounting, stating that it was regularly employed by the assessee and could not be rejected. The Tribunal reiterated that the cash method of accounting, which was consistently followed by the assessee, could not be discarded and upheld the assessee’s method of accounting.

2. Addition of ?5,72,17,800/- to the Total Income:
The AO added ?5,72,17,800/- to the total income, disallowing expenses claimed by the assessee on the accrual basis. The AO treated the return of income filed on a cash basis as if it were filed on an accrual basis, which led to the disallowance of expenses. The Tribunal found that the AO failed to examine the nature, purpose, and amount of the expenses claimed. The AO’s action of disallowing the expenses without any enquiry or verification was deemed unjustified. The Tribunal held that the AO grossly misunderstood the concept of rejection of books, adoption of a particular method of accounting, and disallowance of expenses. Consequently, the addition made by the AO was deleted.

3. Allegation of No Real Business Activity:
The AO and CIT(A) alleged that no real business activity was carried out by the assessee during the year, leading to the disallowance of expenses. The Tribunal found this allegation baseless, noting that the assessee had ongoing business obligations and statutory requirements to maintain operations. The Tribunal emphasized that a company cannot be considered defunct until it is legally wound up or its certificate of incorporation is surrendered. The Tribunal noted that the assessee’s company status was active on the MCA website, and hence, the expenses incurred were necessary for maintaining daily operations.

4. Computation of Total Income:
The AO computed the total income by disallowing expenses and adding them to the income declared on a cash basis. The Tribunal found this approach incorrect, noting that the AO failed to verify the expenses individually. The Tribunal criticized the AO for not conducting necessary enquiries and for misunderstanding the principles of accounting and tax computation. The Tribunal set aside the CIT(A)’s order and deleted the impugned addition, thereby allowing the assessee’s grounds related to the computation of total income.

5. Charging of Interest under Section 234A and Section 234B:
The Tribunal noted that the charging of interest under sections 234A and 234B of the Income Tax Act is statutory and consequential. Therefore, this ground was addressed as a matter of course.

6. Initiation of Penalty Proceedings under Section 271(1)(c):
The Tribunal deemed the initiation of penalty proceedings under section 271(1)(c) premature at this stage and dismissed this ground.

Conclusion:
The appeal of the assessee was partly allowed. The Tribunal upheld the cash method of accounting followed by the assessee, deleted the addition of ?5,72,17,800/-, and found no merit in the allegation of no real business activity. The computation of total income by the AO was deemed incorrect, and the related disallowance of expenses was rejected. The issues of interest under sections 234A and 234B were treated as statutory and consequential, and the initiation of penalty proceedings was dismissed as premature.

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