9911796707
TMI Blog1990 (1) TMI 110X X X X Extracts X X X X X X X X Extracts X X X X ..... , being the previous year relevant to the asst. yr 1985-86 now before us. Earlier, it was adopting mercantile system of accounting for all purposes. This naturally meant that the income receivable under the heads 'advertisement', 'circulation', 'printing' and 'processing' was taken into account on accrual basis. However, given the nature of its business, there was quite some delay in realising the money due to it. At times the dues were not realised at all with the result if the moneys receivable under the said heads were to be fully accounted for on accrual basis; cash realisations being less that the accruals, it would not be in a position to fulfil the statutory requirement of applying its income to charitable objectives. It was, therefore, that the Board of Trustees on 30th April, 1984, resolved "to keep accounts on the basis of actual realisation of cash in respect of its sales and in respect of its expenditure on actual payment made and to be made and publish the accounts accordingly which will represent the real worth and this method will be regularly followed henceforward, from 1st April, 1984". 5. The details of (i) the amounts due to the assessee under the four heads, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sums expended on inputs such as newsprint, labour, etc., aggregating about Rs. 89 lakhs had been booked on accrual basis, whereas, on the receipt side, only the amounts actually realised were accounted for. "There can, thus, be no doubt that the expenses claimed by the appellant were not fully matched with the income arising therefrom". (ii) The ITO was, therefore, justified in considering that the assessee's true profits and gains could not be deduced from the method of accounting followed by the assessee. In this connection, the CIT(A) referred to and relied upon the following reported cases: (a) CIT vs. Sarangpur Cotton Manufacturing Co. (1983) 6 ITR 36 (PC) (b) CIT vs. Krishnaswamy Mudaliar (1964) 53 ITR 122 (SC). (iii) As has been pointed out by the learned author, Ramaiyya, in his commentary on companies Act, "cash system of accounting does not disclose a true and fair view of the state of affairs of the company or its profit or loss for a period". This is true not only of companies but of other assessees also. (iv) In any event, the appellant could not be said to have followed cash system of accounting in respect of its receipts. "What it did was at the first ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eal have been raised, they all relate to the question whether the lower authorities were justified in refusing to recognise the change in the method of accounting introduced by the assessee. 11. Shri G.C. Panda, the learned counsel for the assessee, took us through the facts of the case and vehemently contended that the lower authorities were not justified in rejecting the assessee's claim. He drew our attention to the fact that the assessee is public charitable trust which had been registered under s. 12A of the IT Act, 1961, as far back as on 9th Jan., 1979. For the purpose of exemption under s. 11 of the Act, the focus is on the income actually applied to charitable or religious purposes, including the income which is accumulated or set apart for application to such purposes in India, provided that the income so accumulated or set apart is not in excess of 25 per cent of the income in question. It should, therefore, follow that what is to be ascertained is expendable income, that is to say, the income that is actually and physically available for being expended on charitable, etc., purposes must be determined first. Ex hypothesi, therefore, notional income, or income that had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n to the fact that, even though the balance sheet showed cash in hand of Rs. 6,20,000, the fact is that it represented the collections made on the last day of relevant year of account, that 1st April, 1985, was a holiday and hence the collections made on the last day were banked on 2nd April, 1985 and spent thereafter, and that, therefore, the learned CIT(A) was not justified in reading too much into the fact that the balance sheet showed cash in hand of Rs. 6,20,000. 19. In view of the foregoing, therefore, contended Shri Panda, the assessee is entitled to succeed. 20. On his part, Shri S. Kanungo, the learned Departmental Representative, strongly supported the impugned orders of the lower authorities. Relying on the Calcutta High Court decision in the case of Snow White Food Products Co. Ltd vs. CIT (1983) 141 ITR 847 (Cal), he vehemently contended that, in the case before us, the method of accounting followed by the assessee did not enable the ITO to deduce the true profit and gains of the assessee's business and that, therefore, proviso to s. 145(1) was applicable to this case, 21. Secondly, the provisions of s. 11(4) of the Act squarely applied to this case and, there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly was that it had switched over to hybrid system of accounting which it was entitled to choose; that the hybrid system was consistently followed in the subsequent years; that the hybrid system of accounting was a recognised system of accounting; and that, therefore, the ITO was duty-bound to accept the book results. On his part the CIT(A) examined the matter from two angles. He first proceeded on the premise that there had been a change of method of accounting and held that the revised system of accounting adopted by the assessee did not enable the ITO to deduce the true profits and gains of the assessee 's business. Secondly, the CIT(A) called in question the assessee's claim that it had switched over to hybrid system of accounting. This is what the CIT(A) has to say in paragraph 6 of his order: "6. Secondly, on the facts of the case I find it difficult to accept that the appellant actually followed cash system of accounting in respect of its receipts. What it did was at the first instance it recorded all sales under the heads advertising, circulation, printing, etc. Subsequently, the accounts were adjusted by actual realisation of the sale proceeds leaving the balance as rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itable trust; that it has been registered under s. 12A of the IT Act, 1961; and that it is engaged in the business of publishing newspapers, magazines and periodicals. The asst. yr. is 1985-86, and hence the provisions of s. 11 (4A) of the IT Act, 1961, inserted by the Finance Act, 1983, w.e.f. 1st April, 1984, will come into play. The sub-section provides that the provisions of sub-s. (1) of that section relating to exemption of income derived from property held under trust for charitable or religious purposes; or of sub-s. (2) thereof relating to accumulation or setting apart of such income for application to such purposes; or the connected provisions of sub-ss. (3) and (3A) of the said section will not apply in relation to profits and gains of business. This provision will apply irrespective of whether the profits and gains are derived from a business carried on by the trust or institution or from a business undertaking which is held in trust for such purposes. An exception has, however, been made in relation to profits and gains of business in the following cases: (a) where the business is carried on by a trust wholly for public religious purposes and the business consists o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rch, 1984, the assessee was admittedly accounting for both receipts and expenditure on accrual basis. With effect from 1st April, 1984, however, it started accounting for the receipts under the four heads, referred to supra on cash basis, even while continuing to account for expenditure on accrual basis. The major, stated or ostensible reason for the switch over to the new system of accounting, is: "The Prajatantra Prachar Samity has been taking credit for all bills raised in respect of advertisements and circulations of which a substantial portion remains uncollected, and, in fact, are not collected at all. By taking credit for all such bills, there are in reality unearned credits which enter into unrealised profit, creating problem for compulsory application of profit, which, in fact, is not realised." The reasons adduced by the assessee in support of its opting for the cash system of accounting of the receipts under the four heads may be syllogistically stated as follows: (i) The adoption of the mercantile system of accounting in respect of receipts would mean that credit would have to be taken on accrual basis for all the bills due. (ii) in that event, the amount to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned Departmental Representative, it may be recalled, contended, Inter alia, that the provisions of s. 11 (4) would be applicable to this case. The point made by the learned Departmental Representative is clearly that, since s. 11(4) is applicable, the ITO rightly proceeded to determine the assessee's business income in accordance with the provisions of the IT Act relating to the assessment, and that, consequently, the ITO was justified in applying the provisions of s. 145 which is one of the sections relating to the assessment under the Act. As we see it, s. 11 (A) had a role to play prior to the insertion of s. 11(4A) by the Finance Act, 1983, w.e.f. 1st April, 1984. With the insertion of s. 11(4A), however, s. 11(4) lost its role and rationale and it is no longer necessary to rely on that section for holding that the profits and gains from the assessee's publication business must be determined in accordance with the provisions of the Act relating to assessment. The reason is simple and that is that, once the profits and gains of the assessee's business of publication is denied the benefit of exemption under s. 11(1), 1(2) r/w ss. 11(3) and 11(3A), the computation of the profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o understand the connotation of the term 'profits and gains of business', and secondly, to see how the method of accounting enables one to arrive at the profits of a business. 42. Slightly more than a century ago, Lord Herschell said in Russell vs. Town and County Bank: "the profits of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts". The above definition was amplified by the Lord President in Whimster Co. vs. IRC 12 TC 813 thus: "In computing the balance of profits and gains for the purposes of income-tax, or for the purposes of excess profits duty, two general and fundamental common places have always to be kept in mind in the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profits and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... though not necessarily realised in cash, or the loss computed under this system is the loss actually sustained, though not necessarily paid in cash. The distinguishing feature of this method of accountancy is that it brings into credit what is due immediately it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed". It will be Ex facie clear from the said lucid definition that the matching principle has its full pay in the mercantile system of accounting. Iqbal Ahmed, CJ, went on to define the cash system of accounting in the following words: "The 'mercantile accountancy system' is the opposite of the 'cash system of book keeping' under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed." It will be Ex facie clear from the said definition that the matching principle plays a role in the cash system of accounting also, even though both the expenditure and the receipts are booked on cash basis and not on accrual basis. As for the hybrid system of accounting, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e deviation from the matching principle. It should at once be highlighted that the departure cannot be whimsical or mindless. The nature and extent of the departure from the mercantile system of accounting will depend on the facts and circumstances of the case. But there is one overriding principle which should never be lost sight of in this regard, and that is that the method of accounting should invariably reflect the true profits of the business, present a true and fair picture of the financial position of the business. While deciding to adopt the hybrid system of accounting, that is to say, while deciding to depart or deviate from the mercantile system of accounting, the basic question that should be asked and answered is whether, having regard to the paramount need to arrive at the true profits of the business and to present a true and fair view of the financial position of the business, the departure is absolutely necessary and, if so, to what extent, consistent, of course, with such factors as the availability of full and correct information, convenience, etc. We may now turn to s. 145 of the IT Act, 1961. The section enacts that income chargeable to tax under the head "Prof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ck (which is but an aspect of the method of accounting) adopted by the assessee was held to be inappropriate, inasmuch as, it did not enable the assessing authority to properly deduce the taxable income: (i) Patrik (Inspector of Taxes) vs. Broadstone Mills Ltd. (1954) 25 ITR 377 (CA) (Base stock method) (ii) Minister of National Revenue vs. Anaconda American Brass Ltd. (1956) 30 ITR 84 (PC) (LIFO method) (iii) CIT vs. Mc. Millan Co. (1958) 33 ITR 182 (SC) (Fixed percentage method) 55. Fifthly, the assessee is prohibited from adopting regularly one method of accounting for his own purposes, and yet another method of accounting for income-tax purposes. 56. The learning case on this issue is CIT vs. Sarangpur Cotton Manufacturing Co. Ltd. (1938) 6 ITR 36 (PC). In that case, the assessee employed a regular method of accounting but had also for some years past adopted regularly a method of valuation of stock by taking some price under both cost and market price with the object of creating a 'secret' reserve, which involved the retention of profits as not to be included in the profits shown to the shareholders. For the account year 1930 the assessee submitted th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... undoubtedly kept his accounts regularly on the mercantile basis. He could consistently with that basis have shown the commission earned for the half year ended the 31st of Dec., 1933, and as against that shown as a debit item, the same amount as a bad debt, and if the Commissioner had been satisfied that, in fact, the debt was bad, he would have allowed the debt; if he had not been satisfied and has charged income-tax on the debt, and such debt was ultimately never received, I think the assessee would have been entitled to claim a refund under s. 48A. Here undoubtedly the assessee was trying to alter the basis of accounting from the mercantile basis to a cash basis for this particular half year, and in my view no case is established which justified him in doing that." 58. The same line was taken in the following cases: (i) CIT vs. Shrimati Singari Bai (1945) 13 ITR 224 (All), (ii) Shiv vs. Prasad Ram Sahai vs. CIT (1966) 61 ITR 124 (All), (iii) CIT vs. Confinance Ltd. (1973) 89 ITR 292 (Bom), (iv) Balraj Virmani vs. CIT (1974) 97 ITR 69 (All). 59. In the following cases, the assessee even while following the mercantile system of accounting transferred interest re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee can unilaterally change his method of accounting. The Bombay High Court in the case Ramkumar Kedar Nath, the Calcutta High Court in the matter of M/s Chouthmal Golapchand (1938) 6 ITR 733 (Cal), and the Allahabad High Court in the case of Shiv Prasad Ram Sahai (1966) 61 ITR 124 (All) have taken the line that the assessee should obtain the permission of the ITO before changing the method of accounting. On the contrary, the Calcutta High Court, in the later case of Snow White Food Products Co. Ltd. took the view that a change in the method of accounting need not have the approval of the IT Authorities. We have said that the conflict was apparent and not real, because the Courts were not examining the assessee's right to change the method of accounting in the abstract. They were considering the issue in the context of the provisions of s. 13 of the old Act/s. 145 of the new Act which aim at the computation of the true profits of the assessee. As we see it, the view that the assessee cannot unilaterally change the method of accounting starts from the premise that under s. 145, the ITO is duty bound to ensure that the true profits and gains are deduced from the system of acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y of the assessee. The answer is: per se the reduction in or the postponement of the assessee's tax liability is not a relevant criterion. What is relevant is whether, in the facts and circumstances of the case, the change in the method of accounting was Bona fide. If the change was Bona fide, then it would have to be accepted, even though it may have the effect of reducing or postponing the assessee's tax liability. If, on the contrary, the change over is not Bona fide the ITO can refuse to recognise the change on that ground alone. It bears a repetition that the object is to deduce from the system of accounting followed by the assessee the true profits and gains of the assessee's business or profession. 67. We may now notice a few cases where the hybrid system of accounting has been recognized. In the case of S.R.V.G. Press Co., Kurnool vs. CEPT (1956) 30 ITR 583 (AP) the question arose whether the assessee could account for sales-tax payments on cash basis. The question arose in the context of s. 21 of the Excess Profits Tax Act. Resolving the issue in favour of the assessee, the Court observed: "Sec. 21 of the Excess Profits Tax Act enacts that s. 13 of the IT Act shall a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... counting regularly employed by the assessee and till then accepted by the Department, for the chargeable accounting period, merely because the life of Excess Profits Tax Act expires on 31st March, 1946, and it would be advantageous to the Revenue to disregard the payments of the provisional sales-tax made during the official year ending 31 March, 1945, by bringing into the account of that year the rebates or refunds granted on 18th April, 1946, and entered in the assessee's books under that date." 68. In the Madras case of CIT vs. E.A.E.I. Sundararaj (1975) 99 ITR 226 (Mad), the issue related to the sales-tax account maintained by the assessee. The issue was resolved on the footing that the assessee was maintaining a separate sales-tax account on cash basis. The following observations of the Court are noteworthy: "In this case so far as the separate accounts maintained by the assessee are concerned, they have been kept only on cash basis, that is, the sales-tax collections made had been credited and the actual sales-tax payments have been debited on the respective dates of collection and payment. Neither the sales-tax collections nor the payments made by the assessee which ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich remained irrecoverable, but only at the time when the litigation came to a finality. The assessee claimed revenue deduction in respect of certain litigation expenses but the claim was rejected on the ground that the expenses related to earlier year(s). The Court held, on the facts, that: "the assessee was entitled to deduct the expenses in the account year though they were incurred in earlier years, because for the purposes of calculation of income-tax they could be considered to be expenses incurred in the accounting year on the basis of the regularly employed method of the assessee's accounting on the basis of which income, profits and gains were required to be computed under s. 13 of the IT Act." This is what the Court observed in this regard: "When we come to s. 13 of the IT Act we find that income, profits and gains have to be computed for the purposes of s. 10(1) in accordance with the method of accounting regularly employed by the assessee. There is a proviso to that section which says that if the method employed is such that in the opinion of the ITO the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as been regularly showing the payment of interest in the year in which the interest was actually paid and not in the year in which the interest legally fell due. Having regard to the fact that it is not the case of Revenue that it is not possible to ascertain the true profits from the method of accounting regularly followed by the assessee, the Tribunal is right in holding that it is not open to the Revenue to go back on its stand taken in the earlier years and call upon the assessee either to adopt cash system or mercantile system of accounting." 72. The merits of the case may now be examined in the light of the foregoing principles. 73. To recapitulate, the following two issues were formulated for consideration in this case: (a) Was there a change in the method of accounting regularly followed by the assessee? If so, can the change be regarded as valid in the eyes of law? (b) If this a case where, there being no change in the method of accounting regularly followed by the assessee, certain receipts were treated differently or separately from the system of accounting regularly followed by the assessee, can the treatment be said to be valid in the eyes of law? 74. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he method adopted by the assessee fails to supply the said legal desideratum. 79. The assessee fails the 'Bona fide' test also. The assessee says that it opted for the cash method of accounting of the receipts under the four heads, mainly because it experienced difficulties in collecting the bills due, which, it apprehended, would hamper the statutorily obligatory application of funds to charitable objects. We have already seen how, with the introduction of s. 11(1A), compulsory application of funds to charitable objects is no longer germane to the issue. That leaves for consideration the assessee's claim that it experienced difficulties in collecting the dues. 80. The assessee has been in the publication line for quite some time now. And all along it had maintained its books of account on mercantile basis. By necessary implication, therefore, it did not face any collection problem in those years. When did the problem surface? What was its extent, its magnitude, both in absolute and relative terms? When the problem was in its nascent stage, what corrective steps (form the point of view of commerce and not accounting) did the assessee take? The assessee has nothing to say on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appened in this case. The claim of the assessee that the switch over to cash basis of accounting was Bona fide unsupported by evidence as it is, is fit to be rejected. We accordingly reject it. 86. Appeals ad misericordiam are besides the point. There is a point of law involved here and that is that, in every case, the method of accounting employed by the assessee must have been regularly adopted, and it should be possible to deduce therefrom the true profits and gains of the assessee's business. If this basic requirement is not satisfied-and it is not satisfied in the case before us-the assessee must fail. 87. But the matter does not rest there. The so called hybrid system of accounting alleged to have been followed by the assessee is so arbitrary that it is no method of accounting at all. It should, therefore, follow that the provisions of s. 145(2) also get activated, enabling the Assessing Officer to make a best judgment assessment. This is yet another ground on which we affirm the decision of the lower authorities. 88. In view of the foregoing, therefore, we decline to interfere with the impugned order of the CIT(A). 89. In the result, the assessee's appeal is dism ..... X X X X Extracts X X X X X X X X Extracts X X X X
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