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TMI Blog2008 (1) TMI 491X X X X Extracts X X X X X X X X Extracts X X X X ..... in s. 145 is that while prior to the amendment, there was no need to justify such an accounting treatment on merits and it was possible for the assessee to argue that as long as a method has been consistently followed, no objection can be taken to the same, the situation post amendment is that any non recognition of revenue has to be justified by the assessee on merits. Post amendment, it is also necessary for the assessee to demonstrate that even under the mercantile method of accounting, there are good reasons for not recognizing the revenues in question on accrual basis and that facts and circumstances of the case warrant that such revenues are recognized only when the same are received. That will essentially depend on facts of each case. The facts of the case before us do indeed justify that even under mercantile method of accounting, revenues in question, i.e. accrued interest on seed money loans, are recognized only when the same are actually received by the assessee. No doubt, there is a legal right to receive the interest, but there are also ground realities which do not permit strict enforcement of this right. In our considered opinion, any other view of the matter will re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hether or not the CIT(A) was justified in confirming the addition of Rs. 2,77,26,740 on account of accrued interest on seed money loans. The assessment year involved is 2002-03 and the impugned assessment is framed under s. 143(3) of the IT Act, 1961. 2. The assessee before us is a corporation wholly owned by the Government of Maharashtra. The assessee is engaged in various activities aimed at development of industries and promotion of industrialization in western region of the Maharashtra State. In the course of scrutiny assessment proceedings, the AO noticed that while the assessee had maintained books of accounts on accrual basis in respect of all items of accounts, the assessee has accounted for interest on seed money loan/assistance on cash basis. The AO also noted that this factual position is admitted by the assessee in the notes attached to, and forming part of the annual accounts which, inter alia, state as follows: "The books are maintained on accrual basis, except in the case of income from interest on seed money loans (including penal interest) which is accounted for on cash basis. This is permitted to Government companies engaged in the promotion and development of i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee". It was thus concluded that 'hybrid' method of accounting was no longer a permissible system of accounting; the assessee had to either choose 'mercantile' system of accounting in respect of all transactions or 'cash' system of accounting. It was also noted that the assessee, on the facts of the present case, was following the cash system of accounting so far as income from interest was 'concerned, but the assessee preferred to follow 'accrual' method of accounting in respect of all other transactions. The AO also noted that the reasoned decision of the Tribunal was in the context of the pre-amendment legal position, as applicable for asst. yr. 1996-97 and assessment years prior thereto, and the CIT(A) clearly erred in not taking note of the amended legal position when following the same decision for the post-amendment years. The CIT(A)'s decision in favour of the assessee for the asst. yr. 1997-98, which was apparently relied upon by the assessee, was thus unacceptable. It was in the backdrop of this discussion that the AO rejected the method of accounting followed by the assessee, and added the amount of Rs. 2,77,26,740 on account of accrued interest on seed money loa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee's request, we deemed it fit and proper to reject the request and proceeded ex parte qua the assessee. The assessee's representative, who had come to seek adjournment, was, however, advised to file a written note and other relevant documents that the assessee would seek to rely upon. We have heard Shri Srinivasan, learned Departmental Representative, at considerable length, perused the material on record and duly considered factual matrix of the case as also the applicable legal position. 7. We find that as s. 145(1) unambiguously provides the profits of business are to be computed in accordance with 'either cash or mercantile system of accounting, regularly employed by the assessee'. However, rider is that the provisions of s. 145(1) are subject to the provisions of s. 145(2) which, in turn, provide that the Accounting Standards, as may be notified by the Central Government from time to time, are to be followed by any class of assessee or in respect of any class of income. In other words, therefore, the notified Accounting Standards are to be followed by an assessee even if these Accounting Standards provide for an accounting treatment contrary to the mercantile syste ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting policies is not of a recent origin. It is one of the fundamental principles of accounting that, as a measure of prudence and following the principle of conservatism, the incomes are not taken into account till the point of time that there is a reasonable degree of certainty of its realization, while all anticipated losses are taken into account as soon as there is a possibility, howsoever uncertain, of such losses being incurred. A Co-ordinate Bench of this Tribunal, in the case of Mashreq Bank vs. Dy. Director of IT (2007) 18 SOT 233 (Mumbai) has, while dealing with a somewhat connected issue, made following observations: "...........The accountancy principle of conservatism, which has been duly recognized by the Courts, mandates that anticipated losses are to be provided for in the computation of income but it does not permit anticipated profits to be taken into account till the profits actually arise. That is the underlying reason that in the case of unsold stock, when market rate is higher than the purchase price, the market price is ignored in computation of value of stock, and, as a result, anticipated profit on sale of such stock is ignored. However, when the market pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the connotations of expression 'mercantile method of accounting'. 'Guidance Note on Terms Used in Financial Statements', issued by the ICAI, describes the said method as follows: "Accrual basis of accounting The method of recording transactions by which revenues, costs, assets and liabilities are reflected in the books of accounts in the period in which they accrue. The accrual basis of accounting includes considerations relating to deferrals, allocations, depreciation and amortization. This basis of accounting is also referred to as mercantile basis of accounting." 14. No doubt, as a general principle of the mercantile method of accounting, revenues are reflected in the books of accounts of the period in which revenues accrue, and revenue is recognized as it is earned. However, there are exceptions to this principle and such exceptions are warranted by the considerations of 'prudence' which, in any event, override the strict principles of mercantile method of accounting. In this light, let us take a look at the following extracts from 'Guidance note on accrual basis of accounting', issued by the ICAI, which unambiguously demonstrate the rationale of such exceptions: "..... ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its and it was possible for the assessee to argue that as long as a method has been consistently followed, no objection can be taken to the same, the situation post amendment is that any non recognition of revenue has to be justified by the assessee on merits. Post amendment, it is also necessary for the assessee to demonstrate that even under the mercantile method of accounting, there are good reasons for not recognizing the revenues in question on accrual basis and that facts and circumstances of the case warrant that such revenues are recognized only when the same are received. That will essentially depend on facts of each case. 17. The facts of the case before us do indeed justify that even under mercantile method of accounting, revenues in question, i.e. accrued interest on seed money loans, are recognized only when the same are actually received by the assessee. 18. There is no dispute about the fact that the assessee company is a Government corporation wholly owned by the Government of Maharashtra, and is engaged in various activities aimed at development of industries and promotion of industrialization in western region of the Maharashtra State. These activities are surel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee that even under the mercantile method of accounting, and, on peculiar facts of this case, the assessee is justified in following the policy of not recognizing these interest revenues till the point of time when the uncertainty to realize the revenues vanishes. 19. There is one more aspect of the matter. Let us assume for a minute that the method of accounting followed by the assessee is indeed contrary to the provisions of s. 145(1) but then the AO is not entitled to make adjustments in those books of accounts to bring the same in conformity with the provisions of s. 145(1). All that he can do in such a situation is to lean on s. 145(3) which permits him to make a best judgment assessment under s. 144. In the best judgment assessment. he has to take into account all such material as he has gathered in the course of assessment proceedings. This material obviously includes the 'Government of India notification which, despite the fact that all companies are required to follow accrual basis of accounting, specifically directs the assessee company to book interest income on seed money loans only when the same is actually received. A notification issued by the Government of India ..... X X X X Extracts X X X X X X X X Extracts X X X X
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