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TMI Blog1996 (1) TMI 444X X X X Extracts X X X X X X X X Extracts X X X X ..... mode of computation of income as done by the assessee. It is pertinent to point out that the book profits in terms of s. 115J was much larger than the profit computed under the provisions of IT Act on the basis of EMI method and after discussions with the assessee's representative, the amount of book profit which was larger than the amount computed under EMI method was adopted in the assessment for both the years. The learned CIT was of the view that when the finance charges received by the assessee were accounted for by it in its books of account on the reducing balance basis, the assessments should have proceeded only on that basis and not on the basis of equated monthly instalments (EMI) as has been done in the assessment. According to him, the computation of income for purposes of income-tax was at variance with the method regularly followed by the assessee in its books of account, thus leading to computation of an incorrect amount of income under the head 'Profits and gains of business'. According to him, this has caused serious prejudice to the interests of the Revenue. In this view of the matter, he proposed to intervene under s. 263 of the IT Act. The case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the purpose of income-tax in its anxiety to disclose the correct amount of income, which accrued to it on mercantile basis, the assessee had offered the income on EMI basis. The assessments were not simply completed under s. 143(1) but were completed only under s. 143(3) r/w the provisions of s. 115J after scrutiny and discussion. Therefore, there was no error in the completed assessments which was prejudicial to the interests of the Revenue. The learned CIT has simply invoked s. 263 on a pretence that there was variation between the mode of accounting of the receipts in the books of account (SOD) and the mode by which it admitted the income (EMI basis) for assessment purposes. The learned CIT has not come out with the reason as to which one of the methods is the correct method to be followed in the background of the agreement between the parties. But still merely because there was variation he had concluded that the assessment order suffered from error. In this connection he referred to the agreements entered into between the assessee and the hirers in support of his contention that EMI method (on the basis of which the assessment was completed) was the only appropriate method for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1) of the IT Act and, therefore, his orders suffered from an error which was prejudicial to the interests of the Revenue. If regard is had to these facts and consequences flowing from adopting different standards, one for purposes of accounting in the books and another for purposes of income-tax, one cannot find fault with the order of the CIT under s. 263. 4. Shri Vinay Mohan relied on the decision of the Hyderabad Bench of the Tribunal in ITA No. 2777/Hyd/1988 in ITA No. 2967/Hyd/1988 in relating to the asst. yr. 1985-86 in the case of Nagarjuna Finance Ltd. In that case the assessee adopted the sum of the digits method (for short, SOD method) for recognising its income in its accounts as it was an accepted practice in accounting. However, for the purpose of income-tax the assessee contended that it had adopted mercantile system of accounting, namely, recognition of income on the basis of instalments, whether received or not. The difference between the income computed as per the SOD method and the income computed as per accrual method as termed as differential income and the assessee sought to deduct the same from the income shown in the printed P L a/c. The AO in that case c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4. There is force in the contention of Shri Ramamani, the learned counsel for the assessee, that the CIT has reached a conclusion in his own view of the matter without affording an effective opportunity to the assessee to state its case in all its dimensions. On this score alone the order of the CIT for asst. yr. 1989-90 is liable to be set aside. 6. For the asst. yr. 1990-91, the CIT set aside the assessment order stating : For the asst. yr. 1989-90 in the case of the assessee, I have set aside the assessment with a direction to the AO to complete the assessment afresh on an issue similar to the issue mentioned at (i) in para. 2 above after affording an opportunity to the assessee to furnish its submissions. The assessment for the asst. yr. 1990-91 is also set aside for the sake of uniformity in treatment and also because I am satisfied that interest of Revenue were seriously prejudiced since these issues were not duly considered in the assessment. It may be incidentally mentioned that in respect of asst. yr. 1990-91, the time-limit for passing an order under s. 263 did not expire by 31st March, 1994, unlike in the case for the asst. yr. 1989-90 and still the assessee w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ance charge is '126. From actuarial tables, the rate of interest is 1-3/4 per cent per month. . Outstanding hire purchase Simple interest for 1 month added Instalment paid deducted Balance c/f 30th November . 1,274 . . . Less : Depositss 200 . . 31st December 1,074x1-3/4% 19 100 993 Interest for December . . . . quarter . 19 . . 31st January 993x1-3/4% 17 100 910 28th February 910x1-3/4% 16 100 826 31st March ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... digits. Illustration (8): Facts as in Illustration (7). The sum of the digits is 78. Quarter Digit(s) given to instalment(s) paid during quarter Fraction Interest apportioned to quarter . . . December 12 12/78 19 March 11, 10, 9 30/78 48 June 8, 7, 6 21/78 34 September 5, 4, 3 12/78 20 December 2, 1 3/78 5 Sum of the digits 78 Finance charge 126 This method gives a very close approximation to the accurate results given by the interest on the reducing balance method. It would be used by both a buyer or a seller instead of that method. It may be immediately seen that the rate of interest charged by the financier is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 1/12 11 March 3 3/12 31 June 3 3/12 32 September 3 3/12 31 December 2 2/12 21 Number of instalments 12 Finance charge 126 .In the above illustration also, the rate of interest is not indicated as in the earlier method. These are text-book illustrations. It should also be emphasised that the apportionment of larger income to the earlier period or to the later period as between these methods is only on a comparative basis but not on the basis of any contract between the parties as none of these illustrations indicate the rate of interest and the terms on which the instalments are to be appropriated. Nor is there any indication of the instalments are to be appropriated. In other words, in the absence of the rate of interest and the terms of appropriation, one can follow any one of these three ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontract in a particular accounting year, by some fiction the amount received by him in a subsequent year in connection with the contract, though not arising out of a right accrued to him in the earlier year, could be related back to the earlier year and made taxable along with the income of that year. In other words, income has to be computed even under the accrual system of accounting only on the basis of accrual as provided for in the agreements evidencing the transactions. In short, there can be no accrual of income de hors the terms and conditions of the agreement. Viewed in this light we hold that the technique of accounting followed by the assessee (Reducing balance method or the SOD method) in its books of account for recording the transactions cannot determine the accrual of income. Accrual would depend on the terms and conditions of the contract between the parties, but not at the whims of either party. 10. We have before us a few sample copies of the agreements. To illustrate our point we give below the terms and conditions of Contract No. A-462. The hirer is Batco Roadways, Old Peelkhana, Hyderabad. The date of agreement is 29th Nov., 1989. The terms and condition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o between ALF and IDBI in terms of which IDBI has a right to collect monthly instalments directly from the hirer in certain events as provided for in the said loan agreement. In the event of IDBI exercising such right, I/we the hirer(s) agree and undertake to pay the monthly instalments directly to IDBI instead of to the owner (ALF), in the manner indicated in Second Schedule. Accordingly the owner (ALF) hereby authorises the hirer to pay the monthly instalments to IDBI, on receipt of a notice to the effect from IDBI. The receipt(s) issued by IDBI to the hirer for such payments shall discharge the hirer from his/its obligations to the owner hereunder. Clause IV: If the hirer shall duly perform and observe all the terms and conditions contained in this agreement and the covenants on his part to be performed and observed and shall in the manner aforesaid pay to the owner monthly sums by way of hire amounting (together with the said sum of ₹ 51,278 paid on the execution of the agreement as aforesaid) to the sum of ₹ 3,42,175 and shall also pay to the owner all other sums of money which pay become payable to them by the hirer under the agreement, the hiring shall come to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9-06-90 9.950 Service charges : Rs. 500 7 29-07-90 9,950 Total : Rs. 3,48,675 8 29-08-90 9,950 Less: . . 9 29-09-90 9.950 Service charges Recd. Rs. 500 10 29-10-90 9,950 Balance Rs. 3,48,175 11 29-11-90 9,950 Add: . . 12 29-12-90 9,950 Insurance premium . . 13 29-01-91 9,950 For Rs. . . 14 29-02-91 9,950 2nd Year Rs. . 15 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2 9,950 . . . 35 29-11-92 9,950 It is seen that the rate of interest is given in the agreement. That rate is applied on the amount advanced for the period for which the contract will be in force. The principal amount of loan together with the finance charge thereon will be recovered in EMI as given in the Schedule to the agreement. As per the agreement the assessee has a right to demand the principal component and the interest component comprised in the instalment only under the EMI method. It has no right to demand the interest component and the principal component embedded in the instalment in any manner other than that provided for in the agreement. In other words, the assessee has no right to adopt SOD method or the reducing balance method when the agreement is to the contrary. So long as the income stood computed in conformity with the agreement the assessment order cannot be called to question. In other words, there is no error and prejudice in the assessment orders which would attract the provisions of s. 263. 11. We have gone carefully th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... IT Act. When an ITO proceeds to include a particular income in the assessment, he should ask himself, inter alia, two questions, namely, (i) what is the system of accountancy adopted by the assessee? and (ii) if it is the mercantile system of accountancy, subject to the deemed provisions, when has the right to receive that amount accrued? If he comes to the conclusion that such a right accrued or arose to the assessee in a particular accounting year, he shall include the said income in the assessment of the succeeding assessment year. No power is conferred on the ITO under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year on the ground that the said income arose out of an earlier transaction. Nor is the question of reopening of accounts relevant in the matter of ascertaining when a particular income accrued or arose. Equated monthly instalment is what has been agreed upon between the assessee and its constituents or clients and the income could arise and did arise only under that method. In the face of an agreement for payment by equated monthly instalment of the principal amount and the interest thereon, neither the debtor nor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreement. Sec. 145 is as follows : 145(1) income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee: Provided that in any case where the accounts are correct and complete to the satisfaction of the AO but the method employed is such that, in the opinion of the AO, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the AO may determine: Provided further that where no method of accounting is regularly employed by the assessee, any income by way of interest on securities shall be chargeable to tax as the income of the previous year in which such interest is due to the assessee : Provided also that nothing contained in this sub-section shall preclude an assessee from being charged to income-tax in respect of any interest on securities received by him in a previous year if such interest had not been charged to income-tax for any earlier previous year. (2) Where the AO is not satisfied about the correctness or the completeness of the accou ..... X X X X Extracts X X X X X X X X Extracts X X X X
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