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TMI Blog1996 (8) TMI 140X X X X Extracts X X X X X X X X Extracts X X X X ..... sed its funds more towards housing finance besides also utilising them in the field of equipment leasing and consultancy. Over a period of years, the emphasis of the business shifted to housing finance. From what was only 24.16 per cent of the total loans in the year 1980, housing loans jumped to 68.90% in the year 1985. For the years under appeal also there was a further jump in the composition of the housing loan vis-a-vis the total loans given by the assessee. 3. The huge jump in housing advances also brought within its wake of problems for the assessee. The problem was recovery of the interest on such loans which slowed down substantially mainly because the interest was paid by the borrower only on the completion of their housing projects. In recognition of this reality, the assessee-company began entering into agreements for housing loans under which the interest itself would be due for payment only on completion of the house building projects. 4. Up to and including the accounting year ended 31-12-1985, the assessee was following the mercantile system of accounting in respect of all its transactions. The previous year for the assessment year 1987-88 was a period of fiftee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ----------------------------------------- 1981 52,08,497 5,29,501 1.1% 1982 52,05,038 12,95,929 23.9% 1983 61,51,714 23,85,839 38.7% 1984 57,18,089 40,28,510 70.4% 1985 49,72,219 54,93,301 110.4% ------------------------------------------------------- From the above, it may kindly be noted that our outstanding interest as at the end of the year has been more than the interest for the year 1985. This shows that we are paying income-tax on interest which has not been realised and accumulating to the huge amount of 54.93 lakhs. We shall have to pay debenture interest to our holders since under a scheme of amalgamation as approved by the Calcutta High Court, 50% of the shares held by the shareholders of United Bank of India Ltd. which was merged with this company, was converted into debentures and every six months we are required to pay the debenture interest which comes to 12.22 lakhs every year. Therefore, in the interest of business expediency and commercial prudence and in view of substantial charges in the investment pattern of our funds from industrial ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y affecting Company's liquidity. The situation has further been aggravated by the depressive economic condition and industrial decline in the Eastern Sector of the country. To ensure check on further erosion of Company's liquidity, your Directors had to change the accounting method. Keeping in view the above situation and the low profit for the period under review, your Directors are not in a position to recommend any dividend for the period. However, your Directors are confident that such a realistic approach in accounting would have positive reflection in results of operations in future years. " 6. The interest income which was accounted by the assessee on cash basis or receipt basis from the accounting period relevant to the assessment year 1987-88 was continued to be accounted in the same basis in an the subsequent years including the assessment year 1988-89 which is before us. It is not in dispute that the assessee has regularly accounted the interest income on cash basis after the change and this fact has been accepted by the CIT(A) in his common order in paragraph 23. 7. The assessee filed returns of income on the basis of the new method of accounting in respect of the i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is acceptable that the appellant can have its interest a/c. on cash basis and a/cs. for expenses such as stationery, salary, rent, telephone expenses, motor car expenses, etc., on mercantile basis. But in the interest a/c. itself, by the nature of the business of the appellant, there are receipts of interests as well as payments of interest. The appellant can have cash system of accounting for both the receipt as well as payments of interest or mercantile system of accounting for both the receipts as well as payments as it was having earlier. But the appellant cannot be allowed to have cash system for receipts side of the same interest a/c. and mercantile system for the payment side of the same interest a/c. Because that cannot be said to be a recognised and regular system of accounting. The results arising out of such an unsystematic and unequal way of accounting the two sides of the same account would result in lop-sided picture of the actual affairs of the appellant's business. If the appellant later on finds it difficult to recover the interests accrued after taking of the possible action including legal action, the appellant is always free to right off the same as bad debt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and so far as the interest expenditure was concerned, the assessee continued to adopt the mercantile method of accounting. This is common ground. It is also common ground and in fact, it has been accepted by the CIT (Appeals), that the assessee has regularly followed the changed method of accounting in respect of the interest in the subsequent years. Under these circumstances, it is for consideration whether the interest income has to be computed only in accordance with the assessee's method, which takes into account the interest receipts only when they are actually received but claims deduction on account of interest on accrual basis. It is now well-settled that apart from the cash system of accounting and the mercantile system of accounting, "there are innumerable other systems of accounting which may be called hybrid or heterogeneous--in which certain elements and incidences of the cash and mercantile system are combined--CIT v. A. Krishnaswamy Mudaliar [1964] 53 ITR 122,130 (SC). The Calcutta High Court in the case of Reform Flour Mills (P.) Ltd. v. CIT [1981] 132 ITR 184/[1980] 4 Taxman 531 observed that the expression "Hybrid" indicates the birth of a system born out of an in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -tax collections and payments. The method was approved and the following observations at page 231 are relevant : " An assessee may employ one method of accounting for one part of his business or one class of customers, and a different method for another part of his business or one class of customers, and a different method for another part of his business or another class of customers. He may also keep accounts in respect of different parts of the same business on different basis. If such different methods are employed regularly and consistently the profits have to be computed in accordance with the respective methods, provided it results in a proper determination of the true profits. " In the case of CIT v. North Arcot District Co-operative Spinning Mills Ltd. [1984] 148 ITR 406/19 Taxman 240 (Mad.), the assessee was generally adopting the mercantile system of accounting but in respect of the import of plant and machinery from foreign suppliers he was adopting the cash system of accounting and debited the interest not when it was due, but only when it was actually paid. Since this method was being regularly adopted, the same was approved. 13. We may now refer to some decisio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee in following a regular method of accounting and that the bona fides of the change would be established if the assessee establishes that the new method of accounting has been followed regularly by it in the subsequent years. The second condition was that the assessee should lead evidence to show that the changed method of accounting has in fact been employed by it in all the subsequent years thus showing that the new method has been adopted for regular employment and not as a casual departure or only for the year under consideration. In the present case, the bona fides of the change have not been challenged by the departmental authorities. It may be recalled that the assessee had submitted an application seeking the change and in that application eleborate reasons with facts and figures were furnished by the assessee in support of the change. Portions of the application have been extracted in the earlier part of our order. The existence of the reasons or the facts necessitating the change were never doubted by the income-tax authorities and in fact, the refusal communicated to the assessee was rather cryptic in the sense that it merely stated that the ITO was not in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed or not. This decision was followed by the Kerala High Court in the case of Forest Industries Travancore Ltd. v. CIT [1964] 51 ITR 329. In the case of West Coast Paper Mills Ltd., where the assessee changed its method of accounting for bonus from cash system to mercantile system on the basis of the recommendation of the Company Law Board and claimed both the actual bonus paid as well as the liability for bonus as donation in the year of change and where such claim was resisted by the income-tax authorities on the ground that there would be loss of revenue, it was held by the Bombay High Court that whenever there is a change of the method, something of this kind is bound to happen in the year of change but that will be no reason for not allowing the claim on the basis of the changed method, provided the bonus liability had not been allowed in any of the earlier assessment years. In the case of Salig Ram Kanhaya Lal v. CIT [1982] 133 ITR 915/[1981] 5 Taxman 173, the Punjab Haryana High Court held that there were times when some peculiar business transactions do not admit of one or the other form of accounting and in such a situation, the ITO has only to look at the substance of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture of the financial position of the assessee-company. On the contrary, not taking into account the interest accrued, but taking into account only the interest actually realised would not reflect a distorted picture of the financial position ; rather that would show a realistic position. The details given by the assessee in its application for permission for the change in the method of accounting themselves bear testimony to the unrealistic position exhibited in the accounts up to the year ended 31-12-1985 till which year the assessee was following the mercantile system in respect of both interest income and interest expenditure. For instance, the interest credited for that year to the profit and loss account on accrual basis is Rs. 49.72 lakhs whereas the outstanding interest accumulated on the loans advanced by the assessee as on that date was Rs. 54.93 lakhs. Thus, far from being an unscientific system of accounting, the system sought to be followed by the assessee from the assessment year 1987-88 attempts to exhibit a realistic picture. Therefore, the mere fact that under the same head, namely, interest, the assessee seeks to adopt two different systems of accounting, namely, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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