2011 (9) TMI 43 - AT - Income Tax

Assessee's Right to Choose Cash-Based Accounting Upheld by Tribunal

The Tribunal upheld the CIT(A)'s decision that the Assessee, a private limited company providing professional services, can be taxed based on the cash ... MAT - System of accounting - Mercantile system versus Cash system - whether provisions of Section 209(3) of Companies Act, 1956 overrides the provisions of Section 145 of the Act - Computation of book profit u/s 115JB (Minimum Alternate Tax) - Held that: - in the case of Chennai Finance Co. Ltd. (2001 -TMI - 66128 - ITAT HYDERABAD) it has held that the provisions of section 209(3) of the Company Act 1956 do not override provisions of section 145 of the Act.Regarding rejection of books of accounts - AO rejected the books on the ground that when the assessee was following cash system of accounting there cannot be any sundry creditors appearing in the balance sheet. - Held that: the reply given by the assessee justifies the action of the assessee in showing sundry creditors in the balance sheet. Therefore, this cannot be a valid basis for rejecting the books of account. - The system followed by the assessee does not in any way detract from the cash system of accounting. - The reasons assigned by the AO for rejecting the books of account are not proper.Regarding applicability of Accounting Standard (AS-9) - Held that: - those accounting standards are applicable only to the assesses, who follow mercantile system of accounting. Since the assesse, in the present case follows cash system of accounting, we are of the view that the rejection of books of accounts on this basis cannot be upheld. Principle of consistency - Held that: - right from A.Y 1983-84 till A.Y 2003-04 the revenue has accepted the cash system of accounting followed by the assessee and has completed the assessment on that basis. In A.Y 2004-05 the AO cannot be allowed to take a different stand. As rightly contended on behalf of the assessee there should be finality and certainty in all litigation including litigation arising out the Act. Issues Involved:1. Whether the CIT(A) was right in holding that the Assessee cannot be taxed on the basis of the mercantile system of accounting as against the cash system followed by the Assessee.Issue-Wise Analysis:1. Method of Accounting:The primary issue in these appeals is whether the Assessee, a private limited company rendering professional services, can be taxed based on the mercantile system of accounting instead of the cash system which it follows. The Assessee has been maintaining its books on a cash basis since AY 1983-84, which has been accepted by the Income Tax Department consistently. The Assessee argued that it switched to the cash system due to the nature of its income from professional services, which involves uncertainties in bill settlements and payment realizations. The CIT(A) upheld that the Assessee regularly employed the cash system for its business and maintained additional records for compliance with the Companies Act.2. Provisions of the Companies Act vs. Income Tax Act:The AO contended that under Section 209(3) of the Companies Act, 1956, it is mandatory for companies to maintain books on an accrual basis, which overrides Section 145 of the Income Tax Act that allows the choice of accounting method to the Assessee. However, the CIT(A) held that the provisions of the Companies Act do not override the Income Tax Act. Section 145 allows an Assessee to choose between cash or mercantile systems, and this choice is not restricted by the Companies Act. The CIT(A) also noted that the Act does not prohibit companies from maintaining books on a cash basis.3. Consistency Principle:The Assessee emphasized the principle of consistency, arguing that the cash system has been accepted by the Revenue from AY 1983-84 to 2003-04. The CIT(A) agreed, stating that the Revenue should not disturb the cash system of accounting that has been consistently followed and accepted in previous years.4. Rejection of Books of Accounts:The AO rejected the Assessee's books maintained on a cash basis, arguing that the presence of sundry creditors in the balance sheet is inconsistent with the cash system. The Assessee explained that these sundry creditors were related to government dues, staff deductions, and advances for company activities, which were justified under the cash system. The CIT(A) found the Assessee's explanations satisfactory and held that the rejection of books was not proper.5. Applicability of Accounting Standards:In AY 2006-07, the AO also argued that Accounting Standard (AS) 9 issued by the ICAI, which advocates the mercantile system, should be followed. The CIT(A) clarified that AS-I and AS-II are the only standards notified under Section 145 and are applicable only to those following the mercantile system. Since the Assessee follows the cash system, these standards were deemed irrelevant.6. Case Law References:The AO relied on the ITAT Delhi Bench decision in Amarpali Mercantile (P) Ltd., where it was held that a company cannot maintain two sets of accounts. However, the CIT(A) distinguished this case, noting that the Assessee in the current case has been consistently following the cash system for day-to-day business, unlike in Amarpali Mercantile where the change was not consistent.Conclusion:The CIT(A) concluded that the Assessee's method of accounting on a cash basis is valid and should be accepted. The AO's rejection of the books of accounts and determination of income based on the mercantile system was not proper. The Tribunal upheld the CIT(A)'s order, emphasizing the principle of consistency and the Assessee's right to choose its method of accounting under Section 145 of the Act. All the appeals by the Revenue were dismissed.