1985 (10) TMI 67 - HC - Income Tax

Under s.11(1)(a) income tax is deductible as outgoing when computing charitable trust surplus; bona fide cash accounting allowed.

GUJARAT HC held that for deduction under s.11(1)(a) the tax liability must be treated as an outgoing when determining surplus available for application or ... Deduction of income-tax liability u/s 11(1)(a) - Charitable Trust - change of system of accounting - mercantile system of accounting - Whether the finding of the Tribunal that in order to give meaning to the expression 'income', the deduction of income-tax liability must be taken as an outgoing before the surplus could be ascertained and that while determining the 'income' or the surplus available to the trust for the purpose of application of its income towards charitable or religious objects, it is the surplus realised or available on commercial principles that has to be taken into consideration and not as per the provisions of the Income-tax Act, is correct in law? - HELD THAT:- It is only from the surplus income that remains in the hands of the trustees that actual application or accumulation for the purposes of the trust can be expected. If there is no income which could be actually applied or accumulated by the trustees for the purposes of the trust, the trustees would be incapable of actually applying or accumulating the income for taking the benefit of section 1l(1)(a) of the Act. Therefore, even in the case of an assessee following the mercantile system of accounting, there can be no doubt that for the purposes of actual application or accumulation or setting apart of income from trust property for the purposes of the trust, the trustees must have on hand income which could be so utilised and what are outgoings towards payment of income-tax must be deducted for working out such surplus income. If a notional income calculated on the basis of accrual under the mercantile system of accounting is conceived as income for the purposes under section 1l(1)(a) of the Act, it must be conceded that such notional income can never be actually applied or accumulated or set apart for the purposes of the trust and the assessee-trust, while being liable to pay income-tax on accrual basis, will not be able to derive the benefit conferred by the said provision. We are, therefore, of the view that the Tribunal was right in coming to the conclusion that the income derived from trust property must be determined on commercial principles and in doing so, all outgoings including outgoing by way of income-tax paid by the assessee-trust must be deducted and it is only from the surplus income in the hands of the trustees that the question of application or accumulation or setting apart of income can arise. In this view that we take, we do not feel called upon to examine the second contention based on the decisions referred to above, whether the expenditure incurred by the trust for the payment of income-tax can be said to be actual application of income for the charitable purposes of the trust in India. Change of system of accounting - HELD THAT:- There is nothing in the Act which precludes the assessee, who bona fide desires to switch over to another system of accounting, from doing so. There is no finding of fact that the switch over to the cash system of accounting in the previous year relevant to the assessment year 1972-73 was not bona fide. Besides, it is not shown by the Revenue that this change lacked durability or regularity and was merely a stop-gap arrangement to avoid payment of tax. In such fact situation, we fail to understand, why a bona fide assessee should be precluded from switching over to another system of accounting which he finds convenient and which would reflect his real income. It is only in a case where the assessee changes his regular method of accounting by another method and does not follow the changed method regularly hereafter that it may be possible to say that by introducing successive changes in his method of accounting, he proposes to exclude certain items in the computation of his total income. In such a case, the bona fides of the assessee may be doubted. Unless there is material on record to hold that the assessee's action is not bona fide, the change in the method of accounting must be accepted. Thus, we are of the opinion that the circumstances in which the assessee was placed compelled the trustees to switch over to cash system of accounting which was the only course open to a prudent trustee for preserving the property of the trust. In the view that the Tribunal took, the Tribunal has not expressed any opinion on this question, but since the question has been specifically referred to us, we have dealt with the same. We are, therefore, of the opinion that the assessee-trust was entitled to switch over to the cash method of accounting in view of the peculiar circumstances in which the trust was placed. Thus, we answer both the questions relating to the assessment year 1971-72 in the affirmative. Issues Involved:1. Deduction of income-tax liability u/s 11(1)(a) of the Income-tax Act, 1961.2. Justification for changing the method of accounting from mercantile to cash system.Summary:Issue 1: Deduction of Income-tax Liability u/s 11(1)(a)The assessee, a charitable trust, claimed a deduction of Rs. 76,972 as an amount applied for charitable purposes u/s 11(1)(a) for the assessment year 1971-72. The Income-tax Officer denied the deduction, considering the payment of income-tax as an appropriation of income. The Appellate Assistant Commissioner upheld this decision. However, the Tribunal allowed the deduction, stating that the payment of income-tax was a necessary outgoing to be considered before determining the net income for application under section 11(1)(a). The High Court agreed with the Tribunal, emphasizing that income must be determined on commercial principles, and all outgoings, including income-tax, must be deducted to ascertain the surplus income available for application or accumulation for the trust's purposes.Issue 2: Change of Accounting MethodFor the assessment year 1972-73, the assessee switched to the cash system of accounting due to non-receipt of interest income from financially troubled companies. The Income-tax Officer objected, but the Appellate Assistant Commissioner allowed the change, noting the financial difficulties faced by the deposit companies. The Tribunal upheld this decision, stating that income should be computed on general commercial principles and not on a notional basis. The High Court supported the Tribunal's view, stating that the change in the method of accounting was bona fide and necessary due to the peculiar circumstances faced by the trust. The Court emphasized that there is no prohibition in the Act against changing the method of accounting if done bona fide and regularly.Conclusion:The High Court answered both questions for the assessment year 1971-72 and the first question for the assessment year 1972-73 in the affirmative, favoring the assessee and against the Revenue. The reference was disposed of with no order as to costs.