1981 (11) TMI 27 - HC - Income Tax

High Court allows change in accounting method for interest income, interest not received not taxable

The High Court held in favor of the assessee, allowing the company to change its accounting method from the mercantile system to the cash system for ... Change of method of accounting - regular method of accounting - cash system versus mercantile system - bona fide change - income to be computed in accordance with the method of accounting regularly employed by the assessee (section 145) - res judicata not applicable in revenue assessmentsChange of method of accounting - cash system versus mercantile system - regular method of accounting - income to be computed in accordance with the method of accounting regularly employed by the assessee (section 145) - Whether the assessee was entitled to change its method of accounting in respect of interest income and thereby exclude interest accrued but not received from assessment years 1971-72 and 1972-73. - HELD THAT: - The Court held that an assessee is entitled to substitute one recognised regular method of accounting by another and that such change can be effected in respect of a part of the assessee's income. Where it is established that the assessee has employed the substituted method regularly thereafter, the income must be computed in accordance with that regularly employed method under section 145. The Tribunal's reliance on earlier assessments to include accrued interest was misplaced because there was evidence that the assessee had maintained the changed method in the subsequent years and no material on record showed that interest from any debtor was accounted for on the mercantile basis in the years in question. Consequently the accrued but unrealised interest could not be included for the assessment years 1971-72 and 1972-73 where the cash method was being regularly followed.Answered in favour of the assessee; the assessee was entitled to the changed method and the accrued interest need not be included for 1971-72 and 1972-73.Bona fide change - regular method of accounting - change of method of accounting - Whether the question of the assessee's bona fides in changing its method of accounting remained open for challenge in the subsequent assessment years once the changed method was regularly followed. - HELD THAT: - The Court explained that the concept of bona fides is primarily relevant when a change is first introduced: revenue authorities must be satisfied that the change is intended to be regularly followed. However, once a taxpayer has in fact substituted one recognised regular method by another and has followed the new method regularly thereafter, the revenue cannot reopen the question of bona fides for those subsequent years. Thus absence of a specific finding in the relevant assessment years that the assessee acted otherwise than bona fide meant the Revenue could not impugn the continued application of the cash method for 1971-72 and 1972-73.The Court held that bona fides, relevant only at the stage of initial change, could not be successfully challenged where the changed method was shown to have been regularly followed; this supported the assessee's claim for the years in question.Res judicata not applicable in revenue assessments - change of method of accounting - Whether the earlier findings in respect of prior assessment years operated as res judicata to preclude reconsideration of the accounting method in the subsequent assessment years. - HELD THAT: - The Court noted that principles of res judicata do not apply to revenue matters in the manner urged by the Revenue; findings of fact in an earlier year are not binding in later assessments and may be re-agitated in light of new evidence. Here, the fact that the assessee maintained the changed method for two further years constituted new material which the Tribunal had overlooked; therefore the Tribunal was not justified in treating the matter as finally settled by prior orders.The Court held that res judicata did not bar fresh consideration of the accounting method for the assessment years before it; the subsequent conduct of the assessee was material and permitted re-examination.Final Conclusion: Both questions referred were answered in the negative and in favour of the assessee: the assessee was entitled to the changed regular method of accounting (cash basis for interest) for assessment years 1971-72 and 1972-73, the Revenue could not impugn bona fides where the new method was regularly followed, and the earlier findings did not operate as res judicata; no order as to costs. Issues Involved:1. Whether the assessee-company was entitled to change its method of accounting from the mercantile system to the cash system for interest income.2. Whether the interest accrued during the relevant years but not received was liable to be included in the assessment.Summary:Issue 1: Change of Accounting MethodThe primary issue was whether the assessee-company was entitled to change its method of accounting from the mercantile system to the cash system for interest income. The Tribunal had previously upheld the Revenue's decision rejecting the change, citing a lack of evidence that the change was intended to be regular. The Tribunal's decision was challenged, and the High Court had upheld the Tribunal's order on the ground that there was no material to show that the change was intended to be regular.Issue 2: Inclusion of Accrued InterestThe second issue was whether the interest accrued during the relevant years but not received was liable to be included in the assessment. The Tribunal had upheld the inclusion of accrued interest in the assessee's income, following its earlier decision for the assessment year 1969-70. The High Court noted that the Tribunal had not found any new facts or issues in the present appeals and had followed its earlier order.Legal Arguments and Precedents:The assessee argued that it was entitled to change its method of accounting for one part of its business, provided it substituted one regular system with another. The assessee cited several precedents, including *Sarupchand v. CIT* [1936] 4 ITR 420 (Bom), *Sundaram & Co. Ltd. v. CIT* [1959] 36 ITR 162 (Mad), and *Indo-Commercial Bank Ltd. v. CIT* [1962] 44 ITR 22 (Mad), to support its contention that the change in the method of accounting was bona fide and regularly employed.Revenue's Contention:The Revenue argued that the change in the method of accounting was not bona fide and was intended only for one debtor. The Revenue cited decisions such as *Ramkumar Kedarnath v. CIT* [1937] 5 ITR 261 (Bom) and *Forest Industries Travancore Ltd. v. CIT* [1964] 51 ITR 329 (Ker) to support its contention that the change was not bona fide and should not be accepted.Court's Analysis:The High Court observed that there was no material to show that the interest received from any debtor was accounted for on the mercantile basis in the relevant years. The Court also noted that the assessee had maintained the change in its method of accounting for two years since the assessment year 1969-70, which was not considered by the Tribunal. The Court held that the principles of res judicata were not applicable in revenue matters and that the findings of fact in an earlier year were not binding in subsequent years.Conclusion:The High Court concluded that the assessee had regularly employed the changed method of accounting and that the question of bona fides was not relevant once the change was regularly followed. The Court answered the questions referred to it in the negative and in favor of the assessee, holding that the assessee was entitled to change its method of accounting and that the interest accrued but not received was not liable to be included in the assessment. The judgment was delivered by both judges without separate opinions.