2011 (12) TMI 771 - AT - Income Tax

Tribunal rules in favor of Chartered Accountants firm in tax appeal

The Tribunal ruled in favor of the assessee, a firm of Chartered Accountants, in an appeal against the CIT(A)'s order for A.Y. 2007-08. The Tribunal ... - ISSUES PRESENTED AND CONSIDERED 1. Whether credit balances shown in the balance-sheet as 'Sundry creditors - staff' and 'Sundry creditors - others', arising from unpaid travel/conveyance and similar reimbursements, constitute taxable receipts under the cash system of accounting or are merely outstanding reimbursable expenses not assessable as income for the year. 2. Whether ad hoc disallowance (one-sixth) of specified expenses - telephone expenses, senior partner's car expenses, other car expenses, and depreciation on cars - is justified in the absence of specific evidence of personal use, and whether part or whole of such disallowances should be upheld or deleted. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Taxability of balance-sheet credit entries for unpaid staff/client reimbursements Legal framework: Under a cash system of accounting an assessee is generally assessable on receipts actually received in the relevant year; outstanding unpaid liabilities or unpaid reimbursable expenses reflected as credit balances in the balance-sheet do not ipso facto constitute cash receipts. Guidance notes of the professional accounting body and section 145 principles govern treatment of accounting methods and recognition of income. Precedent Treatment: Earlier decisions dealing with similar bookkeeping practices of professional firms (as relied upon by the assessee) treat unpaid reimbursable expenses recorded as creditors or staff accounts as balance-sheet items and not as taxable cash receipts where such method has been consistently followed and no diversion to income is demonstrated. The Tribunal expressly relied on such authorities in reaching its conclusion (precedents cited by parties were applied rather than distinguished or overruled). Interpretation and reasoning: The Tribunal examined the accounting entries and explanation showing (a) initial crediting of staff accounts when staff/partners submit bills, (b) creation of a recoverable traveling and conveyance expenses account, (c) subsequent crediting/receipt entries when clients reimburse, and (d) eventual payment to staff. The entries were longstanding, consistent with professional guidance, and demonstrably represent amounts payable to staff/partners for expenses incurred on behalf of clients but not yet reimbursed. There was no evidence that such credit balances represented cash receipts diverted to the balance-sheet to evade taxation. The Tribunal emphasized that balance-sheet entries of unpaid staff travel expenses cannot be equated to cash receipts under the cash system by mere ipse dixit of the assessing authority. Absent distinguishing facts or proof of diversion, a change to the assessee's consistent accounting treatment was unwarranted. Ratio vs. Obiter: Ratio - Where an assessee following a cash system consistently records unpaid reimbursable expenses as creditor or staff accounts and provides credible documentary trail showing they are recoverable from clients, such balance-sheet credit entries do not constitute taxable receipts in the year under review. Obiter - Observations on the inapplicability of hypothetical accounting changes or speculative assumptions about taxpayer intent are ancillary explanatory remarks supporting the ratio. Conclusion: The additions made by the assessing officer treating the cited creditor balances as income were deleted; the Tribunal allowed the ground challenging their inclusion in income. Issue 2 - Validity of ad hoc disallowance (1/6th) of telephone, car expenses and related depreciation Legal framework: Deductibility of business expenses is governed by the statutory scheme permitting deduction of expenses incurred wholly and exclusively for business. Where expenses potentially include elements of private use, disallowance must be based on evidence or reasonable allocation; ad hoc disallowance without factual basis is not warranted. Where the assessee itself concedes and offers a portion for taxation, further disallowance requires specific justification. Precedent Treatment: Authorities emphasize assessment based on material and specific evidence of personal expenditure; blanket percentage disallowances without documentary foundation are not sustainable. The Tribunal applied these principles to the facts and the authorities below were not followed to the extent they sustained ad hoc disallowance without supporting material. Interpretation and reasoning: The Tribunal noted (a) the assessee had already disallowed 25% of senior partner car expenses and offered that portion to tax, (b) the firm is a busy professional practice where partners and staff predominantly use telephones and cars for business purposes, and (c) vouchers and records substantiated staff car expenses and telephone bills to the extent practicable in a professional firm context. No instance or evidence was produced by revenue to show private use by partners or staff for the impugned items. Given absence of specific proof, the assessing officer's assumption of private use and consequent ad hoc 1/6th disallowance were deemed unjustified. The Tribunal also held that depreciation relating to cars should not be disallowed when the underlying car expenses were held to be business-related and unsupported evidence of personal use was absent. Ratio vs. Obiter: Ratio - Ad hoc percentage disallowance of expenses (telephone, car expenses, depreciation) cannot be sustained in the absence of specific evidence of private use; where the assessee provides vouchers, follows a consistent accounting method, and has already conceded a portion, further disallowance is not permissible. Obiter - Remarks on practical limitations of maintaining granular telephone usage records in professional firms are explanatory and not essential to the ratio. Conclusion: The Tribunal deleted the ad hoc disallowance of 1/6th in respect of telephone expenses, senior partner's car expenses, other car expenses and related depreciation; the ground challenging these disallowances was allowed.