TaxTMI 
TaxTMI 
TaxTMI 
1990 (1) TMI 110
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....year of account ending on 31st March, 1985, being the previous year relevant to the asst. yr 1985-86 now before us. Earlier, it was adopting mercantile system of accounting for all purposes. This naturally meant that the income receivable under the heads 'advertisement', 'circulation', 'printing' and 'processing' was taken into account on accrual basis. However, given the nature of its business, there was quite some delay in realising the money due to it. At times the dues were not realised at all with the result if the moneys receivable under the said heads were to be fully accounted for on accrual basis; cash realisations being less that the accruals, it would not be in a position to fulfil the statutory requirement of applying its income to charitable objectives. It was, therefore, that the Board of Trustees on 30th April, 1984, resolved "to keep accounts on the basis of actual realisation of cash in respect of its sales and in respect of its expenditure on actual payment made and to be made and publish the accounts accordingly which will represent the real worth and this method will be regularly followed henceforward, from 1st April, 1984". 5. The details of (i) the amounts d....
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....imed by the appellant were not fully matched with the income arising therefrom". (ii) The ITO was, therefore, justified in considering that the assessee's true profits and gains could not be deduced from the method of accounting followed by the assessee. In this connection, the CIT(A) referred to and relied upon the following reported cases: (a) CIT vs. Sarangpur Cotton Manufacturing Co. (1983) 6 ITR 36 (PC) (b) CIT vs. Krishnaswamy Mudaliar (1964) 53 ITR 122 (SC). (iii) As has been pointed out by the learned author, Ramaiyya, in his commentary on companies Act, "cash system of accounting does not disclose a true and fair view of the state of affairs of the company or its profit or loss for a period". This is true not only of companies but of other assessees also. (iv) In any event, the appellant could not be said to have followed cash system of accounting in respect of its receipts. "What it did was at the first instance it recorded all sales under the heads advertising, circulation, printing, etc., Subsequently, the accounts were adjusted by actual realisation of the sale proceeds leaving the balance as receivable. Thus, while accounting for the actual realisation as re....
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....he facts of the case and vehemently contended that the lower authorities were not justified in rejecting the assessee's claim. He drew our attention to the fact that the assessee is public charitable trust which had been registered under s. 12A of the IT Act, 1961, as far back as on 9th Jan., 1979. For the purpose of exemption under s. 11 of the Act, the focus is on the income actually applied to charitable or religious purposes, including the income which is accumulated or set apart for application to such purposes in India, provided that the income so accumulated or set apart is not in excess of 25 per cent of the income in question. It should, therefore, follow that what is to be ascertained is expendable income, that is to say, the income that is actually and physically available for being expended on charitable, etc., purposes must be determined first. Ex hypothesi, therefore, notional income, or income that had accrued but had not been realised will have to be excluded. It would be unfair to expect a public charitable trust to apply to charitable purposes income that had not physically come into its hands. 12. It was keeping in view the foregoing consideration that the Boar....
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....ed on 2nd April, 1985 and spent thereafter, and that, therefore, the learned CIT(A) was not justified in reading too much into the fact that the balance sheet showed cash in hand of Rs. 6,20,000. 19. In view of the foregoing, therefore, contended Shri Panda, the assessee is entitled to succeed. 20. On his part, Shri S. Kanungo, the learned Departmental Representative, strongly supported the impugned orders of the lower authorities. Relying on the Calcutta High Court decision in the case of Snow White Food Products Co. Ltd vs. CIT (1983) 141 ITR 847 (Cal), he vehemently contended that, in the case before us, the method of accounting followed by the assessee did not enable the ITO to deduce the true profit and gains of the assessee's business and that, therefore, proviso to s. 145(1) was applicable to this case, 21. Secondly, the provisions of s. 11(4) of the Act squarely applied to this case and, therefore, the profits and gains of business run by the assessee fell to be determined in accordance with the provisions of the Act. And this is what the ITO had done and no exception could possibly be taken to it. 22. Thirdly, the provisions of Expln, (2) to s. 11(1) of the Act wer....
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....und to accept the book results. On his part the CIT(A) examined the matter from two angles. He first proceeded on the premise that there had been a change of method of accounting and held that the revised system of accounting adopted by the assessee did not enable the ITO to deduce the true profits and gains of the assessee 's business. Secondly, the CIT(A) called in question the assessee's claim that it had switched over to hybrid system of accounting. This is what the CIT(A) has to say in paragraph 6 of his order: "6. Secondly, on the facts of the case I find it difficult to accept that the appellant actually followed cash system of accounting in respect of its receipts. What it did was at the first instance it recorded all sales under the heads advertising, circulation, printing, etc. Subsequently, the accounts were adjusted by actual realisation of the sale proceeds leaving the balance as receivable. Thus, while accounting for the actual realisation as receipts, the appellant did not take into account the amounts receivable either in the profit and loss account or in the balance sheet. In the primary records, however, all the sales were recorded so that the ITO could cull out....
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.....f. 1st April, 1984, will come into play. The sub-section provides that the provisions of sub-s. (1) of that section relating to exemption of income derived from property held under trust for charitable or religious purposes; or of sub-s. (2) thereof relating to accumulation or setting apart of such income for application to such purposes; or the connected provisions of sub-ss. (3) and (3A) of the said section will not apply in relation to profits and gains of business. This provision will apply irrespective of whether the profits and gains are derived from a business carried on by the trust or institution or from a business undertaking which is held in trust for such purposes. An exception has, however, been made in relation to profits and gains of business in the following cases: (a) where the business is carried on by a trust wholly for public religious purposes and the business consists of printing and publication of books or the business is of a kind notified by the Central Government in this behalf in the official Gazette; (b) the business is carried on by an institution wholly for charitable purposes and the work in connection with the business is mainly carried on by th....
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....l basis. The major, stated or ostensible reason for the switch over to the new system of accounting, is: "The Prajatantra Prachar Samity has been taking credit for all bills raised in respect of advertisements and circulations of which a substantial portion remains uncollected, and, in fact, are not collected at all. By taking credit for all such bills, there are in reality unearned credits which enter into unrealised profit, creating problem for compulsory application of profit, which, in fact, is not realised." The reasons adduced by the assessee in support of its opting for the cash system of accounting of the receipts under the four heads may be syllogistically stated as follows: (i) The adoption of the mercantile system of accounting in respect of receipts would mean that credit would have to be taken on accrual basis for all the bills due. (ii) in that event, the amount to be applied to charitable purposes would have to be calculated on the basis of the income computed on accrual basis. (iii) Actual cash realisations in a year is, however, but a part of the total bills due. (iv) This naturally means that the physical funds actually available for application to cha....
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....ness income in accordance with the provisions of the IT Act relating to the assessment, and that, consequently, the ITO was justified in applying the provisions of s. 145 which is one of the sections relating to the assessment under the Act. As we see it, s. 11 (A) had a role to play prior to the insertion of s. 11(4A) by the Finance Act, 1983, w.e.f. 1st April, 1984. With the insertion of s. 11(4A), however, s. 11(4) lost its role and rationale and it is no longer necessary to rely on that section for holding that the profits and gains from the assessee's publication business must be determined in accordance with the provisions of the Act relating to assessment. The reason is simple and that is that, once the profits and gains of the assessee's business of publication is denied the benefit of exemption under s. 11(1), 1(2) r/w ss. 11(3) and 11(3A), the computation of the profits and gains of the said business will necessarily have to be made in accordance with the provisions of the Act relating to assessment. 37. One other argument that was advanced by the learned Departmental Representative was that Expln. (2) to s. 11(1) applied to this case. With the insertion of s. 11(4A) it....
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....e surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts". The above definition was amplified by the Lord President in Whimster & Co. vs. IRC 12 TC 813 thus: "In computing the balance of profits and gains for the purposes of income-tax, or for the purposes of excess profits duty, two general and fundamental common places have always to be kept in mind in the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profits and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the IT Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of merchant'....
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....and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed". It will be Ex facie clear from the said lucid definition that the matching principle has its full pay in the mercantile system of accounting. Iqbal Ahmed, CJ, went on to define the cash system of accounting in the following words: "The 'mercantile accountancy system' is the opposite of the 'cash system of book keeping' under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed." It will be Ex facie clear from the said definition that the matching principle plays a role in the cash system of accounting also, even though both the expenditure and the receipts are booked on cash basis and not on accrual basis. As for the hybrid system of accounting, as pointed out by the Hon'ble CJ., "in actual business practice, however, the system of book keeping followed in many cases are such that they can be called neither the full "mercantile accountancy system" nor the cash basis of book keeping. They are simply mixtures of the two systems and styled as "hybrid systems of boo....
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....ight of in this regard, and that is that the method of accounting should invariably reflect the true profits of the business, present a true and fair picture of the financial position of the business. While deciding to adopt the hybrid system of accounting, that is to say, while deciding to depart or deviate from the mercantile system of accounting, the basic question that should be asked and answered is whether, having regard to the paramount need to arrive at the true profits of the business and to present a true and fair view of the financial position of the business, the departure is absolutely necessary and, if so, to what extent, consistent, of course, with such factors as the availability of full and correct information, convenience, etc. We may now turn to s. 145 of the IT Act, 1961. The section enacts that income chargeable to tax under the head "Profits and gains of business or profession" or under the head "Income from other sources" must be computed in accordance with the method of accounting regularly employed by the assessee. Proviso to s. 145(1) gives the power to the ITO to compute the assessee's income on such basis and in such manner as the ITO may determine, in c....
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....l Revenue vs. Anaconda American Brass Ltd. (1956) 30 ITR 84 (PC) (LIFO method) (iii) CIT vs. Mc. Millan & Co. (1958) 33 ITR 182 (SC) (Fixed percentage method) 55. Fifthly, the assessee is prohibited from adopting regularly one method of accounting for his own purposes, and yet another method of accounting for income-tax purposes. 56. The learning case on this issue is CIT vs. Sarangpur Cotton Manufacturing Co. Ltd. (1938) 6 ITR 36 (PC). In that case, the assessee employed a regular method of accounting but had also for some years past adopted regularly a method of valuation of stock by taking some price under both cost and market price with the object of creating a 'secret' reserve, which involved the retention of profits as not to be included in the profits shown to the shareholders. For the account year 1930 the assessee submitted their profit and loss account showing a profit of Rs. 2,64,086 and a return of the total income of the company showing an income of Rs. 1,99,086 which was arrived at by taking into account the result of under valuation of stock which the company had adopted in the previous years. The ITO, without considering whether the true income could be ar....
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....ve allowed the debt; if he had not been satisfied and has charged income-tax on the debt, and such debt was ultimately never received, I think the assessee would have been entitled to claim a refund under s. 48A. Here undoubtedly the assessee was trying to alter the basis of accounting from the mercantile basis to a cash basis for this particular half year, and in my view no case is established which justified him in doing that." 58. The same line was taken in the following cases: (i) CIT vs. Shrimati Singari Bai (1945) 13 ITR 224 (All), (ii) Shiv vs. Prasad Ram Sahai vs. CIT (1966) 61 ITR 124 (All), (iii) CIT vs. Confinance Ltd. (1973) 89 ITR 292 (Bom), (iv) Balraj Virmani vs. CIT (1974) 97 ITR 69 (All). 59. In the following cases, the assessee even while following the mercantile system of accounting transferred interest receipts not to the profit and loss account, but to a suspense account. The Courts refused to recognize the practice: (i) The B.C.G.A. (Punjab) Ltd. vs. CIT (1937) 5 ITR 279 (Lah) (ii) State Bank of Travancore vs. CIT (1977) 110 ITR 336 (Ker), (iii) James Finlay & Co. vs. CIT (1981) 22 CTR (Cal) 289 : 137 ITR 698 (Cal), (iv) CIT vs. Bihar State....
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.... of the ITO before changing the method of accounting. On the contrary, the Calcutta High Court, in the later case of Snow White Food Products Co. Ltd. took the view that a change in the method of accounting need not have the approval of the IT Authorities. We have said that the conflict was apparent and not real, because the Courts were not examining the assessee's right to change the method of accounting in the abstract. They were considering the issue in the context of the provisions of s. 13 of the old Act/s. 145 of the new Act which aim at the computation of the true profits of the assessee. As we see it, the view that the assessee cannot unilaterally change the method of accounting starts from the premise that under s. 145, the ITO is duty bound to ensure that the true profits and gains are deduced from the system of accounting adopted by the assessee. From this premise it proceeds to conclude that the ITO's approval is necessary. The prior approval of the ITO will essentially be in the nature of an advance ruling on the issue whether the change in the system of accounting enables the ITO to deduce the true profits and gains of the assessee's business. 63. The apparently con....
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....ing or postponing the assessee's tax liability. If, on the contrary, the change over is not Bona fide the ITO can refuse to recognise the change on that ground alone. It bears a repetition that the object is to deduce from the system of accounting followed by the assessee the true profits and gains of the assessee's business or profession. 67. We may now notice a few cases where the hybrid system of accounting has been recognized. In the case of S.R.V.G. Press Co., Kurnool vs. CEPT (1956) 30 ITR 583 (AP) the question arose whether the assessee could account for sales-tax payments on cash basis. The question arose in the context of s. 21 of the Excess Profits Tax Act. Resolving the issue in favour of the assessee, the Court observed: "Sec. 21 of the Excess Profits Tax Act enacts that s. 13 of the IT Act shall apply to assessments under the Excess Profits Tax Act as s. 13 had been incorporated therein. Under s. 13 of the IT Act, the assessee is free to choose a proper method of accounting and the profits and gains have to be computed in accordance with the method of accounting regularly employed by the assessee. The assessing authority is bound by the assessee's choice of a metho....
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.... account of that year the rebates or refunds granted on 18th April, 1946, and entered in the assessee's books under that date." 68. In the Madras case of CIT vs. E.A.E.I. Sundararaj (1975) 99 ITR 226 (Mad), the issue related to the sales-tax account maintained by the assessee. The issue was resolved on the footing that the assessee was maintaining a separate sales-tax account on cash basis. The following observations of the Court are noteworthy: "In this case so far as the separate accounts maintained by the assessee are concerned, they have been kept only on cash basis, that is, the sales-tax collections made had been credited and the actual sales-tax payments have been debited on the respective dates of collection and payment. Neither the sales-tax collections nor the payments made by the assessee which have been recorded in the separate accounts have gone into the general accounts maintained by the assessee for his business, as the assessee has always been contending that he had been making collections as an agent of the Government and even the excess collections will have ultimately to be paid to the Government. In these separate accounts as and when the amounts have been p....
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....e incurred in earlier years, because for the purposes of calculation of income-tax they could be considered to be expenses incurred in the accounting year on the basis of the regularly employed method of the assessee's accounting on the basis of which income, profits and gains were required to be computed under s. 13 of the IT Act." This is what the Court observed in this regard: "When we come to s. 13 of the IT Act we find that income, profits and gains have to be computed for the purposes of s. 10(1) in accordance with the method of accounting regularly employed by the assessee. There is a proviso to that section which says that if the method employed is such that in the opinion of the ITO the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the ITO may determine. It seems, therefore, to follow that if profits are to be computed in accordance with the method of accounting regularly employed by the assessee, then it is to the method of accounting that one must look. And if the method of accounting regularly employed is a method whereby litigation expenditure is, so to say, kept in a suspens....
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.... is not open to the Revenue to go back on its stand taken in the earlier years and call upon the assessee either to adopt cash system or mercantile system of accounting." 72. The merits of the case may now be examined in the light of the foregoing principles. 73. To recapitulate, the following two issues were formulated for consideration in this case: (a) Was there a change in the method of accounting regularly followed by the assessee? If so, can the change be regarded as valid in the eyes of law? (b) If this a case where, there being no change in the method of accounting regularly followed by the assessee, certain receipts were treated differently or separately from the system of accounting regularly followed by the assessee, can the treatment be said to be valid in the eyes of law? 74. The second question may be answered first. This issue can be approached from two angles. First, as has been held by the Privy Council in the case of Sarangpur Cotton Manufacturing Co. Ltd., the assessee cannot adopt one method of accounting for his own purposes and totally different method for IT purposes. 75. Secondly, as has been held by the Calcutta High Court in the case of Reform ....
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.... charitable objects. We have already seen how, with the introduction of s. 11(1A), compulsory application of funds to charitable objects is no longer germane to the issue. That leaves for consideration the assessee's claim that it experienced difficulties in collecting the dues. 80. The assessee has been in the publication line for quite some time now. And all along it had maintained its books of account on mercantile basis. By necessary implication, therefore, it did not face any collection problem in those years. When did the problem surface? What was its extent, its magnitude, both in absolute and relative terms? When the problem was in its nascent stage, what corrective steps (form the point of view of commerce and not accounting) did the assessee take? The assessee has nothing to say on these questions. 81. If the problem was as serious as the assessee makes it out to be, then one would have though that the assessee would have collected sufficient material to prove its case. This the assessee should have done suo motu, because it is assessee's case that the collection problem forced it to resort to the cash method of accounting. For example, it could have shown what was th....