TaxTMI 
TaxTMI 
1995 (10) TMI 79
X X X X Extracts X X X X
X X X X Extracts X X X X
....It commenced its business in October, 1984 and closed the accounts on 31-5-1985. The appellant adopted a peculiar method of accounting. It adopted the "mercantile system" of accounting for purchases and other expenses and 'cash system' for sales. It is a hybrid system whereunder the sales for which consideration was realised were shown as receipts while the credit sales were shown in the "suspense account". When the invoice is raised and goods are despatched to customers, the customer's account is debited, crediting the sales to suspense account. When the money is realised from the customers, the entry is reversed by crediting the sales account. At the end of the previous year when books are closed, the sales account is credited with the sales which were realised. The balance sales which were not realised by the end of the previous year, are kept in the sales suspense account. As and when they are realised during the subsequent year or years, they are credited to sales account in that year. The manufacturer M/s. Quinn India Ltd. allows 90 days' credit to the appellant. For payments beyond 90 days, it collects 18 per cent interest. The appellant also allows 90 days' credit to its cu....
X X X X Extracts X X X X
X X X X Extracts X X X X
....duce correct profits of the year and that the method adopted by the appellant is such whereunder tax can be evaded or at least payment of tax can be delayed or postponed indefinitely. He came to the conclusion that the appellant's method of accounting, if accepted, the appellant would never pay tax. In that connection the Assessing Officer referred to the loss returns filed by the assessee for the following assessment years : Assessment year 1986-87 Rs. 33,82,824 Assessment year 1987-88 Rs. 11,55,391 Assessment year 1988-89 Rs. 15,66,236 The Assessing Officer observed that in this line of business, the net profit normally varies between 2 pet cent to 10 per cent in general, that the unrealised sales at the end of each accounting year would be definitely more than 10 per cent, considering the fact that the assessee-firm allows 90 days' credit, that in that view of the matter, the net profit would always be less than the sale proceeds realisable (Sundry Debtors) and that by adopting this method, the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....p; 33,90,813(-) Add: Sales credited to Suspense Account. 34,29,793 --------- Rs.  ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bsp; ------------ Rs. 1,95,544 &n....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e assessment should not be enhanced. In reply to the said notice, the appellant contended before the First Appellate Authority that the Assessing Officer had no right to unilaterally change the method of accounting at all and that the Assessing Officer should have determined the income in accordance with the method of accounting regularly employed by the appellant. Further, the appellant contended before the First Appellate Authority that its customers are petty traders, doing business in Tamil Nadu, that the appellant was apprehensive whether the sales could be realised or not, that at the same time, the appellant had to push up the sales by giving credit facility etc. to customers who are small traders, for surviving in this highly competitive business and that the appellant out of business expediency thought it fit to adopt the hybrid system of accounting regarding its business transactions wherein sales and income are accounted for only when they are realised and the purchases and other expenditure are accounted for on accrual basis. It was, further, contended before the First Appellate Authority that this hybrid method of accounting adopted by the appellant in the first year h....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ment year 1986-87. Further, he upheld the disallowance of 50 per cent of travelling expenses incurred by Smt. K. Vijayalakshmi, Manager of the appellant-firm and also upheld part disallowance of commission payments made to two firms and further confirmed the disallowance of 20 per cent of the carriage outwards. Aggrieved by it, the assessee came up with this second appeal before the Tribunal. 8. On the issue pertaining the method of accounting adopted by the appellant and rejected by the Authorities below, the contentions of Sri R. Ganesan, the learned Authorised Representative of the appellant are broadly as follows : " (1) Section 145(1) of the Income-tax Act mandates that the income from profits and gains of business or profession should be computed in accordance with the method of accounting regularly employed by the assessee in its business. (2) It is the choice of the assessee to adopt his own method of accounting that best suits the requirements of his business. (3) Even though it is the first year of the business, the method of accounting adopted by the assessee in the very first previous year also can be considered to be a method regularly employed by it, since the ass....
X X X X Extracts X X X X
X X X X Extracts X X X X
....its, that the method is so devised to postpone tax liability indefinitely and, therefore, it cannot be encouraged much less accepted, that it is only a device to avoid tax liability, that from a system of accounting wherein, for one and the same source mercantile system is followed for purchases, and cash system is followed for sales, true profits of the year can never be properly deduced and that the Assessing Officer, very rightly, rejected the said method and determined the total income in accordance with the proviso to section 145(1) of the Income-tax Act. He also contended that it is not a case of the Assessing Officer arbitrarily changing the method of accounting regularly employed by the assessee and imposing his own method of accounting on the assessee, but it is only a case where the Assessing Officer determined the correct income in the best possible manner by taking the suspense sales account as real or realised sales. Further, he submitted that the various disallowances made by the Assessing Officer and upheld by the First Appellate Authority are fully justified. 11. In reply, the learned Authorised Representative of the appellant contended that the method adopted by t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....roadly speaking two principal methods accounting are prevalent in the country. One is the cash system and the other one is the mercantile system. In cash system entries are passed when money or monies' worth is actually received, collected or disbursed. In the mercantile system entries are made in the books on the date of the transaction i.e., on the date on which the right accrued or liability incurred irrespective of the date of receipt or payment. In addition to the aforementioned principal systems of accounting current in the country, some more systems viz., hybrid method, plural or heterogeneous method, dual method, etc. also are in vogue. In these systems, certain elements and incidences of cash and mercantile systems are combined or exist side by side. 13. As has been laid down by the Supreme Court, in the case of Investment Ltd. v. CIT [1970] 77 ITR 533, a tax payer is free to employ for the purpose of his trade any method of keeping accounts and a method or accounting adopted by the trader consistently and regularly, cannot be discarded by the Departmental Authorities on the mere ground that he should have adopted a different method of accounting. However, the Supreme Cou....
X X X X Extracts X X X X
X X X X Extracts X X X X
....f from the method of accounting adopted by the assessee, profits cannot properly be deduced, it is the duty of the Assessing Officer to reject it and determine the income on a proper basis, though the method adopted is a recognised one and has been regularly employed by the assessee. It has been authoritatively pronounced by the Apex Court in the case of CIT v. British Paints India Ltd. [1991] 188 ITR 44, that the Assessing Officer is not bound to accept the system of accounting regularly employed by the assessee when he is satisfied that correct income cannot be deduced therefrom. Even if the method is a perfectly legal and valid one, still if it is not possible to deduce profits properly from the said method, it is the duty of the Assessing Officer to reject the same and determine the taxable income by making such computation as he thinks fit. Section 145(1) proviso confers sufficient powers on the Assessing Officer to make such computation in such a manner as he determines, for deducing the correct profits and gains. What is the profit of a trade or business is a question of fact and it has to be ascertained with reference to the relevant evidence available in each case. 15. Ke....
X X X X Extracts X X X X
X X X X Extracts X X X X
....on the ground that the assessee had been regularly following a particular method in respect of this lease income and the Department having accepted the same in all these years, cannot now change the said method. On the appeal filed by the revenue, the Tribunal upheld the order of the first appellate authority rejecting the Revenue's contention that the assessee cannot be permitted to adopt accrual basis for expenses and cash basis for receipts. In that case there was no finding recorded by the Assessing Officer that it is not possible to deduce true profits properly from the method adopted by the assessee therein. Added to it, the said method adopted by the assessee was accepted continuously for several earlier assessment years. In the case on hand, the Assessing Officer by quoting facts and figures in his assessment order has demonstrated as to how it is not possible to deduce true profits from the method of accounting adopted by the assessee viz., mercantile system for purchases and other expenses and cash system for sales. Assessee had been giving 90 days' credit to its customers. Naturally, there would be substantial unrealised sales at the end of the accounting year. They were....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d for rejecting the method itself. According to him, in the long run, this phenomenon would be offset if the system is followed over a period of years, and, therefore, the method itself cannot be rejected. He placed reliance on Indo Commercial Bank Ltd.'s case. It is not for mere postponement of tax liability, the method was rejected. It was rejected on the ground that it is not possible to deduce true profits from this method. Even, otherwise, a method in which postponement of tax liability for a long period is inherent or inbuilt, cannot be said to be a method from which profits can properly be deduced. Reliance on Indo Commercial Bank Ltd.'s case has no relevance. 20. The contention of the appellant that the action of the Income-tax Officer in rejecting the appellant's method and bringing to tax, the sale suspense account would amount to unilaterally changing the method of accounting regularly employed by the assessee, has no substance. As has been held by the Madras High Court in the case of Sundaram & Co. Ltd., when the system failed to disclose the assessee's true income, it is open to the Department to ignore the results of that system to deduce the true income of the asses....