TaxTMI 
TaxTMI 
2012 (12) TMI 134
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....rendering services to the chit subscriber only at the end of the chit period and therefore completed contract method of accounting is the proper method of accounting? 2. Whether in law, in the light of Section 5 of the Income Tax Act 1961 and Section 2 of the Chit Funds Act 1982 commission cannot be taxed as income without meeting the cost of services to be provided till the end of the chit period and the cost of bad debts?" In so far as Tax Case Appeal Nos.616/2005, 628/2005, 627/2005, 624/2005, 625/2005, 617/2005, 213/2004, 618/2005, 626/2005, 620/2005, 622/2005, 623/2005, 621/2005, 619/2005, 425/2006, 2445 and 2449/2006 are concerned, they are relating to the assessment years 1988-89, 1988-89, 1989-90, 1989-90, 1990-91, 1990-91, 1991-92, 1991-92, 1992-93, 1992-93, 1993-94, 1993-94, 1994-95, 1994-95 and 1995-96, 1995-96 and 1999-2000 respectively. Apart from the above two questions of law, the assessee raised two other questions in the above Tax Case Appeals. Thus, the questions of law raised in these Tax Case Appeals are as under:- "1.Whether in law taxable income accrues in the case of chit company rendering services to the chit subscribers only at the end of the chit ....
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....stribution of the dividend income, which had already accrued to the assessee; hence, assessable without postponing the same to the end of the chit period and there was no question of postponing the accounting to the end of the chit period. The Commissioner of Income Tax (Appeals) further pointed out that even though the assessee claimed that it had to suffer bad debts on the different auctions when the subscribers defaulted in not meeting their commitments, yet, the assessee had not placed before the Commissioner, materials to show that the system of accounting it followed till 01.04.1986 showed impracticable results; in the circumstances, the change in the presentation of accounts based on completion of contract, did not facilitate the determination of correct profits of the assessee. Thus, the presentation of accounts did not help in the determination of correct profits of the assessee's business. This reasoning was followed in other appeals. Aggrieved by the same, the assessee went on appeal before the Income Tax Appellate Tribunal. 4. After referring to the various provisions of the Chit Funds Act, the Tribunal pointed out that the foreman is allowed a fixed percentag....
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....Bilahari Investment P.Ltd reported in (2008) 299 ITR 1 (SC), wherein, the Supreme Court had an occasion to consider the case of the subscriber to a chit and the distinction between the completed contract method of accounting and the proportionate system of accounting, income and realisation in chit transaction. Referring to the various obligations in the Chit Funds Act, particularly, dividend declaration, learned counsel pointed out that even in preparing the financial statement, the assessee is guided by the historical background; the transaction period of every chit runs over a number of months and hence, the nature of business cannot be lost sight of for the purpose of appreciating the claim of the assessee; that the income, in effect, has to be necessarily worked out only at the end of the transaction period when results are available on how much, in fact, would be the discount and the dividend accruing through the particular series. Hence, it is too impracticable for anyone to say with any degree of certainty, what could be the income for the purpose of apportioning during any particular period. In short, the submission of the learned counsel for the assessee is that the compl....
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....used as key element. Given the nature of responsibilities of the foreman under the Chit Funds Act, on a chit holder bidding the prize amount, he becomes a prized chit holder. Under Section 31 of the Act, the prized subscriber has to furnish security for the due payment of all future subscriptions. In the event of a default committed by this prized subscriber, it is no doubt true that the company suffers a loss. Yet, the assessee is always backed up by a good security. Thus, the uncertainty spoken to by the assessee is without any legal or factual basis. In case of non-prize chit holder, in the event of default, Section 28 of the Chit Funds Act, 1982 provides for the remedy as by way of removal of the non-prized subscriber or alternatively, a foreman may substitute any person in place of the defaulting subscriber as per Section 29 of the Chit Funds Act. Thus, in either case, there is no loss for the assessee to contend that uncertainty in respect of payment of instalments leads to indeterminate income for the assessee to follow the completed contract method. Thus, while Sections 28 and 29 of the Act provide for substitution, Section 31 of the Chit Funds Act provides for protectio....
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.... by the assessee is not completed contract method, even if the change in the system of accounting is to be accepted as bona fide. Pointing out to the decisions of the Supreme Court that there should be matching concept of income and expenditure, learned Standing Counsel pointed out that while the assessee has taken the commission and dividend to the end of the chit period, there are certain expenditure apart from the administrative expenditure which are claimed then and there and not deferred. Expenses incurred like advertisement costs, which are for the particular chit group, are also claimed as expenditure in the year in which it had incurred and not deferred. While there is accumulation of profit to the chit end period while calculating the real income, there exists distortion in identifying the income and as such, the system of accounting adopted by the assessee is not completed contract method. Learned Standing Counsel pointed out that if the assessee had taken the entire costs to the end, thereby postponing the entire costs as in the case of receipts, the Revenue might not have any objection, wherein, one may find matching principle on income and expenditure. Thus, taking the....
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....t method was erroneous. Learned counsel further pointed out that the said decision was a case of a subscriber where the assessee had accepted the view of the High Court as regards chit dividend that the completed contract method was not correct. The question before the Supreme Court in the appeal at the instance of the Revenue was as to whether the completed contract method of accounting adopted by the assessee for chit discount is required to be substituted by the percentage of completed contract method. Learned counsel pointed to paragraph 16 of the judgment, wherein the Apex Court pointed out that in the completed contract method, revenue is not recognised till the contract is complete. The profit and loss is established in the last accounting period and transferred to the profit and loss account. This determined the results on the completed contract method. The Apex Court pointed out that this method leads to the objective assessment of the results of the contract. 13. Given the fact that each chit series is a transaction by itself, with intervening activities in the conduct of the chit transaction, with the conduct of the auction of every month facing ups and down....
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....scriber in the amount of discount available under the chit agreement for rateable distribution among the subscribers at each instalment of the chit. " Section 12 of the Chit Funds Act speaks on the prohibition on chit company from carrying on any other business and if a company desires to carry on other business, it has to get the permission of the State Government. Section 14 of the Chit Funds Act provides for the utilisation of funds. In Chapter III, Sections 20 to 28 of the Act refer to the rights and duties of the foreman and Chapter IV (Sections 27 to 30) refers to the rights and duties of non-prized subscribers. Section 21 in Chapter III speaks about the rights of the foreman. Sub Section (1)(b) of Section 21 states that the foreman would be entitled as by way of commission, remuneration or for meeting the expenses of running the chit, a sum not exceeding five per cent of the chit amount. Section 25 deals with the liability of the foreman to the subscribers that every foreman shall be liable to account to the subscriber for the amounts due to them. Section 27 in Chapter IV speaks about the payment of the subscription by a non-prized subscriber and Section 28 deals with the re....
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.... which deals with accounting standards on Construction Contracts. It is fairly stated by the Revenue that even though this has no relevance to the case on hand, yet, the concepts stated for revenue recognition with reference to completed contract method and proportionate completion method offer the guidance and hence, need to be referred to. Accounting Standard AS-7 provides for Revenue recognition in case of construction contracts. Revenue recognition on the rendering of services is made either by proportionate completion method or completed service contract method, which reads as under:- " (i) Proportionate completion method Performance consists of the execution of more than one act. Revenue is recognised proportionately by reference to the performance of each act. The revenue recognised under this method would be determined on the basis of contract value, associated costs, number of acts or other suitable basis. For practical purposes, when services are provided by an indeterminate number of acts over a specific period of time, revenue is recognised on a straight line basis over the specific period unless there is evidence that some other method better represents the pattern ....
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....he contract activity in general and can be allocated to specific contract and (iii) costs that relate to the activities of the contractor generally, or that relate to the contract activity but cannot be related to specific contract. Accounting Standards also describe about selection of a method of accounting for a construction contract. 20. A reading of Accounting Standards 7 and Accounting Standards 9 shows that both speak in one voice at least as regards the proportionate completion method, completion contract method and both these methods aim at the methodology for arriving at the revenue recognition with a certain degree of certainty, taking into consideration, the significance of the services performed and to be performed in relation to the particular transaction. 21. In the decision reported in (2008) 299 ITR 1 (SC) (CIT Vs. Bilahari Investment P.Ltd.), cited supra, the Supreme Court considered the relevance of completed contract method, particularly with reference to chit transactions. The said decision was an appeal by the Revenue as against the decision of this Court reported in (2007) 288 ITR 39 (Mad) (Bilahari Investments P.Ltd. Vs. Commissioner of....
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....e assessee, that the assessee cannot contend uncertainty on the discount. This Court, however, held that it is not correct to hold that the discount should be spread over for the remaining period on a proportionate basis. This Court held against the assessee, holding that the dividend was assessable in the year of accrual itself; as regards discount/loss claimed by the assessee in the year of its accrual, this Court answered the same against the Revenue that the same was allowable in the year of accrual itself and cannot be postponed or allowed on a proportionate basis. The Revenue took on appeal before the Apex Court as regards the assessability of the discount in the year itself. 22. It is a matter of record that the assessee accepted the view of this Court as regards the assessability of the dividend income in the year of accrual itself and thereby rejection of the assessee's case of completed contract method in dividend aspect. 23. In considering the question as to whether discount was to be considered as in the case of dividend on accrual basis, the Apex Court considered the difference between the completed contract method and the proportionate contract met....
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....theless, the decision of the Apex Court is an authority for the proposition that the revenue recognition in any system or method of accounting followed must rest on the matching concept of income and expenditure. On a reading of this decision along with Accounting Standards 9, it is clear that in following any system of accounting, one has to have the correlation of income in relation to the extent of service performed, that the income earned must be an ascertainable one with reference to the services rendered and the services to be performed and its significance in relation to the transaction. 26. In the context of the decision of the Apex Court dealing with completed contract method and the proportionate completion method, the claim of the assessee, running the business in chit transaction, assumes significance. As noted already, every transaction on chit spreads over a fairly good number of months from twelve months and exceeding 12 months, with auction held for every month for every series. The multiple acts performed over the chit transaction period, thus relate to the transaction cycle of the chit scheme. As held by the Apex Court, in the chit transaction, which is ....
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....admanabha Chettiar and Sons Vs. Commissioner of Income Tax), relied on by the Revenue, does not, in any manner, advance its case. 29. Looked at from the angle of the subscriber, while there may be a certainty as to the dividend received every month for considering the same for assessment on accrual basis, as far as a company running the chit business is concerned, the dividend and the discount can properly be ascertained only at the completion of the transaction and not in the midway. Given the significant nature of the service yet to be performed in relation to the chit series, till the series come to an end, it is difficult to assess with any certainty, the amount that would be properly called as income for the purpose of assessment. "Discount" as defined under Section 2(g) of the Chit Funds Act, means the money set apart under the chit agreement to meet the expenses of running the chit or for distribution among the subscribers or for both. Dividend is the share of the subscriber in the amount of discount available for reasonable distribution among the subscribers at each instalment of the chit. Given the rights of the subscriber, when Section 21 provides for 5% chit am....