TaxTMI 
TaxTMI 
TaxTMI 
1996 (8) TMI 140
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.... towards housing finance besides also utilising them in the field of equipment leasing and consultancy. Over a period of years, the emphasis of the business shifted to housing finance. From what was only 24.16 per cent of the total loans in the year 1980, housing loans jumped to 68.90% in the year 1985. For the years under appeal also there was a further jump in the composition of the housing loan vis-a-vis the total loans given by the assessee. 3. The huge jump in housing advances also brought within its wake of problems for the assessee. The problem was recovery of the interest on such loans which slowed down substantially mainly because the interest was paid by the borrower only on the completion of their housing projects. In recognition of this reality, the assessee-company began entering into agreements for housing loans under which the interest itself would be due for payment only on completion of the house building projects. 4. Up to and including the accounting year ended 31-12-1985, the assessee was following the mercantile system of accounting in respect of all its transactions. The previous year for the assessment year 1987-88 was a period of fifteen months from 1-1-19....
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....t Loss the end of each a/c. year ------------------------------------------------------- 1981 52,08,497 5,29,501 1.1% 1982 52,05,038 12,95,929 23.9% 1983 61,51,714 23,85,839 38.7% 1984 57,18,089 40,28,510 70.4% 1985 49,72,219 54,93,3....
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....income the profit for the period has been shown less by Rs. 44,90,438. " Subject to the above, the auditors certified that the accounts for the year ended 31-3-1987 gave a true and fair view of the profit for the said period. 5. The directors' report on the accounts for the period ended 31-3-1987 also referred to the change in the method of accounting in the following words : "During the period under review the accounting policy of the Company with regard to interest income on loan has been changed from accrual to realisation basis with a view to make a realistic and appropriate presentation of the financial statements. It has been the experience of your Directors that in case of term loan for Industrial Finance or Housing Finance, which is the main business of your Company, realisation of the interest on loans are being consistently slowed down accumulating the accrued interest from year to year adversely affecting Company's liquidity. The situation has further been aggravated by the depressive economic condition and industrial decline in the Eastern Sector of the country. To ensure check on further erosion of Company's liquidity, your Directors had to change the accounting met....
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.... regular method ; and (v) That where the assessee followed a particular system of accounting, it cannot effect a change in the method in respect of a particular item of income, i.e., interest income of loans only in this case. " 8. In the assessment order for the assessment year 1988-89 for the same reasons the interest income was computed on accrual basis. The action of the ITO gave rise to the additions which are contested in the present appeals. 9. The CIT(A) disposed of the matter in the following words : " In the case of the appellant it is a fact that the appellant has followed the changed system of accounting year after year. The plea of the appellant that it has got the right to change the system of accounting of the one of the sources of income is acceptable. But, it is to be kept in mind that interest income is a source of income which has to be worked out on certain basis. Even if it is acceptable that the appellant can have its interest a/c. on cash basis and a/cs. for expenses such as stationery, salary, rent, telephone expenses, motor car expenses, etc., on mercantile basis. But in the interest a/c. itself, by the nature of the business of the appellant, there a....
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....nt for the interest expenditure on mercantile basis. According to him, the view taken by the CIT (Appeals) on this aspect of the matter was against the ratio laid down in the aforesaid decisions. 11. The Ld. D. R. strongly relied on the orders of the departmental authorities and also pointed out that the facts in the decisions relied on behalf of the assessee were distinguishable inasmuch as in all those cases the change was in respect of a single source whereas in the present case the change was only in respect of the income aspect of the source without corresponding change in the expenditure aspect thereof. In his submission, such partial change cannot be permitted. He, therefore, contended that the interest income was rightly computed on accrual basis. 12. We have carefully considered the rival contentions. The change adopted by the assessee was in respect of only the interest income and so far as the interest expenditure was concerned, the assessee continued to adopt the mercantile method of accounting. This is common ground. It is also common ground and in fact, it has been accepted by the CIT (Appeals), that the assessee has regularly followed the changed method of accounti....
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....tiyar Firm [1935] 3 ITR 193, the method of accounting followed by the Nattukotta Chettiars, a trading community in South India, under which accounts were kept in the mercantile basis in respect of transactions with Nattukotta Chettiar community but on cash basis in respect of transactions with outsiders. The Andhra Pradesh decision cited supra also affords an instance, wherein the assessee which maintained its books on the mercantile basis adopted the cash basis of accounting only in respect of the sales-tax. This decision has been approvingly cited by the Calcutta High Court in the case of Reform Flour Mills (P.) Ltd.'s case at page 191. In the case of CIT v. E. A. E. T. Sundararaj [1975] 99 ITR 226, the Madras High Court was also faced with the similar situation where the assessee which was maintaining the books generally on mercantile basis adopted the cash basis in respect of the sales-tax collections and payments. The method was approved and the following observations at page 231 are relevant : " An assessee may employ one method of accounting for one part of his business or one class of customers, and a different method for another part of his business or one class of custom....
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....the law appears to be settled that an assessee is entitled to change his regular method of accounting by another regular method and such a change can be effected in respect of a part of the assessee's income. There is nothing on record to show that in the two assessment years involved, interest received from any debtor was accounted for by the assessee on the mercantile basis. We are, therefore, unable to accept the contention of the revenue that the change in the method of accounting was being followed in respect of only one item in the assessee's account. " The High Court further proceeded to lay down the conditions on the satisfaction of which alone any change in the method of accounting can be accepted. The first condition was that the change should have been made bona fide. On this aspect, it was held that section 145 in terms does not require any enquiry into the bona fides of the assessee in following a regular method of accounting and that the bona fides of the change would be established if the assessee establishes that the new method of accounting has been followed regularly by it in the subsequent years. The second condition was that the assessee should lead evidence t....
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....casual departure or on a temporary basis. The real objection of the income-tax authorities in the present case, when they say that the assessee cannot be permitted to follow the cash system in respect of the interest income while allowing the assessee to continue to follow the mercantile system in respect of interest expenditure, is that there would be loss of revenue and thereby prejudice would be caused to the income-tax department. A perusal of the decided case on this point shows that the fact that there would be loss of revenue cannot be a valid objection to the changed system of accounting being accepted. In the case of Indo-Commercial Bank Ltd. v. CIT [1962] 44 ITR 22, the Madras High Court held that the detriment to the revenue was not a relevant factor in deciding whether the change in the method of valuation of stock, which is part of the method of accounting, can be accepted or not. This decision was followed by the Kerala High Court in the case of Forest Industries Travancore Ltd. v. CIT [1964] 51 ITR 329. In the case of West Coast Paper Mills Ltd., where the assessee changed its method of accounting for bonus from cash system to mercantile system on the basis of the re....
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....bona fide of the reasons has not been disputed by the income-tax authorities. Further the interest liability of the assessee consisted of the following : " 1-4-1987 1-1-1986 to to 31-3-1988 31-3-1987 (Assmt. Yr. 1988-89) (Assmt. Yr. 1987-88) On Bank Borrowings 2,01,946 3,89,073 On Debentures 12,22,884 15,28,606 On Deposits (Fixed period) 19,145 38,996 -------------------- ------------------- 14,43,975 19,56,675 " -------------------- ------------------- These figures have been taken from Schedule 10 to the printed accounts for the assessment year 1988-89. As the break-up would show the interest liability cannot be wished away or refused to be taken into consideration by the assessee in ascertaining the true profits. It is, therefore, not possible to adopt the cash system of accounting even in respect of the interest liability. That would show an unrealistic picture of the financial position of the assessee-company. On the contrary, not taking into account the interest accrued, but taking into account only the interest actually realised would not reflect a distorted picture of the financial position ; rather that would show a realistic position. The details given by the ....