Income Tax Appellate Tribunal - Mumbai
Credit Rating Information Services Of ... vs Deputy Commissioner Of Income Tax on 3 May, 2001
Equivalent citations: [2003]84ITD247(MUM), (2003)79TTJ(MUM)219
ORDER
Pradeep Parikh, A.M.
1. The assessee is in appeal before us against the order of the learned CIT(A), dt. 17th July, 1998, for asst. yr. 1992-93. The assessee is aggrieved against considering fees amounting to Rs. 1,66,67,685 as having accrued during the relevant previous year ending on 31st March, 1992.
2. The assessee-company is engaged in the activity of assigning ratings to various debt instruments issued by various companies. For the year under consideration, a total income of Rs. 80,54,673 was returned. Vide assessment order dt. 21st Nov., 1994, it was assessed at Rs. 1,14,11,995 under Section 143(3) of the IT Act, 1961 (the Act). By the order of the CIT(A) dt. 10th Oct., 1995, the income was finally determined at Rs. 1,13,94,700. Subsequent to the passing of the order under Section 143(3), following note appearing in the notes forming part of the accounts in the Annual Report for accounting year 1991-92 was noticed :
"There has been a change in the method of accounting for initial rating fees received from companies using the assigned ratings.
Unlike in the past, when such fees were treated as income of the period in which the ratings were assigned by the rating committee, in the current year such fees have been treated as accruing over a period of twelve months from the date on which the rating committee assigns a rating upto the date on which surveillance fees on it becomes receivable. As a result of this change in accounting policy, the profit for the year is lower by Rs. 1,66,67,685."
As a result of noticing the above note in the annual accounts, after recording the reasons in writing, assessment proceedings were reopened under Section 147 of the Act. Notice under Section 148 was issued in response to which assessee filed its return of income on 23rd June, 1995. The gist of assessee's submissions, as noted by the AO in his order, is as follows :
"Fees received from clients from whom no official acceptance or rejection of rating is received are held in abeyance and credited to rating fee suspense account pending determination of income. These are accounted fully as income in the next accounting year."
3. The AO noted that the impugned amount was kept in abeyance by the assessee-company. He further noted that in asst. yr. 1994-95, a sum of Rs. 66.49 lacs kept in abeyance was treated as the income of the assessee for that year itself. CIT(A), vide his order dt. 2nd Sept., 1997 allowed only 10 per cent of the fees to be retained in abeyance and remaining 90 per cent was treated as income for asst. yr. 1994-95. AO took note of the fact that services had been rendered by the assessee-company during financial year 1991-92 itself for which the fees had been received and kept in abeyance. Only because communication from the constituents was not received, the income cannot be put into Suspense Account. It was also noted that till asst. yr. 1991-92, assessee used to return such income in the year of receipt itself. It was only during the year under consideration, assessee changed the method of accounting and started showing it as "Rating Fees Suspense Account." Since the assessee was following mercantile system of accounting and since services had been rendered for which expenses also had been incurred, AO treated the amount of Rs. 1,66,67,685 as the income of the year whereby total income came to be assessed at Rs. 2,80,62,385.
4. Before the CIT(A) various arguments were advanced on behalf of the assessee. The entire process of assigning a rating was explained. CIT(A) was apprised of the three possible eventualities--acceptance, rejection and no communication at all. The fourth possibility, that of a review of the preliminary rating was also taken note of. In case of rejection, fees were recognised as income in the accounting year in which the rating was assigned as in that case the rating was not required to be kept under surveillance. In case of acceptance of rating, it was contended that the rating had to be monitored for the next twelve months, after which the annual surveillance fee would become payable, and hence the initial rating fees were spread over the next twelve months. In case of no indication of usage, the fees were kept in suspense account as it was not possible for the assessee to apportion the same to income. The elaborate submissions of the assessee did not find favour with the CIT(A). He observed that the initial rating fees were non-refundable and that there was no merit in the contention that the same could be spread over twelve months. According to the CIT(A), the method of accounting was changed merely because of the enormous increase in fees from the current year onwards. Accordingly, he confirmed the inclusion of Rs. 1,66,67,685 in the total income of the assessee.
5. Mr. Soli Dastur, the learned counsel, argued on behalf of the assessee. At the outset, he apprised us of the working of the assessee-company. Upto asst. yr. 1991-92, it was submitted, assessee used to account for the initial fee on the date the rating was given and would return it as income in that very year. However, from asst. yr. 1992-93 onwards, the initial fee was spread over the next twelve months, as in the event of the client-company accepting the rating, it was necessary for the assessee-company to monitor the operations of the clients for the next twelve months, after which period, the client would be paying annual surveillance fees. Reacting to the CIT(A)'s observation that the fees were not refundable. Mr. Dastur submitted that whether the fees were refundable or not was not at all relevant. The change effected by the company has been continued thereafter. It was submitted that the assessee-company is mainly owned by public financial corporations and that the board of directors is comprised of persons of public eminence. Our attention was drawn to the Board resolution effecting the change. Admittedly, the billing had gone up from Rs. 44.15 lacs in accounting year 1990-91 to Rs. 304.02 lacs in the accounting year under consideration. This was because the Government had made rating compulsory for all companies issuing debt instruments. But simply because the fees had increased manifold and the company had a second look at the accounting method, no mala fides could be attached. It was argued that everything is bona fide till mala fide is proved and a thing is mala fide only when, by a device, a taxable item is rendered non-taxable. In this connection, the Commentary by Kanga & Palkhivala was also referred to. With the help of voluminous material placed in the paper book, it was explained that tremendous effort went into the monitoring exercise for the next twelve months which necessarily entailed costs. Hence, on matching cost concept, it was emphatically stated by Mr. Dastur that there was nothing wrong in the new method. On the contrary, it enabled the assessee to arrive at the real income. It was stated that a method adopted may not necessarily be the best method but what had to be seen was whether it was an acceptable method or not. For his various contentions, Mr. Dastur relied on the decisions Sarup Chand v. CIT (1936) 4 ITR 420 (Bom), 162 ITR 618 (sic), 103 TTR 363 (sic), CIT v. K. Sankara Pandia Asari & Sons, Competent Authority, IAC and Ors. v. Smt. Bani Roy Chowdhary and Ors. (1981) 131 ITR 578 (Cal).
6. Mr. Jaisinghani, the learned Addl. Solicitor General of India, argued on behalf of the Department. His first submission was that the initial rating fee was only for assigning the rating and that it had nothing to do with surveillance. Our attention was drawn to the following note appearing in the annual accounts of the assessee as extracted by the CIT(A) in his order.
"There has been a change in the method of accounting for initial rating fees received from companies using the assigned ratings. Unlike in the past, when such fees were treated as income of the period in which the ratings assigned by the rating committee in the current year such fees have been treated as accruing over a period of twelve months from the date on which the rating committee assigns a rating upto the date on which surveillance fees on it becomes receivable. As a result of this change in accounting policy, the profit for the year is lower by Rs. 16,667,685."
Our attention was also drawn to the assessee's own version about initial rating fee as extracted by the CIT(A) which is as follows :
"The client approaches CRISIL when it requires a rating for any of its debt instruments or its fixed deposits program or for a credit assessment. The client usually approaches with a letter of request and a cheque for the amount of initial rating fees as per the fee structure set by CRISIL at that point of time."
Annual surveillance fees, it was submitted, would start from the second year only and that after assigning the rating nothing was to be done by the assessee. If at all there was monitoring for the next twelve months after assigning the rating, it was to save its own image and in its self-interest only. But actually there was no contractual obligation to do so. It was further submitted that the earlier method was not absurd and in fact, assessee had not changed the method of accounting but a sub-system was created within the method followed. Hence, it was contended, the decisions cited by Mr. Dastur were not applicable which spoke of change from cash to mercantile or vice versa. The new method adopted by the assessee was a sub-system within the mercantile system also.
Even the Board resolution did not give any reason for the change. Assuming that expenses were incurred for monitoring for the next twelve months after assigning the rating, then assessee could, following the decision of the Supreme Court in the case of Calcutta Co. Ltd. v. CIT (1959) 37 ITR 81 (SC), could claim the expenses in this year, but perhaps there may not be any basis for apportionment for expenses. Even there was no evidence regarding monitoring as claimed by the assessee and there was no obligation to refund the initial rating fee under any circumstances. Thus, Mr. Jaisinghani concluded his arguments by stating that income accrued and became due and was receivable as soon as the initial rating was assigned by the assessee-company.
7. We have duly considered the rival contentions and the material on record. The only issue before us is as to when the revenue earned by the assessee-company as initial rating fees (IRF for short) should be recognised--whether at the time of assigning the rating as contended by the Department, or should it is spread over twelve months as contended by the assessee. Undisputedly, assessee follows mercantile system of accounting and hence what we are called upon to decide is the exact time of accrual of IRF. Therefore, it would be relevant to briefly understand the activity carried out by the assessee and the modus operandi of carrying out the same.
8. Assessee-company is one of the fee credit rating agencies to whom constituents approach to obtain a rating for any of its debt instruments or its fixed deposit programme or for a credit assessment. Sometime during the year 1991-92. The Securities and Exchange Board of India (SEBI) made it mandatory for a company to disclose the rating for its debenture issue. Assessee charges two types of fees for a rating assignment viz., initial rating fees (IRF) and annual surveillance fees (ASF). No formal agreement is entered into between the assessee and the client, but rating exercise is undertaken by the assessee only at the written request of the client. The IRF is paid along with the letter of request for rating. Clients who agree to use the rating pay the specified ASF commencing one year after the date of assigning the initial rating. Analysts employed by the assessee and industry experts on its roll carry out the initial rating process and prepare a rating note which is presented to the internal rating committee (IRC) which gives the preliminary rating. The rating note alongwith the preliminary rating is presented to the external rating committee (ERC) which in turn studies it and assigns the initial rating. This rating is conveyed to the client. The client either accepts the rating or rejects it or asks for a review. It case of review, a fresh rating is given which is again communicated to the client and the client prefers to either use the rating or not to use the rating.
9. We now consider the accounting policy in each of the three eventualities as followed by the assessee. In case of rejection of the rating assigned, IRF are recognised as income of the year in which the rating is assigned. It is the case of the assessee that in such cases it has no further dealing with the clients since the rating assigned is not required to be kept under surveillance and hence assessee is not required to incur any expenses to keep the rating under surveillance.
10. In case of no official acceptance or rejection, of rating by the client, IRF received is held in abeyance, pending determination of apportionment to income and credited to rating fee suspense account. It is the case of the assessee that for these ratings surveillance continues till either the client decides not to use the rating or the completion of one year from the date of assigning the rating.
11. In case of acceptance of ratings, according to the assessee there is a duty cast upon it to monitor the ratings on an ongoing basis. The case of the assessee is that in such cases, IRF represents consideration not only against the initially assigned ratings, but also for monitoring activities which it has to carry out in the period of twelve months following the date of assigning the rating, i.e., till the date on which surveillance fees first becomes payable. It is the submission of the assessee that during this period, it continues to incur expenses to monitor the rating assigned. In order to achieve proper matching of revenues and expenses, such income is recognised over a period of twelve months from the date of assignment of rating.
12. Earlier we have mentioned that there is no formal agreement between the assessee and the client, but the rating assignment is accepted on a written request from the client which is accompanied with IRF. In this connection, it will be useful to examine the contents of the request letter, a specimen of which is placed in the assessee's paper book. We are giving only the relevant excerpts from the said letter.
(1) "We request you to determine the rating of our fixed deposits and should we decide to use the rating in any manner, to keep the rating under surveillance during the life of the fixed deposit programme."
(2) "We also understand that CRISIL does not guarantee the completeness or accuracy of the information on which the rating is based."
(3) "We note that the right to use the rating will rest with us; however, should we decide to use the rating in any manner, CRISIL will also have the right to publish the rating and the rationale therefor."
(4) "We are pleased to enclose our cheque for Rs......... being non-refundable fees payable for obtaining the initial rating. Should we decide to use the rating, we also undertake to pay an annual surveillance fee, from the second year onwards, at rates as applicable from time to time for the continuous monitoring of the rating of the fixed deposits over their life. We also agree to reimburse CRISIL all travel and out-of-pocket expenses that it may incur in connection with the initial rating as well as surveillance."
(5) "Should we decide to use the rating in any manner, we shall communicate our decision to you in writing within one month of your assigning the rating, and we agree to provide on a continuing and timely basis all such information that we consider material, or that CRISIL may require, for the proper monitoring of the rating assigned to the fixed deposits. We understand that CRISIL has the right to revise the rating, based on any event which is CRISIL's opinion warrants a revision of the rating assigned. We also understand that failure to provide such information or to properly answer your enquiries in a timely manner or pay the surveillance fees could result in your suspending or withdrawing or revising the rating assigned to the fixed deposits. It shall also be within your rights to publicise/disseminate in any manner you choose such suspension/withdrawal/revision in the ratings without reference to us and you may also assign such reasons for the suspension/withdrawal/revision of the rating as you may consider appropriate."
13. To the above factual aspect of the matter, we shall advert a little later. Before that let us briefly deal with the matching cost concept on which rest the assessee's main arguments. Undoubtedly, matching cost concept is one of the fundamental principles of accounting. All the costs incurred to earn the income of the year must be accounted for to match the revenues of that year. Then only one can arrive at the correct net profit for that year. This is particularly true for trading and manufacturing concerns because in such cases the nexus between cost of goods purchased or manufactured and sales effected can directly be established. But it may not be so in case of consulting firm. Take for example, the case of a management consulting firm. It has taken up an assignment which lasts for fifteen months. For fifteen months, the firm goes on incurring expenditure. The expenses incurred in the first twelve months are accounted for in one year and of the last three months in the next accounting year. At the end of the fifteen months, on completion of the assignment the firm raises its bill. The amount of this bill can be said to have accrued only in the year in which the bill is raised. Simply because part of the expenditure has been accounted for in the earlier year, no part of the corresponding income can be brought to tax in the earlier year, nor can the expenses incurred in earlier year be accounted for in the next year on the ground that costs should match the corresponding revenue. This is the peculiarity of firms rendering consultancy services. Again, apart from assignment specific costs, there may be certain common costs also which cannot be allocated to specific assignments. Hence, in case of firms rendering such services, matching cost concept do not work in the true sense of the term.
14. Let us now examine the case of the assessee in the light of the above discussion. Though the request letter, part of which is reproduced above, indicates that the client will communicate its decision in writing within one month of assigning the rating, there appears to be no sanctity about this one-month period. At para 3.3.1 of the note on rating fees (p. 1 of the paper book), it is mentioned that where there is no indication of usage, IRF are held in abeyance and pending determination of apportionment, they are credited to rating fee suspense account. In the same para it is mentioned that for these ratings surveillance continues till either the client decides not to use the rating or the completion of one year from the date of assigning the rating. In other words, if the client remains silent for twelve months, according to the assessee, surveillance continues for twelve months. It automatically follows that if surveillance continues, assessee must be incurring costs for the same. We fail to understand that, if immediately after giving the rating, assessee starts incurring costs, then why keep the IRF in abeyance. On the basis of matching cost concept, at least that part of IRF should be recognised, which can be related to the part of the accounting year in which the rating is given. Hence, here the assessee itself does not follow the matching cost concept and its argument fails.
15. We also fail to appreciate the argument (p. 9 of the paper book) that unless the decision to accept and use the rating is communicated, the assignment is not considered to be complete. As per the material on record, the IRF is for assigning the rating, because, before assigning the rating much exercise is undertaken as is described in the note on rating fees. Thus, if the rating is assigned on 1st of March, then obviously all the costs necessary to arrive at the rating to be given have been incurred till 1st March. In such cases, if the IRF is spread over the next twelve months, then fees relatable to eleven months will fall in the next accounting year whither matching cost concept in such cases ? If we accept the accounting policy adopted by the assessee, then in the illustration just given, all the costs incurred to arrive at the rating will get accounted for in one accounting year and the major portion of corresponding revenues will be recognised in the subsequent accounting year. The point we are trying to drive home is that in activities like that carried out by the assessee, the argument of matching cost concept cannot stand.
16. It is also argued that IRF represent consideration not only against the initially assigned rating but also for the monitoring activities which the assessee will have to carry out in the period of twelve months following the date of assigning the rating. If this is the case, then the assessee should have, at least in broader terms, bifurcated the IRF into two parts--one representing the initial rating and the other representing post-rating monitoring till the ASF becomes first payable. But no such exercise appears to have been done and even if it is done, it would be quite vague if not arbitrary. Then, as mentioned earlier, there will be common costs as well which would pose great difficulty in allocating them to each assignment. Further, it is said that during the twelvemonth period, every user company is allocated to an industry-specialist-analyst to monitor the company's progress and performance. It is not known whether the assessee has a specialist for each type of industry or a few specialists who can take care of most of the industries. It is also not known whether one specialist handles only one assignment at a time or several assignments at a time. In all probabilities, latter situation would be prevailing. Then, in such a situation, the question of allocating the cost attributable to that specialist amongst the several assignments handled by him would arise. In short, the matching cost concept is an absolute fallacy in the assessee's case.
17. Besides this, neither the request letter nor any other material on record indicate that there is a contractual obligation on the part of the assessee to monitor the rating for the next twelve months till the ASF becomes first payable. As a matter of fact, assessee's obligation is over once the rating is given, whether rejected or accepted by the client. The initial rating fees, therefore, accrue to the assessee once the rating is assigned irrespective of the fact whether it is accepted, rejected or the client chooses to remain reticent and hence revenue therefrom has to be recognised in the year the rating is assigned. Accordingly, we decide this issue against the assessee and sustain the addition of Rs. 1,66,67,685.
18. An alternative ground has been raised that CIT(A) should have considered the allowability of estimated expenses in terms of Supreme Court decision in the case of Calcutta Company Ltd. (supra). In the main ground above, we have held that assessee's obligation is over once the rating is assigned. There is no contractual liability to incur any expenditure for the twelve months following the assignment of rating. For this reason, and also for the reason that matching cost concept fails in the assessee's case, we see no rationale to accept the alternative plea either. Thus, this ground, though not raised before the CIT(A), has been adjudicated by us and is decided against the assessee.
19. Before taking leave from this ground, we would like to advert to one particular argument of Mr. Dastur which apparently was quite attractive. It was submitted that the IRF received by the assessee is akin to insurance premium received by the general insurance companies who amortise them over a period of twelve months. We do not see any kinship between the two. When a general insurance company collects premium, it is under a contractual obligation to cover the risk for the next twelve months and hence rightly amortises the same over a period of twelve months. We have earlier discussed that such is not the case here and hence this argument is also not acceptable.
20. An additional ground against levy of interest under Section 234B and 234C has been raised. The grievance is that such interest is levied without passing a specific order to that effect. The ground being a legal one, the same is allowed to be raised. It has been held by the Supreme Court in the case of CIT v. Ranchi Club Ltd. (2001) 247 ITR 209 (SC) that in the absence of any specific order of the assessing authority interest could not be charged and determined by the assessing authority. In the instant case, there is no such specific order and hence, respectfully following the decision in Ranchi Club (supra) we direct the deletion of interest levied under Sections 234B and 234C of the Act.
21. In the result, the appeal of the assessee is partly allowed.