Calcutta High Court
K.S. Mehta (Huf) vs Commissioner Of Income Tax on 11 February, 2005
Equivalent citations: (2005)195CTR(CAL)293, [2005]278ITR59(CAL)
Author: D.K. Seth
Bench: D.K. Seth
JUDGMENT D.K. Seth, J.
The question :
1. The short question involved in these two appeals is as to whether hybrid method/system of accounting was permissible; if permissible, then could its consequences be avoided or ignored and the first proviso to Section 145 of the IT Act, 1961 (IT Act), as it stood for the respective previous years 1986-87, 1987-88 and 1988-89, could be invoked for the purpose of holding that the income could not be deduced from such mixed accounting system.
The admitted facts :
2. In this case, the facts are more or less admitted. The assessee used to maintain mercantile system of accounting in respect of its outgoings, whereas it used to maintain cash system of accounting in respect of the receipt of interest against financing of vehicles, a part of its business. In the earlier years, this mixed system of accounting was permitted and accepted by the IT authorities and its income was accordingly assessed. But for the previous years 1986-87, 1987-88 and 1988-89, the AO took a different view. The AO held that the hybrid system of accounting could not be permitted. The CIT(A) reversed the said orders holding, inter alia, that Section 145 permitted maintaining of hybrid system of accounting provided the accounts were complete and accurate. Therefore, it set aside the addition. The learned Tribunal also upheld that the hybrid system of accounting was permissible. But, however, according to it, in this case the cash system in respect of the receipt of interest earned on the financing of vehicles represented a distorted picture of the income inasmuch as, the income shown was less than that what would have been shown under the mercantile system of accounting. Therefore, it reversed the order of the CIT(A) and restored that of the AO; and hence the appeal.
The appellant's submission :
3. Mr. J.P. Khaitan, learned counsel for the appellant, pointed out from the materials that there was no inaccuracy or incompleteness in the hybrid system of accounting. One part of the business, namely, in relation to the outgoings of the assessee, the mercantile system of accounting was followed, whereas only in respect of all the transactions related to the receipt of interest out of its business of financing vehicles was maintained on the cash receipt basis. Mr. R.N. Bajoria, senior counsel leading Mr. Khaitan, pointed out that the Madras view was not accepted by the Calcutta High Court. In CIT v. United Credit Ltd. , this Court had held that mixed accounting system is permissible when it was followed over a long range and span of assessment years. This view was reiterated in Juggilal Kamlapat Udyog Ltd. v. CIT (IT Appeal No. 82 of 1999), disposed of by Hon'ble Aloke Chakrabarti and Hon'ble S.K. Gupta, JJ. on 16th Jan., 2004. Speaking for the Court, Hon'ble Chakrabarti, J. had taken the same view that hybrid system of accounting was permissible.
The Department's submission :
4. Mr. Dipak Deb, learned counsel for the Department, on the other hand, strenuously argued and pointed out that even according to the view taken by the Calcutta High Court, the proposition is not absolute. It was subject to the proviso as it stood before the amendment. In terms of the said proviso, though the income may be accurate and complete, the authorities under the Act can intervene in case the income is not possible to be deduced or a distorted picture of the income is presented by reason of such method of accounting. To substantiate his contention, Mr. Deb relied on the decision in CIT v. British Paints India Ltd . He also distinguished the decision in CIT v. United Credit Ltd. (supra) and the unreported decision of this Court in Juggilal Kamlapat Udyog Ltd. v. CIT (supra) disposed of on 16th Jan., 2004, by Hon'ble Aloke Chakrabarti and Hon'ble S.K. Gupta, JJ. He also drew our attention to p. 57 of the paper book and contended that the said system of accounting was subject to the satisfaction of the AO and the authorities under the IT Act in succession. In case the AO or the learned Tribunal found that the income could not be deduced from the kind of the accounting method followed and it presented a distorted picture of the account, it was open to the authorities to determine the income in any of the manners of accounting system, as it might deem fit and proper. In the present case, Mr. Deb pointed out from para 10 of the decision of the learned Tribunal, that such a finding was arrived at due to which the proviso to Section 145 became applicable.
4.1 Mr. Shom, learned counsel for the Department, in the other appeal, adopted the submission made by Mr. Deb and in his usual eloquence, added that it is the opinion of the authorities under the Act which is relevant. The authority is free to act on the basis of his opinion, which he might form on the basis of this account maintained. It is not the question of system or it is not the question of conversion of the system but it is the method of accounting, which is relevant. If the method presents a distorted picture of the account, the authorities are free to adopt a method for finding out the correct picture of the income. He referred to the decision in G. Padmanabha Chettiar & Sons v. CIT , particularly to the last paragraph in order to support his contention.
Section 145 : Before amendment : Hybrid accounting : Whether permissible :
5. Section 145 was amended and replaced w.e.f. 1st April, 1997, by introducing the principle that the assessee has to follow one or the other system of accounting exclusively and had done away with the mixed or hybrid system of accounting. Prior to this substitution of Section 145 in 1997, the mixed or hybrid system of accounting was permissible. However, after 1st April 1988, a further proviso was added and again w.e.f. 1st April, 1989, the third proviso was added. However, we are not concerned with the changes on account of the reason that it is not the case of the Revenue that the changed propositions of law would apply.
5.1 An assessee was entitled to maintain his accounts in the manner it was maintaining over a long period of time. Therefore, if the assessee maintained mercantile system of accounting in respect of particular class of transactions, as in this case, namely, in respect of its outgoings and cash receipt system in respect of the whole of its transactions related to the receipt of interest out of financing vehicles, in that event, the same was supposed to be recognized and accepted by the Department. Admittedly, the assessee had been maintaining this hybrid system, namely, mercantile system in respect of its outgoings and cash receipt system in respect of the interest receipt out of financing of vehicles on the basis of cash received in the relevant previous year. As soon as such hybrid system was recognized and accepted over a long period of time, in view of Section 145, when maintained accurately and completely, unless it was not possible to deduce the income out of such accounting, the system of accounting could not be questioned. Once the system of accounting is accepted, then its consequences could not be avoided or ignored.
5.2 In Investment Ltd. v. CIT ; CIT v. E.A.E.T. Sundararaj ; CIT v. North Arcot District Co-operative Spinning Mills Ltd. ; G. Padmanabha Chettiar & Sons v. CIT (supra); Wood Craft Products Ltd. v. CIT ; CIT v. Woodcraft Products Ltd. ; CIT v. Citibank N.A., (1994) 208 ITR 930 (Bom) and CIT v. United Credit Ltd. (supra), the hybrid system of accounting was held to be acceptable. Relying on these decisions, Hon'ble Chakrabarti, J. speaking for the Court held that hybrid system could not be ignored in the absence of any finding that the income could not be deduced from the accounts maintained by the assessee.
5.3 The proposition is well-settled. Language employed in Section 145 and the proviso, as it stood for the previous years concerned, permit acceptance of hybrid system of accounting provided the same was followed over a long period of time and was accurate and complete, and that income was possible to be deduced therefrom. Therefore, once the hybrid system was accepted, its consequences could not be avoided or ignored and so long the income could be deduced from the system of accounting, the IT authorities could not interfere with the system of accounting, when it is accurate and complete and income is deducible. The IT Department could not object to the system of maintaining accounts by the assessee so long it was permissible under Section 145 before its substitution in 1997, under which hybrid system was acceptable, as was held by the different High Courts in various decisions on which reliance was placed in the decision in Juggilal Kamlapat Udyog Ltd. (supra).
Section 145 and the proviso :
6. Section 145, as discussed earlier, permitted an assessee to compute its income in accordance with the method of accounting regularly employed by the assessee. If the assessee follows one or the other method or a mixed method in order to be acceptable by the IT authority, the same must be a method regularly employed. The assessee is not permitted to switch over from one method to the other method; at the same time, it cannot adopt the other method in part. Whether it is one or the other method or a mixed method, the same must be proved to have been followed/employed regularly by the assessee. In the present case, admittedly, the assessee was following this hybrid system or mixed method of accounting. Therefore, the authorities under the Act could not compel the assessee to follow or adopt a method different than the method regularly employed by the assessee. Since he was following the mixed method, the same has to be accepted by the authorities under the Act.
6.1 However, this is subject to the proviso that it must be correct and complete. This correctness and completeness is dependent on the satisfaction of the AO. Even if the AO is satisfied that the accounts are correct and complete, yet he is free to compute the income in such a manner as the AO may determine in case he is of the opinion that the method employed is such that the income cannot be properly deduced therefrom. Relying on British Paints India Ltd. (supra), Mr. Deb contended that it is within the power of the AO to form an opinion whether or not the income can be properly deduced from the accounts maintained by the assessee, even though the accounts may be correct and complete to his satisfaction. This proposition is undisputed. It is well within the power of the AO, even if he is satisfied with the correctness and completeness of the accounts, to form an opinion whether or not the income chargeable under the Act can be properly deduced from the accounts so maintained. What is or is not profit or gain is primarily a question of fact. Such fact is to be ascertained by the tests ordinarily applied in such kind of business. In this connection, reference may be made to the ratio decided in Sun Insurance Office v. Clark (1912) AC 443 (HL) and Chhabildas Tribhuvandas Shah v. CIT , dealing with Section 13 of the Indian IT Act, 1922, corresponding to Section 145 of the 1961 Act, wherein it was held that it is not the question of correctness but it is a question whether there was material to support the findings of the learned Tribunal involving the applicability of the proviso to Section 13 of the 1922 Act. It is a question of fact, namely, whether the profits and gains can or cannot be properly deduced from the method of accounting regularly employed by the assessee. The question is whether there is any material to form such an opinion, 6.2 In fact, the question is not dependent as to whether the account is correct or not, whether the regularly applied method should be discarded or not, it is the question whether the AO could compel the assessee to change the method of accounting, admittedly, when the assessee was free to adopt one or the other method or a mixed method, which he employed regularly. The authorities under the Act could not compel the assessee to switch over to a method different from the method regularly employed by him. But, it was only a question of forming an opinion as to whether the income could be deduced from the accounts so maintained. Therefore, the first ingredient for the AO was to find out whether the accounts maintained were correct and complete. If it were not correct and complete, the AO had a right to intervene. The proviso used the expression, "but the method employed is such that, in the opinion of the AO, the income cannot be properly deduced therefrom". If the AO was satisfied that the account maintained was correct and complete, but he formed an opinion that the method employed was such that from such accounts the income could not be deduced, in other words, it is only when the AO formed an opinion that the method employed was such that the income could not properly be deduced therefrom, the AO was entitled to compute the income in such manner and basis as he might determine. Thus, unless it appears from the materials available on record and it is shown that the authority under the Act had formed an opinion that the method applied was such that it did not present a picture from which the income could be properly deduced, to put it differently, the accounts should disclose a true picture of the assessee's profits and gains, and if the method employed was such that it did not disclose the true state of affairs for the determination, of taxes, even if it ideally suited for the purpose of the business, it was the duty of the AO to adopt any such method of computation as he might deem fit for the proper determination of the true income of the assessee. This view was adopted as far back as in 1938 in the decision in CIT v. Sarangpur Cotton Manufacturing Co. Ltd. (1938) 6 ITR 36 (PC) followed in CIT v. McMillan & Co. ; S.N. Namasivayam Chettiar v. CIT and CIT v. A. Krishnaswami Mudaliar since referred to in British Paints India Ltd. (supra).
6.3 However the British Paints India Ltd. (supra) would not be a decision which can be applied in the present facts and circumstances of the case in relation to the findings about the distorted picture of the income for the simple reason that in British Paints India Ltd. (supra), the method of accounting was not the question involved. The question that was under consideration in the said decision related to the evaluation of the stock-in-trade, which was prepared on expert advice in the interest of efficient administration of the company. In arriving at the valuation of the stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products were excluded. This system of evaluation of the stock-in-trade was held likely to result in a distorted picture of the true sight of the business for the purpose of computing the chargeable income and such a system had produced a comparatively lower valuation of the opening stock and the closing stock showing a comparatively low difference between the two. This was found by the learned Tribunal that in a period of rising turnover and rising prices, the system adopted by the assessee was apt to diminish the assessment of the taxable profit of that year and that the profit of one year was likely to be shifted to another year which was held to be an incorrect method of computing profits and gains for the purpose of assessment, since each year being a self-contained unit and the taxes of a particular year being payable with reference to the income of that year as computed in terms of the Act. It was only when the method employed by the assessee was found to be such that the income could not be properly deduced therefrom, the exercise of the power by the AO in terms of the proviso was justified. Thus, it is only when having reference to the method of accounting if it appeared that such method resulted into a distorted picture of the income then only the right of the AO to intervene accrued.
6.4 In the present case, the method employed was sufficient to deduce the income, and the income so accrued was reflected in the books of account as and when received. Therefore, there was no scope of presenting a distorted picture of the income. Might be, the income was shifted to another year; but when a mixed method is acceptable and permissible, the shifting of the income when deducible would not attract the mischief of the proviso since such income would be taxable in the year of its receipt. For example, where 100 per cent interest payable was reflected under the mercantile system in the account and a percentage of the interest received or the whole was accounted for on the cash receipt method in a subsequent previous year, the said receipt would become taxable in that subsequent previous year along with the interest receivable and received in that previous year, therefore, despite being shifted, it would not escape the income. It might be a case where in that previous year the interest payable in the earlier previous year, though reflected in the account, but not paid, was paid in that previous year, which cannot be adjusted against the receipt of interest of that previous year. In British Paints India Ltd. (supra), the method of computing profits and gains was held to be incorrect by reason of the system adopted for evaluation of the stock-in-trade. In this case, it is not the method of evaluation which is in dispute. It is the system or method of accounting, which has since been questioned by the authorities under the Act, which it cannot do. It is not a case that one class of income was being maintained in different system or method. Admittedly, all receipts of interest were maintained on cash basis, namely, a particular class and all outgoing interest payable was maintained in another system. When such a system was permissible, the assessing authority was not supposed to find fault with the same simply because there might be shifting of income by reason of such system. If we accept such a proposition, then an assessee would not be entitled to follow a mixed/hybrid method of accounting. Such an absolute proposition cannot be laid down which has since been recognized in law over such a long period of time and has been done away with by virtue of the amendment brought about by substituting Section 145 w.e.f. 1st April, 1997.
6.5 Mr. Deb's attempt to distinguish United Credit Ltd. (supra) simply on the ground that it has not given any reason does not seem to be sustainable by reason of the unreported decision in Juggilal Kamlapat Udyog Ltd. (supra) by the other Division Bench of this Court. This decision was sought to be distinguished by Mr. Deb on the ground that there was no finding by the Revenue authority that the income could not be deduced. In our view, it would not be a distinguishing feature inasmuch as in the present case, it is not a finding that the income cannot be deduced. On the other hand, the learned Tribunal had found that the income, which was capable of being deduced from the method employed, resulted into shifting of the income out of its interest receipt presented a distorted picture of the income. Such a proposition cannot be supported for the simple reason that once the method of accounting regularly employed was recognized in law, the consequence thereof could not be a ground for derecognizing the method employed compelling the assessee to switch over to a method other than that regularly employed by it. The Madras decision in G. Padmanabha Chettiar & Sons (supra), with due respect to the decision, does not seem to persuade us to follow the same in view for the reason that it had not dealt with the question as is involved in the present case having regard to the facts and circumstances at hand, elaborately.
The principle : Whether amounts to avoidance of tax/unjust enrichment :
7. Mr. Deb contended that it was a kind of avoidance of tax. This proposition is wholly misconceived. In case any amount was not received in the particular previous year, tax could not be avoided in the subsequent previous year when the same was received. He further contended that the accumulated loss that might be carried forward would be an advantage for setting off the income of the subsequent previous year. This proposition does not seem to be sound. The outgoings or income of a particular year if carried forward and if it is otherwise permissible in law, the consequences therefor cannot be a ground to hold contrary to law. Furthermore, it might be a case that the loans obtained by the assessee on which interest was payable by it was paid and a block receipt of several years was received in a particular previous year or subsequently, then the assessee would be liable to pay the tax in that previous year when the cash was or would be received. The next contention raised by Mr. Deb is that in those days the rate of tax was very high and the rate was reduced for the subsequent years. Taxability is not dependent on the decrease and increase in the rate of taxes applicable to the subsequent previous years; it is dependent on the earning of the income in the particular previous year.
The present case : The principle : How applicable :
8. In the present case, the finding at para 10 in the order of the learned Tribunal is that the system of accounting presented a distorted view of the income. But, the said finding cannot be construed to mean that from the hybrid system of accounting maintained by the assessee was inaccurate or incomplete or that income was not possible to be deduced from such system of accounting. Whether such system of accounting would present a distorted figure of income is wholly immaterial inasmuch as once the system is accepted, its consequences cannot be avoided or ignored.
Conclusion :
9. It may be noted that the learned Tribunal had accepted the hybrid system of accounting, but, even then, it had ignored the system and attempted to deduce the income under the mercantile system. It had figured different income from the accounts maintained. Therefore, it is apparent that the income maintained was accurate and complete from which it was possible to deduce the income. The income would be at variance from such hybrid system of accounting if calculated under the mercantile system instead of cash system. But when one system was followed, whether mercantile or cash or hybrid, as the case may be, the income was to be deduced according to the system maintained.
9.1 In the present case, it is clear that the income can be deduced under the system maintained and was, in fact, deduced both by the AO and the learned Tribunal. Therefore, the proviso to Section 145, as it stood for the respective previous years, could not be resorted to and applied for the purpose of interfering with the system of accounting maintained by the assessee, in the absence of any finding that the account maintained was inaccurate or incomplete and that it was not possible to deduce the income therefrom.
Order :
10. In the result, these appeals succeed and are allowed. The order under appeal is, thus, modified. The respective question No. 1, which is identical, is answered in negative in favour of the assessee. The respective question No. 2, which is identical, is answered also in the negative in favour of the assessee.
10.1 There will, however, be no order as to costs.
R.N. Sinha, J.
11. I agree.