A.K. Jalan (HUF) vs Commissioner of Income Tax

Ajit K. Sengupta, J.—In this reference u/s 256(1) of the income tax Act, 1961 (''the Act'') for the assessment years 1983-84 to 1985-86 the following common question of law has been referred to this Court:

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in not allowing the changeover in the system of accounting from mercantile to cash?

Shortly stated, the facts are that the assessee-HUF had given an advance of Rs. 3,50,000 to Dupent Trading & Investment Co. Ltd. The said advance carried interest at the rate of 12.5 per cent per annum. Earlier, the assessee was accounting for the interest on the said loan on accrual basis. From the accounting year ending on 20-4-1983, being the previous year relevant to the assessment year 1983-84, the assessee did not account for the interest on accrual basis. Before the Assessing Officer the assessee claimed that since the debtor-company was not paying the interest for same years in the past, it had decided to account for the interest on cash basis. The Assessing Officer rejected this contention of the assessee and brought to tax the interest on the said loan on accrual basis in all the assessment years under reference.

The assessee challenged the action of the Assessing Officer before the Commissioner (Appeals) and contended that it was entitled to change the method of accounting in respect of interest income from mercantile to cash as the debtor-company was not paying interest regularly. The assessee further claimed that the above change was bona fide.

The Commissioner (Appeals) declined to interfere with the order of the Assessing Officer on this point.

The assessee came up in second appeal before the Tribunal. The Tribunal after considering the rival submissions of the parties and the facts of the case held that the assessee was entitled to change the method of accounting regularly followed by it. For this purpose prior approval of the Assessing Officer was not necessary. However, the Assessing Officer was entitled to go into the bona fides of the change. The Tribunal held that the change of method of accounting from mercantile to cash was not bona fide.

The assessee thereafter made a miscellaneous application for recalling of the order passed by the Tribunal and for re-hearing which the Tribunal rejected holding that there was no case for recalling of the order.

At the hearing before us Mr. Chopra, the learned counsel for the assessee, has contended that when an assessee changes his regular method of accounting by another method, the question of his bona fides has little relevance and it is not open to the revenue authorities to go into the question of bona fides of the introduction and continuation of the change. His contention is that the expression bona fide does not occur in section 145 of the Act. He has relied on several decisions of this Court in support of this contention that the concept of bona fides is not relevant in deciding a question whether the change should be allowed or not. The revenue, however, has supported the order of the Tribunal.

Mr. Chopra has drawn our attention to a decision of the Division Bench of this Court in the case of Snow White Food Products Co. Ltd v. CIT [1983] 141 ITR 8471. In that case in the return of income filed for the assessment year 1968-69, the assessee claimed that its interest income should be assessed on cash basis and not on accrual basis as was being done in the previous assessment years. The ITO held that the assessee was not entitled to revert to the cash system of accounting in respect of its interest income and the interest accrued but not received, amounting to Rs. 1,58,336, was assessed as the income of the assessee in the said year. On appeal to the AAC, the assessee contended that interest in respect of its outstanding loans had not been received for a number of years and that there was no chance of recovery of either the interest or the principal amounts, that accounting on receivable basis would give a false impression of its profits and that the change in the method of accounting was bona fide. The AAC held that the departure from the previously employed system was not permissible as the accounts would then cease to reflect the true profit and loss and, hence, affirmed the order of the ITO. On further appeal to the Tribunal, the assessee contended that it was open to it to make a change in its regular method and employ a different method of accounting.

The Tribunal found that the assessee had been following the mercantile system of accounting hitherto and had done so even in the relevant year except for the interest income, that there was no resolution of the Board of directors or the shareholders of the assessee-company supporting the change except for a statement in the annual report, from which it could not be established that the assessee had decided to change its regular method of accounting and had adopted something else as the regular method, that there was no variation in the contracts between the assessee and its debtors in respect of the interest receivable and there being no material on record to show that the debtors were unable to pay interest or that there was no prospect of realisation of such interest, it was not open to the assessee unilaterally at any time during the relevant accounting year to say that the regular system will not be followed in respect of a particular source and, therefore, rejected the assessee''s appeal. In that case it was contended on behalf of the revenue that the change in the method of accounting of the assessee was not bona fide as no evidence was produced in support of the change nor any reason was given for the necessity of the change.

After considering all the decisions cited from the Bar the Division Bench of this Court held as follows:

...The law appears to be settled that in the event the assessee regularly employs a method of accounting its income has to be computed in accordance with such regular method. The assessee is, however, entitled to change his regular method of accounting by another regular method. An assessee is also entitled to follow one method of accounting in respect of income from one source and another method in respect of other sources. We are unable to accept the contention of the Revenue that a change in the method of accounting has to have the approval of the income tax authorities. The further contention that a change has to be supported by cogent reasons showing the bona fides of the assessee cannot also be accepted. If the method of accounting followed by the assessee does not reflect the correct income, the ITO can always compute the income on a different basis u/s 144 of the Act.

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We are unable to appreciate the contention of the Revenue that the Tribunal has held indirectly that the change claimed by the assessee was not bona fide. Fides of an act have to be found as a fact and such a finding of fact must be specific.

The Tribunal has, however, held specifically that on the evidence on record it cannot be said that the assessee had decided to change its existing regular method of accounting by another regular method. This conclusion of the Tribunal appears to be correct. The statement in the annual report of the assessee only records that the management had decided to account for the interest receivable during the year on cash basis and this indicates that the change was suggested only for the year. There is nothing else on record to indicate that the change was intended to be followed regularly in future by the assessee. On this ground only the Revenue is entitled to succeed in this reference. (p. 859)

The case of the said assessee, i.e., Snow White Food Products Co. Ltd''s case (supra) for the assessment years 1971-72 and 1972-73 also came up for consideration before the same Division Bench of this Court which is reported in Snow White Food Products Co. Ltd. Vs. Commissioner of Income Tax, In that case it found that the facts and circumstances were not the same as those prevailing in the assessment year 1969-70. The assessee had maintained the change in its method of accounting from 1969-70 onwards. This Court held that the principles of res judicata are not applicable in revenue matters and findings of fact in an earlier year are not binding in the assessments in subsequent years and can be reagitated on new evidence, and, accordingly, held that the Tribunal lost sight of the fact that the assessee was following a regular method of accounting since 1969-70. There a question was also agitated as to whether the change was bona fide or not.

In that context it has been observed as follows:

The concept of bona fides in the context of a change in the method of accounting appears to have its genesis in Sarupchand v. CIT [1936] 4 ITR 420 (Bom.). Rangnekar, J. of the Bombay High Court observed that an assessee was entitled to change its method of accounting provided he satisfied the Revenue authorities that he was doing so in good faith. This observation does not occur in the judgment of Beaumont, CJ. In Indo-Commercial Bank Ltd. v. CIT [1962] 44 ITR 22 (Mad.), the Madras High Court, following Sarupchand [1936] 4 ITR 420 (Bom.), observed that where an assessee changed its method of accounting bona fide and satisfied the department that he intended to adopt the changed method of accounting, thereafter the requirements of section 13 of the Indian income tax Act, 1922, would be satisfied.

In Eastern Bengal Jute Trading Co. Ltd. [1978] 112 ITR 575 (Cal.) this Court upheld a change in the method of accounting, noting, inter alia, that the Tribunal had found that the change was not introduced mala fide. A similar observation of the Tribunal was noted by this Bench in CIT v. Rajasthan Investment Co. (P.) Ltd. [1978] 113 ITR 294 (Cal.).

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All that the section lays down is that if an assessee regularly employs a method of accounting, his income should be computed in accordance therewith. The section, in its terms, does not require any enquiry into the bona fides of the assessee in following a regular method.

A recognised method of accounting followed regularly would necessarily result in a proper computation of the assessee''s real income. Even if one regular method of accounting is substituted by another regular method, the same result will follow. Only in a case where the assessee changes his regular method of accounting by another method and does not follow the change regularly thereafter, it might be possible for the assessee by introducing successive changes in his methods of accounting to exclude items of his income from being included in the computation of his total income. Therefore, when an assessee changes his regular method of accounting by another regular method, the question of his bona fides have little relevance.

Only in the year where a change in the method of accounting is introduced for the first time, it is to be examined by the Revenue authorities whether the change introduced is meant to be regularly followed or not. It appears to us that it is in this context only that the expression ''good faith'' and ''bona fide'' occur in the observations in the earlier judgment noted earlier.

In our opinion, where it is found that an assessee has employed (changed?) his regular method of accounting by another recognised method and has followed the latter method regularly, thereafter, it is not open to the revenue authorities to go into the question of bona fides of the introduction and continuance of the change. (p. 873)

In the case of Hada Textile Industries Ltd. v. CIT [1991] 187 ITR 371 (Cal.), the Division Bench held that-

...Once having chosen and regularly employed the cash system in respect of the transaction in question that is, in the matter of its liability for casual leave payment in the earlier years, the assessee cannot make a departure in the year under consideration to give a go-by to that method and claim the deductions both on payment basis for the earlier year and on mercantile basis for the year under consideration by making a provision in the accounts. The change was only for the year under reference. It was not the case of the assessee that he intended to adopt and in fact had adopted thereafter the changed method of accounting. Although section 145(1) in terms does not require any enquiry into the bona fides but it becomes relevant where the conduct of the assessee shows that such change was not introduced for continuance henceforth but it was a casual departure from the method regularly employed till then. The conduct of the assessee in this case proves the absence of bona fides on its part. We are, therefore, of the view that the Tribunal was justified in negativing the claim of the assessee for deduction of the provision for casual leave payments. For the reasons aforesaid, the first question is answered in the negative and in favour of the Revenue. (p. 374)

The expression bona fide has to be understood in the context it is used. It is no doubt true that section 145(1) in terms does not show this expression bona fides. The term bona fide means good faith or honest intention. This intention becomes relevant in the context of the facts and circumstances of a particular case. There may be a reference of a particular method of accounting in showing its income and when the assessing authority finds that there is a departure, he is entitled to ask the question as to why the assessee had introduced such a change, inasmuch as such change necessarily in the first year would involve distortion in the profit or loss as shown in the return.

The learned counsel for the assessee seeks to eliminate the question of bona fides altogether. According to him, the question of the change being bona fide is an extra-statutory requirement. There is nothing in the provisions of section 145 which carves out any place for such question. T herefore, according to him, the Tribunal unnecessarily or irrelevantly concerned itself with a matter which could not at all be in controversy according to the requirement of law. If we concede to this line of argument, it will amount to saying that the honest intention to project the true profit is not a necessary ingredient of section 145. Thus, we are urged to hold that section 145 permits of a change which is manifestly mala fide. Such a view-is not at all rational.

In fact, strictly literal reading of section 145 as canvassed by Mr. Chopra is destructive of his own case in a way. If we go by the strict words of section 145(1), we would find that the statute is silent just as well on the assessee''s right to change from its pre-existing method of accounting; it speaks only of regular employment of an accounting method but not of change from one to another. As a logical corollary of his argument he would then be shut out from pleading for the permissibility of any change from the earlier method because law in terms does not provide for a change. It is only Judge-made law which by construction has laid down that a method once chosen cannot just be permanently fixed on the assessee even where for honest and good cause a change is indicated and the change is with no intention or for no collateral purpose of dodging tax. It is only for an even deal to the revenue that the judiciary in the same breath requires that permissibility should go only to the extent the change is bona fide. Therefore, the attempt to have any change pushed through on the plea that bona fide or mala fide, every change is lawful, must fail. The absence of express requirement in the law cannot be capitalised on. The attempt to do so would, in fact, recoil on the case of the assessee. The Revenue could retort likewise saying that the law permits no change and the method once employed has to be followed all the time without variation.

The question in the instant case that figures upper-most is that the Tribunal found as a fact that the change-over in the case is not bona fide. This is a finding of fact which has not, however, been challenged in the question which was framed at the assessee''s own asking. Therefore, the finding of a fact not being assailed as perverse and the want of bona fides being a proved fact shall hold the field. It is futile for the assessee to say that the Tribunal erred in law in not allowing the change-over.

Even if the Tribunal''s finding of fact as to the want of bona fides would have been challenged, the same would not fare better than the assessee''s main argument here that bona fides is not a requisite factor or a material consideration. The Tribunal has appraised all materials available before it and the appraisal is balanced and correct not calling for an interference.

The Tribunal correctly found that the interest was shown regularly in the account on receivable basis and if it is not received in a particular year, one cannot hasten to the conclusion that the income of the assessee was necessarily to be computed on receivable basis as adopted in the return filed or in the books of account maintained for that particular year. The change in the case was found by the Tribunal to be not because of the assessee''s inability to recover the interest from the debtor. This finding has not been contested. The Tribunal further found that the assessee did not credit any interest in the years 1980-81 and 1981-82 in the assessee''s accounts on accrual basis. In the subsequent years it was shown on accrual basis. Thus, one cardinal test of the bona fides in the change-over, viz, the accounting method being followed consistently was conspicuous by its absence and the assessee adopted a fluctuating method of accounting for the interest income. Another reason rendered by the Tribunal for holding against the bona fides of the change-over is that the assessee''s representation as regards the debtors'' inability to pay the interest is not an honest representation. The Tribunal found that the assessee never wanted in confidence that the debtor-company would clear both the loan and the interest thereon nor did it show that the financial position of the company is bad. This finding also goes unchallenged.

In our view, on the above facts and circumstances, the Tribunal came to a correct conclusion that the change which was made by the assessee could not be permitted. In this case, the debtor was not only solvent to pay the principal but also the interest due.

For the reasons aforesaid, we answer this question in this reference in the affirmative and in favour of the revenue. There will be no order as to costs.

Sen, J.

I agree.