Asstt. Commissioner of Income Tax vs Coromandal Investment Pvt. Ltd.

K.A. Puj, J.—The Revenue has filed this Tax Appeal u/s 260A of the Income Tax Act, 1961 for assessment year 1986-87 proposing to

formulate the following substantial questions of law.

(A) Whether, the Appellate Tribunal is right in law and on facts in holding that change in the method of accounting from mercantile to cash basis

was bonafide and thereby deleting the addition made on account of interest chargeable ?

(B) Whether, the Appellate Tribunal is right in law and on facts in holding that penalty u/s 271(1)(c) is not attracted ?

This Court has admitted Appeal on 6.9.2000 on the following substantial question of law.

Whether, in the peculiar facts and circumstances of the case, the Appellate Tribunal was right in law and on facts in holding that the change in the

method of accounting made by the present assessee, a subsidiary of the holding company with whom deposits were placed, from mercantile to

cash basis was bona fide and deletion of the addition made on account of interest chargeable was justified in law ?

This Appeal is heard at great length along

with other group matters. It was agreed and understood by and between the parties that this is a lead matter and decision rendered in this matter

would govern all other Appeals involving the same substantial question of law. The Court, therefore, considers the above referred substantial

question of law in this Appeal.

The principal issue in this appeal relates to the Assistant Commissioner''s of Income Tax (A.C.I.T for short) disapproval of a change in the

method of accounting effected in the accounting for income and expenditure by way of interest from the mercantile method of accounting which the

assessee was following hitherto, to the cash method of accounting. Apparently, this change in the accounting system resulted into the profit of the

assessee Company being lower by a sum of Rs. 4,39,888/- then what it would have been if the erstwhile method of accounting had been

continued. The A.C.I.T''s action was primarily on the basis that the change was not made bonafide, that it lacked durability and regularity and that

the change in the method was such that income of the assessee could not properly be deduced from accounts maintained on the changed method.

He, therefore, made an addition of the said sum of Rs. 4,39,888/- to the total income of the assessee.

Being aggrieved by the said order of the A.C.I.T. the assessee has challenged the said action of A.C.I.T. of bringing to tax the said sum of Rs.

4,39,888/- on account of interest income on the basis of his disapproval of the change in the method of accounting. The learned CIT(A) after

detailed discussion and after considering the entire facts and circumstances of the case and relevant statutory provisions as well as case law on the

subject has decided the Appeal in favour of the assessee and deleted the addition.

Being aggrieved by the said order of the learned CIT(A) the Revenue took up the matter before the Income Tax Appellate Tribunal,

Ahmedabad. The Tribunal has dismissed the Appeal filed by the Revenue and confirmed the order of the learned CIT(A).

In the above background of the matter, the present Tax Appeal is filed by the Revenue.

The brief facts of the case giving rise to the present Tax Appeal are;

That in April, 1984 the Board of Directors of the assessee company resolved to lend a sum or sums not exceeding Rs. 50 lacs to Alkapuri

Investments Pvt. Ltd., (for short ''Alkapuri'') The amounts advanced by the assessee to Alkapuri were accounted in the loan account of Alkapuri.

This account was to carry interest @ 10.1/2 % per annum. There was, however, no stipulation with regard to any periodicity of payment of

interest.

In January, 1985 the Board of Directors of the assessee company resolved to open a current account of the Company with Alkapuri with

authority to keep a sum or sums not exceeding Rs. 25 lacs therein. The amounts paid to Alkapuri pursuant to this Resolution were accounted in the

current account of Alkapuri. This account carried interest at 5.1/2 % p.a. There was, however, no stipulation with regard to the periodicity of

payment of interest.

As per Balance Sheet of the assessee Company as at 30.9.1985, the debit balance in these two accounts of Alkapuri were as under:

Current Account Rs. 19,70,000/-

Loan Account Rs. 32,68,000/-

These two were the only interest earning accounts with the assessee Company.

Ever since its inception the assessee was following the mercantile method of accounting and apparently in order that its accounts showed a true

and fair view of its profit or loss and of its state of affairs as required under the Companies Act, 1956, its income and expenditure had to be

accounted on accrual basis under that method. Accordingly, even though there was no specific stipulation with regard to the periodicity of payment

of interest on the above two accounts, interest thereon used to be accounted on accrual basis.

The assessee, however, subsequently started facing difficulties in following mercantile method of accounting in respect of interest income. The

difficulties are as under:

(a) It had to offer for tax interest income in the year of accrual even though it was not actually received. This, in turn, resulted into the assessee

having to find resources for meeting tax liability on such interest income ​ a difficulty which was insufferable, especially considering that interest was

the main source of income for the assessee.

(b) Since, as per provisions of Section 194A, Alkapuri would deduct tax at source on interest payable to the assessee on the above accounts at

the time of crediting it to the assessee''s accounts in their books or at the time of its payment to the assessee, whichever was earlier, TDS

Certificate from Alkapuri in favour of the assessee would not be forth coming even by the time the assessee''s Income Tax returns were filed. The

TDS certificate would accordingly have to be furnished during the course of assessment proceedings. There again, as was the case with a large

number of companies to which the assessee belonged, although credit for the tax deducted at source as per the TDS certificates would be given in

arriving at the tax liability, such TDS, to the extent that it was actually paid to the credit of the government after the expiry of the financial year

corresponding to the assessment year in which interest would be offered for being taxed on accrual basis, would not be taken into account for the

purposes of deciding whether or not interest u/s 215 and 217 was attracted in the assessee''s case. This approach of the department had already

resulted into substantial levy of interest u/s 215 and 217 in a large number of group cases including the case of the assessee.

(c) The department did not stop merely at levying interest u/s 215 and 217 but went further and initiated even penalty proceedings u/s 273. While

such proceedings in the assessee''s case were pending, penalty had already been levied in the case of several other group companies.

(d) Just as the assessee was following the mercantile method of accounting, Alkapuri also followed that method. Accordingly, in order that its

accounts showed a true and fair view as required by the Companies Act, Alkapuri had to account for interest expenditure in the year of accrual

irrespective of the year of actual payment. This, it did by crediting the amount to interest payable account in the year of accrual, especially keeping

in view that there was no stipulation with regard to the periodicity of the payment of interest. According to Alkapuri so long as interest was not

actually paid to the assessee or credited to the account of the assessee, the provisions of Section 194A were not attracted. Therefore, Alkapuri

deducted TDS only at the time of actual payment of interest to the assessee or at the time of crediting it to the assessee''s account, whichever was

earlier. However, a difficulty arose in that wise that the department took the view in Alkapuri''s case that they had failed to deduct TDS in the year

in which interest had accrued and was credited to the interest payable account and that deduction of TDS in the subsequent period when it was

actually paid or credited resulted into deferment of payment of TDS liability. This resulted into further avoidable litigation so much so that even

prosecution proceedings have been initiated in their case for an alleged failure to deduct TDS and to pay it to the credit of the government in time.

To get over the difficulties, with effect from the accounting year ended 30.9.1985 corresponding to the present assessment year, the assessee

decided to discontinue accounting for interest income in general on mercantile basis. Instead, it was decided to account for interest income in the

year of actual receipt or in the year in which the interest paying party had credited its account with the amount of interest. The Board of Directors

of the assessee company in their meeting held on 3.8.1985 had passed the following Resolution.

Resolved that commencing from the accounting year 1984-85 the Company do adopt cash basis for accounting of income by way of interest and

accordingly to take credit for interest only when it is received or the Company receives and advice that the amount is credited by the party

concerned to the account of the company, together with a certificate for tax deducted at source.

It is in the above background of the matter, the change in the method of accounting from mercantile to cash was adopted by the assessee. The

learned CIT(A) has felt that the A.C.I.T. has not and could not have established that the change in the method of accounting made by the assessee

was not bonafide. He was satisfied that the changed method having been adopted for three assessment years and thereafter its continuance had

become impossible of account of an amendment in the Companies Act, 1956, a factor which was entirely beyond the control of the assessee,

could not be regarded as suffering from lack of durability. He was also satisfied that the Assistant Commissioner had not and could not have shown

that the change in the method was such that income could not properly be deduced. Therefore, he held that the A.C.I.T has wrongly disapproved

the change in the method of accounting and hence he deleted the addition of Rs. 4,39,888/- made on the basis of disapproval of the change in the

method of accounting.

When the order of the learned CIT was challenged before the Tribunal, the Tribunal found that the finding of the CIT(A) is based on material

on record. The Tribunal was satisfied on the basis of the facts available on record that the change of method of accounting was bonafide. The

decision of this Court in the case of Commissioner of Income Tax Vs. Ganga Charity Trust Fund, supports the action of the assessee. The Tribunal

relying on the decision of the Apex Court in the case of UCO Bank, Calcutta Vs. Commissioner of Income Tax, West Bengal, took the view that

the facts of the assessee''s case are covered by the decision of the Apex Court and hence no interference is called for in the order passed by the

learned CIT(A).

Mr.Manish Bhatt, learned Senior Standing Counsel appearing for the Revenue has submitted that the Appellate Tribunal has erred in law and

on facts in holding that change in the method of accounting from mercantile to cash basis was bonafide and thereby further erred in deleting the

addition made by the A.C.I.T. on account of interest chargeable. He has further submitted that the tribunal has upheld the order of the learned

CIT(A) following the decision of Apex Court in the case of UCO Bank v. CIT (Supra). The said decision was in respect of banking company/

financial institution and the said interests were in respect of ''sticky loans'' whereas the assessee in this case is an investment company and the loans

were not sticky. Further in respect of the assessment years for and before 1988-89 the Act provided vide Sections 18 to 21 as they stood at the

relevant time that the income under the head interest on securities shall be chargeable on due basis. Thus, the assessee had no power to change the

method of accounting in respect of interest receivable. For the assessment years 1989-90 and, thereafter, the change in accounting system was

held to be malafide because the assessee had changed the system of accounting instead of making any effort to recover the money from the group

companies. He has further submitted that the assessee has effected the change in the accounting system solely with a view to wrongfully deferring

the payment of tax and the intention of the assessee was not genuine and bonafide. He has, therefore, submitted that the orders of learned CIT(A)

as well as Tribunal are required to be reversed and the question posed before this Court is required to be answered in favour of the Revenue and

against the assessee.

Mr. R.K.Patel, learned advocate appearing for the assessee on the other hand has supported the order passed by the learned CIT(A) as well

as the Tribunal. He has further submitted that although the change in the method of accounting was primarily intended to enable the assessee to

account for interest income in the year of receipt instead of in the year of accrual, the changed method also envisaged accounting of interest income

in the year in which it was credited to the assessee''s account by the interest paying parties. This had been done keeping in view the fact that in that

event, the assessee would be certain to get the tax deduction certificate which was one of its major anxieties. Mr.Patel further submitted that

simultaneously with the change in the method of accounting for interest income, a corresponding change had also been made in the method of

accounting for interest expenses. He has further submitted that the change in the method of accounting had been made conspicuously disclosing by

a note appearing in Schedule A forming part of annual accounts of the assessee and also by putting a note appearing on the statement of

computation of total income accompanying the return of income for the assessment year. He has further submitted that Alkapuri has also made an

identical change in its method of accounting simultaneously with the assessee. The changed method of accounting has been followed for three

assessment years, namely, assessment year 1986-87, 1987-88 and 1988-89.

In support of his submission Mr.Patel has relied on the decision of this Court in the case of Commissioner of Income Tax Vs. Ganga Charity

Trust Fund, and the decision of Calcutta High Court in the case of Snow White Food Products Co. Ltd. Vs. Commissioner of Income Tax,

Mr.Patel has further submitted that the learned A.C.I.T had unwarrantedly proceeded on the assumption that the true reason for making the

change in the method of accounting was that the assessee did not want to pay income tax on the income due to it and that, in any case, it wanted to

defer its payment so as to suit the convenience of itself and its associate companies from which it earned interest income. He has submitted that the

very assumption of the learned A.C.I.T is incorrect. Although the interest could be said to have been accrued, in absence of stipulation for

periodicity of its payment, it could not be said that it had fallen due. Further the assessee was seeking the change in the method of accounting only

to ensure that interest income was accounted in the year of actual receipt so that it did not have to run here and there for funds required for

payment of tax liability in the year of accrual of interest. The assessee was of the view that by changing the method of accounting it would be able

to avoid litigation with the department in the matter of applicability of Sections 215 and 217 and u/s 273. He has further submitted that not only the

Company Law but the Income Tax Law itself clearly permitted the assessee to choose a method of accounting of its own choice or to make a

change therein without seeking any permission from any authority, provided that the changed method was such as would permit proper deduction

of income and that it was consistently followed, that no provision of the Income Tax Act entitled the learned A.C.I.T. to attribute motives to an

assessee just because it sought to so arrange its affairs that it was not required to pay tax on income which it had not actually received and so that it

had to pay taxes on that income only in the year of receipt.

Mr.Patel has further submitted that the amendment was made to Section 199 of the Act, simultaneously with the amendment to Section 194A

of the Act, by the Finance Act, 1987, with effect from 1.7.1987. This amendment clearly underlined the anxiety of the legislature ensuring that

credit for TDS in respect of a particular item of income be given against the tax liability for that assessment year in which that income is assessed in

the hands of the assessee. He has, therefore, submitted that the changed method of accounting even if adopted long before this amendment, was

quite consistent with this logic adopted by the legislature. Mr.Patel has, therefore, submitted that the order passed by the learned CIT as well as

Tribunal are in accordance with the settled legal position and the change of accounting method from mercantile to cash in no way can be said to be

malafide. He has, therefore, submitted that the Appeal filed by the Revenue deserves to be dismissed.

We have considered the rival submissions of the parties. We have also gone through the orders passed by the authorities below. We have

given our thoughtful consideration to the relevant provisions as well as authorities cited before us. Having considered the facts and circumstances of

the present case, we are of the view that the view taken by the learned CIT(A) as well as the Tribunal after having considered the entire facts and

circumstances and having applied the correct principle of law to the facts of the assessee, is the correct view, which cannot be interfered with by

this Court while exercising its appellate jurisdiction. The Tribunal had enumerated the difficulties which led the assessee company for changing its

accounting system which are as follows:

(i) Compulsion of payment of tax without receipt of interest.

(ii) Aspect of T.D.S.

(iii) Not allowing the TDS while calculating the interest u/s 215.

(iv) Commencement of penalty proceedings etc. under Sections 273 and 271(1)(c) of the Act.

(v) Not giving credit while raising the demand of ''tax deductible'' and

(vi) Launching of prosecutions by filing 123 complaints against different group companies son the same point though ultimately this Court has

quashed and set aside all these complaints while exercising its extraordinary writ jurisdiction.

All the above factors proved beyond any doubt that the system changed by the assessee is bonafide and for genuine reason. The Tribunal has also

taken into consideration the fact that the Company had gone into liquidation voluntarily under the Companies Act, 1956 and hence it had to follow

cash system of accounting for both the income and expenditure. The assessee had been following the mercantile system of Company right from the

assessment year 1974-75 to assessment year 1984-85. The Board of Directors in its meeting held on 3.8.1985 resolved that the accounting

method for the interest income and interest payment would be adopted on cash basis. In the annual account of assessee the fact of change was

mentioned by way of a note stating that from the accounting year 1984-85 the receipt of interest and the expenses thereon is to be accounted on

cash basis. Due to genuine difficulties the assessee had to opt for cash system of accounting. When any system of accounting is changed by the

assessee the assessee had to see whether it is genuine and bonafide. In the case of Ganga Charity Trust Fund v. CIT (Supra), wherein it is held

that income derived from trust property must be determined on commercial principles and in doing so, all outgoings including outgoings by way of

income tax paid by the assessee trust must be deducted and it is only from the surplus income in the hands of the trustees that the question of

application or accumulation or setting apart of income can arise. In that case the assessee trust maintained its accounts on the mercantile system.

When it experienced difficulty in the assessment year 1971-72 because of non-receipt of income from interest from two parties with which it had

placed its funds by way of deposits, it decided to switch over to the cash system of accounting, so that it may not be required to pay income tax on

notional income. The Income Tax Officer held that the assessee could not change the method of accounting but the Tribunal accepted the change.

On a reference this Court held that there was no finding of fact that the switch over to the cash system of accounting in the previous year relevant

to the assessment year 1972-73 was not bona fide. Besides, it was not shown by the Revenue that this change lacked durability or regularity and

was merely a stop gap arrangement to avoid payment of tax. The assessee-trust was entitled to switch over to the cash method of accounting in

view of the peculiar circumstances in which the trust was placed. Here in the present case the assessee Company was placed in somewhat similar

situation. It cannot be said that the change was not bonafide nor can it be said that the change adopted by the assessee lacked durability or

regularity or that it was merely a stop gap arrangement to avoid payment of tax. This decision squarely applies to the facts of the present case.

In the case of UCO Bank v. Commissioner of Income Tax (Supra) it is held by the Apex Court that under the accounting practice, interest

which is transferred to the suspense account and not brought to the profit and loss account of the company is not treated as income. The question

whether in a given case such ​accrual of interest is doubtful or not, may also be problematic, if, therefore, the Board has considered it necessary to

lay down a general test for deciding what is a doubtful debt, and directed that all Income Tax Officers should treat such amounts as not forming

part of the income of the assessee until realised, this direction by way of a circular cannot be considered as travelling beyond the powers of the

Board u/s 119 of the Income Tax Act.

Following the aforesaid decision of the Hon''ble Supreme Court the Madras High Court in the case of Commissioner of Income Tax Vs. India

Equipment Leasing Ltd., took the view that the interest on sticky loans not being brought into the profit and loss account but being taken to the

suspense account was an accepted mode of treatment of notional income in accounting practice. The fact that the assessee, although generally

using a mercantile system of accounting, kept such interest amount in a suspense account and did not bring those amounts to the profit and loss

account, showed that the assessee was following a mixed system of accounting by which such interest was included in its income only when it was

actually received. This view of the Madras High Court support the case of the assessee.

In light of the aforesaid decisions of this Court as well as of Hon''ble Supreme Court, we are of the view that the change in the method of

accounting adopted by the assessee is genuine and bonafide. There was no reason for the learned A.C.I.T. to disapprove the said change and

merely on the basis of such disapproval, to make an addition of interest income which, in fact, has not been received by the assessee in the year

under consideration. The addition made by the learned A.C.I.T. is, therefore, not just and proper and it has rightly been deleted by the learned

CIT(A) as well as Tribunal. We, therefore, confirm the order of the Tribunal and answer the question posed before us in affirmative, in favour of

the assessee and against the Revenue. We hold that the Appellate Tribunal was right in law and on facts in holding that the change in the method of

accounting made by the assessee, a subsidiary of holding Company with whom deposits were placed from mercantile to cash basis was bonafide

and deletion of the addition made on account of the interest chargeable was justified in law.

This Appeal is accordingly dismissed without any order as to costs.