Commissioner of Income Tax vs Baroda Industrial Development Corpn. Ltd.

A.M. Ahmadi, J.—The assessee, Ganga Charity Trust Fund, is a charitable trust. The relevant assessment years are 1971-72 and 1972-73. In the assessment year 1971-72 the assessee claimed an amount of Rs. 76,972 by way of deduction as an amount applied for charitable purposes u/s 11(1)(a) of the income tax Act, 1961 (''the Act''). In that year the assessee was following the mercantile system of accounting. The ITO refused the deduction whereupon the assessee carried the matter in appeal before the AAC. The AAC confirmed the order of the ITO on the ground that the payment of income tax was merely an appropriation of income and could not, therefore, be allowed by way of deduction. In further appeal to the Tribunal, the assessee attempted to raise an alternative contention, but the Tribunal did not permit it, since that alternative contention is not raised in the question referred for our opinion, we need not state it. However, on the substantive ground the Tribunal held that the payment of income tax was a charge on income on outgoing which ought to be taken into consideration before determining the net income for the purpose of application or setting apart, as the case may be, u/s 11(1)(a). In the view of the Tribunal, the deduction of income tax is a necessary outgoing which has to be considered before the net income capable of application for the purposes of the trust could be ascertained. The Tribunal, therefore, upheld the assessee''s contention and allowed the deduction. On the above facts, so far as the assessment year 1971-72 is concerned, two questions have been referred for this Court''s opinion. They read as under:

1.Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that income tax liability for an amount of Rs. 76,972 should be allowed as deduction u/s 11(1)(a) of the income tax Act, 1961 ? and

Whether the finding of the Tribunal that in order to give meaning to the expression ''income'' the deduction of income tax liability must be taken as an outgoing before the surplus could be ascertained and that while determining the ''income'' or the surplus available to the trust for the purpose of application of its income towards charitable or religious objects it is the surplus realised or available on commercial principles has to be taken into consideration and not as per the provisions of the income tax Act is correct in law ?

In the subsequent assessment year 1972-73 the assessee changed to cash system of accounting. It submitted a return showing a deficit of Rs. 25,828. The contention of the assessee was that it had not received any income during the previous year relevant to the assessment year in question and, therefore, it was not required to apply any income towards the purposes of the trust. The assessee pointed out to the ITO that the companies with which the assessee had deposits had not paid any interest to the assessee and, therefore, the assessee had not actually received the interest amount in cash and was, therefore, not in possession of income which it could apply for the purposes of the trust. It may here be mentioned that the assessee had placed deposits on interest with Hindustan Tractors and Earth Movers (P.) Ltd., which were in financial difficulties and were, therefore, not able to pay interest on the deposit money. The ITO, however, took the view that the assessee was liable to pay tax on accrued interest and was not justified in changing the method of accounting during the relevant assessment year. The assessee carried the matter in appeal to the AAC, who took note of the fact that the assessee was a charitable trust which had in vested various funds into two concerns and had not received any payment towards interest because the said two concerns were in financial difficulties. The AAC also pointed out that since the method of accounting had been changed to cash basis, the assessee was not under obligation to apply the income for charitable purposes u/s 11(1)(a) since such income was not available for application and allowed the deduction of Rs. 68,674. The revenue carried the matter in appeal to the Tribunal. The Tribunal reiterated its view in regard to the deduction permitted for the assessment year 1971-72 and stated that income had to be computed on general commercial principles and not on notional basis for the purpose of application u/s 11(1)(a). Applying the general commercial principles it held that the assessee had not received any income which could be applied or set apart for the purposes of the trust. The Tribunal, accordingly, dismissed the revenue''s appeal.

On the facts, so far as the assessment year 1972-73 is concerned, the following questions have been referred to us for opinion:

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the assessee was justified in changing its method of accounting from ''mercantile'' to ''cash system'' as the companies where the assessee had deposited the monies and had not paid any interest during the past years including the previous year relevant to the assessment year in question on account of financial difficulties ?

Whether, on the facts and in the circumstances of the case, the Tri- bunal was justified in law in holding that the assessee could not be said to have received any income in commercial sense of the term during the previous year relevant to the assessment year in question and, hence, it was not under any obligation to apply any income towards trust objects u/s 11(1)(a) of the Act ? and

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the action of the income tax Officer in bringing to tax income of the assessee which was notional could not be justified in law ?

It would appear from the above facts and the questions formulated for our opinion that mainly two questions arise for consideration, namely, whether the assessee-trust was entitled to deduct the amount of income tax paid by it from the total income in order to be able to apply or set apart the income u/s 11(1)(a). Secondly, we are called upon to decide whether the assessee was justified in switching over to the cash system of accounting from the assessment year 1972-73 in view of the difficulties experienced because of non-receipt of interest income from the depositary companies as they experienced financial difficulties.

Section 11(1)(a) with which we are concerned reads as under:

(1) Subject to the provisions of sections 60 to 63, the following income shall not be included in the total income of the previous year of the person in receipt of the income-

(a)income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of twenty-five per cent of the income from such property;

On a plain reading of this sub-section it becomes clear that the income referred to in clause (a) is not liable to be added to the total income of the previous year of the assessee in receipt of the income to the extent to which such income is applied for the purposes of the trust in India and where such income is accumulated or set apart for application to such purposes in India, to the extent to which the income is so accumulated or set apart is not in excess of 25 per cent of the income from such property. It is, therefore, clear that the income derived from property must be such as can be applied for the purposes of the trust or accumulated or set apart for such application at a future date not exceeding 25 per cent of the income from such property. The word ''applied'' was construed by the Supreme Court in H.E.H. Nizam''s Religious Endowment Trust, Hyderabad Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, and the Supreme Court stated that it envisaged actual application of the income for the purposes of the trust. Similarly, the word ''accumulated'' meant the income so set apart during the year for future spending on such purpose. There can be no actual application or setting apart or accumulation of income derived from trust property unless it is actually available for application or accumulation in the hands of the trustees. Where an assessee is following the mercantile system of accounting income on accrual basis may be reflected in the account books, but such notional income is incapable of actual application or accumulation u/s 11(1)(a) and if the assessee-trust is called upon to pay income tax for want of such application or accumulation, it would result in rendering the benevolent provision found in clause (a) of section 11(1) nugatory. Therefore, on plain reading of section 11(1)(a) the view taken by the Tribunal commence to us.

In Commissioner of Income Tax Vs. Trustee of H.E.H. The Nizam''s Supplemental Religious Endowment Trust, the Andhra Pradesh High Court held that the payment of income tax and wealth-tax, made during the relevant year related to the previous assessment years, were incidental to the carrying out of charitable purposes of the trust. Such payments were, outgoing in that particular year and were, therefore, incidental to the carrying out of the objects of the trust and had, therefore, to be excluded from the income of the trust. In Commissioner of Income Tax Vs. Rao Bahadur Calavala Cunnan Chetty Charities, , the Madras High Court held that the income from the properties of the trust would have to be arrived at in the normal commercial manner without classification under the various heads set out in section 14 of the Act. The same High Court in Commissioner of Income Tax Vs. Estate of V.L. Ethiraj (by Official Trustee), held that income from the property held under trust would have to be arrived at in the normal commercial manner without reference to the provisions of section 14. In Commissioner of Income Tax Vs. Janaki Ammal Ayya Nadar Trust, , the Madras High Court held that where the entire income of the trust during the relevant assessment year had been applied for payment of tax, it had to be treated as having been applied for charitable purposes and the assessee would be entitled to exemption. It further held that in such a situation there would be no income in the relevant assessment year for being spent for charitable purposes, as the amount of income tax paid be taken into account of income for the determination of the commercial profits and available surplus in the hands of the trustees for application for the purposes of the trust. The said payment must, therefore, be taken to be an outgoing of the year in which it was paid and as such treated as actual expenditure to be deducted before calculating the surplus income.

The view taken by the Courts in the above referred cases is that before determining the income which could be actually applied or accumulated for the purposes of the trust u/s 11(1)(a) all outgoings, including the outgoing in the nature of payment of income tax, must be deducted. It is only from the surplus income that remains in the hands of the trustees that actual application or accumulation for the purposes of the trust can be expected. If there is no income which could be actually applied or accumulated by the trustees for the purposes of the trust, the trustees would be incapable of actually applying or accumulating the income for taking benefit of section 11(1)(a). There fore, even in the case of an assessee following the mercantile system of accounting, there can be no doubt that for the purposes of actual application or accumulation or setting apart of income from trust property for the purposes of the trust, the trustees must have on hand income which could be so utilised and what is outgoing towards payment of income tax must be deducted for working out such surplus income. If a notional income calculated on the basis of accrual under the mercantile system of accounting is conceived as income for the purposes u/s 11(1)(a), it must be conceded that such notional income can never be actually applied or accumulated or set apart for the purposes of the trust and the assessee-trust would while being liable to pay income tax on accrual basis not be able to derive the benefit conferred by the said provision. We are, therefore, of the view that the Tribunal was right in coming to the conclusion that the income derived from trust property must be determined on commercial principles and in doing so all outgoings, including outgoing 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 this view that we take, we do not feel called upon to examine the second contention based on the decisions referred to above, whether the expenditure incurred by the trust for the payment of income tax can be said to be actual application of income for the charitable purposes of the trust in India.

On the second question regarding the change of system of accounting, we find that when the assessee-trust 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 cash system of accounting, so that it may not be required to pay income tax on notional income as on earlier occasions. There is nothing in the Act which precludes the assessee, who bona fide desires to switch over to another system of accounting from doing so. There is no finding of fact that the switch over to the cash system of accounting in the previous year relevant to the assessment year 1972-7 3 was not bona fide. Besides, it is not shown by the revenue that this change lacked durability or regularity and was merely a stop-gap arrangement to avoid payment of tax. In such a situation we fail to understand, why a bona fide assessee should be precluded from switching over to another system of accounting which he finds convenient and which would reflect his real income. In Commissioner of Income Tax Vs. Rajasthan Investment Co. (P.) Ltd., , the Calcutta High Court held that on the Tribunal''s finding that the change of the method of accounting of the assessee was bona fide and in keeping with real state of affairs of its business the Court held that the change in the method of accounting was proper and permissible. In Reform Flour Mills (P.) Ltd. v. CIT [1978] 114 ITR 227, the Calcutta High Court held that it was open to a taxpayer to adjust his own affairs in such a way that his tax liability may be reduced, provided the means employed are lawful. It further held that section 145(1) of the Act does not place any embargo on the assessee''s right to alter the method of accounting. In other words, according to their Lordships, the assessee was entitled to change his method of accounting unilaterally. In Snow White Food Products Co. Ltd. Vs. Commissioner of Income Tax, , the Calcutta High Court reiterated that an assessee is entitled to change his regular method of accounting by another regular method and such a change can be effected even in respect of a part of the assessee''s income. According to their Lordships, a recognised method of accounting followed regularly would necessarily result in a proper computation of assessee''s real income. Even if one regular method of accounting is substituted by another regular method, the same result will follow. It is only in a case where the assessee changes his regular method of accounting and does not follow the change regularly thereafter that it may be possible to say that by introducing he proposes to exclude certain items in the computation of his total income. In such a case the bona fides of the assessee may be doubted. Unless there is material on record to hold that the assessee''s action is not bona fide the change in the method of accounting must be accepted.

In view of the above discussion, we are of the opinion that the circumstances in which the assessee was placed compelled the trustees to switch over to cash system of accounting which was the only course open to a prudent trustee for preserving the property of the trust. In the view that the Tribunal took, the Tribunal has not expressed any opinion on this question, but since the question has been specifically referred to us, we have dealt with the same. We are, therefore, of the opinion that 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. For the above reasons, we answer both the questions relating to the assessment year 1971-72 in the affirmation, i.e., in favour of the assessee and against the revenue, and the first question relating to the assessment year 1972-73 also in the affirmative, i.e., in favour of the assessee and against the revenue. In view of our reply to question No. 1, it is not necessary for us to answer question Nos. 2 and- 3 insofar as the assessment year 1972-73 is concerned. The reference stands disposed of accordingly with no order as to costs.