ITR/7/1997 1/20 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No. 7 of 1997 With TAX APPEAL No. 22 of 2000 For Approval and Signature: HONOURABLE MR.JUSTICE D.A.MEHTA Sd/- HONOURABLE MR.JUSTICE Z.K.SAIYED Sd/- ========================================================= 1 Whether Reporters of Local Papers may be allowed to see the judgment ? YES 2 To be referred to the Reporter or not ? YES 3 Whether their Lordships wish to see the fair copy of the judgment ? NO 4 Whether this case involves a substantial question of law as to the interpretation of the constitution of India, 1950 or any order made thereunder ? NO 5 Whether it is to be circulated to the civil judge ? NO ========================================================= M/S.ECHKE LTD. - Applicant(s) Versus COMMISSIONER OF INCOME-TAX - Respondent(s) ========================================================= Appearance : MR M.J.SHAH for Applicant(s) : 1, MR MANISH R BHATT for Respondent(s) : 1, ========================================================= CORAM : HONOURABLE MR.JUSTICE D.A.MEHTA and HONOURABLE MR.JUSTICE Z.K.SAIYED Date : 12/03/2008 COMMON JUDGMENT (Per : HONOURABLE MR.JUSTICE D.A.MEHTA) 1 Both in Tax Appeal and the Reference identical ITR/7/1997 2/20 JUDGMENT questions of law as follows have been referred at the instance of the assessee and hence the Tax Appeal and the Reference have been taken-up for hearing together : “1. Whether on the facts and in the circumstances of the case, the Tribunal was right in law in upholding the change in method of accounting adopted by the assessee ? 2 Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the change was such that it disabled the officer to deduce properly the income ? 3 Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the change was for convenience only and was not bonafide as it was adopted at the fag end of the accounting year and that too half heartedly ?” 2 The Tax Appeal relates for Assessment Year 1984- 85 and the Reference relates to Assessment Year 1985-86. The relevant accounting period is the Financial Year ended on 31.03.1984 and 31.03.1985 ITR/7/1997 3/20 JUDGMENT respectively. The common issue arising relates to the change of method of accounting adopted by respondent assessee and rejected by the Revenue. In Assessment Year 1984-85 the Assessing Officer has noted that the assessee had changed the method of accounting from mercantile to cash which resulted in reduction of profits. The assessee was therefore called upon to explain why the amount of Rs.21,14,924/- should not be added to be taxable income. The explanation tendered by the assessee, that the assessee was acting as indenting agent/commission agent for textile mills and due to deterioration in the financial position of the textile mills the commission was not being received by the assessee the method of accounting had been changed from mercantile to cash bonafidely, was rejected. The reasons advanced by the Assessing Officer for Assessment Year 1984-85 read as under : “4. The assessee's arguments are not accepted for the following reasons :- (i) Till 15-3-1984. when the assessee filed the estimate in Form No.29 the income estimated was Rs.22,61,000/- which could not be there, had the assessee ITR/7/1997 4/20 JUDGMENT changed the system of accounting by then. (ii) The decision to change the system was, if it is admitted for the sake of logic, only for the purpose of income-tax. (iii)The Balance sheet of the company reveals that the companies from which the assessee had been getting commission had been paying the commission to assessee regularly as the assessee has not been able to prove that huge amounts were outstanding for long time. The business now-a-days is not based on ready cash settlement but is based mainly on credits. The assessee has shown actual receipts of commission of Rs.9,26,762/-. A temporary phase of delay in receipt cannot justify the change in the method of accounting. (iv) The commission accrued on the supply having been made and the responsibility for collection/realisation being on the assessee it is a hollow argument that the financial conditions of Textile Mills were critical and hence receipts were doubtful. 5. I, therefore, hold that the change of method, if it was, was not for good and sufficient reasons. It may be noted that the expenses booked in the basis of cash method are far in excess of last year. This indicates that assessee has endeavoured to reduce the tax liability ITR/7/1997 5/20 JUDGMENT only. Accordingly, the sum of Rs.21,14,924/- are added to the income of the assessee adopting mercantile system of accounting”. 3 Similar is the position for Assessment Year 1985- 86, the only difference being that in Assessment Year 1985-86 the Assessing Officer has estimated certain expenses on accrual basis and after deducting the same made an addition of Rs.13 lacs. 4 For both the Assessment Years the matter was carried in Appeal before Commissioner (Appeals) who confirmed the orders made by the Assessing Officer. For Assessment Year 1984-85 it has been recorded by Commissioner (Appeals) that :(i) commission agency of the assessee company was terminated at the end of the previous year relevant to Assessment Year 1985-86, and (ii) the outstanding commission was received by the assessee during subsequent Assessment Years. Commissioner (Appeals) thereafter held that : “6.1 Right from the beginning the appellant company has been following the mercantile system of accounting and the only ground ITR/7/1997 6/20 JUDGMENT for the change in the method of accounting with effect from the Assessment Year 1984- 85 is that a substantial part of the commission income was not actually received. In my view, this cannot be a bonafide ground for the change in the method of accounting. Merely because outstanding commission was received by the assessee subsequently over a period of years, it cannot be said that the assessee had become entitled to a change in the method of accounting. I am in full agreement with the view adopted by the learned C.I.T.(A) for the Assessment Year 1985-86 and, therefore, I hold that the Assessing Officer was right in rejecting the claim of the assessee company and, therefore, the addition of Rs.21,14,924/- is confirmed.” 5. For Assessment Year 1985-86 Commissioner (Appeals) rejected the claim made by the assessee on the ground that : (i)the assessee was not in a position to show that the assessee had taken steps to recover outstanding commission, hence delayed receipt of commission payment may as well be understood to be an offshoot of the close proximity which the assessee company had ITR/7/1997 7/20 JUDGMENT with the other two companies, (ii) the assessee company has not established with any evidence that the two principal companies had fallen into financial difficulty and were not in a position to make timely payment of commission, (iii) the assessee continued to carry on business with the same principal companies, (iv) scrutiny of details of sundry credits showed that some unpaid expenditure was also included, (v) as estimate of an advance tax had been made on the basis of mercantile system of accounting and there was long delay in filing return of income the change was an afterthought. 6 The Tribunal took-up the Appeal for Assessment Year 1985-86 prior to Appeal for Assessment Year 1984-85 and recorded that : (i) since the inception of the assessee company commission receipts had been recorded on accrual basis, (ii) as estimate of advance tax was filed considering the receipts on accrual basis switch over to cash system of accounting at the fag end of the accounting ITR/7/1997 8/20 JUDGMENT year indicated that this was an afterthought, (iii) resolution passed by the Board of Directors for effecting the change in method of accounting reveals that the act was motivated by the only consideration that the assessee company was receiving commission belatedly from the two principal companies, (iv) late receipt of commission would not constitute a valid and bonafide cause considering the proximity of relationship between the directors of the assessee company and the two principal companies, (v) in agency business commission accrues as soon as the services are rendered unlike charging of interest which accrues only at a particular point of time, (vi) the change effected by the assessee was such which disabled Assessing Officer to properly deduce the profits and gains of business. The Tribunal accordingly upheld the orders made by Commissioner (Appeals) for both the Assessment Years. 7 Mr. M.J. Shah, learned Advocate appearing on ITR/7/1997 9/20 JUDGMENT behalf of the assessee submitted that the order of the Tribunal has taken into consideration factors which are neither relevant nor germane in light of settled legal position. It was submitted that despite the assessee having categorically pleaded that the change in the method of accounting was not casual or temporary as it had been regularly followed in the subsequent years not only the tax authorities but even the Tribunal has failed to deal with the said issue, and that the said averment has remained undisputed. In support of the submissions made reliance has been placed on three decisions of this Court : (1)C.I.T.Vs.Advance Construction Co.(P) Ltd.(2005)193 CTR 127. (2)C.I.T. Vs. Atul Products Ltd.(2002) 255 ITR 85. (3)C.I.T. Vs. Ganga Charity Trust Fund (1986) 162 ITR 612. It was further contended that in terms of provisions of section 145 of the Act an assessee was entitled to choose the method of accounting, subject to the said method being consistently followed by the assessee. That an assessee is not expected to pay tax on income which is not received during the year even as per the system of accounting followed by the assessee. He, therefore, urged that the orders of the ITR/7/1997 10/20 JUDGMENT Tribunal are required to be reversed and the questions answered in favour of the assessee. 8 Mr. M.R.Bhatt, learned Standing Counsel submitted that the Tribunal had recorded six findings, which were findings of fact, and the cumulative effect of those six findings would go to show that the Tribunal was justified in upholding the view adopted by the departmental authorities. That whether a change in the method of accounting was bonafide or not was a question of fact and this Court should not go behind such a finding of fact. That under provisions of section 145 of the Act, more particularly Proviso under sub-section(1) of section 145 of the Act, the Assessing Officer was entitled to compute the income upon such basis and in such a manner as the Assessing Officer may determine if it was found that the method employed by the assessee, in the opinion of the Assessing Officer, did not permit the Assessing Officer to properly deduce the income even if the accounts are correct and complete. That if it was found that the profits of year one are sought to be shifted to another year, as laid down ITR/7/1997 11/20 JUDGMENT by the Apex Court in the case of C.I.T. Vs. British Paints India Ltd. (1991) 188 ITR 44, the Assessing Officer was entitled to and duty bound to reject the method of accounting and compute the income in the most appropriate manner. 9 In rejoinder the learned Advocate for the assessee submitted that the Apex Court decision in the case of C.I.T. Vs. British Paints India Ltd.(supra) was pressed into service on behalf of the revenue as can be seen from the decision rendered in the case of C.I.T. Vs. Atul Products Ltd.(supra) and after considering the same the Court has come to the conclusion that the said decision of the Apex Court cannot be pressed into service. 10 As can be seen from the frame of three questions referred for the opinion of this Court, the Court is called upon to answer as to whether the Tribunal was justified in law in not upholding the change in the method of accounting adopted by the assessee and for this purpose also answer whether the change was such which would disable the Assessing Officer to properly ITR/7/1997 12/20 JUDGMENT deduce the income and further whether the change was for convenience only, was not bonafide as it was adopted at the fag end of the accounting year and that too half heartedly? Thus, in effect all the findings recorded by the Tribunal, whether on facts or on law, are open for consideration. 11. In the case of CIT Vs. British Paints India Limited the Apex Court was called upon to determine as to whether the method of accounting followed by the assessee therein for valuing the goods in process and finished products exclusively at cost of raw materials totally excluding overhead expenditure was justified or not. The Assessing Officer, the Appellate Authority and the Tribunal held that there was no justification for excluding the overhead expenditure in valuing the stock, that such valuation was not appropriate to the computation of income chargeable under the Act. The High Court had reversed the findings of the Tribunal having regard to the consistent practice of the assessee in valuing the stock-in-trade. While reversing the decision of the High Court the Apex Court held that even if the ITR/7/1997 13/20 JUDGMENT assessee had adopted a regular system of accounting it was the duty of the Assessing Officer u/s. 145 of the Act to consider whether correct profits and gains could be deduced from the accounts so maintained. If the Assessing Officer was of the opinion that the correct profits could not be deduced from the accounts, the Assessing Officer was obliged to have recourse to the Proviso to Section 145 of the Act. As already noticed hereinbefore, neither for A.Y. 1984- 85 nor for A.Y. 1985-86 has the Assessing Officer recorded any finding that due to change in method of accounting the Assessing Officer is not in a position to properly deduce the income of the year under consideration. At the cost of repetition, it is required to be recorded that the principal reason which has weighed with the Assessing Officer is that the assessee was not in a position to show that the financial condition of textile mills was critical and hence receipts were doubtful and that responsibility for collection/realisation of the commission was that of the assessee; that the assessee was not in a position to show that huge amounts were outstanding for a long time. These findings can in no way be ITR/7/1997 14/20 JUDGMENT read to mean that the Assessing Officer was not in a position, on the basis of method of accounting employed by the assessee, to properly deduce the taxable income. In fact, the assessment order itself shows what was the amount which could be treated as commission receipts on accrual basis and what was the amount actually received by the assessee as commission on the basis of cash system of accounting. In these circumstances, the finding of the Tribunal that the change in the method of accounting was such that the change disabled the Assessing Officer to properly deduce the income is a finding without any basis and not supported by any evidence on record. The Tribunal has travelled beyond the scope of the Appeal. The Tribunal could have only recorded such a finding if either the Assessing Officer or the Commissioner (Appeals) had in the first instance invoked the Proviso to section 145(1) of the Act. In none of the two assessment years under consideration has either the Assessing Officer or Commissioner (Appeals) even referred to Proviso to section 145(1) of the Act, much less invoked the said provision and applied to the facts of the case. ITR/7/1997 15/20 JUDGMENT 12 The Courts have consistently held that any change in a method of accounting is bound to make some change in the taxable income, more particularly in the year of change. However, merely because by virtue of the change in the method of accounting employed by the assessee, the taxable income of the assessee stands reduced in a particular year, can by no stretch of imagination, be treated as a factor that the said action was undertaken with an intention to deliberately reduce the tax burden. An assessee is not expected to pay tax on a notional income. Commissioner (Appeals) in his order for Assessment Year 1984-85 has set out the figures for the two years under consideration in the following tabular form : “Asstt. Year Accrued Received. 1984-85 Rs.30,58,037/- Rs.9,26,762/- 1985-86 Rs.16,50,590/- Rs.7,83,255/-” In fact, these figures themselves reflect that only the changed method of accounting would require the assessee to pay tax on real income and not ITR/7/1997 16/20 JUDGMENT notional income on the basis of accrual simplicitor, considering the fact that the principals were not in a position to discharge their respective liabilities. 13 Furthermore, the finding by the Tribunal regarding the change being “half hearted” is neither here nor there. The phrase “half hearted” in plain language means a person does not fully act and whatever action is taken is not followed-up to the hilt. In the present case it is nobody's case that the change in the method of accounting had not been implemented in full. Similarly merely because the change in the method of accounting was undertaken after having filed estimate of income during accounting period in question on the basis of earlier method of accounting cannot be termed as a half hearted act, nor can it be considered to be a relevant factor for considering the bonafides of the action. The reference to the resolution by the Board of Directors and then brushing the same aside on the specious ground that the resolution was motivated by only consideration that the assessee company was actually receiving commission belatedly is not ITR/7/1997 17/20 JUDGMENT warranted; in fact this is a factor which would establish the soundness of the decision to change the method of accounting instead of reading it otherwise. Any existing assessee, when a change in method of accounting is effected, is bound to do so after having regularly employed one type of method of accounting, but that factor cannot be determinative of the bonafides of the assessee in effecting the change because even if such a factor is considered to be a relevant factor, in no case can an existing assessee change the method of accounting. The term change itself indicates that it is a change from an existing state of affairs. Hence, the emphasis on the fact that the asseseee had been following mercantile system of accounting right since inception of the company is misplaced and the said fact can have no relevance while determining whether the change is bonafide or not. The factor about the directors of the assessee company and the two principal companies being closely related is again an irrelevant factor. The revenue has not taken a stand that the two principal companies and the assessee company are not independent entities, or are benamidars of one or the ITR/7/1997 18/20 JUDGMENT other. In fact the two principal companies and the assessee company have been assessed separately as independent entities. Therefore, this factor also, which has weighed with the Tribunal and the departmental authorities is not a relevant factor. 14 The position in law is well settled. That an assessee has to establish that the change in the method of accounting is bonafide and has been consistently followed. This fact can be established only by considering the conduct for the period subsequent to the change. In the present case, despite the assessee having in terms pleaded that the change has been consistently followed after adopting the cash method of accounting, as already noticed hereinbefore, none of the authorities or the Tribunal have dealt with, much less brought any contrary evidence on record to disprove the said statement. Therefore also the finding of the Tribunal that the change was not bonafide does not merit acceptance. 15 The learned Senior Standing Counsel also raised additional contention at this stage that if the ITR/7/1997 19/20 JUDGMENT Tribunal has not dealt with the pleading of the assessee that the changed method of accounting had been consistently followed in subsequent years the matter be restored to the file of the Tribunal for recording a finding because it would not be open to the Court to assume that the averment made by the assessee is correct. This submission requires to be stated only to be rejected. The Tribunal has in terms noted the submission made by the representative of the asseseee in paragraph No. 4 of the impugned order. If the Tribunal has thereafter failed in its duty neither the Revenue can be given second innings nor can the Tribunal be given a chance to buttress its order. The assessee, who putforth its case in no uncertain terms cannot be put to rack because the Revenue and the Tribunal failed in their respective duties. A pleading which has gone unchallenged is deemed to have been accepted and stands proved, that is the basic law of pleadings, and in tax jurisprudence there is no warrant to depart from this settled legal position. 16 In the aforestated facts and circumstances of ITR/7/1997 20/20 JUDGMENT the case each of the three questions are answered in the Negative i.e. in favour of the assessee and against the revenue, both in the Tax Appeal and the Reference. The Appeal is allowed accordingly and both the Reference and the Tax Appeal stand disposed of with no order as to costs. Sd/- (D.A.Mehta, J.) Sd/- (Z.K.Saiyed, J.) M.M.BHATT