TAXAP/58519/1999 1/30 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD TAX APPEAL No. 585 of 1999 For Approval and Signature: HONOURABLE MR.JUSTICE K.A.PUJ HONOURABLE MR.JUSTICE BANKIM.N.MEHTA ========================================================= 1 Whether Reporters of Local Papers may be allowed to see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ? 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 ? 5 Whether it is to be circulated to the civil judge ? ========================================================= ASSTT. COMMISSIONER OF INCOME TAX - Appellant(s) Versus COROMANDAL INVESTMENT PVT. LTD - Opponent(s) ========================================================= Appearance : MR MANISH R BHATT for Appellant(s) : 1, MR RK PATEL for Opponent(s) : 1, ========================================================= CORAM : HONOURABLE MR.JUSTICE K.A.PUJ and HONOURABLE MR.JUSTICE BANKIM.N.MEHTA Date : 28/07/2008 ORAL JUDGMENT (Per : HONOURABLE MR.JUSTICE K.A.PUJ) 1. The Revenue has filed this Tax Appeal under TAXAP/58519/1999 2/30 JUDGMENT Section 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 ?” 2. 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 TAXAP/58519/1999 3/30 JUDGMENT 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 ?” 3. This Appeal is heard at great length alongwith 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. 4. 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 TAXAP/58519/1999 4/30 JUDGMENT 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. 5. 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 TAXAP/58519/1999 5/30 JUDGMENT 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. 6. 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). 7. In the above background of the matter, the present Tax Appeal is filed by the Revenue. 8. The brief facts of the case giving rise to the present Tax Appeal are; TAXAP/58519/1999 6/30 JUDGMENT 8.1 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. 8.2 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. TAXAP/58519/1999 7/30 JUDGMENT 8.3 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. 8.4 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 TAXAP/58519/1999 8/30 JUDGMENT thereon used to be accounted on accrual basis. 8.5 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 TAXAP/58519/1999 9/30 JUDGMENT 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 under Section 215 and 217 was attracted in the assessee's case. This approach of the department had already resulted into substantial levy of interest TAXAP/58519/1999 10/30 JUDGMENT under Section 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 under Section 215 and 217 but went further and initiated even penalty proceedings under Section 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 TAXAP/58519/1999 11/30 JUDGMENT 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 TAXAP/58519/1999 12/30 JUDGMENT pay it to the credit of the government in time. 9. 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 TAXAP/58519/1999 13/30 JUDGMENT concerned to the account of the company, together with a certificate for tax deducted at source.” 10. 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. TAXAP/58519/1999 14/30 JUDGMENT 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. 11. 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 Ganga Charity Trust Fund, reported in 162 ITR 612 supports the action of the assessee. The Tribunal relying on the decision of the Apex Court in the case of UCO Bank Vs. CIT, reported in (1999) 237 ITR 889 took the view that the facts of the assessee's case are covered by the decision of the Apex Court and hence no interference TAXAP/58519/1999 15/30 JUDGMENT is called for in the order passed by the learned CIT(A). 12. 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 Vs. 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 TAXAP/58519/1999 16/30 JUDGMENT 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. TAXAP/58519/1999 17/30 JUDGMENT 13. 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 TAXAP/58519/1999 18/30 JUDGMENT 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. 14. In support of his submission Mr.Patel has relied on the decision of this Court in the case of CIT Vs. Ganga Charity Trust Fund, reported in 162 I.T.R. 612 and the decision of Calcutta High Court in the case of Snow White Food Product Company (P) Ltd. Vs. CIT, West Bengal, (1983) 141 I.T.R. 861. TAXAP/58519/1999 19/30 JUDGMENT 15. 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 TAXAP/58519/1999 20/30 JUDGMENT 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 under Section 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. TAXAP/58519/1999 21/30 JUDGMENT 16. 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 TAXAP/58519/1999 22/30 JUDGMENT Revenue deserves to be dismissed. 17. 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. TAXAP/58519/1999 23/30 JUDGMENT (ii) Aspect of T.D.S. (iii) Not allowing the TDS while calculating the interest under Section 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 TAXAP/58519/1999 24/30 JUDGMENT 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 Vs. CIT (Supra), wherein it is held that income derived from trust property must be determined on commercial principles and in doing so, all TAXAP/58519/1999 25/30 JUDGMENT 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 TAXAP/58519/1999 26/30 JUDGMENT 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. 18. In the case of UCO Bank Vs. 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 TAXAP/58519/1999 27/30 JUDGMENT loss account of the company is not treated as income. The question whether in a