Case: Commissioner of Income Tax, Chennai Vs. M/s. Bilahari Investment (P) Ltd

2. This batch of civil appeals filed by the Department is directed against judgment of the Division Bench of the Madras High Court dated 19.6.2006 in which it has been held that in the matter of chit transaction, the Completed Contract Method of accounting adopted by the respondents-assessees was erroneously rejected by the Department and that the Tribunal had erred in directing the discount to be spread over the balance period of the chit on a proportionate basis. In other words, the controversy arising in the present appeals is whether the Completed Contract Method followed by the assessees and accepted by the Revenue in the past needed to be substituted by percentage of Completion Method as contended by the AO.3. We are concerned with assessment years 1991-1992 to 1997-1998.4. Assessees are private limited companies subscribing to chits as their business activities. They were maintaining their accounts on mercantile basis and they were computing profit/loss, as the case may be, at the end of the chit period following completed contract method, which was earlier accepted by the Department over several years.5. Chit funds are basically saving schemes in which certain number of subscribers join together and each contributes a certain fixed sum each month, the total number of months being equal to the total number of subscribers. The subscriptions are paid to the Manager of the fund by a certain prescribed date each month and the total subscriptions to the fund are auctioned each month amongst the subscribers. At each auction, the lowest bidder is paid the amount of his bid and the balance received from out of the total subscriptions received is distributed equally amongst other subscribers, as premium. The Manager is paid a certain percentage of the collections each month on account of expenses and charges for conducting the auction. In the auction, a maximum amount, which the highest bidder agrees to forego, is the amount, which is distributed to the other members, subject to deduction of the Managers commission.6. In this case, we are concerned with the tax treatment of the difference between the amount contributed and the amount received. In other words, in this case, we are concerned with allowability of the claim for discount underthe Income-tax Act, 1961 ("1961 Act") in order to arrive at "income" under that Act.7. As stated hereinabove, assessees herein have been following completed contract method over the years, which was accepted by the Department. However, for the assessment years under consideration, the AO came to the conclusion that the completed contract method was not accurate in recognizing/identifying "income" under the 1961 Act, and according to him, therefore, in the context of the "chit discount", the correct method was deferred revenue expenditure calculated on proportionate basis. In other words, the AO has preferred percentage of completion method as the basis for recognizing/identifying "income" under the 1961 Act in substitution of completed contract method.8. According to the Department, chit dividend had to be subjected to tax on accrual basis as the assessees were following the mercantile system of accounting. According to the Department, income accrued to the assessees in the form of chit dividend during the year whereas liability arose in the form of chit discount over the relevant period depending upon the remaining number of instalments to be paid.9. As far as the chit dividend is concerned, the Department rejected the completed contract method as suggested by the assessees, which has been accepted by the Tribunal and the High Court. However, in the matter of chit discount, the High Court, overruling the Tribunal, has held that the completed contract method of accounting adopted by the assessees was valid and that the Department had erred in spreading the discount over the remaining period of the chit on proportionate basis.10. In the matter of chit dividend, assessees have accepted the view of the Tribunal and the High Court that the completed contract method was not correct. Therefore, to that extent, the controversy is settled.

Reasoning: 19. In the judgment of the Bombay High Court in Taparia Tools Ltd. (supra) it has been held that in every case of substitution of one method by another method, the burden is on the Department to prove that the method in vogue is not correct and it distorts the profits of a particular year. Under the mercantile system of accounting based on the concept of accrual, the method of accounting followed by the assessees is relevant. In the present case, there is no finding recorded by the AO that the completed contract method distorts the profits of a particular year. Moreover, as held in various judgments, the Chit Scheme is one integrated scheme spread over a period of time, sometimes exceeding 12 months. We have examined computation of tax effect in these cases and we find that the entire exercise is revenue neutral, particularly when the scheme is read as one integrated scheme spread over a period of time.20. As stated above, we are concerned with assessment years 1991-1992 to 1997-1998. In the past, the Department had accepted the completed contract method and because of such acceptance, the assessees, in these cases, have followed the same method of accounting, particularly in the context of chit discount. Every assessee is entitled to arrange its affairs and follow the method of accounting, which the Department has earlier accepted. It is only in those cases where the Department records a finding that the method adopted by the assessee results in distortion of profits, the Department can insist on substitution of the existing method. Further, in the present cases, we find from the various statements produced before us, that the entire exercise, arising out of change of method from completed contract method to deferred revenue expenditure, is revenue neutral. Therefore, we do not wish to interfere with the impugned judgment of the High Court.21. Before concluding, we may point out that under section 211(2) of the Companies Act, Accounting Standards ("AS") enacted by the Institute of Chartered Accountants have now been adopted [see: judgment of this Court in J.K. Industries case (supra)]. Shri Tripathi, learned counsel for the Department, has placed reliance on AS 22 as the basis of his argument that the completed contract method should be substituted by deferred revenue expenditure (spreading the said expenditure on proportionate basis over a period of time). He also relied upon the concept of timing difference introduced by AS 22. It may be stated that all these developments are of recent origin. It is open to the Department to consider these new accounting standards and concepts in future cases of chit transactions. We express no opinion in that regard. Suffice it to state that, these new concepts and accounting standards have not been invoked by the Department in the present batch of civil appeals.