SUPREME COURT OF INDIA

Commissioner of Income-tax

Bilahari Investment (P.) Ltd.

S. H. Kapadia and B. Sudershan Reddy, JJ.

Civil Appeal No. 1625 to 1632 of 2008

February 27, 2008

Section 145 of the Income-tax Act, 1961- Method of accounting - Change of -Assessment years 1991-92 to 1997-98 - Whether every assessee is entitled to arrange its affairs and follow method of accounting, which Department has earlier accepted, and it is only in those cases where Department records a finding that method adopted by assessee results in distortion of profits, it can insist on substitution of existing method - Held, yes - Assessee-company was subscribing to chits as its business activity - It was following ‘completed contract method’ of accounting which was earlier accepted by department over several years - For relevant assessment years, Assessing Officer substituted ‘completed contract method’ of accounting followed by assessee for chit discount by ‘deferred revenue expenditure method’ - Whether since entire exercise arising out of change of method from completed contract method to deferred revenue expenditure was revenue neutral and method adopted by assessee did not result in distortion of profits, method of accounting adopted by assessee was valid- Held, yes

FACTS

The assessee was a private limited companies subscribing to chits as its business activities. It was maintaining its accounts on mercantile basis and was 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. For the assessment years under consideration, the Assessing Officer came to the conclusion that the completed contract method was not accurate in recognizing /identifying ‘income’ under the Act, and according to him, therefore, in the context of the ‘chit discount’, the correct method was deferred revenue expenditure calculated on proportionate basis. On appeal, the Tribunal rejected the method adopted by the assessee and directed discount to be spread over balance period of chit on a proportionate basis. However, the High Court, overruled the order of Tribunal, and held that the completed contract method of accounting adopted by the assessee was valid and that the department had erred in spreading the discount over the remaining period of the chit on proportionate basis.

On revenue’s appeal to the Supreme Court:

HELD

Recognition/identification of income under the Act is attainable by several methods of accounting. It may be noted that the same result could be attained by any one of the accounting method. Completed contract method is one such method. Similarly, percentage of completion method is another such method. [Para 15]

Under the completed contract method, the revenue is not recognized until the contract is complete. Under the said method, costs are accumulated during the course of the contract. The profit and loss is established in the last accounting period and transferred to profit and loss account. The said method determines results only when contract is completed. This method leads to objective assessment of the results of the contract. [Para 16]

On the other hand, percentage of completion method tries to attain periodic recognition of income in order to reflect current performance. The amount of revenue recognized under this method is determined by reference to the stage of completion of the contract. The sage of completion can be looked at under this method by taking into consideration the proportion that costs incurred to date bears to the estimated total cost of contract. [Para 17]

The above indicates the difference between completed contract method and percentage of completion method. (Para 18)

In the judgment of the Bombay High Court in Taparia Tools Ltd. v. Jt. CIT [2003] 260 ITR 102 it was held that in every case of substitution of one method by another method, the burden is on 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 instant case, there was no finding recorded by the Assessing Officer that the completed contract method distorted the profits of a particular year. Moreover, the Chit Scheme is one integrated scheme spread over a period of time, sometimes exceeding 12 months. On examination of computation of tax effect in instant case it was found that the entire exercise was revenue neutral, particularly when the scheme was read as one integrated scheme spread over a period of time. (Para 19)

In the past, the department had accepted the completed contract method and because of such acceptance, the assessee in the instant case had followed the same method of accounting, particularly in the context of chit discount. Every assessee is entitled to arrange its affairs and follows 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 instant, case it was found from the various statements produced that the entire exercise, arising out of change of method from completed contract method to deferred revenue expenditure was revenue neutral. (Para 20)

Therefore, there was no reason to interfere with the impugned judgment of the High Court and, accordingly, the instant appeal was to be dismissed. [Para 22]

Case review:

Bilahari Investment (P.) Ltd. v. CIT [2007] 164 Taxman 443 (Mad.) affirmed.