TMI Blog2002 (3) TMI 221X X X X Extracts X X X X X X X X Extracts X X X X ..... to have sustained the rejection of accounts when the Assessing Officer himself has observed that the accounts are correct and complete and in accordance with the guidelines of the Institute of Chartered Accountants of India. 5. The learned CIT(A) ought to have considered the detailed explanations and submissions made by the assessee to establish the correctness of the system followed by it both for the purposes of Companies Act as well as Income-tax Act. 6. The learned CIT(A) failed to appreciate that the method followed by the assessee being based on the guidance of the Institute of Chartered Accountants of India, is very scientific and considered every aspect of the transaction and the business in contra distinction to the method followed by the Assessing Officer which fails to address several issues that will arise like, treatment of balancing charge at the time of completion of transaction, treatment of lease adjustment account credited etc. 7. The CIT(A) ought not to have been carried away by the conclusions drawn by the Assessing Officer which appear to have been heavily based upon the consideration that the allowance for depreciation under Income-tax Act is much more t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... minal adjustment account amounting to Rs. 13,16,123. On appeal, the learned Commissioner of Income-tax (Appeals) upheld the order of the Assessing Officer. While doing so, he held that the method prescribed by the ICAI is perfectly alright as long as depreciation is claimed as per Companies Act but not when depreciation is claimed as per the Income-tax Act, and held that the assessee cannot have the benefit of both the systems. He held that by claiming a higher depreciation under the Income-tax Act, the assessee had already obtained more deduction than the amount of principal recovered as per its method of accounting. The learned Commissioner (Appeals) concluded that by choosing to claim depreciation as per the I.T. Act, the assessee had already excluded itself from the method of calculation of lease equalisation method for which depreciation debited in its books of account was the determining factor. Aggrieved by this addition, the assessee preferred this appeal. 6. The learned counsel for the assessee vehemently contended that the Assessing Officer erred in invoking the provisions of section 145(1) of the Act. He submitted that the nature of transaction was not properly underst ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her debited or credited depending on the quantum of allowable statutory depreciation. He submitted that if the capital recovery is more than statutory depreciation, lease equalisation will be debited and that if the capital recovery is less than statutory depreciation, lease equalisation fund will be credited. He further submitted that over the period of lease term, the targeted return implicit in the lease is disclosed in the profit and loss account. 6.1 He vehemently argued that the company has followed the method of accounting not only because this is the only method available but also because the company is legally bound to follow the method of accounting prescribed by the Institute of Chartered Accountants of India. He argued that the company is a non-banking finance company registered with the Reserve Bank of India and that the Department of Non-banking Supervision of the Reserve Bank of India in its regulatory framework for Non-Banking Financial Companies, 1998 clearly states that all NBFCs have to comply with the Guidance Note issued by the Institute of Chartered Accountants of India on accounting for leases etc. and that it is mandatory and incumbent on the part of NBFCs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lowed the methods suggested in the Guidance Note scrupulously. The only difference, as per the counsel, is that the terminology used was 'lease terminal adjustment account' instead of 'lease adjustment account'. He further submitted that the Assessing Officer himself had agreed that the assessee had scrupulously followed the guidance note. The Assessing Officer did not agree with the method suggested in the guidance note as according to the Assessing Officer the accounting treatment may be good for the purpose of Companies Act or for the purpose of Reserve Bank of India regulation but not for the purpose of Income-tax Act. He submitted that the Assessing Officer held: (a) that the method of accounting cannot affect the charging section itself; (b) that the rates of depreciation under Income-tax Act are higher compared to the rates of depreciation allowed under Companies Act; and (c) that if the rate of depreciation under the Income-tax Act is adopted for the purpose of accounting gross rentals would increase substantially. He argued that the Assessing Officer with a view to demonstrate that the method of accounting suggested by the Guidance Note is not good enough for the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he first accounting year, but in the subsequent years, there would be divergence in both. He argued that lease equalisation account is a revenue item dealt with in the profit and loss account whereas lease adjustment account is a capital item dealt with in the balance sheet. The balance in the lease Adjustment Account at the end of the year actually represents the cumulative position of the Lease Equalisation Account. The learned counsel for the assessee pointed out that this aspect does not appear to have been noticed by the Assessing Officer while disallowing the deduction of Lease Adjustment Account. Though the Assessing Officer has explained the lease terminal adjustment account rather correctly at page 5 of his order, according to the counsel for the assessee, he erred while illustrating the Lease Equalisation Account. It is here, he submitted that the Assessing Officer lost track of the concept and he might have thought that because Income-tax Rules are providing for more depreciation that Schedule XIV, it would also take care of the true and fair view of the account. The Assessing Officer has given an illustration at page 8 of his order to show that there would be a substant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... counsel submitted that this clarification cannot be taken as a licence to disturb the entire method of accounting in whatever fashion one may desire. According to him, the clarification is only to be understood in the limited sense that whenever certain provisions of taxation laws are available for treating certain taxable incomes such provisions take precedence over the recommendations made in the guidance note. A statute will always have precedence over other forms of guidance available. He therefore submitted that the said clarification should not be misconstrued as otherwise it will make the entire exercise in evolving the guidance note on a complex issue like this an exercise in futility. He submitted that if a statute provided for a particular rate of depreciation that should be applied. The assessee has only followed a method of accounting recommended by a competent professional body i.e. the Institute of Chartered Accountants of India which has the statutory mandate. He pointed out that the assessee's case is not isolated one as there are large number of companies in this line of business which have published accounts almost all of whom have followed the concept lease equa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d substantially as the depreciation rates under I.T. Rules are much higher than what is prescribed under Schedule XIV of the Companies Act. This gives distorted picture of the profits for the current year. (c) By following the guidance note, the assessee intends to shift his tax liabilities to another year which is an incorrect method of computing profits and gains for tax purposes. As held by the Supreme Court, such assessment year is a self-contained unit and the profits of one year cannot be shifted to another year. Under section 5 of the I.T. Act, since the income has already accrued by way of lease rentals, the same cannot be shifted to another year by way of appropriation towards lease equalisation. (d) The method of accounting followed by the assessee for accounting lease rentals is such that true and correct profits cannot be deduced therefrom, and therefore, under the first proviso to section 145(1), the total gross lease rentals of Rs. 26,03,246 are adopted for computing income for I.T. purposes without any adjustments towards lease equalisation. (e) The CIT (Appeals)-I vide order No. 25/DC(A)-I/CIT(A)-II/97-98 dated 27-1-1998 in the case of Global Trust Bank Ltd. f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bench found that when the method in the books of account represented real income, the same has to be taken into account and where it does not so represent, section 5 takes precedence. He submitted that he relied on this very judgment of the Tribunal as the submissions of the assessee in the present case are the same as in the above case viz., (i) that the accounts are made in accordance with the guidance note issued by the Institute of Chartered Accountants of India and (ii) that these are approved by the Board of Directors and shareholders and auditors. He then drew the attention of the Bench to the methodology adopted by the Institute of Chartered Accountants of India while issuing the guidance note to demonstrate that it was well debated by an Expert Committee after circulation of draft proposals and submitted that it should not be disturbed so easily. 9. The learned counsel for the Revenue arguing on the departmental appeal submitted that the learned Commissioner (Appeals) erred in holding that methods like IRR method on the net loan amount should be adopted in determining the income from those leasing finance items covered under VDIS. He relied on the order of the Assessing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ejecting the method of accounting employed by the assessee in its books and directing the Assessing Officer to recompute the income with reference to the terms contained in hire purchase agreements and leasing agreements entered into by the assessee with its customers. The learned CIT(A) made certain uncharitable remarks against the assessee for adopting this internationally recognised and scientifically devised method of accounting under the wrong notion or belief that the assessee by adopting the said method had shown non-existent income. The assessee cannot be found fault with for adopting SOD/index method of accounting. It is in accordance with Accounting Principles from which income can properly be deduced. Accordingly we hereby set aside the order of the first appellate authority on this issue and restore that of the Assessing Officer rejecting the assessee's claim for deduction of the differential income of Rs. 77,18,317 from the net profit as per the profit and loss account in the printed accounts of the assessee company. Accordingly, the Revenue's appeal is allowed upholding the assessment made by the Assessing Officer in accordance with the method of accounting employed b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s asset on which the lessor has claimed depreciation. In the case of lease rentals the assessee has not apportioned the total amount realised from the lessees between the finance charge and the principal component, but has credited the entire amount as income of revenue nature. The assessee has not periodically transferred any amount in lease equalisation Account with a corresponding debit or credit to lease adjustment account, as indicated in the Guidance Note. In fact, the IAS-17 shows that where plant and equipment is shown as an asset and depreciation is claimed by the lessor, the rental income should be recognised on a straight line basis over the lease term and depreciation of leased assets should be termed on a basis consistent with the lessor's normal depreciation policy. 42.1 In the aforesaid example, the assessee has a right to receive annual lease rent of Rs. 30 per annum as per the lease agreement. The income which accrues to the assessee as per the Agreement is only Rs. 30 per annum. Any amount of income accounted for in the books of account in the first few years of the lease term beyond the amount of Rs. 30 clearly represents hypothetical income which did not in fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of even the Institute of Chartered Accountants of India, the assessee cannot be permitted to change it for tax purposes merely on the ground that it accounted for the higher income than what according to the assessee was alleged to have accrued or arisen in the previous year as per tax jurisprudence. The SOD/Indexing Method, according to the assessee itself, is a system for accounting income on accrual basis, how can they therefore, be allowed to say that the accounted income was higher than what had accrued to them? It cannot be alleged that SOD/Indexing Method is such as does not reflect the proper income of an assessee. This system has been accepted under the Companies Act whereunder also income is accounted on accrual, basis in an accounting year. It would, therefore, be anomalous to say that the accounts maintained by SOD/Indexing Method depict true and fair picture of the profit and loss under the Companies Act, but a different picture when it is seen with reference to income-tax." 13. In the case on hand the arguments of revenue are just the opposite to their arguments in these two cases. The pleadings of the Department in those cases that the income should be computed in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ason to the application of the provisions of section 145 of the I.T. Act, especially in view of the fact that this system of accounting is followed by the assessee uniformly and regularly for the past several years, and was accepted by the Department without quarrel. It is not open to the ITO to intervene and substitute a system of accounting different from the one which is followed by the assessee, on the ground that the system which commends to the ITO is better." The principles that can be deduced from this jurisdictional High Court decision which to our mind are in favour of the assessee are: (a) The choice to account for income on an acceptable basis, or in other words the choice of the Method of Accounting is that of the assessee though it is not an unlimited choice. (b) There should be some material to indicate why the Income-tax Officer considers the system of accounting regularly employed by the assessee to be defective. (c) There should be a finding that the system of accounting followed by the assessee is such that correct profit cannot be deduced therefrom. (d) The Assessing Officer has power as per provisions of section 145 to substitute the system of account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... epartments felt that this is a fair method to arrive at correct profits. The assessee, has exercised his choice of the method which is considered fair and correct and thus the Assessing Officer has no choice to reject the same under section 145. 15. Now we shall examine the assessment order. The Assessing Officer has agreed that the Company has followed the methods suggested in the Guidance Note scrupulously. The first aspect to be considered is whether the Assessing Officer is right in coming to the conclusion that the method of accounting followed by the assessee does not show the correct profit. The second aspect to be examined, is whether the Assessing Officer could substitute the method of accounting followed by the assessee. By a suitable alternative which can also be said to be a correct method of accounting. 15.1 Coming to the second aspect first, we observe that the Assessing Officer could not come out with a substitute or alternative method of accounting. The learned counsel for the assessee has clearly demonstrated that the Assessing Officer has erred on a number of issues and that the examples cited by him are flawed and incorrect and that when completed lead to ill ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le or rejected as a whole and when so rejected an alternative and demonstratedly acceptable and recognised method of accounting has to be adopted. Thus we hold that the Assessing Officer could not come up with a suitable and acceptable method of accounting as a substitute to the one adopted by the assessee." 15.2 Coming to the first aspect, we do not agree with the proposition of the Assessing Officer that the method of accounting suggested by the Institute of Chartered Accountants of India is not one from which correct profit cannot be deduced. This is an internationally accepted method having the sanction of the Institute of Chartered Accountants of India. As already stated this method has been approved and made mandatory by the RBI and also under the Company Law. In fact a number of companies have been following this method. An illustrative list of companies which have published their accounts cited before us by the learned counsel for the assessee and not controverted by revenue are as under: 1. Raymond Synthetics Ltd. 2. DCM Shriram Leasing Finance Ltd. 3. Greaves Leasing Finance Ltd. 4. Gujarat Lease Financing Ltd. 5. Gujarat Gas Financial Services Ltd. 6. ITC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contention of the appellant." demonstrate to our mind, a prejudice against the higher rate of depreciation provided under the Income-tax Act rather than the method of accounting followed by the assessee. We do not understand how a higher rate of depreciation upsets a method of accounting. When we carefully go through the method of accounting given by the ICAI, we find that out of the four elements considered in the Profit Loss account i.e. (i) Lease rentals, (ii) Implicit rate of return, (iii) Depreciation, and (iv) Lease equalisation, while three are known factors, i.e. lease rentals, I.R.R. and depreciation, the fourth one is obviously arrived at by balancing the other three. Thus the quantum of depreciation that is allowed does not invalidate the method of accounting as lease equalisation varies directly in proportion to the quantum of depreciation. The depreciation whether arrived at by applying the rates provided in the Companies Act or arrived at by rates provided under the Income-tax Act does not in any way affect the recognition of income. The logic that, when a particular rate of depreciation is applied or when a particular rate of I.R.R. is applied would res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the proposition of the learned Departmental Representative as it is not the basis on which the assessment is done. This also demonstrates that the assessee has declared income as per that the method of accounting suggested by the Institute of Chartered Accountants of India which is a proper method and has to be accepted. We, therefore, hold that the method of accounting regularly followed by the assessee cannot be rejected by application of section 145 of the Act as it cannot be said that proper income cannot be deduced there from. This is an acceptable basis for arriving at income and it is the choice of the assessee, which the Assessing Officer should accept. This is not a case of a mere disallowance of a claim. Moreover, the judgment of the jurisdictional High Court in the case of Margadarsi Chit Funds the decision of the Tribunal in the case of Shri Dinesh Mills Ltd, of the Bombay High Court in the case of Indo Nippon Chemical Co. Ltd. and those of the Hyderabad Bench of the Tribunal in the cases of Nagarjuna Finance Ltd. and Nagarjuna Investment Trust Ltd. are in favour of the assessee. 18. In the result, the appeal of the assessee is allowed and the addition of Rs. 13,16, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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