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2017 (5) TMI 841 - PUNJAB AND HARYANA HIGH COURT

2017 (5) TMI 841 - PUNJAB AND HARYANA HIGH COURT - [2017] 393 ITR 248 - Method of accounting - switch over from the mercantile to the cash system in the midst of the accounting year - whether the Tribunal was right in holding that the assessees could not adopt a cash system of accounting in respect of the commission received from MAL? - Held that:- Under the second agreement, although the commission was fixed at 1.5 per cent. The receipt thereof may well have been the subject matter of controver .....

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accounting systems ought to be followed. The assessee was, therefore, entitled to switch over from one system to the other.In these circumstances, the assessees were entitled to follow a different system of accounting in respect of their transactions under the new agreement although with the same party, namely, MAL. - A switch over in the midst of an accounting year, especially in such cases, could lead to skewed results. An assessee could then avoid paying the correct advance tax by follow .....

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iderable difficulties in carrying out the assessment. The authorities would understandably be far more reluctant to accept a switch over in the midst of the financial year. Their decision to refuse to accept the switch over in the midst of financial year ought not be interfered with lightly. A switch over in the midst of financial year ought to be permitted by the authorities only in exceptional cases where the same poses no difficulty whatsoever in computing income and the switch over is justif .....

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For the Assessee : Akshay Bhan, Senior Advocate, Alok Mittal, Advocate For the Commissioner : Zora Singh Klar, Senior Standing Counsel JUDGMENT S. J. Vazifdar, CJ. 1. This is a reference by the Income-tax Appellate Tribunal pertaining to the assessment year 1984-85. 2. The Tribunal was of the opinion that the following questions of law raised by the applicant-assessee in their application under section 256(1) of the Income-tax Act, 1961, do arise from its order : "(1) Whether on the facts a .....

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e following facts : (A) The assessee, a registered firm, earned income by way of commission for the accounting period ending March 31, 1984 from M/s. Hero Cycles (P.) Limited, M/s. Highway Cycle Industries Limited, M/s. Rockman Cycle Industries and M/s. Majestic Auto Limited (MAL). This reference relates to the validity of the assessees' having changed their accounting system from the mercantile system to the cash system in the midst of the accounting period ending March 31, 1984. The assess .....

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onth including expenses of TA, DA, postage, telephone, telegrams and other incidentals of the assessee's travelling agent and other staff members and executives, the assessees agreed to provide the services mentioned therein which included sending their representative to the dealers of MAL at various places throughout India. The assessee's representatives were required to forward to MAL daily reports of their visits to each dealer, inter alia, in respect of showroom condition, sale of an .....

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to sell its products to its bulk buyers for which the assessee was not entitled to any commission. Clauses 4, 5, 6, 11, 12 and 13 of this agreement read as under : "4. The selling agents hereby agree to obtain or procure from financially sound buyers in India, orders for minimum 75 per cent. of total production of the product of the principals during any period at the prices and upon the terms specified herein and in the event of his failure to do so, the principals shall have right to ter .....

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ose of the company, whether alone or in conjunction with any other goods, without obtaining the previous consent in writing of the company. 6. That the selling agents will use its best endeavours and shall employ necessary staff to promote and extend the sales of product to all potential buyers thereof . . . 11. That the selling agents shall be entitled to get commission at 1.5 per cent. (including de-lcredere commission) upon the invoice price of the product issued by the principals in India, o .....

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ents shall be responsible for making good the loss on account of bad debts arising out of sale of the products of the principals made during the period of agreement. 13. That all the disputed bills shall be settled by the selling agents at their expenses and the loss on return of goods shall also be borne by them." (C) After entering into the agreement dated October 1, 1983, the assessee changed its system of accounting from the mercantile to the cash basis. The change was only in respect o .....

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arch 31, 1984. 5. The Assessing Officer did not accept the change on the ground that the source of income in respect of all four concerns was the same. The Commissioner of Income-tax (Appeals) upheld the Assessing Officer's decision, as did the Tribunal. The Assessing Officer referred to the authorities relied upon by the parties some of which we will shortly deal with. He also referred to section 145(1), which at the relevant time, read as under : '145. Method of accounting.-(1) Income .....

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e upon such basis and in such manner as the Income-tax Officer may determine. (2) Where the Income-tax Officer is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting has been regularly employed by the asses see, the Income-tax Officer may make an assessment in the manner provided in section 144." The Assessing Officer was of the opinion that the income cannot be properly deduced on account of the change in the accounting .....

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eir having entered into a fresh agreement with MAL dated October 1, 1983. The Commissioner of Income-tax (Appeals), however, held that the nature of income was almost the same even after and in respect of the new agreement dated October 1, 1983 and that it is the same source of income. He upheld the Assessing Officer's opinion that the assessees cannot be allowed to adopt two different methods of accounting. On behalf the Department, considerable emphasis was placed on the following observat .....

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nts of income because the expenses have been claimed on mercantile basis and the gross income has been shown on receipt basis. Keeping in view the above discussion and also the forceful argument of the Income-tax Officer I hold that all the case law quoted by the appellant are not relevant on the facts of this case and the arguments of the appellant's counsel also stand on no footing. I, therefore, further held that it is not a new source of income and keeping in view the dubious method of p .....

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(Appeals). The Tribunal held that the assessee had not adopted the change in the accounting system from mercantile to cash in respect of their other three principals and that the four principals formed a class. The Tribunal, therefore, held that the assessee was not entitled to switch over from the mercantile to the cash system only in respect of its agreement with MAL. The Tribunal also held that the source of income remained the same in respect of all the principals but that it is only the inc .....

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of the respondent/Department that by the word "source", the Tribunal actually meant the "nature" of income. We find that to be so for the source is admittedly different, namely, the four principals. The Tribunal meant that the nature of the income was the same. The Tribunal, however, observed that even assuming that the two agreements were different from each other, the question that remained was whether the change had been brought in respect of a specific source of income or .....

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assessee from switching over from one system to the other. Further, at the relevant time, an assessee was entitled to follow a hybrid system, to wit, a different accounting system in respect of its various transactions. Even in respect of similar transactions, an assessee was entitled to follow either system. This, however, was subject to the Income-tax Officer's power under the proviso to section 145(1) to prevent the assessee from doing so. Under the proviso, even where the accounts are c .....

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counting in respect of different transactions even if they were similar in nature. Strictly, the proviso does not even prohibit the assessee from switching over from one system to the other in the middle of the accounting year. The assessee could do so subject to the Income-tax Officer's right to insist upon a particular basis of accounting in the event of his being of the opinion that income cannot properly be deduced on the basis of the system adopted by the assessee. 11. For the first acc .....

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hypothetical situation where an assessee may switch over several times during the first accounting year or for that matter in any accounting year poses no difficulty. In such a case, the Income-tax Officer would be entitled to decide which system was regularly being followed within the meaning of that expression in section 145(1). It would make no difference even if he comes to the conclusion that neither system could be said to have been regularly followed. In such a case, the Income-tax Offic .....

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n the first principles it is clear that, once the assessee has adopted the mercantile system of accounting, there is no alternative for the Income-tax Officer but to compute the assessee's income on that system, i.e., on the accrual and not the receipt basis. The choice is entirely that of the assessee. He may even choose to adopt the mercantile system for certain trans actions and the cash basis for other transactions, but once having chosen and regularly employed that system, it is not ope .....

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. This is the very evil on account of which section 13 in the Act of 1922 was brought on the statute book. If the assessee could at any moment of time say that he will not debit the interest because of some reason or the other, then it would open the floodgates of evasion. There is also no hardship as the Legislature has expressly provided that, if the income on the accrual basis has been included in the assessee's total income and tax paid thereon but subsequently it is found that that inco .....

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ial position of the debtor was good or not, and whether there was any justification for the assessee not to have made the debit of ₹ 20,400 in the account of this particular debtor. That will be a matter which falls to be considered if and when the assessee claims the amount as a bad debt. It will not be right or proper to make any observations on that aspect of the case in these proceedings, as it may embarrass the assessee. For the reasons given above, the answer to the question will be .....

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ect of a particular transaction and that it would be open to the assessee to vary the terms of a particular contract but the variation must be by mutual agreement. Our view is not inconsistent with these observations. 13. A similar view was also taken by a Division Bench of the Calcutta High Court in CIT v. Kesoram Industries and Cotton Mills Ltd. [1993] 204 ITR 154 (Cal). The Division Bench held as under (page 156) : "The assessee has been consistently following this system in respect of b .....

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ti). The Division Bench held as under (page 500) : "It is for the assessee to adopt any recognised method of accounting for his business. The income shall be computed in accordance with the method of accounting regularly employed by the assessee. In other words, it is open to the assessee to opt for such method of accounting as he deems reasonable and appropriate. He may opt to adopt the manufacturing cost price method or the market price method provided the method is followed in regard to .....

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We agree with these observations except to the effect that the changeover is not permissible in the same assessment year. Section 145 does not prohibit the same. Our attention was not invited to any other provision of law that prohibits it either. As a matter of fact, a switch over in the same assessment year would be allowed far less readily for reasons we will furnish later. That, however, is an aspect that relates to the exercise of discretion in the facts of a case and not to an absolute leg .....

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sion to switch over is otherwise perfectly valid. 16. The entire nature of the two agreements, i.e., the agreement dated March 18, 1981 and the agreement dated October 1, 1983 is different. While considering whether an assessee ought to be permitted to switch over from one accounting system to another, the source of income is not relevant and at least not always relevant. It certainly is not the only relevant consideration. The source may be the same but the nature of the remuneration, the terms .....

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upon the volume of sales or the extent of the marketing services provided. Further, although the title to this agreement was "sole selling agent", the terms and conditions stipulated therein do not indicate that the assessee was a sole selling agency. There was no bar against MAL appointing other agents. Even if there was an implied bar on account of the title, it would make no difference. On the other hand, under the agreement dated October 1, 1983, the assessee's responsibilitie .....

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ly as principal, agent or employee in selling similar goods without MAL's consent in writing. There was no such bar under the earlier agreement. More important, whereas under the first agreement dated March 18, 1981, the assessee was entitled to a fixed remuneration of ₹ 30,000 per month, clause 11 of the agreement dated October 1, 1983 entitled the assessee to commission at 1.5 per cent. upon the invoice price. Equally important is the fact that under clause 13 the disputed bills were .....

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hough the commission was fixed at 1.5 per cent. The receipt thereof may well have been the subject matter of controversy and uncertainty, inter alia, on account of clauses 11 and 13. The controversy and the disputes could lead to litigation which in turn would be resolved only after years. The assessees, therefore, would not at any given point of time know with any degree of certainty as to the amount that they would be entitled to during the financial year. The uncertainty of receiving the amou .....

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justified in refusing to permit the assessees switching over from the cash to the mercantile system during the midst of the financial year. We think he was, for more than one reason. For instance, as recorded in paragraph 5.1 of the assessment order : "5.1 . . . Further the income (net income) means the gross income less expenditure relevant for earning that gross income. In the case under appeal the Income-tax Officer has established beyond doubt while arguing the case before me that the .....

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