Bombay H.C : The petitioners are a firm of solicitors and advocates enrolled more than fifty years ago. As such the petitioners are subject to the Rules framed by the Bombay High Court in respect of maintenance of accounts relating to their professional work.

High Court Of Bombay

Manilal Kher Ambalal & Co. vs. A.G. Lulla, ITO & Ors.

Section Art. 226, 145, 144A

Asst. Year1985-86

Sujata V. Manohar, J.

W.P. No. 822 of 1988

8th June, 1988

Counsel Appeared

Dilip Dwarkadas, R.J. Kolaha, P.D. Shah & Vikram B. Trivedi i/b Manilal Kher Ambalal and Co., for the Petitioners : V.R. Bhatia, for the Respondents


The petitioners are a firm of solicitors and advocates enrolled more than fifty years ago. As such the petitioners are subject to the Rules framed by the Bombay High Court in respect of maintenance of accounts relating to their professional work.

2. Under r. 10 of the Rules of the Bombay High Court, Original Side, the petitioners are required to keep separate accounts in respect of monies received from or on account of their clients. This amount is required to be kept in a separate account in the bank in the name of the advocates which is known as “Client’s account”. Rule 12 describes what money can be paid into a client’s account. Rule 13 prescribes what money can be withdrawn from a client’s account. It, inter alia provides that no money shall be drawn from a client’s account other than money properly required for payment to or on behalf of a client or for or towards payment of a debt due to the advocate from a client or money drawn on client’s authority. For over 35 years, the petitioners have followed a system of accounting which is consistent with these rules. As per their accounting practice, the petitioners treat all deposits received from their clients as deposits towards costs and they are deposited in clients’ account. The expenses which are incurred over the years by the petitioners in connection with the matter of any client are included as professional expenses in the profit and loss account of the year in which the expenses are incurred. After the litigation of the matter of the client is over, the account is finalised and an amount which covers the fees of the petitioners as also reimbursement for the expenses incurred over the years is brought from the client’s account into the profit and loss account of the relevant year as income of the petitioners. In other words, the account between the petitioner and their client is finally adjusted after the work is complete and the income is shown in the year in which the work is so completed. This method has been accepted by the IT Department as a valid method for computing income for the last 30 years or more.

For the asst. yr. 1985-86, however, the ITO raised an objection to this method of accounting. By his letter dt. 1st Dec., 1987, he called upon the petitioners to furnish details in respect of client’s deposits showing (i) name of the client and suit number; (ii) amounts received as deposit; (iii) nature of deposit; (iv) expenses incurred during the year on behalf of the client; (v) whether set off against the deposit during the year ; (vi) if yes, the date of set off ; and (vii) if no, reasons thereof. He also stated, “Please state as to why expenses incurred on behalf of the clients and not set off against the deposits should not be added to the professional receipts and taxed accordingly.”

The petitioners objected to being called upon to give these particulars which would require them to re-examine their accounts for the last several years. Ultimately, the ITO, by his letter dt. 25th Jan., 1988, made a reference to the IAC under s. 144A of the IT Act, 1961, regarding the taxability of clients’ deposits. By his order dt. 23rd March, 1988, the IAC has given directions to the ITO that he should call upon the petitioner to furnish the information called for by the ITO and to take appropriate measures if the assessee fails to comply with the questionnaire. He has also given directions to the ITO that he should decide major expenses incurred on behalf of the clients by the petitioners to be adjusted against the relevant clients’ deposits and, on this basis, he should work out the correct income of the assessee. It is not clear from this direction as to whether the ITO has to examine the accounts for one year or past years and how many assessments are required to be reopened if this system of accounting has to be followed. The IAC has also given a further direction that if the ITO is unable to determine correctly all facts relating to such deposits he may make a fair estimate of income. These directions are challenged in the present writ petition.

Under s. 145 of the IT Act, 1961, income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall be computed in accordance with the method of accounting regularly employed by the assessee : provided that where the accounts are correct and complete to the satisfaction of the ITO but the method is such that, in the opinion of the ITO, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the ITO may determine.

In the present case, the petitioners are following regularly a method of accounting which is acceptable in their profession and this method of accounting has been accepted as disclosing the correct income of the assessee by the ITO for the past 30 years and more.

In Principles and Practice of Book-keeping and Accounts by B.G. Vickery, Twenty-first edition, at page 380, there is a discussion on solicitors’ accounts. It says “The fiduciary relationship which is usually found to exist between solicitor and client points to the need for a careful and accurate system of accounting.” The rules relating to the maintenance of accounts which are cited in this connection are very similar to the Rules which are framed by the Bombay High Court under its Rules on the Original Side. There appears to be a total confusion and misunderstanding in the minds of the IAC in relation to the method of accounting which has been adopted by the petitioners. He has failed to appreciate that litigation may be protracted over a number of years. The deposit which is made in advance may or may not cover the expenses which have to be subsequently incurred over a number of years. There may even be expenses incurred in connection with such litigation which may not be covered by the deposit at all. It is when the final accounts are made up between the advocate’s firm and his client that the expenses are adjusted and the fees are realised. There is nothing, therefore, improper in keeping such deposit in a client’s account and adjusting it on the termination of the professional work. In fact, it is quite possible that in the years in which expenses are incurred in connection with a particular matter, the advocate may not have received any amount at all. Such receipt may have been in the previous years or may even be in the subsequent years. It would be extremely cumbersome to adjust every item of expense against the deposit. There would also be difficulties on account of the rules relating to such adjustment.

In fact, the IAC has himself referred to the converse method which is sometimes adopted by firms of solicitors and advocates where some of the firms credit the entire deposits received as their income and offer it to tax in the year of receipt ; while expenses are deducted as and when they are incurred. Whether one method is followed or the other, the result is the same. Anyway it is not possible to co-relate deposits received with expenses incurred. There was, therefore, absolutely no basis for coming to the conclusion that the method of accounting adopted by the petitioners was such that income could not properly be deduced therefrom or that any change was required in the method of accounting.

In fact, if adjustments are required to be made against deposits in each year in which expenses are incurred, accounts of several years will have to be reopened. It would cause tremendous hardship and harassment to the petitioners though no fault of theirs and to no purpose.

It is difficult to appreciate the assumption of the respondents that deposits in clients’ accounts constitute income of the petitioner. In the case of CIT vs. Tanubai D. Desai (1972) 84 ITR 713 (Bom), a Division Bench of this Court has held that the position of a solicitor vis-a-vis the moneys received by him from or on behalf of his clients is that of a quasi-trust. He holds such money in a fiduciary capacity. In that case, the question arose about the interest derived from moneys kept in clients’ accounts. The Court held that this cannot be considered as the income of the solicitor. After referring to the Rules then in force which are similar to the Rules in force now, the Court observed : “A mere reading of these Rules shows that a solicitor of this Court is obliged to keep a separate banking account in respect of all the moneys received by him from or on behalf of his clients. He can appropriate moneys out of the said account to himself personally only in the limited class of cases provided for by these Rules. These moneys are to be segregated and kept by a solicitor in a separate bank account in the title of which the word ‘client’ must appear and he can withdraw and appropriate it to himself only in so far as the Rules permit him to do so. In this connection it must also be borne in mind that a solicitor who is a creature of the Rules made by this High Court is subject to the inherent and disciplinary jurisdiction of this Court and any breach committed by him of these Rules is capable of entailing what would be a disastrous consequence to him of his name being struck off the roll of solicitors maintained by the Court. Therefore, not only do these Rules provide for the segregation and holding in a water-tight compartment of the amounts received by a solicitor from or on behalf of his clients, but there also is enough sanction provided by the Rules for enforcing that what these Rules provide is complied with…

In view of the provisions of the said Rules of this High Court, the position of a solicitor vis-a-vis the moneys received by him from or on behalf of his clients is that of a quasi-trust and he holds such moneys in a fiduciary capacity.”

In the case of CIT vs. Sandersons and Morgans (1970) 75 ITR 433 (Bom), the firm of solicitors concerned had transferred to its profit and loss account some unclaimed balances in the personal ledger of their clients. This amount was ultimately apportioned between the partners in their respective profit-sharing ratio. The Court held that this amount was not a revenue receipt liable to income-tax. It said that when a solicitor receives money from his client, he does not do so as a trading receipt but he receives the money of the principal in his capacity as an agent and that too in a fiduciary capacity. The solicitor remains liable to account for this money to his client. It is only when the final adjustments of accounts are made between the solicitor and his client and the amount is brought to the profit and loss account that it becomes income in the hands of the solicitor.

In the Law and Practice of Income-tax by Kanga and Palkhivala, Seventh Edition. Volume 1, at page 870) some of the methods of accounting are described. One such method is where an assessee holds some of his realisations in suspense and shows them in the accounts as income or profit in a later year in which event the amounts would be chargeable in the subsequent year in which the final impress of profits is stamped upon them.

There is nothing to show that by following such a method of accounting, the income of the assessee is reduced. Apart from s. 145, there is no power in the ITO to impress his own method of accounting on the assessee. (See in this connection CIT vs. K. Sankarapandia Asari and Sons (1981) 130 ITR 541 (Mad) : TC1R.561. The directions, therefore, which are given by the IAC are without jurisdiction. They would result in great harassment and severe hardship to the petitioners and this is a fit case where intervention is called for under Art. 226.

It was submitted by Mr. Bhatia that the IT Act is a complete code by itself. No intervention, therefore, is warranted under Art. 226. He has relied upon a decision of the Karnataka High Court in the case of Karnataka Industrial Area Development Board vs. CIT (1987) 64 CTR (Kar) 332 : (1987) 168 ITR 96 (Kar) . This decision, however, does not support his contention. In that case, the petitioner had claimed exemption under s. 10(20A) of the IT Act, 1961. The claim for exemption was rejected by the Commissioner. The petitioners contended that having regard to the view expressed by the Commissioner, it would be futile to appear before the assessing authority and hence they approached the Court under Art. 226 of the Constitution. The High Court rejected the contention and said that the petitioners had an alternative and equally efficacious remedy open to them. There was no need to exercise substantial jurisdiction under Art. 226. This decision is of no assistance in the present case. Where a method of accounting accepted by the IT authorities for a large number of years is sought to be altered for no reason causing great hardship and harassment to the petitioner, the directions issued under s. 144A are without jurisdiction. The petitioner did not have any equally effective or alternative remedy. Complying with these directions would involve the petitioners in lengthy proceedings which may involve reopening of assessments for several past years. [See in this connection Calcutta Discount Co. Ltd. vs. ITO (1961) 41 ITR 191 (SC)].

The petition is, therefore, allowed.

The respondents are restrained from taking any steps or proceedings pursuant to the impugned letter dt. 1st Dec., 1987 (exhibit ‘E’) and/or impugned direction (exhibit ‘H’). The respondents are also restrained from completing the assessments for the asst. yr. 1985-86 and subsequent years adopting the method and manner as proposed in the said exhibits and from rejecting the method adopted by the petitioners.

The rule is made absolute accordingly.

The respondents to pay to the petitioners costs of the petition.

[Citation : 176 ITR 253]

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