Bombay H.C : Whether the Department is right in issuing notice under s. 148 of the IT Act, 1961, for the asst. yr. 1994-95 on the ground of underassessment within the meaning of s. 147 of the IT Act for having reason to believe that the expenditure of Rs. 6,70,758 ought to have been disallowed as the said amount represented unpaid purchase?

High Court Of Bombay

Dr. Amin’s Pathology Laboratory vs. P.N. Prasad, JCIT & Ors.

Sections 145, 147, 148

Asst. Year 1994-95

S.H. Kapadia & V.C. Daga, JJ.

Writ Petn. No. 955 of 2001

17th September, 2001

Counsel Appeared

S.E. Dastur with F.V. Irani & Mrs. M. Rao, for the Petitioner : R.V. Desai with J.P. Devdhar & P.S. Jetly i/b H.D. Rathod, for the Respondents

JUDGMENT

S.H. KAPADIA, J. :

The above writ petition came for hearing on 17th Sept., 2001. After hearing the arguments, the following order was passed : “For the reasons to be recorded separately in the oral judgment, the writ petition is rejected.”

2. We now proceed to give reasons : Whether the Department is right in issuing notice under s. 148 of the IT Act, 1961, for the asst. yr. 1994-95 on the ground of underassessment within the meaning of s. 147 of the IT Act for having reason to believe that the expenditure of Rs. 6,70,758 ought to have been disallowed as the said amount represented unpaid purchase?

3. In order to answer the above question, the following facts may be noted: Facts The petitioner is a partnership firm. It is assessed under the IT Act, 1961, for the last 18 years. It is engaged in running a pathology laboratory. Since its inception, the petitioner has been following the accrual system of accounting for all items of expenditure and it has been following the cash/receipt basis for all collections. The petitioner says that it has been assessed from the asst. yr. 1983-84 onwards; that right from inception, its accounts have been prepared on the above basis; that computation of income on the above basis has been submitted to the IT Department for the last 18 years; that during the said period, its method of accounting has never been questioned by the IT Department; that the income returned by it has been consistently accepted by the Department in the past. For the asst. yr. 1994-95, the petitioner filed its return of income. This was on 31st Oct., 1994, showing a total income of Rs. 1,53,174. This return was accompanied by duly audited accounts for the year ending 31st March, 1994, and by a tax audit report under s. 44AB of the Act. Respondent No. 1 is the Joint CIT. He is the AO. Initially, respondent No. 1 issued an intimation under s. 143(1)(a) on the return of income filed by the petitioner accepting the income returned by the petitioner. Thereafter, the case of the petitioner came for scrutiny. Accordingly, notices under s. 143(2) of the Act seeking clarifications came to be issued. According to the petitioner, after detailed examination, the AO passed an assessment order for the asst. yr. 1994-95 assessing the petitioner on an income of Rs. 2,17,030. On 16th March, 2001, the petitioner received the impugned notice dt. 14th March, 2001, which was issued by the AO under s. 148 of the IT Act calling upon the petitioner to file its return of income within 30 days. By letter dt. 21st March, 2001, the petitioner called upon the AO to furnish to it a copy of reasons. These reasons have been annexed as Ext.-1 to the affidavit-in-reply. Ultimately, the present writ petition has been filed challenging the notice under s. 148. Arguments

4. Mr. Dastur, learned senior counsel appearing on behalf of the petitioner, contended that the petitioner followed a hybrid system of accounting. That, in the present case, we are concerned with the asst. yr. 1994-95. That, at that time, it was permissible for the assessee to follow either of the three prevailing systems of accounting, viz., the mercantile system of accounting, or the receipt based system of accounting or a hybrid system of accounting. That, in the present case, the petitioner has been following the mercantile system of accounting for all items of expenditure and income except collections which are shown on cash basis. He contended that the petitioner has been following the hybrid system of accounting for the last 18 years. That the Department has never questioned the system followed by the assessee. That the assessee followed the said system even for the asst. yr. 1994-95. That, after detailed scrutiny, respondent No. 1 had framed an assessment on the petitioner for 1994-95 assessing the petitioner on an income of Rs. 2,17,030 under s. 143(3). That, this assessment order was passed on 28th Feb., 1997. That the reasons given in the order sheet (Ext.-1 to the affidavit-in-reply) shows that respondent No. 1 had invoked s. 148 only on the ground that the assessee had adopted the hybrid system of accounting. He pointed out that by the Finance Act, 1995, which received the assent of the President on 26th May, 1995, s. 145(1) of the IT Act came to be amended. That, before the said amendment, income was computed by following one of the three methods of accounting, viz., (i) cash or receipt basis, (ii) accrual or mercantile basis, and (iii) mixed or hybrid method, which has elements of both the aforestated two methods. That, by the said amendment, it was decided that income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall be computed in accordance with either the cash or the mercantile system of accounting. In other words, by the said amendment, the hybrid system of accounting was done away with. Mr. Dastur, however, pointed out that the said amendment took effect only from the asst. yr. 1997-98. He, therefore, contended that, in the present case, the AO erred in issuing notice under s. 148 only on the ground that the petitioner has computed its income on the basis of a mixed or hybrid method of accounting. Mr. Dastur pointed out that during the asst. yr. 1994-95, it was open to the assessee to follow that method. That the assessee has been following that method continuously. That the assessee was, in fact, assessed on that basis vide assessment order dt. 28th Feb., 1997. He, therefore, contended that the AO erred in issuing the impugned notice. Mr. Dastur pointed out that the hybrid system of accounting was permissible. That the impugned notice has been issued only on the ground that the hybrid system of accounting was not permissible. He submits that by reopening the assessment, grave prejudice is caused to the petitioner. He contended that no prior notice was given to the petitioner by the Department not to follow the hybrid system of accounting. He further pointed out that the present case involves a fundamental change in the method of accounting. He gave a comparison of a fundamental change by relying upon certain judgments of the Supreme Court. He contended that in cases where the change is fundamental, like a change in status or a change in the method of accounting then reopening should not be allowed as it causes prejudice to the assessee. He submitted that this is not a case of shifting of income from one head to another. He, therefore, contended that in the present case the Department should not be permitted to reopen the assessment. He further submitted that, in the present case, there was no underassessment of income. That, in the present case, there was no revenue loss to the Department. That, in the present case, the assessee would be liable to pay interest on an advance tax of a larger amount if the above expenditure of Rs. 6,70,758 is disallowed. He, therefore, contended that, in any event, in the present case, there is no escapement of income. He further contended that, in this case, the assessment order was made under s. 143(3). That this was the order passed after detailed scrutiny. That the assessment order was in respect of the asst. yr. 1994-95. That the period of four years elapsed on 31st March, 1999. That, in the present case, therefore, the assessment can be reopened only if there was failure on the part of the assessee to disclose truly and fully all the facts. Mr. Dastur pointed out that, in the present case, the proviso to s. 147 was applicable. He submitted that this was a case of change of opinion. That, in the present case, all the requisite facts were disclosed. That, even in the order sheet giving reasons there is no allegation of failure on the part of the assessee to disclose fully and truly all the facts. Hence, it was submitted that there was no reason to reopen the assessment. That, there is no averment for failure to disclose all the facts in the order sheet. That, this was a case of change of opinion. That, earlier the Department had accepted the hybrid system of accounting followed by the assessee and now the Department insists on the assessee not following the said system for the asst. yr. 1994-95 and, therefore, it was a case of change of opinion. In support of his arguments, Mr. Dastur relied upon various authorities. Findings

5. In the present case, it cannot be disputed that, at the relevant time, mixed/hybrid system of accounting did prevail. That, this system of accounting has been well recognised by the Institute of Chartered Accountants of India (see cl. 6 of Monograph on Compulsory Maintenance of Accounts). However, in the present case, the first respondent has now found that through inadvertence he overlooked the entry of Rs. 6,70,758 representing unpaid purchase in respect of which he had wrongly granted a deduction. That, such unpaid expenses should not have been allowed. That the assessee has claimed expenses in respect of purchases but the balance sheet shows that Rs.

6,70,758 was still unpaid. That, the above unpaid expenses were not disallowed. That, by not doing so, the correct income was not assessed. That, this has resulted in underassessment within the meaning of s. 147 of the Act. Hence, there is no change of opinion in the present case. Mr. Dastur has relied upon numerous authorities in support of his contention that the hybrid system of accounting was a well recognised system and that the Courts have also accepted that system of accounting. He, therefore, relied upon various judgments. However, at the outset, we may point out that the two principles which emerge from the judgments cited by Mr. Dastur on behalf of the assessee show that firstly, the hybrid system of accounting has been accepted in cases having certain peculiarities of their own like valuation of work-in-progress. Secondly, in none of the cases cited, there is escapement of income from assessment.

6. In the case of CIT vs. Geo Tech Construction Corporation (1996) 133 CTR (Ker) 468 : (1996) 221 ITR 164 (Ker) : TC 55R.192, cited on behalf of the assessee, the facts were as follows. The assessee, in that case, was a contractor. The assessee was a construction corporation. It was engaged in the business of construction of multi- storeyed buildings. The Court found that there were certain peculiarities in relation to the valuation of the work-in- progress. It was in these circumstances that the Court held that it was for the assessee to decide as to which system of accounting should be followed in order to value the work-in-progress. In that matter, the hybrid system of accounting was accepted. However, there is no finding in that judgment to the effect that by the assessee following the hybrid system of accounting, there has been escapement of income from assessment. Generally, assessees who are builders have to value work-in-progress. They may adopt project completion method or they may adopt proportionate method to value such items. Generally, such activities have certain peculiarities. These peculiarities do not come into the picture in our case. In our case, the petitioner is a professional. In our case, all collections have been put under cash basis and all items of expenditure and income (other than collections) have been put under the mercantile basis which resulted in deduction being allowed for unpaid purchases. Secondly, in the judgment of the Kerala High Court, there is no escapement of income from assessment. In the circumstances, the judgment of the Kerala High Court has no application to the facts of the present case. Similarly, in the case of CIT vs. Citibank N.A. (1994) 119 CTR (Bom) 383 : (1994) 208 ITR 930 (Bom) : TC 39R.844, S1.15, this Court has taken the view that the hybrid system of accounting is a well known system of accounting and if the assessee follows such hybrid system of accounting in respect of certain transactions and if the assessee follows the mercantile system of accounting in respect of certain other transactions, then no fault can be found with the hybrid system followed by the assessee. In that matter, the assessee was Citibank. It has certain non-performing assets. Therefore, for problem loans, they followed one system of accounting and for other loan accounts which had no such problems, they followed a different system of accounting. As stated hereinabove by us, the cases cited on behalf of the assessee show that the peculiar problem was faced by the bank or by the construction company with regard to certain items of income or expenditure which led the bank or the construction company to follow a hybrid system of accounting. Therefore, under such peculiarities, the Courts accepted the applicability of the hybrid system of accounting for problem loans. None of such peculiarities apply to our case. Moreover, even in the judgment of this Court in CIT vs. Citibank (supra), it was found, on the facts, that the hybrid system of accounting followed by Citibank, did not in anyway affect the real income of the assessee. In the present, at this stage, therefore, we have to go by the reasons given in the order sheet. They disclose that deduction for purchase has been claimed and allowed when the assessee has, in fact, not paid for such purchase. Hence, the judgment in the case of CIT vs. Citibank (supra) has no application to the facts of the present case. In the present case, the AO has found that certain purchases remained unpaid. That, although, they remained unpaid the assessee claimed deduction. That claim was allowed under the order of assessment. The said aspect was overlooked by the AO while passing the order of assessment under s. 143(3). Therefore, the AO has issued the notice under s. 148 of the IT Act. Before us, learned counsel for the assessee contended that, in this case, there is no loss of revenue. That, at the highest, by the aforestated method, the assessee has paid less amount of advance tax. He, however, contended that, at that time, interest for such shortfall in the payment of advance tax was very high and if the Department is allowed to proceed under s. 148 then grave prejudice would be caused to the assessee inasmuch as the assessee would be required to pay interest on such shortfall. This argument itself presupposes escapement of income from assessment. It is true that during the earlier years, the Department assessed the income of the petitioner and never questioned the petitioner for maintaining the hybrid system of accounting. However, the principle of res judicata will not apply. That, each year is a separate unit. That, for the asst. yr. 1994-95, the AO has detected escapement of income. Therefore, we do not find any merit in the contention advanced on behalf of the assessee that the Department was not entitled to reopen the assessment as the Department had assessed the petitioner earlier on the hybrid system of accounting. As stated hereinabove, in none of the judgments cited on behalf of the assessee, the Courts have found escapement of income. Therefore, the judgments cited on behalf of the assessee have no application to the facts of this case. In the case of CIT vs. E.A.E.T. Sundararaj (1975) 99 ITR 226 (Mad) : TC 13R.373, the assessee maintained a separate account in respect of the sales-tax collections and payments. These collections were not brought into the trading account. The ITO treated these collections as the assessee’s income. This led to the dispute. Ultimately, the Madras High Court came to the conclusion that the collection of sales-tax constituted trading receipts and since the assessee, in that case, was maintaining the cash system only in respect of his sales- tax account, the liability to sales-tax can be deducted only when the same is paid to the Government. Therefore, the Court held that it is only when the assessee paid the amount to discharge his sales-tax liability, he can claim deduction. These facts clearly show that there was no case for escapement of income from assessment. The Madras High Court observed that the assessee was entitled to employ one method of accounting for one part of his business and a different method for another part of his business. Therefore, the judgment of the Madras High Court in the case of CIT vs. E.A.E.T. Sundararaj (supra), has no application to the facts of the present case. To the same effect is the ratio of the judgment of the Madras High Court in the case of CIT vs. North Arcot District Co- operative Spinning Mills Ltd. (1984) 148 ITR 406 (Mad) : TC 1R.353. In this case also, as in the earlier case before the Madras High Court, the assessee adopted mercantile system of accounting in general except for imports of plant and machinery from foreign sellers. As far as the said imports were concerned, it was shown that the assessee paid interest to the sellers and claimed deductions in the year in which interest was actually paid and not in the year in which interest became legally due. Therefore, only to that extent, the assessee followed the cash system of accounting. It was in these set of circumstances that the Madras High Court took the view that, to the limited extent, the hybrid system of accounting was permissible. It is not so in the present case. In the present case before us, all collections are shown on receipt basis. Therefore, the judgments of the Madras High Court have no application to our case. We may once again repeat that a hybrid system of accounting was permissible during the relevant assessment year. However, if on account of that system, income has escaped assessment then certainly notice under s. 148 cannot be set aside. In CIT vs. A. Krishnaswami Mudaliar (1964) 53 ITR 122 (SC) : TC 1R.131, it has been observed by the Supreme Court that besides the cash system and the mercantile system, there are other systems of accounting which may be called hybrid system of accounting. To this extent, there is no dispute. However, in the same judgment, the Supreme Court has laid down that it is the duty of the ITO to examine in every case the method of accounting employed by the assessee and to see whether or not it has been regularly employed and to determine whether income could be properly deduced therefrom. In that matter, the facts were as follows. The assessee-firm exploited a motion picture and maintained its accounts on the cash system basis. It returned a profit of Rs. 28,643. This amount was arrived at by debiting Rs. 18,206 against the total receipts of Rs. 1,46,849 from the exploitation of the film. A further amount of Rs. 1,00,000 was also debited. This amount of Rs. 1,00,000 was the price paid for exploitation. However, the assessee did not take credit for the value of the unexpired exploitation rights at the end of the accounting period. It was in this context that the Supreme Court held that in the case of a trading venture whichever method of book-keeping is adopted for computing the true profits of the year the stock-in-trade must be taken into account. It is in this context that the Supreme Court made an observation that there are different systems of book-keeping. The Supreme Court further laid down that under the IT Act, the tax is levied on income, profits and gains and not on receipts. That taxable profits cannot be deduced only from cash receipts. That, if in the computation of profits only the cash receipts are taken into account then, in substance, the profits would be deferred thereby transforming what in truth are the profits of the business into capital by merely making book entries. Therefore, the principle settled by the judgment is that even if the assessee is entitled to keep his accounts under a mixed system of accounting, he cannot do so if it results in income escaping assessment. Therefore, in the present case, the basic question is regarding income escaping assessment. Therefore, issuance of notice under s. 148 cannot be interfered with.

7. Mr. Dastur, learned counsel for the assessee, next contended that, in the present matter, the period of four years elapsed on 31st March, 1999, whereas, notice under s. 148 is issued on 14th March, 2001. He contended that under the proviso to s. 147, reopening of assessment could be effected only if the assessee had failed to disclose truly and fully all the facts. He contended that, in the present case, the assessee has disclosed all the facts. In this connection, he relied upon the order sheet. He contended that there is no averment in the order alleging failure on the part of the assessee to disclose full facts. He contended that, in the present case, the documents on record show that the assessee had supplied all information to the AO who made the order of assessment on the basis of full facts disclosed by the assessee. He, therefore, contended that the present case involves change of opinion. He further contended that it is a well settled position in law that reasons for reopening are required to be recorded by the assessing authority before issuing any notice under s. 148. That only the reasons so recorded can be looked at for sustaining or setting aside such a notice. He contended that, in the present case, no such reason has been assigned in the order sheet. That the AO does not allege escapement of income for failure to disclose full facts. In this connection, reliance was placed on the judgment of the Bombay High Court in the case of N.D. Bhatt, IAC vs. I.B.M. World Trade Corporation (1993) 115 CTR (Bom) 103 : (1995) 216 ITR 811 (Bom) : TC 51R.1152. The judgment of the Bombay High Court has no application to the facts of the present case. In that matter, the appeals pertain to the asst. yr. 1959-60 to the asst. yr. 1973-74. It was a decision rendered by the Bombay High Court in the context of pre-amended law whereas, after the introduction of changes w.e.f. 1st April, 1989, the scope of reassessment has been widened. After the amendment, the only restriction put in the section is “reason to believe”. That reason has to be a reason of a prudent person. That reason should be fair and not necessarily due to failure of the assessee to disclose fully or partially some material facts relevant for assessment. That, if any item has escaped from assessment which was otherwise includible within the assessment and the AO notices it subsequently by his own investigation or by reason of some information received by him, one cannot say that it constitutes change of opinion : [See Praful Chunilal Patel vs. M.J. Makwana (1998) 148 CTR (Guj) 62 : (1999) 236 ITR 832 (Guj) : TC S51.4077. However, in the present case, the period of four years has since elapsed. Therefore, the proviso to s. 147 comes into the picture. Under the said proviso, no action can be taken after four years unless any income chargeable to tax has escaped assessment by reason of the failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment. Therefore, it was contended on behalf of the assessee that, in the present case, there is no allegation of failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment. In the present matter, as stated above, the assessee has been following the mercantile system of accounting for all items of expenditure and income except for all collections which are under cash basis. A reading of the assessment order clearly shows that the AO failed to notice an important item, viz., an amount of Rs. 6,70,758 which represented unpaid purchases. The assessee-firm had claimed expenses in respect of all purchases. However, an amount of Rs. 6,70,758 represented unpaid purchases. It is for this reason that the AO has come to the conclusion for issuance of notice under s. 148 that the assessee-firm had suppressed an income to the extent of Rs. 6,70,758. Under Expln. 1 to the proviso, mere production of account books from which material evidence could have been discovered by the AO will not necessarily amount to disclosure within the meaning of the proviso. Therefore, mere production of the balance sheet, P&L a/c or account books will not necessarily amount to disclosure within the meaning of the proviso. In the present case, the facts show that the AO overlooked the aforestated item. That, he noticed it subsequently. That, at the time of passing the original order of assessment, he could not be said to have opined on the above item. Therefore, there was no change of opinion. Therefore, in the present case, the impugned notice is sustained. Conclusion

For the above reasons, there is no merit in the writ petition. The writ petition fails. The writ petition standsrejected.

[Citation : 252 ITR 673]

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