Facts of the Case

The assessee, Cyber Media (India) Ltd., was engaged in the business of publishing magazines including Data Quest and PC World. The company earned income from subscriptions, sale of magazines, advertisement space, research and survey reports, and software development activities.

For income tax purposes, the assessee had consistently followed a hybrid system of accounting, whereby subscription and advertisement income were accounted for on a cash basis, while income from magazine sales, research activities, survey work, and software development was accounted for on a mercantile basis.

Pursuant to the amendment made in Section 209 of the Companies Act, 1956 through the Companies (Amendment) Act, 1988, companies were required to maintain books of account on an accrual basis under the double-entry system. Consequently, the assessee prepared its statutory accounts on the mercantile basis.

During Assessment Year 1989-90, an amount of ₹5,85,428 represented advertisement income that had accrued but had not been received. Since the assessee continued to follow the hybrid system for income tax purposes, it deducted the said amount while computing taxable income.

The Assessing Officer disallowed the deduction, holding that after switching to mercantile accounting in the books, the assessee could not exclude accrued advertisement income from taxation.

The Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal also upheld the disallowance, leading to the appeal before the Delhi High Court.

Issues Involved

  1. Whether the assessee was entitled to claim deduction of advertisement income accrued but not received amounting to ₹5,85,428 while following the hybrid system of accounting for income tax purposes?
  2. Whether amendment in Section 209 of the Companies Act, 1956 requiring maintenance of books on accrual basis automatically altered the method of accounting permissible under the Income Tax Act, 1961?
  3. Whether the Tribunal was justified in disallowing the deduction despite accepting that the assessee had consistently followed a hybrid system of accounting in earlier years?

Petitioner’s Arguments

The assessee contended that:

  • It had consistently followed a hybrid system of accounting which had been regularly accepted by the Income Tax Department in preceding assessment years.
  • The switch to mercantile accounting in the books was necessitated solely because of the statutory amendment under the Companies Act.
  • No corresponding amendment had been made in the Income Tax Act compelling the assessee to abandon its hybrid system for tax purposes.
  • Under Section 145(1) of the Income Tax Act, income was required to be computed according to the method of accounting regularly employed by the assessee.
  • The Assessing Officer wrongly concluded that income could not be properly deduced from the hybrid method.
  • The Tribunal itself had found that the assessee’s method had been regularly employed and accepted by the department and that the change in accounting system was bona fide.
  • Therefore, the deduction of accrued but unrealized advertisement income ought to have been allowed.

Respondent’s Arguments

The Revenue argued that:

  • The assessee had adopted mercantile accounting in its books and therefore accrued advertisement income had become taxable.
  • Allowing expenses on accrual basis while accounting advertisement income on receipt basis created a mismatch between income and expenditure.
  • Such accounting treatment resulted in improper determination of taxable income.
  • Consequently, the Assessing Officer had rightly disallowed the deduction claimed by the assesse.

Court Findings

The Delhi High Court allowed the appeal and decided the matter in favour of the assessee.

The Court observed that:

  • The assessee had consistently followed the hybrid system of accounting up to Assessment Year 1988-89.
  • The Revenue had accepted the said method in earlier years.
  • The Tribunal itself recorded a finding that the assessee’s accounting method had been regularly employed and accepted by the department.
  • The Tribunal further held that the shift from hybrid accounting to mercantile accounting was bona fide and was made only because of the amendment in the Companies Act.
  • Merely because statutory books were maintained on the mercantile basis, the assessee could not be denied computation of taxable income under the accounting method regularly followed for income tax purposes.
  • The Tribunal had rejected the Assessing Officer’s allegation that income could not be properly deduced from the assessee’s accounting method.
  • Once such a finding was recorded, there was no justification for disallowing the deduction.

Accordingly, the Court held that the Tribunal’s conclusion was perverse and unsustainable in law.

The substantial question of law was answered in favour of the assessee and against the Revenue.

The appeal was allowed.

Important Clarification

The Court clarified that:

  • Compliance with accounting requirements under the Companies Act does not automatically alter the accounting method permissible under the Income Tax Act.
  • At the relevant time, Section 145(1) of the Income Tax Act permitted computation of income according to the method of accounting regularly employed by the assessee.
  • Income-tax computation can involve adjustments from statutory accounts maintained under the Companies Act.
  • The mere adoption of mercantile accounting in statutory books does not prevent an assessee from claiming legitimate tax treatment under the accounting method consistently followed and accepted for tax purposes.

Sections Involved:    

  • Section 145(1) of the Income Tax Act, 1961
  • Section 260A of the Income Tax Act, 1961
  • Section 143(2) of the Income Tax Act, 1961
  • Section 115J of the Income Tax Act, 1961
  • Section 209 of the Companies Act, 1956
  • Companies (Amendment) Act, 1988

Link to download the order - https://delhihighcourt.nic.in/app/case_number_pdf/2011:DHC:727-DB/RAS07022011ITA671999.pdf 

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