1. The assessee is a firm. It entered into an agreement with Khyber Enterprises Inc., Chicago, running an Indian hotel at Chicago. The assessee under the agreement was to get a commission of 3 per cent on the gross sales made by the Chicago party for the services done by the assessee as per the agreement. For the assessment year 1977-78, the assessee filed an original return for Rs. 21,529. Subsequently a revised return was filed showing a loss of Rs. 7,590. The reason for filing the revised return was stated to be the fact that the assessee, who had computed its income originally under the mercantile system, had changed it over to the cash system. The ITO did not accept the assessee's case of changing of the system of accounting. The return was filed long after closing the books. There was, according to the ITO, no necessity to revise the return. There was also no need to reverse an entry relating to the receipt of commission. Holding that the assessee, thus, had acted on an after-thought, the ITO did not accept the assessee's case for adopting the commission income on the receipt basis as required under a cash system. He estimated the commission receivable at Rs. 50,000 for the assessment year 1977-78 and completed the assessment. For the assessment year 1978-79 likewise, the ITO estimated the commission at Rs. 80,000.
2. On appeal, the AAC upheld the ITO's order to the extent he rejected the alleged cash system adopted by the assessee but she did not accept the ITO's estimate of commission income for both these years, since, according to her, the estimate involved an element of guess and bare suspicion and had not been arrived at on a proper and just basis. She, therefore, directed the ITO to make a fresh assessment on the basis of necessary facts and details which the assessee offered to furnish. The assessee has come up on appeal against the order of the AAC for both the years before the Tribunal.
3. The learned counsel for the assessee, taking us through the details of the case, has pointed out that the assessee entered into the agreement with the overseas party. Though the agreement stipulated that quarterly statement of accounts had to be furnished to the assessee and remitting of commission on that basis regularly, the assessee was not able to get the commission on account of the recalcitrance of the foreign party. The party being abroad, the assessee also could not enforce the regular payment of commission. The business was started during this year. Based on the terms of the agreement the assessee started maintaining books of account on the mercantile basis. Since, however, during the course of the year the assessee found that the foreign party, over whom it had no control, was not remitting the profits included in the commission regularly, it would not be prudent for it to maintain books of account on the accrual basis and pay the tax on the same also. For all one knows, if the foreign party did not fulfil the terms of the contract and send money regularly, the assessee might lose. It might be almost impossible for it to resort to litigation to collect the amount. To do this, even if possible, after paying the tax on unrealised or even unrealisable amounts would have been highly imprudent. It was based on these considerations that the assessee adopted a cash system. A revised return was, consequently, filed. The return which was for consideration of the ITO for the purpose of making an assessment having been based on the altered system of accounting and no assessment, thus, so far having been made, there was no question of the assessee following one method of account and changing it. Even if there was a change, according to the learned counsel, the assessee was entitled to make the change if it was bona fide required for the purposes of its business. The decisions in Sarupchand v. CIT [1936] 4 ITR 420 (Bom.) and CIT v. Eastern Bengal Jute Trading Co. Ltd. [1978] 112 ITR 575 (Cal.) support the assessee in this regard. The decision in Investment Ltd. v. CIT [1970] 77 ITR 533 (SC) lays down that the assessing anthority is bound by the assessee's choice of method of accounting. According to the learned counsel, therefore, it was an established fact to be accepted in law that the assessee was following the cash system of accounting and if this be so, the returns filed by it-revised return for the first year and the original return for the second year represented the correct returns. No omissions, etc., have been found in the accounts on the basis of the system of accounting followed by the assessee. Relying on the decisions in Raja Mohan Raja Bahadur v. CIT [1967] 66 ITR 378 (SC), Indermani Jatia v. CIT [1959] 35 ITR 298 (SC), Keshav Mills Ltd. v. CIT [1953] 23 ITR 230 (SC) and CIT V. K.R.M.T.T. Thiagaraja Chetty & Co. [1953] 24 ITR 525 (SC), the learned counsel has pointed out that the ITO was bound to accept the assessee's method of accounting and compute its income from commission on that basis. The estimates made by the ITO for both the years, therefore, were also not justified.
4. For the department stress is laid on the order of the ITO. Here was a clear case where the ITO was informed about accounts being originally maintained on the accrual basis by filing a return. The revised return consequent on change over to the cash system clearly indicated, as a matter of fact, that the assessee has adopted the new system rejecting the old. The ITO in such circumstances was entitled to reject the books and work out the profit for the year on an acceptable basis. It is also pointed out that the assessee received the income under an agreement.
The agreement stipulated that the commission was to be regularly made over to the assessee, quarterly accounts also being rendered to it.
Merely because, perhaps due to collusion, the assessee did not enforce its rights since it suited it to do so, it cannot escape a liability to tax. The learned counsel has pointed out that while any method of accounting could be adopted for arriving at the profit of an assessee, where such profit was not properly ascertainable, even the law permitted the rejection of the books and an estimate of the income.
This is what the ITO has done. According to the learned counsel, therefore, the assessee had without any valid reason changed the method of accounting. The method followed was not capable of giving the correct profit for the year also. At any rate, the AAC has only remitted the matter back to the ITO to work out the correct profit for the year. Under Section 145 of the Income-tax Act, 1961 ('the Act'), according to the learned counsel, fixing the correct profit for the year is within the power of the ITO. That has to be done even if proper accounts are maintained but they do not give the correct figure of profit.
5. The facts lie within a short compass. Under an agreement dated 25-8-1975 the assessee-firm entered into a contract with Khyber Enterprises Inc. of Chicago. The assessee was to procure, train and supply Indian cooks and executive chefs to the company at Chicago. As consideration for this and other services rendered by the assessee, the foreign company was to pay to the assessee commission at the rate of '3 per cent of the gross sales of the company, it being understood and agreed that the gross sales will mean the total sales of the company, less sales tax and service charges'. Clause 4 of the agreement provided that the company will send a statement of its gross sales to the assessee on or before the 10th of every previous month and in case of dispute the company should obtain and forward to the assessee a certificate from recognised auditors. The certificate would be binding on the parties. The agreement deals with other covenant also, such as payment of an advance to the cooks by the assessee on behalf of the future foreign employer, payment of salary by the foreigner to the employees, their conditions of service, etc. The agreement was acted upon by the parties. The assessee started maintaining books of account allegedly on the accrual basis and a return was also filed.
Subsequently it would appear since the foreign party did not send the statement of accounts on time or remit any money towards commission, the assessee altered its method of accounting to the cash system and on this revised method of accounting filed a revised return. Apparently this latter return also has been filed before the ITO looked into the matter or proceeded to make an assessment. The first controversy between the parties relates to a change of method of accounting followed by the assessee. In fact, the ITO had decided the matter against the assessee on this ground. In our view, on the facts of the present case, this view of the authorities cannot be accepted.
Following a method of accounting would be relevant for computing the profit and income for the purpose of making an assessment. Final accounts are made on the basis of primary and subsidiary books and entries Making of final accounts is only a process followed long after the transactions have taken place. If, therefore, from the primary material and books an assessee were to make out his final books of account on one basis and subsequently finding a valid reason for it altered the basis of accounting, there is neither any manipulation in that nor any irregularity. Both under the normal law as well as under the provisions of the Act an assessee can maintain accounts in the manner he likes. If the income of the assessee has been computed for one or more years for the assessment purposes by the authorities and subsequemly by the changed method of accounting, it becomes difficult to find out the income of the subsequent year, since the regularly followed method was changed ; it would be open to the ITO to re-estimate the income for a particular assessment year. But where all that the assessee has done is to make a final set of books on one method and even before an assessment has been made, correct that method, the ITO does not come into picture at all on the ground of objection to a change of method of accounting. As far as the ITO is concerned, he has to consider the revised return and this is based on a proper method of accounting followed by the assessee. Whether the assessee fixed this as its method of accounting for the first time or it went through different changes and finally fixed this as its method of accounting is of no relevance to the income-tax assessment or consequence to the ITO. We have no hesitation, therefore, in holding that for arriving at the income, for these years under appeal, especially the first year when the assessment was made, no objection can be taken on the ground of change of method.
6. The other issue is about the computation of profit itself. The assessee's claim was that it had to follow the cash method of accounting in view of the intransigence of the foreign party over whom it had no control. Prima facie if this be so, no objection could be taken to that and the income worked out on the cash basis will have to be adopted. There are, however, substantial constraints on this and on the basis of this we do not think that the assessee's claim can be accepted in the present instance.
7. The learned counsel for the assessee has referred to the decisions in Raja Mohan Raja Bahadur's case (supra), Indennani Jatia's case (supra) and Keshav Mills Ltd.'s case (supra). In Raja Mohan Raja Bhadur's case (supra), the assessee maintained his accounts on the cash basis and obtained a decree against a debtor. In the place of the amount payable by the debtor, the assessee obtained certain Government bonds. The value of the bonds brought to tax was claimed by the assessee as not realised interest at all and could be treated as realised only on their sale. Their Lordships of the Supreme Court held that the bonds were convertible in terms of money and, therefore, income was received by the assessee when the bonds were received and not when he sold them. In the course of the judgment their Lordships referred to the nature of accounts maintained on the accrual and the cash basis but this case cannot be regarded as an authority for the actual determination of liability in the case of a particular assessee as in the appeals before us.
8. Indermani Jatia's case (supra) discussed the nature of the mercantile and cash systems of book-keeping and dealt with a situation where interest on capital invested in a shop in a native State was credited in the accounts. The question was one of receipt and in fact the Court held against the assessee in that case. The general discussion on the method of accounting in that case does not help the assessee.
9. In Keshav Mills Ltd.'s case (supra) the Supreme Court held that Section 13 of the Indian Income-tax Act, 1922, is an integral part of computation of total income of an assessee and is binding on the income-tax authorities. Being a mode of computation of income, the income-tax authorities are under an obligation to accept the mode of accounting regularly adopted by the assessee except where the proviso to that section comes into operation. The same position apparently obtains under the Act with regard to Section 145, Keshav Mills Ltd.'s case (supra), however, provided that the chargeability of income received in India cannot be escaped by a non-resident in that case on the ground that his regular method of accounting is mercantile.
Analogically the chargeability of income accruing to cannot be escaped on the ground that the assessee maintains his accounts on the cash system. This case does not, therefore, seem to support the assessee. On the contrary, on the authority of CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), it could he held that under Section 145 the assessee's regular method of accounting determines the mode of computing his taxable income but it cannot determine or even affect the range of taxable income or the ambit of taxation. The provision for computation of income contained in Section 145 cannot derogate from the basis of the charging sections so that the charge imposed by Section 5 of the Act cannot be avoided by any method of accounting, however, scientific or correct it be. In fact the charging sections are not dependent on the computation sections or Section 145. These latter are subsidiary rules which cannot affect the liability to tax at all. By the mere process, therefore, of maintaining the books of account on a particular basis a liability which exists cannot be warded off. This would mean that, according to the decisions, while the method of accounting regularly employed by the assessee from year to year should be the basis of computation of the assessee's income from year to year, there are two exceptions to rule, one where the proviso applies and the other where the chargeability itself gets distorted by the method of accounting. In fact this latter is only a consequence of the former insofar as an inconsistency with chargeability resulting from the method of maintenance of accounts would be an indication of the accounts themselves being not in a position to show the correct profit.
10. Apart from the above, there are circumstances in the present case indicating that the assessee's claim of not having received the commission amounts for the purposes of cash system of accounting cannot be accepted. As the agreement shows, the assessee is in receipt of amounts from the foreigner under several heads. The assessee expends amounts mainly through the limited company partner to meet some of the requirements of the foreigner. There is, thus, a current account continuous between the assessee and the foreigner in which several transactions involving large amounts figure. The assessee claims that it has not received the commission only because the foreigner has not designated any amount received by the assessee or sent to the assessee as on account of commission. While on the one hand, under the agreement, the assessee is entitled to regular receipt of accounts and commission amounts from the foreigner from time to time, on the other, the assessee is in receipt through its current account of several amounts from the foreigner. Only specific amounts have not been allocated as relating to the commission. Against such state of affairs, it would not be even possible to say, as a matter of fact, that the assessee has not received the commission so that it cannot be included in a cash method of accounting. On the contrary, the maintenance of a pliable type of current account of the above type enables the assessee to alter the position of the receipts of commission to suit its convenience. Even though, therefore, the charge to tax has become certain, a mere allocation out of the current account between the parties enables the assessee to ward off the liability. As a matter of fact, therefore, it cannot be stated that the assessee has not received the commission amounts for these years. The manner of maintaining the accounts on the alleged cash basis in the particular circumstances of the case does not enable the year's profits to be correctly computed.
We, therefore, direct that the profit for the year be computed on the basis of the assessee's right to receive the amount and its factual capability of allocating amounts from its current account with the foreign party towards such commission. To explain, instead of adjusting amounts received towards expenditure, the assessee could as well adjust the receipts towards commission. We, however, hold that the ITO was not correct in estimating the receipts of commission in a round figure and on this point we uphold the Commissioner's order. The ITO should work out the actual commission taxable for each of the years on the basis of the agreement, the receipts from the foreigner, etc. Only if it is impossible to do this, a reasonable estimate should be made.