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3 Method of Accounting — Chit fund — Chit
discount accounting on completed contract method cannot be rejected especially
when it is revenue neutral.
[CIT v. Bilahari Investment P. Ltd., (2008) 299 ITR I
(SC)]
The assessees are private limited companies subscribing to
chits as their business activities. They were maintaining their accounts on the
mercantile basis and they were computing profit/loss, as the case may be, at the
end of the chit period following the completed contract method, which was
earlier accepted by the Department over several years.
However, for the A.Ys. 1991-92 to 1997-98, the Assessing
Officer came to the conclusion that the completed contract method was not
accurate in recognising/identifying ‘income’ under the 1961 Act, and according
to him, therefore, in the context of the ‘chit discount’, the correct method was
deferred revenue expenditure calculated on proportionate basis. In other words,
the Assessing Officer has preferred the percentage of completion method as the
basis for recognising/identifying ‘income’ under the 1961 Act in substitution of
the completed contract method.
According to the Department, chit dividend had to be
subjected to tax on accrual basis as the assessees were following the mercantile
system of accounting. As far as the chit dividend is concerned, the Department
rejected the completed contract method as suggested by the assessees, which has
been accepted by the Tribunal and the High Court. However, in the matter of chit
discount, the High Court, overruling the Tribunal, has held that the completed
contract method of accounting adopted by the assessees was valid and that the
Department had erred in spreading the discount over the remaining period of the
chit on proportionate basis.
In the matter of chit dividend, the assessees accepted the
view of the Tribunal and the High Court that the completed contract method was
not correct.
Before the Supreme Court the limited controversy was whether
the completed contract method of accounting adopted by the assessees as method
of accounting for chit discount was required to be substituted by the percentage
of completion method. The Supreme Court noted that Chit funds are basically
saving schemes in which a certain number of subscribers join together and each
contributes a certain fixed sum each month, the total number of months being
equal to the total number of subscribers. The subscriptions are paid to the
manager of the fund by a certain prescribed date each month and the total
subscriptions to the fund are auctioned each month amongst the subscribers. At
each auction, the lowest bidder is paid the amount of his bid and the balance
received from out of the total subscriptions received is distributed equally
amongst other subscribers, as premium. The manager is paid a certain percentage
of the collections each month on account of expenses and charges for conducting
the auction. In the auction, a maximum amount, which the highest bidder agrees
to forgo, is the amount, which is distributed to the other members, subject to
deduction of the manager’s commission.
Before the Supreme Court, it was the case of the assessees
that, profits (loss) accrued to the assessees only when the dividends exceeded
the discount paid and that the difference could be known only on the termination
of the chit when the total figure of dividend received and discount paid would
be available. That, it would be possible for the assessees to make profits only
when the sum total of the dividend received exceeded the sum total of discounts
suffered which is debited to the profit and loss account. According to the
assessees, the Department has all along been accepting the completed contract
method and, therefore, there was no justification in law or in facts for
deviating from the accepted practice. According to the assessees, a chit
transaction has been treated by the various Courts as one single scheme running
for the full period and, therefore, according to the assessees, the completed
contract method adopted by it over the years was not required to be substituted
by any other method of accounting.
The Supreme Court observed that recognition/identification of
income under the 1961 Act is attainable by several methods of accounting. It may
be noted that the same result could be attained by any one of the accounting
methods. The completed contract method is one such method. Similarly, the
percentage of completion method is another such method. Under the completed
contract method, the revenue is not recognised until the contract is complete.
Under the said method, costs are accumulated during the course of the contract.
The profit and loss is established in the last accounting period and transferred
to the profit and loss account. The said method determines results only when the
contract is completed. On the other hand, the percentage of completion method
tries to attain periodic recognition of income in order to reflect current
performance. The amount of revenue recognised under this method is determined by
reference to the stage of completion of the contract. The stage of completion
can be looked at under this method by taking into consideration the proportion
that costs incurred to date bear to the estimated total costs of contract.
The Supreme Court held that it was concerned with the A.Ys.
1991-92 to 1997-98. In the past, the Department had accepted the completed
contract method and because of such acceptance, the assessees, in these cases,
had followed the same method of accounting, particularly in the context of chit
discount. Every assessee is entitled to arrange its affairs and follow the
method of accounting, which the Department has earlier accepted. It is only in
those cases where the Department records a finding that the method adopted by
the assessee results in distortion of profits, can the Department insist on
substitution of the existing method.
Further, in the present cases, the Supreme Court noted from
the various statements produced before us, that the entire exercise, arising out
of change of method from the completed contract method to deferred revenue
expenditure, is revenue neutral. Therefore, the Supreme Court did not wish to
interfere with the impugned judgment of the High Court.
Before concluding, the Supreme Court noted that u/s.211(2) of the Companies Act, Accounting Standards (‘AS’) enacted by the Institute of Chartered Accountants of India have now been adopted. The learned counsel for the Department, had placed reliance on AS-22 as the basis of his argument that the completed contract method should be substituted by deferred revenue expenditure (spreading the said expenditure on proportionate basis over a period of time). He also relied upon the concept of timing difference introduced by AS-22.
The Supreme Court observed that all these developments were of recent origin and it was open to the Department to consider these new accounting standards and concepts in future cases of chit transactions. The Supreme Court however expressed no opinion in that regard, stating that these new concepts and accounting standards had not been invoked by the Department in the present batch of civil appeals.
