INCOME TAX ACT, 1961

--Accounting method--Rejection Disclosure of sundry creditors in accounts--The assessee was a private limited company. It rendered professional services/consultancy services in the field of civil/structural engineering and architecture by providing design, supervision and project management. Its income was in the form of fees for services rendered. The assessee, in compliance with its obligations under section 209(3) of the Companies Act, 1956, had maintained books of account in accordance with the mercantile system of accounting. As per the books maintained in accordance with the mercantile system of accounting, the profit as per the profit and loss account was disclosed at certain sums. It is mandatory for companies to maintain books of account in accordance with the mercantile system of accounting in compliance with the provisions of the Companies Act, 1956. The AO called upon the assessee to show cause as to why the assessee maintains two sets of books of account-one under the cash system of accounting and the other under the mercantile system of accounting. The assessee pointed out that ever since the assessment year 1983-84, the assessee has been maintaining its books of account on the cash system of accounting and filing returns of income on the basis of such books of account. The assessee pointed out that the Income-tax Department has accepted such a change in the system of accounting and that its assessments are being completed on the basis of 'cash system of accounting' ever since the assessment year 1983-84. The assessee submitted that when the companies follow the mercantile method of accounting, the profit shown in the profit and loss account are never treated as correct for paying income tax, though accounts are prepared under the mercantile method of accounting. The AO, however, did not accept the submissions made on behalf of the assessee. He held that under section 209(3) of the Companies Act, 1956, every company was obliged to maintain its books of account under the mercantile system of accounting. According to the AO, the provisions of section 209(3) of the Companies Act, 1956 overrides the provisions of section 145 of the Act which provides that the 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. According to the AO, the choice in the matter of selection of the method of accounting under section 145 of the Act is not available to corporate assessees in view of the provisions of section 209(3) of the Companies Act, 1956. According to the AO, the above decision of the Tribunal is authority for the proposition that a company has no option even under the IT Act, 1961 to adopt any system of accounting except mercantile system of accounting. The AO also relied on the fact that in the annual report of the assessee wherein it has been mentioned that the system of accounting followed is mercantile. The Commissioner (Appeals) inter alia found that the reasons given by the assessee for following cash system of accounting are acceptable. He also held that the decision of the ITAT, Delhi in the case of Amarpali Mercantile (P) Ltd. v. Asst. CIT (1993) 45 ITD 386 (Del-Trib) : 1993 TaxPub(DT) 1253 (Del-Trib) on which the AO placed reliance was distinguishable. The Commissioner (Appeals) held that the rejection of books of account of the assessee and determination of income on the basis of the profits as per the mercantile system of accounting was not proper. The total income declared by the assessee as per the cash system of accounting was directed to be accepted. Held: The system followed by the assessee does not, in any way, detract from the cash system of accounting. Therefore, the reasons assigned by the AO for rejecting the books of account are not proper. Even with regard to the Accounting Standard (AS-9) of the ICAI which was the reasons assigned by the AO for rejecting the books of account of the assessee in the assessment year 2006-07, those accounting standards are applicable only to the assessee, who follow the mercantile system of accounting. Since the assessee, in the present case, follows the cash system of accounting, the rejection of books of account on this basis cannot be upheld.