ASSISTANT COMMISSIONER OF INCOME TAX v. ADLABS
[Citation -2007-LL-0105-6]

Citation 2007-LL-0105-6
Appellant Name ASSISTANT COMMISSIONER OF INCOME TAX
Respondent Name ADLABS
Court ITAT
Relevant Act Income-tax
Date of Order 05/01/2007
Assessment Year 1993-94 TO 1995-96
Judgment View Judgment
Keyword Tags mercantile system of accounting • method of accounting • processing charges • work-in-progress • business profit • net profit rate • stock-in-trade • revenue income • profit margin • receipt basis • hybrid system • excess stock • feature film • book result • lease rent
Bot Summary: After such negatives films are processed and the final negative print of the film is taken, the producer place huge orders on the assessee for positive prints and thereafter, the assessee produces the positive prints as per the requirement of producers. From the footage given by the producers, the assessee prepares the negative prints which remain with the assessee and on the basis of the negative print, the producers place orders with the assessee for producing A the negative prints. Regarding the disclosure made by the assessee under s. 132(4), it was pointed out by him that the return of income filed by the assessee is in consonance with the disclosure in as much as the return has been filed after claiming the deduction on account of bad debt. There is no dispute that assessee is required to first process the film footages given by the producers to the assessee and when the negative print is produced, then the producers place orders for preparation of the positive prints so that the film may be exhibited at various theatres across the country. Since the assessee has not shown income from negative print in the relevant years, it can be said that the system followed by the assessee is partly defective. The learned counsel for the assessee has also submitted that certain other grounds raised by the assessee would become academic if the main contention of the assessee is accepted. Since we have decided the main issue in favour of the assessee, we need not adjudicate the remaining issues arising from other grounds raised by the assessee in various years.


These appeals were heard together and are being disposed of by common order for sake of convenience. main issue arising in these appeals, relates to rejection of books of account by invoking provisions of proviso to s. 145(1) of IT Act, 1961 (Act) and estimate of net profit. Briefly stated facts, as stated in assessment order, are these: assessee company is engaged in business of processing negative films exposed by various feature film producers. assessee is having its processing laboratory at Andheri (East), Mumbai. After such negatives films are processed and final negative print of film is taken, producer place huge orders on assessee for positive prints and thereafter, assessee produces positive prints as per requirement of producers. assessee has been following mercantile system of accounting. expenditure incurred are debited as and when incurred but income is credited when bills are raised on producers at time of delivery of positive prints. Further, in process of preparing negative prints, by-product namely "Hypo" containing silver contents is generated which is shown as income as and when it is sold. Such system is being followed since inception of business. survey under s. 133(A) of Act was carried out at premises of assessee on 4th Dec., 1992 and same converted into search action under s. 132 of Act. In course of search, certain cash was seized and at end of search, assessee estimated income for asst. yr. 1993-94 at Rs. 19 lakhs including sale of "Hypo". Another search took place at premises of assessee on 30th June, 1994 in course of which excess stock worth Rs. 4 lakhs was found. For asst. yr. 1993-94, assessee declared total income of Rs. 22,67,410. In course of assessment proceedings, it was noticed by AO that though assessee was following mercantile system of accounting yet it neither billed various producers for processing of negative films while under production nor valued work-in-progress in respect of negative films processed but not billed. AO was, therefore, of view that expenditure debited by assessee on account of processing of negative films were not be allowable unless corresponding receipts are shown. Accordingly, assessee was asked to explain in this regard. explanation of assessee was that, hundreds of films were processed at various stages of completion and amongst these various films, many films were abandoned by producers and, therefore, no billing was done. It was also explained that it was not possible to value work-in-progress. AO was not satisfied with such explanation of assessee. AO also noticed that assessee was in practice of receiving advances against contracts from producers and such advances remained unadjusted for long time till delivery of films when billing was done. This, according to him, amounted to postponement of profits to future years. It was also noticed by him that advances against contract went on increasing year after year while entire production expenditure continued to be debited in P&L a/c. method of accounting adopted by assessee was, therefore, not acceptable to AO since correct profits could not be determined. It was also noted by AO that in course of processing of negative films, by-product called "Hypo" is generated over which there was no control and, therefore, yield of "Hypo" could not be ascertained properly. In view of same, AO invoked first proviso to s. 145(1) of Act. Consequently, he determined net profit by applying rate of 15 per cent of processing charges which amounted to Rs. 16,92,600 for asst. yr. 1993-94. In addition, sale of "Hypo" amounting to Rs. 7,20,227 was considered as income of assessee and same was added to estimated income. Against aforesaid income, AO allowed depreciation and deduction under s. 43B. net income for asst. yr. 1993-94 was thus determined at Rs. 25,77,556. However, he applied net profit rate of 25 per cent for asst. yrs. 1994- 95 and 1995-96 and thus determined income for asst. yr. 1994-95 at Rs. 53,53,570 and for asst. yr. 1995-96 at Rs. 84,39,938 which also included addition of Rs. 4 lakhs on account of excess stock. On appeal, learned CIT(A) confirmed rejection of books of account under first proviso to s. 145(1) but reduced net profit rate to 15 per cent. He further upheld assessment of sale of "Hypo" as income separately. In addition, it was further held that AO failed to assess income by way of lease rent, interest which were assessable separately in addition to business profit assessed under s. 145(1). However, he allowed deduction for expenses on pro rata basis against lease rent and interest. Thus income for asst. yr. 1993-94 was enhanced by Rs. 24,14,023. However, no such enhancement was made for other years. Aggrieved by same, assessee has preferred these appeals before Tribunal. learned counsel for assessee has assailed orders of lower authorities by submitting that method of accounting adopted by assessee is being consistently followed since inception i.e., year 1978 and same was also accepted in past. According to him, choice is with assessee to adopt any method of accounting including hybrid system and Department cannot reject same unless there are materials to form opinion that true profits cannot be ascertained from method adopted by assessee. Reliance was placed on Supreme Court judgment in case of Investment Ltd. vs. CIT (1970) 77 ITR 533 (SC), and judgment of Hon ble Bombay High Court in case of CIT vs. Tata Iron & Steel Co. Ltd. 1975 CTR (Bom) 80: (1977) 106 ITR 363 (Bom). It was further submitted by him that assessee is in business of processing of films, negative as well as positive on basis of films shot by producers. From footage given by producers, assessee prepares negative prints which remain with assessee and on basis of negative print, producers place orders with assessee for producing the negative prints. It is on basis of these positive prints, film is released and exhibited at theatres. Proceedings further, it was submitted that billing is done at time of delivery of positive prints and income is booked at that stage. It was further pointed out by him that no defect has been pointed out by AO with reference to expenditure incurred and remuneration received in respect of positive prints and only objection of AO was that, expenditure in respect of negative print are claimed as deduction without showing corresponding receipt. According to him, this, by itself, is not sufficient to invoke provisions of first proviso to s. 145(1). He also pointed out that no defect has been pointed out with reference to recovery of "Hypo" i.e., silver content. As and when such "Hypo" is sold, same is accounted for in books of account and even AO has assessed same under head "miscellaneous income" on basis of sale shown by assessee. Regarding disclosure made by assessee under s. 132(4), it was pointed out by him that return of income filed by assessee is in consonance with disclosure in as much as return has been filed after claiming deduction on account of bad debt. It was further pointed out that even in course of search no specific incriminating material was found against assessee. Accordingly, it was pleaded that book result shown by assessee be accepted. On other hand, learned Departmental Representative has vehemently relied upon reasoning given by AO. He pointed out that in course of search, assessee agreed that profit margin was in range of 32 per cent to 35 per cent and AO was justified in applying average profit rate of 33.5 per cent. Proceeding further, it was submitted that method of accounting adopted by assessee was such that true profit could not be ascertained inasmuch as assessee was claiming deduction in respect of expenditure incurred for preparing negative prints without showing corresponding receipts for year under consideration. expenditure can be allowed only against receipt. According to him, assessee was postponing profits in respect of negative prints to subsequent years. He relied on decision of Hon ble Supreme Court in case of CIT vs. British Paints India Ltd. (1991) 91 CTR (SC) 108: (1991) 188 ITR 44 (SC), for proposition that if method of accounting adopted by assessee shows distorted picture, then same cannot be accepted merely because it was being accepted in past. In view of same, it was pleaded by him that appeal of assessee be dismissed. Rival submissions of parties have been considered carefully. There is n o dispute that assessee had been following aforesaid method of accounting since inception of its business and same was being accepted by Revenue in past. According to s. 145, as was in force for years under consideration, legislature gave choice to assessee to adopt any method of accounting for computing his business income. However, first proviso to s. 145(1) provided that in any case, where method employed by assessee is such that income cannot properly be deduced therefrom, then income shall be computed on such basis and in such manner as AO may determine. This legal position is fortified by judgment of apex Court in case of Investment Ltd. (supra), wherein it was observed as under: Investment Ltd. (supra), wherein it was observed as under: "A taxpayer is free to employ, for purpose of his trade, his own method of keeping accounts and for that purpose of value his stock-in-trade either at cost or at market price. method of accounting adopted by trader consistently and regularly cannot be discarded by Departmental authorities on view that he should have adopted different method of keeping account or of valuation. method of accounting regularly employed may be discarded only if in opinion of taxing authorities income of trade cannot be properly deduced therefrom. Valuation of stock at cost is one of recognised methods." In view of above legal position, question for our consideration is whether it can be said that facts of case justify action of AO invoking first proviso to s. 145(1). There is no dispute that assessee is required to first process film footages given by producers to assessee and when negative print is produced, then producers place orders for preparation of positive prints so that film may be exhibited at various theatres across country. According to method of accounting followed by assessee, expenditure is booked in books of account as and when incurred while Revenue incomes are credited: (i) in respect of negative prints and positive prints, when billing is made at time of delivery of positive prints and (ii) when by-product "Hypo" is sold. Considering method of accounting, we are of view that it cannot be said that method of accounting is such that entire true profits cannot be deduced therefrom. Our reasons are as follows: (i) No defect has been pointed out by AO in respect of income derived by assessee from preparation of positive prints which is major source of business income. As soon as positive prints are prepared, billing is made along with delivery of such prints. Such method is in consonance with mercantile system of accounting. (ii) income from sale of "Hypo" is also not disputed by AO. Though casual observation has been made by AO to effect that there is no control over yield of above by-product, yet he has accepted sale of "Hypo" as shown by assessee. Hence, no adverse inference can be drawn against assessee. No other defect has been pointed out by AO. income from sale of by-product can be accounted for on receipt basis since hybrid system is permissible in law in view of judgment of Hon ble Bombay High Court in case of CIT vs. Citibank N.A. (1994) 119 CTR (Bom) 383: (1994) 208 ITR 930 (Bom). (iii) As far as income from negative prints is concerned, we are of view that method adopted by assessee does not depict true picture. According to mercantile method of accounting, income is to be booked on accrual basis. income by way of processing charges, in our opinion, accrues to assessee as and when it becomes entitled to receive same. As and when negative print is prepared and producer is informed, assessee would become entitled to recover remuneration since enforceable debt is created in favour of assessee. Even learned counsel for assessee could not controvert this legal position in course of hearing. At this stage, assessee was required to book income and adjust against advance received. income once accrued, cannot be postponed to subsequent years merely on ground that orders for positive prints may not be placed. However, income from negative print is not significant as compared to income from positive prints. In view of above reasons, we are of view that entire system of accounting followed by assessee cannot be doubted. accounting system i n respect of negative prints only can be said to be defective since revenue income is not credited when negative print is ready. However, AO is not correct in observing that expenditure incurred in respect of negative print cannot b e allowed since work-in-progress has not been shown by assessee. concept of work-in-progress relevant only when goods are produced as of its own. In case of jobbers, work-in-progress is never shown in books as material always belongs to customer. In case of jobbers, expenditure is allowable in year in which it is incurred and income is credited when it becomes due from customer. processing charges would become due only when job done by assessee is over and not before. Therefore, in case of assessee, processing charges would become due from producer when negative print is ready for delivery. Since assessee has not shown when negative print is ready for delivery. Since assessee has not shown income from negative print in relevant years, it can be said that system followed by assessee is partly defective. In view of above discussion, we are of view that system of accounting followed by assessee cannot be rejected in toto. book result shown by assessee, in our opinion, should be accepted subject to some modification i.e., processing charges for negative prints should be assessed in year in which such prints become ready as per requirement of customer. We hold accordingly. orders of learned CIT(A) are, therefore, set aside and AO is directed to accept book result shown by assessee subject to modification mentioned above. However, AO is further directed to ensure that assessee is not doubly taxed in respect of processing charges for negative prints. Before parting with this issue, it may be mentioned that Learned Counsel for assessee has also submitted that in case action of AO has to b e upheld, then estimate made by him would also cover profits on account of sale of "Hypo" and consequently no separate addition should be made on account of sale of "Hypo". Since we have accepted main contention of assessee, this aspect of issue has become academic and consequently no adjudication is required. In respect of asst. yr. 1995-96, assessee has also challenged addition of Rs. 4 lakhs made by AO on account of excess stock. No explanation could be offered for same at time of search. In course of assessment proceedings, it was submitted that excess stock belonged to other parties. assessee was asked to produce confirmations for those parties. assessee neither produced confirmations nor names and addresses of parties. Accordingly, addition of Rs. 4 lakhs was made which has been confirmed by learned CIT(A). Assessee is in further appeal before Tribunal. After hearing both parties we do not find any merit in ground raised by assessee in absence of any evidence. order of learned CIT(A) is therefore upheld on this issue. learned counsel for assessee has also submitted that certain other grounds raised by assessee would become academic if main contention of assessee is accepted. Since we have decided main issue in favour of assessee, we need not adjudicate remaining issues arising from other grounds raised by assessee in various years. Revenue has also challenged orders of learned CIT(A). first ground is against reduction of net profit rate for 25 per cent to 15 per cent. second ground is against allowance of expenses on pro rata basis against income by way of interest and lease rent. Thirdly, learned CIT(A) should have made enhancement for asst. yr. 1994-95 as made by him for asst. yr. 1993-94. All these grounds do not survive for our consideration since we have already held that books of account of assessee should be accepted, though subject to some modification. Hence, these grounds stand dismissed. In result, assessee s appeals stand partly allowed while Revenue s appeals stand dismissed. *** ASSISTANT COMMISSIONER OF INCOME TAX v. ADLABS
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