1. This is an appeal arising out of an order passed by the Commissioner, Tamilnadu-IV, Madras, under Section 263 of the Income-tax Act, 1961 ("the Act"), giving direction to the ITO to disallow the provision of Rs. 23,587 to meet the liability of stipends payable to the articled clerks employed by the assessee.
2. The assessee is a firm of chartered accountants employing a large number of apprentices called "articled clerks". The articled clerks are entertained by the firm of chartered accountants under the provisions of the Chartered Accountants Act, 1949. That Act regulated the conduct of the profession of chartered accountancy in India and it laid down several conditions under which a chartered accountant can take apprentices called "articled clerks". They have to enter into agreements in the prescribed form executed on a stamp paper of certain value and register it with the Institute of Chartered Accountants of India. The number of such articled clerks is also regulated. The result is engagement of such articled clerks is not left to the sweet will of the chartered accountant. At one time the apprentices were paying a premium to the chartered accountant, which was to be appropriated by the chartered accountant and later made compulsorily refundable. With the development of the profession, this practice was considered unethical and an anachronism. Since this is a professional course and the chartered accountants are deriving a benefit in the shape of unpaid work and due to the persistent demands made by the articled clerks, the Institute amended the regulations to provide in regulation 32B of the Chartered Accountant Regulations, 1964 as under : (1) Every member engaging an articled clerk on or after 1st July, 1973 shall pay to such clerk a minimum monthly stipend at the rates specified in Sub-regulation (2) or in Sub-regulation (3) hereof, as the case may be.
(2) If the normal place of service of an articled clerk is situated in Bombay, Calcutta, Delhi, New Delhi, Kanpur, or Madras, the following shall be the minimum rates of the stipend payable under Sub-regulation (1) : (a) in respect of the first year of articled training : Rs. 60 per month, (b) in respect of the second year of articled training : Rs. 100 per month, (c) in respect of the remaining period of articled training : Rs. 150 per month.
Pursuant to this regulation, the payment of stipend by a chartered accountant to an articled clerk became a statutory requirement with effect from the date when the regulation came into force, viz., 1-7-1973. The effect of this regulation was, as can be easily seen from a plain reading of it, that the chartered accountant engaging an articled clerk on or after 1-7-1973 was under an obligation to pay stipend at the stipulated rates and the articled clerk so engaged acquired a right to receive the stipend at the stipulated rates. These statutory requirements are enforceable in law and violation thereof can lead to the peril of the practice and profession of the chartered accountant. What the regulation provided for is the minimum, but there are chartered accountant firms which are very munificent and are even paying much larger sums than those provided for as the minimum. The payment was kept at the minimum keeping perhaps in view the chartered accountants having low practice and less income.
3. The assessee-firm, as we have noticed above, incurred the liability towards stipend to the articled clerks as and from 1-7-1973. However, for its own reasons, the assessee-firm did not accept the statutory obligation imposed upon it and resisted it by filing a writ petition in the Madras High Court, but in vain. This judgment of the Madras High Court was received in November 1977, i.e., during the previous year relevant to the assessment year under appeal. Even though the assessee had been contesting its liability to pay stipends to the articled clerks by instituting legal proceedings but for the purpose of its income-tax assessment, it was claiming the liability as a deduction in its accounts, though it did not make a provision for it in the accounts. It could not obviously make a provision in its accounts because it was afraid that such a provision would amount to acquiescence of the liability and this would deviate the purpose of its litigation. But while filing the return of income, the assessee-firm claimed this sum at a deduction in what is popularly known as the adjusted profit and loss account, which is very commonly prepared by the chartered accountant, who by that account computes the income that is liable to tax as per his understanding of the facts and the provisions of the law. In this computation sheet of adjusted profit and loss account, the liability was provided for and claimed as a deduction for the first time in the assessment year 1975-76. In the assessment year 1974-75 this liability was not claimed as, we are told by them, things were too late. In the assessment years 1975-76, 1976-77 and 1977-78 the liability claimed through the adjusted profit and loss account was, however, disallowed by the income-tax department. The assessee contested the disallowance by way of an appeal for the assessment year 1976-77, but in vain. For the assessment year 1977-78 also an appeal was filed before the Commissioner (Appeals) against the disallowance, but in vain. The reason shown by the revenue in support of the disallowance of the claim made by the assessee was that it did not make any provision in its accounts for the liability and no such provision could have been made because the assessee had been following the cash system of accounting. So, the Commissioner (Appeals) dismissed the assessee's claim only on the ground that the claim was not made on the basis of a provision or expenditure debited in the accounts and an expenditure claimed without making an entry in the accounts was not allowable as a deduction. An argument was taken before him that even if no provision was made, the liability must be assumed and that assumed liability must be deducted and to that extent the method of accounting has to be considered that of hybrid system of accounting. The Commissioner (Appeals) rejected this argument also again by emphasising the fact that without making an entry in the books of account, it was not possible to say that the assessee had been following hybrid system of accounting, i.e., cash system for certain items and mercantile system for one particular item alone, viz., stipends.
4. For the assessment year in question, however, the assessee made a provision for it in the accounts in a sum of Rs. 23,587 by debiting the profit and loss account and showing it as outstanding expenses in the balance sheet and claimed it as a deduction.
5. The ITO, who made the. assessment on the assessee, accepted the claim of the assessee and completed the assessment. We are not interested about the other allowances or disallowances made. But the Commissioner in exercise of his powers under Section 263 of the Act, perused the records and came to the conclusion that this allowance was erroneous and caused prejudice to the interests of the revenue. He held that the assessee, which was following cash system of accounting, could not make a provision for stipends in the accounts. Laying utmost emphasis on the system of accounting that the assessee had been following, viz., cash system, and highlighting the fact that under cash system of accounting it was not possible to make an entry providing for a liability, the Commissioner held that the allowance of the claim by the ITO was wrong. He was also of the opinion that even the statutory liability has not arisen in order that the assessee could claim that as a deduction. He came to this view again on the ground that the statutory liability could be allowed as a deduction even if no provision was provided for it in the accounts and if the assessee had been following the mercantile system of accounting, and since in this case the assessee had not been following the mercantile system of accounting, that legal concession as propounded by the Supreme Court in Kedamath Jute Mfg. Co. Ltd. v. CIT  82 ITR 363 was not available to the assessee. Then an argument was addressed before him based upon the Madras High Court decision in CIT v. E.A.E.T. Sundamraj  99 ITR 226 that it is open to an assessee to employ different methods of accounting for different sources of income or one method of accounting for one part of its business or one class of customers and a different method of accounting for another part of business or another class of customers. The High Court in the very same case warned that such different methods are permissible only when the assessee employs them regularly and consistently and not otherwise. The Commissioner rejected this argument on the ground that making a provision for the liability amounted to adopting different method of accounting in respect of the stipends payable to the articled clerks and there was only casual deviation and not a regularly and consistently employed method of accounting. Re-emphasising the fact that in cash system of accounting there was absolutely no scope for claiming deduction in respect of a provision made towards expenses which had not been disbursed, he rejected the argument advanced before him by the assessee. He directed eventually the ITO to disallow the provision made for outstanding stipends and pass a revised assessment order.
6. It is against this order of the Commissioner that the present appeal is directed. After carefully going through the stipulations made in the Chartered Accountants Act, the method of accounting employed by the assessee, the orders passed by the authorities below for the earlier assessment years, rejecting the claim of the assessee for the deduction, and also the impugned order of the Commissioner, we are of the opinion that the matter has to be approached in a manner consistent with the law declared by the Supreme Court and the Madras High Court.
Insofar as the law declared by the Supreme Court is concerned, it is an undisputed fact that if there was a statutory liability, it has to be allowed as deduction irrespective of the fact whether the assessee made any provision for it in the accounts or not, provided the assessee had been following the mercantile system of accounting. If 'the method of accounting followed by the assessee is mercantile, then the statutory liability must be allowed as a deduction merely on the basis of accrual. In this case, the assessee had been adopting consistently and regularly cash system of accounting, Now the question that would at once come to our mind is whether an assessee, who is consistently following cash system of account, can at all change it to mercantile system of accounting, or whether he can adopt different methods of accounting as envisaged, elucidated and permitted by the Madras High Court. If such a conversion is permissible under the law, then what are the requirements of the law in order that such a conversion acquires the sanction of law. So far as the income-tax law is concerned, there is no requirement that prior permission of the department is needed.
All that the Act says is that the ITO shall compute the profits and gains of the business on the basis of a method of accounting regularly employed by the assessee. Even if the method of accounting regularly employed by the assessee is such that correct profits could not be deduced therefrom, the ITO is empowered to disturb the method of accounting and adopt such method of accounting as, in his opinion, would reflect the true profits. The requirement of law is, therefore, that the method of accounting employed must be such that it must be regularly followed and capable of correct profit being deduced. If an assessee who is following cash system of accounting, for the sake of commercial expediency comes across an occasion where he has to convert it into mercantile system of accounting or such a method of accounting as to adopt cash system for certain classes of income or certain classes of persons and mercantile system of accounting for certain other classes of income or certain classes of persons, even that is permissible subject to the condition that it is regularly and consistently followed thereafter. Therefore, the emphasis upon the regularity and consistency in the employment of a method of accounting is not only of the past but also of the future. The question of changing the method of accounting would arise only when it was consistently followed in a particular way. If after the change it is followed consistently thereafter, then the method of accounting thus changed would become the method of accounting regularly followed and consistently applied. This is a trite law and we do not have to discuss the judicial pronouncements on the subject, except to make a reference to the decision of the Madras High Court in the case of CIT v. E.A.E.T.Sundararaj (Supra) which has been cited before the Commissioner and passages from which have also been extracted. The relevant passage which the Commissioner was referring to and we are having in our mind when we make the above proposition of law is : ... An assessee may employ one method of accounting for one part of his business or one class of customers, and a different method for another part of his business or another class of customers. He may also keep accounts in respect of different parts of the same business on different basis. If such different methods are employed regularly and consistently the profits have to be computed in accordance with the respective methods, provided it results in a proper determination of the true profits. . . .(p. 231) Therefore, if the assessee can convert his method of accounting from cash to mercantile, the only requirement of law then is that the conversion must be genuine and for a bonafide purpose to be followed thereafter regularly and consistently and it must not be casual or a pretence or camouflage.
7. In this case the assessee by making a provision for the liability of payment of stipends did convert to the extent the stipends are concerned its cash system of accounting into a system of accounting which could be said mercantile or hybrid. That the assessee had changed its method of accounting is not a matter open to doubt, but only the misconception of the Commissioner in rejecting this ground that it is not open to an assessee to convert the system of accounting from cash to mercantile or hybrid. This, in our opinion, is a wrong approach and is not borne out by law. On the other hand, it has the sanction of the law and is permissible. But the only caution is that it must be for genuine reasons and must be consistently and regularly followed thereafter. We have seen from the accounts of the assessee that after the change had been brought about the assessee had been consistently following this method thereafter. Therefore, from the assessment year under appeal onwards the method of accounting that the assessee has been adopting was a hybrid system of accounting, viz., cash system in respect of certain transactions and mercantile system in respect of a part of the liabilities, i.e., outstanding expenses relating to stipends. At this stage we may point out that even in the case of cash system of accounting it is open for the assessee to make a provision for outstanding expenses at the end of the accounting year in order to arrive at the true and correct income. For example, as on the date of the close of the accounting year there may be outstanding expenditure towards salaries, rents, telephone, taxes, stationery, etc., and myriad other such line of expenses. It is open to an assessee, even though he has maintained his accounts in cash system, to make a provision for all these outstanding expenses as in the case of professional men like authors, artistes, lawyers, chartered accountants and doctors (via-a decision of Lord Denning). In all such cases what is happening in practice is not cash system-pure and simple-but a system of accounting where provisions were made for outstanding expenses also. Therefore, that system of accounting assumed the role of a hybrid system of accounting. When such a thing is permissible and is being in vogue, we are unable to appreciate how it can be said in the case of the assessee herein that it is following cash system of accounting and it is not open to it to make a provision for the liability of payment of stipends and convert the system of accounting into hybrid system of accounting.
If the conversion was not fora bonafide reason, then the assessee is out of bounds. But the conversion, as we have explained earlier in the preceding paragraphs, is for a very bonafide reason. The department has refused to accept the assessee's claim first on the ground that no statutory liability has arisen, and secondly on the ground that no provision in the accounts was made. It is the department whose attitude has driven the assessee to a position of making entries in the accounts in order that its claim is accepted. It is, therefore, not possible to say with any show of reason that the change that the assessee had sought for in the method of accounting is not for a bonafide reason.
8. We have already explained above that this system after its change had been regularly and consistently followed over which there is no dispute, and what is more is that in the assessment year 1979-80, a sum of Rs. 9,487 was given up by the articled clerks and that amount was written back to the profit and loss account and offered as income. This again proves the bonafide of the assessee.
9. Now we have seen that the liability has arisen under a statute, the violation of which would amount to misconduct and may even lead to the removal of a chartered accountant from the rolls of the Institute of Chartered Accountants, that the articled clerks had acquired a right to receive stipends, that the method of accounting had been changed from cash system to hybrid system and that thereafter the same system had been consistently and regularly followed. Thus, all the requirements to allow the statutory liability have been satisfied. It is, therefore, wrong, in our opinion, to call this change a casual deviation. There is no restoration of the old practice but on the contrary the balance sheet of the assessee showed that the change had been consistently followed. Therefore, this change cannot be a casual deviation.
10. The entry being genuine, the departure not being casual and the liability being statutory, the assessee is entitled to the claim of deduction as per the law pronounced by the Supreme Court in the case reported in Kedarnath Jute Mfg. Co. Ltd. (supra) and the Madras High Court decision reported in E.A.E.T. Sundararaj (supra).
11. We are, therefore, of the opinion that the ITO when he allowed the claim of the assessee, had not committed any mistake causing prejudice to the interests of the revenue to be rectified by the Commissioner under Section 263. We, therefore, for the above reasons vacate the order passed by the Commissioner and allow this appeal.