Holding

The Completed Contract Method of accounting for chit discount is permissible for assessing income under the Income‑Tax Act, as the Revenue had previously accepted it and no distortion of profits was demonstrated.

Summary

The Commissioner of Income Tax appealed against the Madras High Court’s decision that the Completed Contract Method of accounting for chit discount, used by M/s Bilahari Investment (P) Ltd., was valid. The assessee companies, engaged in chit fund business, had historically applied the Completed Contract Method, which the Revenue had accepted for several years. The Assessing Officer, however, rejected this method for the assessment years 1991-1992 to 1997-1998, insisting on a Deferred Revenue Expenditure (percentage of completion) approach, alleging that the former distorted profits. The Supreme Court held that the Completed Contract Method is a permissible accounting method for recognizing income under the Income‑Tax Act, especially where the Revenue has previously accepted it and has not shown any distortion of profits; the method yields a revenue‑neutral result. Consequently, the Court affirmed the High Court’s judgment and dismissed the appeals.

Issues considered

The validity of the Completed Contract Method of accounting for chit discount in computing taxable income under the Income Tax Act, 1961.
Whether the Revenue can compel substitution of the Completed Contract Method with the Percentage of Completion/Deferred Revenue Expenditure method absent a finding of profit distortion.
The applicability of Accounting Standard 22 (AS 22) and Section 211(2) of the Companies Act to the method of accounting for chit transactions.

Legislation cited

Companies Acts. 211(2)
Income Tax Act, 1961

Subjects

chit fundcompleted contract methoddeferred revenue expenditurepercentage of completion methodincome tax assessmentaccounting standardsAS 22matching principlerevenue neutral

Judgment

[2008] 3 S.C.R. 477

- "
COMMISSIONER OF INCOME TAX, CHENNAI
\/.
A

M/S BILAHARI INVESTMENT (P) LTD.
(Civil Appeal No. 1625 of 2008)
FEBRUARY 27, 2008
B
(S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.)
... J:

Income Tax Act, 1961:

Chit Fund Scheme - Income - Assessment of -
Accounting of chit discount - Completed Contract Method of c
accounting or Deferred Revenue Expenditure Method - Claim
for chit discount - Held: Income accrued under the chit fund -
scheme could be identified by following several methods of
accounting including Completed Contract Method or Deferred
Revenue Expenditure Method - Completed Contract Method D
": leads to objective assessment of income - No finding recorded
by the Courts below to the effect that the Completed Contract
Method distorts the profits/income - Even calculation of
income from the Deferred Revenue Expenditure Method
brings the same result - In past, .Revenue had accepted the E
Completed Contract Method of accounting for the purpose of
allowability of chit discount -Hence, no interference with the
judgment of High Court allowing Completed Contract Method
,-k of accounting for calculating income called for.
•
Income Tax Act, 1961; S. 211(2): F

Accounting Standards (AS) - Substitution of Deferred
Revenue Expenditure Method in place of Completed Contract
Method of accounting in terms of AS 22 - Held: Not allowed
since Revenue did not invoke AS 22 in the instant appeals.
G
Words and Phrases:
;i. 'Completed Contract Method' and 'Deferred Revenue
Expenditure Method of accounting - Distinction between in
477 H
478 SUPREME COURT REPORTS [2008] 3 S.C.R.

A the context of calculation of income from chit fund scheme.
Assessee companies, subscribing to chit fund
-
..

scheme as their business activities, were maintaining their
accounts on mercantile basis by computing profit/loss at
the end of the chit period following the Completed
B Contract Method of accounting. The said method of
accounting was earlier accepted by the Revenue for
several years. Assessing Authority held that the
Completed Contract Method was not an accurate method
to identify "income" under the provisions of the Income
C Tax Act, and in the context of the "chit discount", the
Deferred Revenue Expenditure calculated on
proportionate basis was the correct method and
accordingly rejected the Completed Contract Method of
accounting as adopted by the assessees. The view of the
D Assessing Authority has been affirmed by the Tribunal and
the High Court. However, in the matter of chit discount,
overruling the order of the Tribunal, the High Court has
held that the completed contract method of accounting
adopted by the assessees was valid and that the Revenue
E had erred in spreading the discount over the remaining
period of the chit on proportionate basis. Hence the
present appeal.
Assessees contended that, profits/loss accrued to
the assessees only when the dividends exceeded the
F discount paid and that 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
G exceeded the sum total of discounts suffered; that the
Revenue 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; .
+
and that a chit transaction has been treated by the various
H courts as one single scheme running for the full period
COMMNR. OF INCOME TAX, CHENNAI v. MIS BILAHARI 479
INVESTMENT (P) LTD .

•• and, therefore, according to the assessees, the Completed A
Contract Method adopted by it over the years was not
required to be substituted by any other method of
accounting.
Dismissing the appeals, the Court
B
HELD: 1.1 Recognition/identification of income
under the Income Tax Act is attainable by several methods
" { of accounting and the same result could be attained by
any one of the accounting methods. The Completed
Contract Method is one such method. Similarly, c
percentage of completion method is another such
method. (Para - 15) (487-D]
1.2 Under completed contract method, the revenue
is not recognised until the contract is complete and costs
are accumulated during the course of the contract. The D
profit and loss is established in the last accounting period
~
and transferred to P & L account. The said method
determines results only when contract is completed. This
method leads to objective assessment of the results of
the contract. (Para - 16) [487-E] E
1.3 On the other hand, 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 F
stage of completion can be looked at under this method
by taking into consideration the proportion that costs
incurred to date bears to the estimated total costs of
contract. (Para - 17) [487-G]
G
1.4 In the present case, there is no finding recorded
by the Assessing Officer that the completed contract
method distorts the profits of a particular year. Moreover,
.:.. as held in various judgments, the Chit Scheme is one
integrated scheme spread over a period of time,
H
480 SUPREME COURT REPORTS [2008] 3 S.C.R.

A sometimes exceeding 12 months. This Court has
examined computation of tax effect in these cases and
found that the entire exercise is revenue neutral,
particularly when the scheme is read as one integrated
scheme spread over a period of time. (Para -19) (488-B-C]
8 Taparia Tools Ltd. vs. Joint Commissioner of Income-
tax (2003) 260 ITR 102 - referred to.
1.5 In the past, the Revenue had accepted the
Completed Contract Method and because of such
C acceptance., the assessees, in these cases, have 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
Revenue has earlier accepted. It is only in those cases
where the Revenue records a finding that the method
D adopted by the assessee results in distortion of profits,
the Revenue can insist on substitution of the existing
method. Further, in the present cases, it is found from the
various statements produced before this Court, that the
entire exercise, arising out of change of method from
E Completed Contract Method to Deferred Revenue
Expenditure, is revenue neutral. Therefore, no interference
with the impugned judgment of the High Court is called
for. (Para - 20) (488-D-G)
2. It is open to the Revenue to consider the new
F accounting standards and concepts in future cases of chit
transactions. However, no opinion has been expressed
in that regard. Suffice it to state that, these new concepts
and accounting standards have not been invoked by
the Revenue in the present batch of appeals. (Para - 21)
G [489-8-C]
J.K. Industries Ltd. & Anr. vs. Union of India & Ors. 2007
(13) SCALE 204 - referred to.
CIVILAPPELLATE JURISDICTION: Civil Appeal No. 1625
H of 2008.
COMMNR. OF INCOME TAX, CHENNAI v. MIS BILAHARI 481
INVESTMENT (P) LTD. [KAPADIA, J.)
..;
"""\
From the final Judgment dated 19/6/2006 of the High Court A
of Judicature at Madras in T.C. (A) No. 81/2003.
WITH
Civil Appeal Nos. 1626 to 1632 of 2008.
Parag P. Tripathi, A.S.G. Vikram Gulati, Ranbir Chandra, B
Vismai Rao and B.V. Balaram Das for the Appellant.
i. I
K. Parasaran, A.S.G., T.L.V. Iyer, P.N. Ramalingam for the .
Respondent.
The Judgment of the Court was delivered by c
KAPADIA, J. 1 Leave granted.
2. This batch of civil appeals filed by the Department is
directed against judgment of the Division Bench of the Madras
High Court dated 19.6.2006 in which it has been held that in the D
~ matter of chit transaction, the Completed Contract Method of
accounting adopted by the respondents-assessees was
erroneously rejected by the Department and that the Tribunal
had erred in directing the discount to be spread over the balance
period of the chit on a proportionate basis. In other words, the E
controversy arising in the present appeals is whether the
Completed Contract Method followed by the assessees and
accepted by the Revenue in the past needed to be substituted
by percentage of Completion Method as contended by the AO.
·"r
F
" 3. We are concerned with assessment years 1991-1992
to 1997-1998.
4. Assessees are private limited companies subscribing
to chits as their business activities. They were maintaining their
accounts on.mercantile basis and they were computing profiU G
loss, as the case may be, at the end of the chit period following
completed contract method, which was earlier accepted by the
.::+ Department over several years .
5. Chit funds are basically saving schemes in which certain
number of subscribers join together and each contributes a H
482 SUPREME COURT REPORTS [2008) 3 S.C.R.

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
B 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
c auction, a maximum amount, which the highest bidder agrees
to forego, is the amount, which is distributed to the other
members, subject to deduction of the Manager's commission.
6. In this case, we are concerned with the tax treatment of
the difference between the amount contributed and the amount
D received. In other words, in this case, we are concerned with
allowability of the claim for discount under the Income-tax Act,
1961 ("1961 Act") in order to arrive at "income" under that Act.
7. As stated hereinabove, assessees herein have been
following completed contract method over the years, which was
E accepted by the Department. However, for the assessment
years under consideration, the AO came to the conclusion that
the completed contract method was not accurate in recognizing/
identifying "income" under the 1961 Act, and according to him,
therefore, in the context of the "chit discount", the correct method
F was deferred revenue expenditure calculated on proportionate
basis. In other words, the AO has preferred percentage of
completion method as the basis for recognizing/identifying
"income" under the 1961 Act in substitution of completed contract
method.
G
8. 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. According to the
+
Department, income accrued to the assessees in the form of
chit dividend during the year whereas liability arose in the form
H
COMMNR. OF INCOME TAX, CHENNAI v. MIS BILAHARI 483
INVESTMENT (P) LTD. [KAPADIA, J.]
-.i of chit discount over the relevant period depending upon the A
remaining number of instalments to be paid.
· 9. 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 8
Court, overruling the Tribunal, has held that the completed
• f- 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. c
10. In the matter of chit dividend, assessees have accepted
the view of the Tribunal and the High Court that the completed
contract method was not correct. Therefore, to that extent, the
controversy is settled.
D
-~ 11. The limited controversy is whether the completed
contract method of accounting adopted by the assessees as
method of accounting for chit discount is required to be
substituted by percentage of completion method.
12. In this connection, it is the case of the assessees that, E
profits (loss) accrued to the assessees only when the dividends
exceeded the discount paid and that 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 F
sum total of the dividend received exceeded the sum total of
discounts suffered which is debited to P & L 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 G
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 H
484 SUPREME COURT REPORTS [2008] 3 S.C.R.

,.
~

A accounting.

13. Before us, Shri Parag P. Tripathi, learned Additional
Solicitor General, relied on the judgment of the Bombay High
Court in the case of Taparia Tools Ltd. v. Joint
Commissioner of Income-tax reported in [2003] 260 ITR 102
B in which the matching principle has been discussed threadbare.
We quote hereinbelow the said concept from the judgment, _, ,.
which reads as follows:

"The mercantile system of accounting is based on accrual.
c Basically, it is a Double Entry System of accounting. Under
the mercantile system of accounting, profits arising or
accruing at the date of the transaction are liable to be
taxed notwithstanding the fact that they are not actually
received or deemed to be received under the Act. Under
the mercantile system of accounting, therefore, book profits
D
are liable to be taxed. The profits earned and credited in
the books of account constitute the basis of computation
.-
of income. The system postulates the existence of tax
insofar as monies due and payable by the parties to whom
they are debited (see Keshav Mills Ltd. v. CIT [1953] 23
E ITR 230, 239 (SC) ). Therefore, under the Mercantile
System of Accounting, in order to determine the net income
of an accounting year, the revenue and other incomes are
matched with the cost of resources consumed [expenses].
,,..
Under the mercantile system of accounting, this matching
F is required to be done on accrual basis. Under this •
matching concept, revenue and income earned during an
accounting period, irrespective of actual cash in-flow, is
required to be compared with expenses incurred during
the same period, irrespective of actual out-flow of cash. In
G this case, the assessee is following mercantile system of
accounting. This matching concept is very relevant to
compute taxable income particularly in cases involving
~
.
DRE. It has been recognised by numerous judgments. In
the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC)
H the facts were as follows: The assessee bought lands and
COMMNR. OF INCOME TAX, CHENNAI v. M/S BILAHARI 485
INVESTMENT (P) LTD. [KAPADIA, J.]
-t
"""' sold them in plots. When the plots were sold the purchasers A
paid only a portion of the purchase price and undertook to
pay the balance in instalments. The assessee, in turn,
agreed to develop the plots within six months. In the relevant
Accounting Year, the assessee actually received only Rs.

-... 29,392. towards sale price of the lands, but, in accordance
with the mercantile system of accounting followed by the
assessee, it credited in its accounts Rs. 43,692
representing the full sale price of the lands. At the same
time, it also debited Rs. 24,809 as expenditure for the
B

development it had undertaken even though, no part of c
that amount was actually spent. The Department, therefore,
disallowed the expenditure of Rs. 24,809 on the ground
that the amount was not actually spent. The assessee
ultimately succeeded in the Supreme Court. It was held by
the Supreme Court that the expression "Profits or Gains"
D
in Section 10(1) of the Income-tax Act, 1922 should be
understood in its commercial sense and there can be no
computation of such profits and gains until the expenditure,
which is necessar:y for the purposes of earning the receipts
is deducted therefrom. Accordingly, the Supreme Court
took the view, that since the assessee was following E
Mercantile System of Accounting and since the assessee
had credited the full sale price of lands in its accounts
amounting to Rs. 43,692, the assessee was entitled to
estimate the expenditure because, without such estimation
of expenditure, it was not possible to compute profits and F
gains. This concept is also applied by the Supreme Court
in the case of Madras Industrial investment Corporation
Ltd. [1997] 225 ITR 802 under following observations
(headnote):
G
"Ordinarily, revenu~ expenditure which is incurred
wholly and exclusively for the purpose of business
4 must be allowed in its entirety in the year in which it
is incurred. It cannot be spread over a number of
years even if the assessee has written it off in his
H
486 SUPREME COURT REPORTS (2008] 3 S.C.R.
•,.
A books, over a period of years. However, the facts
may justify an assessee who has incurred expenditure
in a particular year to spread and claim it over a
period of ensuing years. In fact, allowing the entire

.
expenditure in one year might give a very distorted
B picture of the profits of a particular year. Issuing
debentures is an instance where, although the
..,....
assessee has incurred the liability to pay the discount
in the year of issue of debentures, the payment is to
secure a benefit over a number of years. There is a
c continuing benefit to the business of the company
over the entire period. The liability should, therefore,
be spread over the period of the debentures."
Therefore, the matching concept, which we have referred
to is well recognised by various judgments of the Supreme
D Court. In this case, the issue is whether the entire
expenditure distorts the profits of a particular year." JI

14. Further, learned ASG has also placed reliance on the
judgment of this Court in the case of J.K. Industries Ltd. &
Anr. v. Union of India & Ors. reported in 2007 (13) SCALE
E 204. Paragraphs 82 and 83 of the said judgment are reproduced
hereinbelow:
"82. Matching Concept is based on the accounting period

F
concept. The paramount object of running a business is to
earn profit. In order to ascertain the profit made by the
business during a period, it is necessary that "revenues"
of the period should be matched with the costs (expenses)
•
of that period. In other words, income made by the business
during a period can be measured only with the revenue
earned during a period is compared with the expenditure
G
incurred for earning that revenue. However, in cases of
mergers and acquisitions, companies sometimes
undertake to defer revenue expenditure over future years -
1'"-
which brings in the concept of Deferred Tax Accounting.
Therefore, today it cannot be said that the concept of
H
COMMNR. OF INCOME TAX, CHENNAI v. MIS BILAHARI 487
~
INVESTMENT (P) LTD. [KAPADIA, J.]
-'<
accrual is limited to one year. A

83. It is a principle of recognizing costs (expenses) against
revenues or against the relevant time period in order to
determine the periodic income. This principle is an
important component of accrual basis of accounting. As
stated above, the object of AS 22 is to reconcile the B
>- matching principle with the Fair Valuation Principles. It
i
may be noted that recognition, measurement and
disclosure of various items of income, expenses, assets
and liabilities is done only by Accounting Standards and
not by provisions of the Companies Act." c
15. 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. Completed contract method is one such
D
method. Similarly, percentage of completion method is another
~·
st.1ch method.
16. Under 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. E
The profit and loss is established in the last accounting period
and transferred to P & L account. The said method determines
results only when contract is completed. This method leads to
_..,
objective assessment of the results of the contract.
~

17. On the other hand, percentage of completion method F
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 G
proportion that costs incurred to date bears to the estimated
.....,.
·~
total costs of contract.
18. The above indicates the difference between completed
contract method and percentage of completion method.
H
488 SUPREME COURT REPORTS [2008] 3 S.C.R.
~
,...
A 19. In the judgment of the Bombay High Court in Taparia
Tools Ltd. (supra) it has been held that in every case of
substitution of one method by another method, the burden is on
the Department to prove that the method in vogue is not correct
and it distorts the profits of a particular year. Under the mercantile
B system of accounting based on the concept of accrual, the
method of accounting followed by the assessees is relevant. In
the present case, there is no finding recorded by the AO that 1 "
the completed contract method distorts the profits of a particular
year. Moreover, as held in various judgments, the Chit Scheme
c is one integrated scheme spread over a period of time,
sometimes exceeding 12 months. We have examined
computation of tax effect in these cases and we find that the
entire exercise is revenue neutral, particularly when the scheme
is read as one integrated scheme spread over a period of time.
D 20. As stated above, we are concerned with assessment
years 1991-1992 to 1997-1998. In the past, the Department
had accepted the completed contract method and because of
.-
such acceptance, the assessees, in these cases, have followed
the same method of accounting, particularly in the context of
E 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, the Department can insist on
F substitution of the existing method. Further, in the present cases,
we find from the various statements produced before us, that
the entire exercise, arising out of change of method from
completed contract method to deferred revenue expenditure,
is revenue neutral. Therefore, we do not wish to interfere with
the impugned judgment of the High Court.
G
21. Before concluding, we may point out that under section

,....
211(2) of the Companies Act, Accounting Standards ("AS")
enacted by the Institute of Chartered Accountants have now been
adopted [see: judgment of this Court in J.K. Industries case
H (supra)]. Shri Tripathi, learned counsel for the Department, has
COMMNR. OF INCOME TAX, CHENNAI v. MIS BILAHARI 489
INVESTMENT (P) LTD. [KAPADIA, J.]

placed reliance on AS 22 as the basis of his argument that the A
. 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. It may be
stated that all these developments are of recent origin. It is open B
to the Department to consider these new accounting standards
.. f- and concepts in future cases of chit transactions. We express
no opinion in that regard. Suffice it to state that, these new
concepts and accounting standards have not been invoked by
the Department in the present batch of civil appeals. C
22. Subject to above, we see no reason to interfere with
the impugned judgment of the High Court and accordingly the
civil appeals are dismissed with no order as to costs.
S.K.S. Appeals dismissed. D