Q Can the Assessing officer add  notional interest on Interest free advances ?

the Assessing officer made an addition of Rs. 19,32,0001- on account of interest @ 12% on advances of Rs. 1,61 ,00,0001- given to M/s Smart Tourist Pvt. Ltd. The assessee had given an advance of Rs. l,61,00,0001- to M/s Smart Tourist Pvt. Ltd on 09.04.2007(F.Y. 2007-08 and A.Y. 2008-09). This advance was reportedly given for purchase of land. This advance was shown as outstanding on 31.03.2009.

Held

HIGH COURT OF DELHI

Shivnandan Buildcon (P.) Ltd.

v.

Commissioner of Income-tax

W.P. (C) NOS. 6265 & 6326 OF 2013

APRIL  30, 2015

Parag Tipathi, Sr. Adv., Kunal Bahri and Ankit Verma, Advs. for the Petitioner. N.P. Sahni, Adv. for the Respondent.

JUDGMENT

Badar Durrez Ahmed, J. – These two writ petitions raise a common issue and, therefore, are being taken up together. The facts of W.P.(C) No.6265/2013 shall be referred to.

2. The assessment year concerned in both the petitions is assessment year 2009-10. The present writ petitions are preferred against the orders passed by the Commissioner of Income Tax under Section 264 of the Income Tax Act, 1961. In W.P.(C) 6265/2013, the assessee had filed his return of income declaring a loss of income of Rs. 32,934/- on 25.09.2009. The assessment under Section 143(3) was completed on 12.12.2011, by the Assessing Officer at an income of Rs. 18,99,070/- as against the above mentioned loss. In the assessment order, the addition of Rs. 19,32,000/- on account of notional interest earned on advances given to Smart Tourist Private Limited was made. The petitioner is aggrieved by the fact that the said addition did not have any factual basis and it is for this reason that the petition under Section 264 of the said Act was filed before the Commissioner seeking revision of the assessment order on account of the said addition.

3. The considerations and the findings of the Commissioner of Income Tax are as under:—

‘5.1 I have carefully considered the petition u/s 264, submissions of the assessee, comments of the Assessing Officer and assessment records of the assessee. In his petition reproduced ante, in clause (ii) and (iv) the appellant has raised objections on the addition of Rs. 19,32,000/-, on account of notional income on advances. In clause (i), (iii), (v), (vi), (vii) and (viii) the assessee has raised general legal objections I observations which are not required to be separately addressed and will be considered while discussing factual issues.

5.2 The only issue involved is on the addition of Rs. 19,32,0001- on account of interest @ 2% on advances of Rs. 1,61 ,00,0001- given to M/s Smart Tourist Pvt. Ltd. The assessee had given an advance of Rs. l,61,00,0001- to M/s Smart Tourist Pvt. Ltd on 09.04.2007(F.Y. 2007-08 and A.Y. 2008-09). This advance was reportedly given for purchase of land. This advance was shown as outstanding on 31.03.2009. The addition in A.Y. 2009-10 was made based on the assessment of preceding year. While making addition of interest @ 12% on these advances, the A.D. has stated as under in the assessment order for A.Y. 2008-09:

“The assessee has given Loan & Advances of Rs. 1,61,00,000/- to M/s Smart Tourist Pvt. Ltd on 09.04.2007. There is no explanation why the assessee has given loan to the above concern out of its funds and no interest has been charged for this loan. In the absence of any explanation, evidence regarding identities of the parties and purpose of the loans, notional interest at 12% per annum is charged on the loan amount given. Sum of Rs. 19,32,000/- is added to the total income as notional interest on the loan/advances given. Penalty proceedings u/s 271 (l) (c) for concealment of income and for furnishing inaccurate particulars of income are initiated separately.”

5.4 The Assessing Officer has noted that agreement to sell evidencing such advance against land has not been filed. He has further noted that the identity of the parties has not been established. The addition in the assessment of 2009-10 has been made on the basis of findings given in the assessment of earlier year i.e. A.Y. 2008-09. The assessee’s main contention is that since the assessment in 2009-10 on this issue is based on order for earlier assessment of A.Y. 2008-09, this assessment should also be set aside u/s 264 as the earlier assessments were set aside u/s 264. In this connection, I have carefully perused the order u/s 264 dated 16.03.2012 of my Ld. Predecessor. The assessment of A.Y. 2008-09 was set aside by the then Ld. CIT. In the tabular chart given in the order u/s 264 dated 16.03.2012, it is seen that 4 issues were identified. Interest on advance for purchase of land was only one of the issues. Even on this issue, the Ld. CIT has noted the comments of the incumbent A.D. stating that the action of the A.D. in making the said addition cannot be said to be unreasonable.

5.5 I had also called for the records of A.Y. 2008-09 and have examined them. I noticed that the reassessment proceedings u/s 144 r.w.s. 153A r.w.s. 264 have been concluded by the Assessing Officer on 08.03.2013 and he has again made the addition stating as under:—

“10. The assessee during the year, has given loan and advances of Rs. 1,61,00,00/- to M/s Smart Tourist Pvt. Ltd on 09.04.2007. The assessee during the re-assessment proceedings, as filed a copy of ledger account of the assessee and in the said ledger account a remarks has been made that confirmation being enclosed, but ongoing through the entire annexures no such confirmations has been filed by the assessee. The assessee has also not given any explanation why the said loan was given to the above concern out of its funds and no interest has been charges for this loan. In absence of any explanation, evidence regarding identities of the parties, purpose of the loan, notional interest @ 12% per annum is charged on the loan amount given. Accordingly, a sum of Rs. 19,32,000/- is added to the total income as notional interest on the loan/advance given. Penalty proceedings U/s 271(l)(c) of the Income Tax Act is initiated for concealment of income and for furnishing of inaccurate particulars ”

5.6 The assessee’s main argument that order u/s 143(3) for 2009-10 may be set aside on the grounds that earlier orders on the same lines have been set aside has no force behind it. Firstly, the earlier orders were set aside by my Ld. Predecessor after considering many issues, and the impugned issue was only one of the issue. Even on this issue, my Ld. Predecessor had noted the comments of the Assessing Officer about correctness of the addition and has not given any specific finding. On perusal of the records of A.Y 2008-09, I notice that the assessee has again failed to furnish documents like agreement to sell and valid confirmations in support of its contentions. Even during proceedings u/s 264, the assessee has not furnished these vital details. On objective consideration of the facts and circumstances of this case, I am of the opinion that the Assessing Officer was justified in making this addition and therefore, I refuse to interfere in the orders of the Assessing Officer on this issue.

5.7 In view of the above discussion, I am satisfied that this is not an appropriate case for interference in exercise of revisional powers u/s 264. Accordingly, the revision application u/s 264 filed by the assessee is hereby rejected.’

4. On going through the reasoning adopted by the Commissioner of Income Tax, it appears that the only reason why the addition was made was on account of the fact that no explanation has allegedly been given by the assessee as to why the loan/advance was given to Smart Tourist Private Limited. It was also noted that the identity of Smart Tourist Private Limited was not known. The logic that seems to have been applied by the revenue authorities is that the petitioner was a businessman and it would be imprudent for a businessman to advance a sum of Rs. 1.6 crores as in the case of W.P.(C) 6265/2013 to Smart Tourist Private Limited and to not charge anything in return. The explanation sought to be given by the petitioner in both these cases was that the advances were made in the course of their business and it is not at all necessary that an advance given by a businessman at all times must have an element of interest also. There are various other considerations which come into the calculations when a businessman advances money to another. It is not at all necessary that interest must be charged. It was further submitted by the learned senior counsel appearing on behalf of the petitioners that there is no finding in the assessment orders or in the order of the Commissioner of Income Tax that the petitioners had, in fact, received some amount by way of interest and that such amount was not shown in the accounts. It is also contended that the revenue authorities have not rejected the books of accounts of the petitioner. It was, therefore, submitted that unless and until there was a concrete finding that something was received by the petitioner from the said Smart Tourist Private Limited and other persons similarly situated, nothing can be added by way of notional income. A reference was made to the decision of the Guwahati High Court in B and A Plantations & Industries Ltd. v CIT [2000] 242 ITR 22/[2001] 117 Taxman 323 . The relevant portion of that decision reads as under:—

‘As regards the addition of notional interest the assessee made an interest free advance of Rs. 19,58,256 to Jorhat Investments Ltd., which is a sister concern. The case of the assessee is that they did not charge interest on that advance and in consideration of the same the assessee got the premises at a very low rent of rupees two per sq. feet in a prime locality of Calcutta.

15. The Assessing Officer added a notional interest of 18 per cent. on the advance amount and added the income as the amount of interest. The said addition was approved by the Commissioner of Income Tax (Appeals) and the Tribunal.

16. In this case there is no finding when the assessee had in fact received the interest or that the Jorhat Investments Ltd., had in fact paid the interest to the assessee and the interest was not reflected in the accounts. The finding is that the assessee ought to have charged interest.

17. The facts in the instant case are more or less identical with the case of Highways Construction Co. Pvt. Ltd. v CIT[1993] 199 ITR 702, wherein this court held (page 708) :

“There is no finding of fact to the effect that actually the loan had been granted to the managing director or any other person on interest, or that interest had actually been collected and the collection of the interest was not reflected in the accounts. The finding of the Income Tax Officer is that the assessee ought to have collected interest. In other words, the view of the Income Tax Officer, which has been accepted by the Tribunal, was that the assessee, as a good business concern, should not have granted interest-free loan, or should have insisted on payment of interest. If the assessee had not bargained for interest, or had not collected interest, we fail to see how the Income Tax authorities can fix a notional interest as due, or collected by the assessee. Our attention has not been invited to any provision of the Income Tax Act empowering the Income Tax authorities to include in the income, interest which was not due or not collected. In this view, we answer question No. (ii) in the negative, that is, in favour of the assessee and against the Revenue.”‘

5. On going through the said decision, it can be discerned that the Guwahati High Court held that there was nothing to show that the assessee had, in fact, received interest or that the company to whom the loan was given had, in fact, paid interest to the assessee. There was also nothing on record to show that the alleged interest was not reflected in the accounts. The only finding recorded was that the assessee “ought to” have charged interest. Referring to an earlier decision of the Guwahati High Court, in Highways Construction Co. (P.) Ltd. v. CIT [1993] 199 ITR 702, the Court observed that their attention had not been invited to any provision of the Income-Tax Act empowering the income-tax authorities to include in the income, interest which was not due or not collected.

6. In similar vein, when we asked Mr Sahni, who is appearing for the respondent to point out some provision of the Income Tax Act, whereunder such ‘notional’ interest could be made the subject matter of tax, the only reference he made was to Section 144 of the said Act. However, we are clear that Section 144 does not at all apply to the present proceedings because the present proceedings originate from an assessment under Section 143(3) of the said Act.

7. In the absence of any specific provision under which the so called notional income on advances, could be brought to tax, we do not see as to how the impugned orders passed by the Commissioner of Income Tax can be sustained.

8. Consequently, we allow these writ petitions. The impugned orders are set aside. The addition on account of a notional income on advances is deleted. These writ petitions have been decided only in respect of the respective assessment orders for the assessment year 2009-10 and will not have any bearing on the other assessment years, the facts of which we have not examined.

L. NARASIMHA REDDY AND CHALLA KODANDA RAM, JJ.

JUDGMENT

L. Narasimha Reddy, J. – This appeal under section 260A of the Income-tax Act, 1961 (for short “the Act”), is preferred by the Revenue, feeling aggrieved by the order dated March 3, 2003, passed by the Hyderabad Bench A of the Income-tax Appellate Tribunal (for short “the Tribunal”), in I.T.A. No. 40/Hyd/2000.

2. The facts that gave rise to filing of the appeal are as under :

3. The respondent is a civil contractor. It was awarded a contract by the Hyderabad Municipal Water Supply and Sewerage Board. The terms of the contract provided for deduction of 7.5 per cent. on each bill. Out of this, 5 per cent. would be released to the respondent on successful completion of the work and the remaining 2.5 per cent., on expiry of the defect liability period, on finding that no defects in the work are noticed during that period.

4. In its return, filed for the assessment year 1996-97, the respondent did not include the amount representing 2.5 per cent. of the bills. According to them, such amount can be shown as income, only on its being received. The Assessing Officer, however, took the view that since the respondent was following the mercantile system of accounting, the amount of 2.5 per cent. of bills can be said to have accrued to it, along with the amount paid under the bills and the same is liable to be treated as income for that year. The respondent filed an appeal before the Commissioner of Income-tax (Appeals). The same was rejected on October 29, 1999. Thereafter, it filed I.T.A. No. 40 of 2000 before the Tribunal. The appeal was allowed and the Revenue has challenged the order of the Tribunal by filing this appeal.

5. Ms. Kiranmayee, learned counsel, representing, Sri J.V. Prasad, learned counsel for the appellant, submits that it is only when the cash system of accountancy is followed by an assessee, that he can reflect the receipts, when the amount is actually received, and in contrast, if mercantile system is followed, the amount deserves to be shown, in the returns of the year, in which it was mentioned in the books of account, irrespective of the date of actual receipt. She contends that 2.5 per cent. of the bill amount has already accrued to the respondent, except that the payment thereof is deferred, and that the Tribunal was not justified in taking a different view.

6. Sri A. V. Shiva Kartikeya, learned counsel for the respondent, on the other hand, submits that even where the mercantile system is followed, the distinction between the true accrual, on the one hand, and mere entry made in the books, on the other hand, needs to be maintained. Placing reliance upon certain precedents, he submits that an amount can be said to have accrued to an assessee, as income, only when the corresponding right to receive it, arises and not otherwise.

7. Section 145 of the Act gives the liberty to an assessee to follow either mercantile system or cash system of accounting. The distinction between these two, is too well-known. At the same time, certain niceties involved in understanding the true purport of certain expressions, which are used in the process, present some amount of difficulty.

8. An assessee, who follows the cash system, would be under obligation to pay tax only on the amount received by him, after assessment, in accordance with law. In contrast, an assessee, who follows the mercantile system, would be liable to pay tax on the amounts reflected in the books of account, irrespective of the fact whether he received the amount or not. The same is the case with the deductions and they do not depend upon the actual payments. Two judgments rendered by the hon’ble Supreme Court, which are almost classics, would be helpful to have a clear idea about the concept. Of course, most of the players in the administration of tax regime are fairly acquainted with it. In CIT v. Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC), Sri Hidayatullah J. explained it as under (page 148) :

“Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt ; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book keeping, an entry is made about a hypothetical income, which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account.”

9. Equally educative and instructive is the judgment of the hon’ble Supreme Court in CIT v. A. Gajapathy Naidu [1964] 53 ITR 114, the hon’ble Justice Sri Subba Rao K., in his inimitable style, explained the distinction between the two, succinctly, by addressing the root of the matter. The discussion was commenced by taking note of section 4(1)(b)(i) of the 1922 Act, as it stood then. The provision reads as under :

“Subject to the provisions of this Act, the total income of any previous year of any person includes all income, profits and gains from whatever source derived which —

(b) if such person is resident in the taxable territories during such year, –

(i) accrue or arise or are deemed to accrue or arise to him in the taxable territories during such year.”

10. The concentration was on sub-clause (i).

11. The following passage from Rogers Pyatt Shellac & Co. v. Secretary of State for India [1925] 1 ITC 363, 371 was taken note of :

“. . . both the words are used in contradistinction to the word ‘receive’ and indicate a right to receive. They represent a stage anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate.”

12. The hon’ble Supreme Court proceeded to observe (page 118 of 53 ITR) :

“Under this definition accepted by this court, an income accrues or arises when the assessee acquires a right to receive the same. It is commonplace that there are two principal methods of accounting for the income, profits and gains of a business ; one is the cash basis and the other, the mercantile basis. The latter system of accountancy brings into credit what is due immediately it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The book profits are taken for the purpose of assessment of tax, though the credit amount is not realised or the debit amount is not actually disbursed. If an income accrues within a particular year, it is liable to be assessed in the succeeding year. When does the right to receive an amount under a contract accrue or arise to the assessee, i.e., come into existence ? That depends upon the terms of a particular contract.”

13. The problem was explained with the help of an illustration, as under (page 119 of 53 ITR) :

“When an Income-tax Officer proceeds to include a particular income in the assessment, he should ask himself, inter alia, two questions, namely : (i) what is the system of accountancy adopted by the assessee ? and (ii) if it is the mercantile system of accountancy subject to the deemed provisions, when has the right to receive that amount accrued ? If he comes to the conclusion that such a right accrued or arose to the assessee in a particular accounting year, he shall include the said income in the assessment of the succeeding assessment year. No power is conferred on the Income-tax Officer under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year on the ground that the said income arose out of an earlier transaction. Nor is the question of reopening of accounts relevant in the matter of ascertaining when a particular income accrued or arose. Section 34 of the Act empowers the Income-tax Officer to assess the income which escaped assessment or was under-assessed in the relevant assessment year.”

14. One does not need any further help or material to understand the basics of the concept than this. A clear distinction is maintained between right to receive the amount and acquisition of right, as such. In the present context, the distinction is mostly between the acquisition of a right to receive, on the one hand, and being in a position to claim, on the other hand. On acquisition of a right to receive the amount, the assessee would be in a position to enforce it, and the enforcement may, in a given case take sometime. In the context of the mercantile system, the mere acquisition of a right to receive would be sufficient to saddle the assessee, with the obligation to pay tax. Where, however, he is yet to acquire right but is in a position to claim of such right, the matter stands on a different footing. As observed by the hon’ble Supreme Court, that would depend upon the terms of a contract. Issues of this nature crop up mostly, when the conditions are contingent in nature.

15. In the instant case, the clause in the contract provided for deduction of 7.5 per cent. from each bill. Out of this, 5 per cent. would be payable on successful completion of the work and balance 2.5 per cent. after the expiry of the defect-free period. For instance, if the value of the contract is Rs. 1 crore and the amounts are paid under the four bills of Rs. 25 lakhs each. From each of the first 3 bills, sums representing 7.5 per cent. are deducted. On successful completion of the work, the amounts representing 5 per cent. deducted from the first three bills, would become payable along with the final bill. However, even from the final bill, 2.5 per cent. would be deducted. This amount of 2.5 per cent., which stood deducted from all the four bills, becomes payable, only on expiry of the defect-free period. If such period is one year, the amount becomes payable only when no defects whatever are found or noticed, during that period.

16. The controversy, in the instant case, is about the year in which the amount representing 2.5 per cent. had accrued to the respondent. It is, no doubt, true that in all the bills, reference was made to these amounts and the corresponding entries were made in the books of account. However, the right to receive that amount was contingent upon there not being any defects in the work, during the stipulated period. It is then, and only then, that the amount can be said to have accrued to the respondent. It is represented by the learned counsel for the respondent that the amount was received by his client in the subsequent assessment year on expiry of the defect-free period and that the amount has been brought under the tax.

17. The view taken by the Tribunal accords with the law laid down by the hon’ble Supreme Court and we do not find any basis to interfere with the order under appeal.

18. The I.T.T.A. is, accordingly, dismissed. There shall be no order as to costs.

19. The miscellaneous petitions filed in this appeal shall also stand disposed of.