2014 (5) TMI 1083 - AT - Income Tax

Interest accrued to the assessee - @18% p.a. as claimed by the assessees in the suits filed for recovery of advances - Held that - As assessees have stated before the CIT(A) that the amounts advanced are from out of the share application monies and temporary advances. It is so stated on the basis of entries in the Balance Sheet and the Profit & Loss Accounts of the respective assessees filed along with their returns of income. In the absence of any contract between the assessee companies and M/s. SCSL for charging of interest on the advances, the assessees are not entitled to receive any interest income on such advances. Therefore, merely because the assessee is following mercantile is system of accounting, it cannot be said that the interest has accrued to the assessees .Further, merely because the assessees have claimed interest at the rate of18% per annum in the suits filed for recovery of advances, it cannot be said that the said rate of interest is applicable as M/s.SCSL has not admitted the liability of even the amounts of advance. As such, we find that there is no certainty with regard to the said rate of interest. Therefore, it cannot be presumed that the interest accrued to the assessee at the rate of 18% p.a. as claimed by the assessees in the suits filed for recovery of advances. The Civil Courts would consider and decide the liability of M/s. SCSL to repay the amounts of advances and would also consider the liability of M/s. SCSL to payinterest thereon and the rate of interest at which the advances should be repaid. Therefore, unless and until the liability to pay the advances and the rate of interest at which the temporary advances are to be repaid is determined by the Civil Court, it cannot be said that the same has accrued or arisen to the assessees. However, if the assessees had advanced interest bearing funds as interest free advances, the interest paid by the assessees towards such borrowed funds would have to be disallowed and treated as the income of the respective assessees. We find that neither the Assessing Officer nor the CIT(A) has examined the issue from this angle. Therefore, the orders of the CIT(A) and the Assessing Officer share set aside and the issue is remitted to the file of the Assessing Officer of the respective assessees for de no consideration in the light of our observations above. Further, we hold that if the amounts advanced to M/s. SCSL by the respective assessees are from their own funds, then the interest expenditure cannot be disallowed and brought to tax

Issues Involved:
1. Accrual of interest on advances made by the assessee companies to M/s. Satyam Computer Services Ltd. (SCSL).
2. Determination of whether interest income should be taxed in the relevant assessment year.
3. Examination of the nexus between interest-bearing funds and interest-free advances.
4. Legal principles governing the accrual of interest income and the disallowance of interest expenditure.

Detailed Analysis:

1. Accrual of Interest on Advances:
The core issue revolves around whether interest on advances made by the assessee companies to M/s. Satyam Computer Services Ltd. (SCSL) has accrued and should be accounted for in the relevant assessment year. The Assessing Officer (AO) observed that the assessee companies, following the mercantile system of accounting, claimed interest at 18% per annum on advances made to SCSL. However, SCSL denied any liability to repay the advances or interest thereon.

2. Taxation of Interest Income:
The AO contended that interest income should be taxed in the assessment year 2008-09, as the assessee companies had an inherent right to receive interest. The Commissioner of Income-tax (Appeals) [CIT(A)] held that interest income could only be taxed when the City Civil Court finalizes the interest rate in the pending civil suits. The tribunal agreed with the CIT(A), stating that without a contract specifying interest, the interest income cannot be deemed to have accrued.

3. Nexus Between Interest-Bearing Funds and Interest-Free Advances:
The tribunal examined whether the advances to SCSL were made from interest-bearing borrowed funds or from the assessee's own funds. It was noted that the advances were made from share application monies and temporary advances, not borrowed funds. Therefore, in the absence of a contract for interest and given that the advances were not from borrowed funds, no notional interest could be brought to tax.

4. Legal Principles:
The tribunal referred to several legal precedents:
- CIT v. Walchand & Co. P. Ltd.: The reasonableness of expenditure should be judged from the businessman's perspective.
- CIT v. Reliance Utilities and Power Ltd.: If both interest-free and interest-bearing funds are available, a presumption arises that investments are made from interest-free funds.
- Highways Constructions P. Ltd. v. CIT: No notional interest can be taxed if the assessee has not actually collected interest.
- CIT v. Abhishek Industries Ltd.: Disallowance of interest expenditure requires proof of a nexus between interest-bearing funds and interest-free advances.

Tribunal's Conclusion:
The tribunal concluded that:
- The assessee companies did not have a contractual right to receive interest from SCSL.
- The advances were made from interest-free funds.
- Interest income cannot be presumed to have accrued in the absence of a contract and the uncertainty of recovery.
- The issue of disallowance of interest expenditure should be re-examined by the AO to determine if the advances were made from borrowed funds.

The tribunal set aside the orders of the CIT(A) and the AO, remitting the issue back to the AO for de novo consideration, emphasizing that interest income cannot be taxed without a contractual obligation and certainty of recovery.

Final Order:
The appeals of the Revenue were allowed for statistical purposes, and the AO was directed to re-examine the issue, providing a fair opportunity to the assessees.

Order pronounced in the court on 1st May, 2014.

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