2010 (3) TMI 806 - AT - Income Tax

Accrual of Interest income - Deep Discount Bond - AO observed that interest accrues year after year and not accrue all of a sudden at the time of redemption/maturity. - Held that the assessees are entitled to recognize the interest income attributable to 8 per cent Reserve Bank of India Bonds on cash basis to be reckoned at the time of redemption of the Bonds - Decided in favour of assessee.

Summary

Issues:
Tax treatment of interest income from 8% RBI Bonds under cash system of accounting vs. accrual basis.

Analysis:
The judgment involves a dispute regarding the tax treatment of interest income from 8% RBI Bonds for the assessment year 2006-07. The assessees contended that they followed the cash system of accounting and should recognize interest income only upon redemption of the Bonds when the interest is paid. The Assessing Officer, however, asserted that interest accrues year after year and should be offered for taxation annually. The CIT(A) upheld the assessing authority's decision based on a Circular issued by the CBDT regarding Deep Discount Bonds, suggesting that differential value be treated as interest income annually. The assessees appealed this decision.

The Tribunal analyzed the situation and ruled that the assessees had the right to choose between accrual or cash basis for recognizing income, unless statutory provisions mandated otherwise. Since no such mandate existed in this case, the assessees were entitled to recognize interest income on RBI Bonds based on their chosen method. The Tribunal highlighted that the terms of the RBI Bonds played a crucial role in determining the appropriate recognition method. In this case, as per the RBI, interest was payable only upon redemption, not annually, and no TDS was deducted until maturity.

Moreover, the Tribunal emphasized the practical implications of recognizing income on an accrual basis, especially concerning TDS credits. Since the RBI did not deduct TDS annually, it would be impossible for the assessees to claim credit for TDS if interest income was recognized annually. The Tribunal also clarified that the Circular regarding Deep Discount Bonds was not applicable to the case of 8% RBI Bonds, as each bond type stood independently.

Furthermore, the Tribunal noted that while Circulars and clarifications issued by the Board were binding on Revenue officials, they were not necessarily binding on Courts or assessees following permissible accounting methods. The Tribunal held that the assessees were within their rights to recognize interest income on a cash basis, to be accounted for at redemption. Consequently, the Tribunal allowed the appeals, deleting the additions made by the assessing authority towards interest income.

In conclusion, the Tribunal ruled in favor of the assessees, affirming their right to recognize interest income from 8% RBI Bonds on a cash basis at the time of redemption, rejecting the assessing authority's contention for annual accrual-based taxation.