2014 (6) TMI 499 - AT - Income Tax

Accrual of interest - Chargeability of interest uncertainty - Money given as advance - dispute between parties Held that - The assessees have advanced the loans/temporary advances to M/s. SCSL - the assessees have advanced the loans or temporary advances through banking channels and immediately after the statement of Sri Ramalinga Raju, the assessees have also issued legal notices for the repayment of the loans and also filed civil suits for recovery of the loan amounts along with interest in the City Civil Court, Secunderabad Relying upon CIT V/s. Walchand & Co. P. Ltd. 1967 (3) TMI 2 - SUPREME Court - the 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. There is no certainty with regard to the said rate of interest - 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 - 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 - 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 the order of the CIT(A) is set aside and the matter is remitted back to the AO for fresh adjudication Decided in favour of Assessee.

Summary

Issues Involved:
1. Whether interest on advances given by the assessee companies to M/s. Satyam Computer Services Ltd. (SCSL) should be taxed on an accrual basis.
2. Whether the advances made by the assessee companies were from interest-free funds or borrowed funds.
3. The applicability of notional interest income in the absence of a contract for interest.

Detailed Analysis:

1. Interest on Advances:
The Revenue contended that the assessee companies should account for interest on the advances given to M/s. SCSL on an accrual basis, as they follow the mercantile system of accounting. The Assessing Officer (AO) calculated interest at 18% per annum on these advances and added it to the total income of the assessee companies for the relevant assessment year. The AO's rationale was based on the companies' inherent right to receive interest, evidenced by their legal claim.

The assessee companies argued that M/s. SCSL had denied liability for these advances and interest, and there was no certainty of recovery. They also pointed out that there was no contract stipulating interest on these advances. The CIT(A) sided with the assessees, stating that interest income could only be taxed when the City Civil Court finalizes the rate of interest, as mentioned in the civil suits filed for recovery.

2. Source of Advances:
The assessee companies claimed that the advances were made from share application money and not from borrowed funds. This distinction is crucial because if the advances were from interest-free funds, no interest expenditure could be disallowed or taxed. The CIT(A) did not examine the nexus between the funds advanced and the interest-bearing funds.

3. Notional Interest Income:
The legal principles governing notional interest were discussed, citing various court rulings:
- The Supreme Court in CIT V/s. Walchand & Co. P. Ltd. emphasized that business decisions should be judged from the businessman's perspective, not the Revenue's.
- The Bombay High Court in CIT V/s. Reliance Utilities and Power Ltd. held that if interest-free funds are sufficient, it is presumed that investments are made from these funds.
- The Gujarat High Court in Highways Constructions P. Ltd. V/s. CIT ruled that notional interest cannot be taxed if there is no contract for interest.
- The Punjab & Haryana High Court in CIT V/s. Abhishek Industries Ltd. stated that the nexus between interest-bearing funds and interest-free advances must be proven for disallowance of interest expenditure.

Conclusion:
The Tribunal found that:
- There was no contract between the assessee companies and M/s. SCSL for charging interest on the advances.
- The certainty of interest accrual depended on the civil court's decision regarding the liability and rate of interest.
- The nexus between the funds advanced and interest-bearing funds was not examined by the AO or CIT(A).

The Tribunal set aside the orders of the CIT(A) and AO and remitted the issue back to the AO for de novo consideration, emphasizing that if the advances were from the assessee's own funds, no interest expenditure should be disallowed. The AO was instructed to provide a fair hearing to the assessees before passing any orders.

Result:
All appeals of the Revenue were allowed for statistical purposes, and the matter was remitted back to the AO for fresh consideration in light of the Tribunal's observations.