2016 (5) TMI 975 - AT - Income Tax

Accrual of Income - Addition towards service fees received - Held that - The assessee was able to supply the man power starting from 20 numbers in Nov 07 and managed to increase this level to 112 nos. by Mar 08, not even 50% mark to the agreed level of service. No doubt assessee agreed to supply the manpower and as understand assessee is a new entrant to this field. The assessee was in the process of setting the business. Our understanding is that the assessee will have right to claim the service charges only when he reaches the level of service agreed and as per the agreement or as per terms of agreement with regard to commencement of the agreement period. In the given case, the assessee neither reached the level of service expected nor the agreement has commenced. Hence, assessee is not in a position to claim any professional fees during the period of 01/11/2007 to 31/03/2008. It is clear that the income has not accrued to the assessee. Income can be recognized only when it is earned or accrued i.e. there is a right to receive. In the present case, neither the assessee had achieved the level of service i.e. to supply 300 manpower nor the terms of contract commenced, resulting in no right to receive. We must interpret the situation in the normal course of business i.e. in a situation where the holding company has to deal with outsiders. Just because the assessee is dealing with holding company, it will not get a right to receive. Even in dealing with the outside party, the right to receive would not have arisen simply because the assessee had not achieved the expected service level nor the terms of agreement has commenced. The business decisions are done purely on commercial basis. When assessee has not achieved the expected level of services it has no right to claim any service charges. Income has to be realized or there has to be a right to receive the income, in absence of such right, income cannot be recognized. Hence, the addition made by the Assessing Officer in this case needs to be deleted. Hence, the addition made by the Assessing Officer is hereby deleted. - Decided in favour of assessee.

Summary

Issues Involved:
1. Addition of ?5,00,000 on a notional basis towards service fees.
2. Disallowance of business loss/expenses of ?1,16,014.

Issue-wise Detailed Analysis:

1. Addition of ?5,00,000 on a notional basis towards service fees:

The assessee company, engaged in manpower recruitment, filed its return for AY 2008-09 declaring a loss of ?1,33,070. The Assessing Officer (AO) completed the assessment u/s 143(3) by adding ?5,00,000 towards service fees for services rendered to its holding company, GMR Hyderabad International Airport Ltd. (GHIAL). The AO took a notional service fee of ?1,00,000 per month for five months (November 2007 to March 2008), despite the agreement stipulating that service fees were payable from April 2008 onwards. The assessee argued that the holding company only reimbursed expenses on a cost-to-cost basis for the period before April 2008, and no service fee was due or receivable.

The CIT(A) upheld the AO's addition, stating that the assessee had rendered services during the said period and, under the mercantile system of accounting, income should be recognized on an accrual basis. The CIT(A) found the agreement favoring the holding company and considered the service fee of ?5,00,000 as accrued income.

The Tribunal, however, disagreed with the CIT(A) and AO. It noted that the assessee had entered into a service agreement effective from April 1, 2008, and was eligible for professional fees only from that date. The assessee had not reached the agreed service level of 300 associates before April 2008, and thus, no right to receive fees had accrued. The Tribunal emphasized that income must be recognized only when it is earned or accrued, citing the Supreme Court's decision in CIT Vs. Shoorji Vallabhadas & Co., which held that hypothetical income not materializing cannot be taxed. Consequently, the Tribunal deleted the addition of ?5,00,000.

2. Disallowance of business loss/expenses of ?1,16,014:

The AO had disallowed the business loss/expenses of ?1,16,014 claimed by the assessee, arguing that all expenses were reimbursed by GHIAL. The CIT(A) directed the AO to allow the expenditure of ?1,16,014 against the income of ?5,00,000. However, since the Tribunal deleted the addition of ?5,00,000, the issue of disallowance of ?1,16,014 became moot.

Conclusion:

The Tribunal allowed the appeal of the assessee, deleting the addition of ?5,00,000 made on a notional basis and recognizing that no service fee income had accrued for the period before April 2008. The Tribunal also implicitly accepted the assessee's claim for business loss/expenses of ?1,16,014, as the primary addition was deleted. The judgment emphasized the principle that income must be recognized only when there is a right to receive it, aligning with established legal precedents.