2016 (6) TMI 99 - AT - Income Tax

Accrual of income - nature of income - whether right to receive the return (or income) on the shares had accrued to the assessee during the relevant year? - irrevocable option to sell these shares at the option price to AT discounting for net present value only to find further endorsement of the said view and further of not impacting the valuation (of the right to receive) or the accrual of the income in any manner. Even de hors the character of the arrangement as a financing arrangement or any other the nature of the investment would not be of much consequence as long as there is accrual of income in the facts and circumstances of the case i.e. by way of right to receive a receivable resulting in a debt realizable even if in future. The fact that the income is realizable as a part of the sale price of shares i.e. an investment by the assessee a investment company as a part of and in regular course of its business to fetch return i.e. along with redemption or liquidation of the investment as only representing the form in which the income imbedded in the increased share value is realized. The same is only a manner of realization of the income since accrued as is the case (in other common day examples of) with interest on (cum) debentures or Bank FDR etc. and thus by itself of little moment. Could it be material one may ask if the interest of Debenture or FDR stands to be received over the tenure of the investment separately or along with redemption of the investment? The increase in the share price to the defined extent would arise irrespective of the performance of the company during the holding period or its intrinsic value (net worth) at the time of transfer of shares. Would it therefore matter even if (say) some management rights were also attached to the shareholding which we observe as not. In our view not. The investment is in a private company shares in which are severely restricted for transfer making it highly illiquid i.e. but for the arrangement in pursuance to which only in fact the investment in shares stands made. That is considerable uncertainty would otherwise exist as to the realizability of the income. The income being also in agreement with the matching principle of accountancy also judicially approved is thus found to accrue from year to year i.e. on time basis and thus for the relevant year. The same further is only by way of business income i.e. as assessed on which we again observe no dispute; rather the two returns ensuing on investment i.e. by way of call option fee (returned and assessed as business income) and the annualized return (over the holding period) found to be para materia forming part of an integrated revenue model and further only in the nature of interest income as defined both in the accountancy as well as by statute. There is no law that interest could be assessed only as income from other sources partake as it does its character from the underlying transaction from which it arises (CIT vs. Govinda Choudhury 1992 (4) TMI 8 - SUPREME Court . The case law cited stands also considered only to find the same to be in agreement with the view expressed herein confirming the stand of the Revenue being essentially a question of fact to be determined on an appreciation of the facts of the case with the law being well settled. Finally we observe the income arising has not been worked out by the A.O. in the manner provided for in the agreement i.e. @ 11% p.a. compounded annually with reference to the date of the investment. The A.O. shall do so of-course after allowing opportunity to present its working with regard thereto and consider the same. We consider ourselves competent to issue such a direction - Decided against assessee.

Issues Involved:
1. Accrual of Income
2. Nature of Income
3. Matching Principle
4. Case Law Analysis

Detailed Analysis:

1. Accrual of Income:
The primary issue is whether the income by way of return on 'equity' accrues to the assessee from day to day or only upon the sale of shares. The assessee argued that the income had not accrued as the option had not been exercised, relying on precedents like E. D. Sassoon and Co. Ltd. vs. CIT and CIT vs. Canara Bank. The Revenue contended that the income accrues on a time basis, citing cases like Madras Industrial Investment Corporation Ltd. vs. CIT and State Bank of Travancore vs. CIT. The tribunal concluded that the income accrues to the assessee on a time basis, reflecting an increase in the option price during the year, thus bringing it to tax.

2. Nature of Income:
The tribunal examined the nature of the right to receive income under the shareholder's agreement. It was determined that the right to an increase in the value of shares, embedded in the option price, accrues over time. The agreement specified a return at 11% p.a. compounded annually, which accrues irrespective of the exercise of the option. The tribunal found that the income, though realized upon the transfer of shares, accrues annually as a function of time, thus constituting business income.

3. Matching Principle:
The tribunal emphasized the importance of the matching principle, which requires that both revenues and costs be accounted for on an accrual basis. The assessee's borrowing costs were allowed as business expenditure, and the corresponding revenue, whether realized or not, was to be recognized as income. This principle ensures that the financial statements reflect a true and fair view of the state of affairs.

4. Case Law Analysis:
The tribunal reviewed various case laws cited by both parties. In A. Gajapathy Naidu, the right to receive compensation arose only upon the government's direction, and thus, the income was taxed in the year it was received. In State Bank of Travancore, the concept of real income was emphasized, but it could not negate accrual where it had already occurred. In E. D. Sassoon and Co. Ltd., the commission accrued only at the end of the year, not apportioned between the assignor and assignee. In Canara Bank, interest was held to accrue only when the securities yielded interest. The tribunal found these precedents consistent with its decision that the income accrues annually on a time basis.

Conclusion:
The tribunal dismissed the assessee's appeal, holding that the income by way of return on investment in shares accrues annually as a function of time, thus constituting business income. The tribunal directed the Assessing Officer to work out the income in the manner provided for in the agreement, ensuring compliance with the matching principle and relevant case laws.

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