2016 (12) TMI 866 - AT - Income Tax

Accrual of interest - real income receipt - Held that - Since the assessee has not received or realized any interest, it has not accrued to the assesee. The assessee has not offered the said interest for taxation in the return of income filed with the Revenue. Only real income can be brought to tax and not hypothetical income is a well settled proposition of tax-laws. In our considered view, there was a mistake committed by partnership while finalizing its return of income filed with Revenue which was corrected by the said assessee on the very next day i.e. On 1st April, 2006 and no expenditure was claimed. Hence, in our considered view this interest income cannot be brought to tax in the hands of the assessee as it is not a real income but a hypothetical income. No prejudice is caused to the Revenue as the said partnership firm did not claimed any expenditure in its return of income towards interest expenditure payable on capital contributed by partners but the same was added to the closing WIP.In any case it is reversed on 01-04-2006 by the firm by reducing WIP. We further find that the A.O. has not made any enquiry with the said firm to bring on record any incriminating material to disprove the contentions and the submissions of the assessee. The addition of interest expenditure of ₹ 33,23,178/- to the income of the assessee is in our considered view is not sustainable in the eyes of law and is hereby ordered to be deleted. - Decided in favour of assessee

Issues Involved:
1. Addition of interest income of ?33,23,178/-.
2. Consideration of interest expenses in the partnership firm's Profit & Loss account.
3. Reversal of entries in subsequent years and its impact on real income.
4. Double taxation due to non-deduction of interest expenses by the partnership firm.

Issue-wise Detailed Analysis:

1. Addition of Interest Income of ?33,23,178/-:
The primary issue is the addition of interest income amounting to ?33,23,178/-. The assessee, engaged in the construction industry, invested ?7.10 crores in the capital of the partnership firm, M/s Kamlashri Builders. The original partnership deed stipulated a 12% interest on the capital, but this clause was amended on 18th January 2006, effective from the original date, to eliminate the interest payment. The AO added the interest to the assessee's income, arguing that the revised deed was an afterthought to evade tax. However, the Tribunal found that the interest was never realized or received by the assessee, and the partnership firm had reversed the interest entry on 1st April 2006, before the reopening notice was issued. Thus, the Tribunal concluded that only real income, not hypothetical income, can be taxed and ordered the deletion of the addition.

2. Consideration of Interest Expenses in the Partnership Firm's Profit & Loss Account:
The assessee argued that the partnership firm did not claim the interest expenses in its Profit & Loss account; instead, it was capitalized and added to the Work In Progress (WIP). The AO observed that the firm did not revise its return to reflect the amended partnership deed, which indicated an afterthought. The Tribunal noted that the interest was debited to the closing WIP and reversed the next day, ensuring no expense was claimed. The Tribunal upheld that the interest provided in the books was a journal entry mistake corrected timely, and no real income was generated.

3. Reversal of Entries in Subsequent Years and its Impact on Real Income:
The assessee contended that the reversal of entries in the subsequent year does not result in real income. The Tribunal agreed, emphasizing that the concept of real income cannot be used to make accrued income non-income due to subsequent reversals. The Tribunal cited precedents, including CIT v. Shoorji Vallabhdas and Co., to support that only realized or received income can be taxed. The Tribunal found that the partnership firm corrected its mistake by reversing the interest entry on 1st April 2006, indicating no real income was generated.

4. Double Taxation Due to Non-deduction of Interest Expenses by the Partnership Firm:
The assessee argued that since the partnership firm did not claim the interest expenses, taxing the same in the assessee's hands would result in double taxation. The Tribunal observed that the interest was not claimed as an expense but added to the WIP and later reversed. Therefore, no double taxation occurred as the interest was never realized or received by the assessee or claimed as an expense by the partnership firm.

Conclusion:
The Tribunal concluded that the interest income of ?33,23,178/- was not real income and should not be taxed. The addition made by the AO was deleted, and the appeal filed by the assessee was allowed. The Tribunal emphasized that only real income, not hypothetical income, can be taxed, and the partnership firm's timely correction of the journal entry mistake supported this conclusion.

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