2025 (1) TMI 274 - AT - Income Tax

Addition of notional interest on the interest free advances - chargeability to tax founded on real income or not? - undisclosed interest income on short term Loans and Advances - HELD THAT - No justification for adding any notional interest on the interest free advances as the assessee had ample interest free funds out of which such advances were made for business purposes. In the case of S.A. BuildeRs 2006 (12) TMI 82 - SUPREME COURT even interest paid on borrowings was allowed as a deduction if the same were advanced for business purposes. There is merit in the arguments of the assessee that only real income which had accrued to it could be assessed and no income could be presumed to have been earned in the absence of any evidence. Even in the case of the three debtors whose replies have been considered by the Ld. AO, no evidence could be ascertained by him that any interest was payable or paid by them to the assessee and the amounts had been reduced from the total advances for calculating the notional interest. The observation of the Ld. AO confirmed by the Ld. CIT(A) that the assessee had paid 9% interest on the funds borrowed is also not borne out of analysis of the facts of the case as reported in the balance sheet and audited accounts and no interest was debited during the year while calculating its income. No justification for presuming notional interest on the amounts advanced merely because replies were not received from the debtors, though the assessee counters that argument by stating that confirmations/replies from eight of the debtors comprising 69.56% of the total advances in value were uploaded. Hence no income could be presumed nor any disallowance out of interest debited could be made when the assessee had not claimed any interest as a deduction. Decided in favour of assessee.

2006 (12) TMI 82 - SC

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment are:

Whether the addition of Rs 4,84,99,218/- as undisclosed interest income on short-term loans and advances by the Assessing Officer (AO) was justified.
Whether the AO had the authority to add notional interest to the income of the assessee under the Income Tax Act.
Whether the assessee had sufficient interest-free funds to justify the interest-free advances made for business purposes.
Whether the AO's failure to consider the set-off of carried-forward business losses was justified.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Justification of Addition of Undisclosed Interest Income

Relevant Legal Framework and Precedents: The Income Tax Act does not have provisions for adding notional interest to income. The case references include S.A. Builders Ltd. v. Commissioner of Income-tax, which emphasizes the commercial expediency of interest-free loans.
Court's Interpretation and Reasoning: The court found that the AO's addition was based on presumption without factual basis. The AO failed to provide evidence of actual interest earned by the assessee.
Key Evidence and Findings: The assessee provided confirmations from eight parties covering 69.56% of the advances, indicating no interest was earned or receivable.
Application of Law to Facts: The court applied the principle that only real income can be taxed, and notional income cannot be presumed without evidence.
Treatment of Competing Arguments: The court rejected the AO's argument of presumed interest, citing lack of evidence and reliance on conjecture.
Conclusions: The addition of Rs 4,84,99,218/- as notional interest was unjustified and was deleted.

Issue 2: Authority to Add Notional Interest

Relevant Legal Framework and Precedents: The judgment references legal principles that prohibit the addition of notional interest, as seen in cases like Highways Construction Co. Pvt. Ltd. v. CIT and Shivnandan Buildcon (P) Ltd. v. CIT.
Court's Interpretation and Reasoning: The court emphasized that the Income Tax Act does not empower the AO to add notional interest to the income of the assessee.
Key Evidence and Findings: The AO did not provide any section of the Income Tax Act under which the addition was made.
Application of Law to Facts: The court found that the AO's actions were beyond jurisdiction and lacked legal basis.
Treatment of Competing Arguments: The court dismissed the AO's presumptive approach and upheld the principle of real income.
Conclusions: The court concluded that the AO had no authority to add notional interest, and the addition was invalid.

Issue 3: Availability of Interest-Free Funds

Relevant Legal Framework and Precedents: The court considered precedents like S.A. Builders Ltd. v. Commissioner of Income-tax regarding the use of interest-free funds for business purposes.
Court's Interpretation and Reasoning: The court found that the assessee had sufficient interest-free funds, negating the need for charging interest on advances.
Key Evidence and Findings: The assessee demonstrated significant interest-free advances from customers, supporting their claim of using interest-free funds.
Application of Law to Facts: The court applied the principle that interest-free funds used for business purposes do not warrant interest charges.
Treatment of Competing Arguments: The court favored the assessee's argument, supported by evidence of interest-free funds.
Conclusions: The court concluded that the assessee's use of interest-free funds was justified, and no interest should be charged.

Issue 4: Set-Off of Carried-Forward Losses

Relevant Legal Framework and Precedents: The Income Tax Act provisions regarding the set-off of carried-forward losses were considered.
Court's Interpretation and Reasoning: The court directed the AO to allow the set-off of losses if allowable as per records and timely filed returns.
Key Evidence and Findings: The court noted the AO's oversight in not considering the set-off of Rs 5,94,64,678/- of carried-forward losses.
Application of Law to Facts: The court applied the relevant provisions to ensure proper calculation of the assessee's total income.
Treatment of Competing Arguments: The court addressed the AO's failure to account for set-off, ensuring compliance with legal provisions.
Conclusions: The court concluded that the AO should allow the set-off of carried-forward losses, impacting the total income calculation.

3. SIGNIFICANT HOLDINGS

Preserve Verbatim Quotes of Crucial Legal Reasoning: "The Income Tax Act does not empower the Assessing Officer to add notional interest to the income of the appellant."
Core Principles Established: Only real income can be taxed; notional income without evidence cannot be presumed. The AO must adhere to the legal framework and provide factual basis for additions.
Final Determinations on Each Issue: The addition of Rs 4,84,99,218/- was unjustified and deleted. The AO lacked authority to add notional interest. The assessee's use of interest-free funds was justified, and the set-off of carried-forward losses should be allowed.

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