2013 (11) TMI 924 - AT - Income Tax

Method of accounting Cash system of accounting or Mercantile system of accounting - Whether assessee is bound to follow the same method of accounting on continuous basis and not permitted to change the same - Held that - The assessee on its part succeeded in establishing the change of bona fide because it had ceased to have any business income and had adopted the change well before the search as well as completion of assessment for block period and also before coming of Circular of No.2 of 2002 on the Statute - Since the assessee had followed the same system in all the subsequent years, we see no reason as to why the assessee s choice/preference to adopt the changed system of accounting be not accepted - In view of the totality of the facts and circumstances of the case as well as settled provisions of laws discussed hereinbefore, we are of the opinion that the assessee had right to adopt the changed system of accounting and by changing the system of accounting from mercantile to cash was a bona fide change - Decided in favour of the assessee. Treatment of interest income on on re-purchase of deep discount bonds (DDB) - Held that - the learned CIT (A) was not justified in sustaining (i) the addition of Rs.1.19 crores by treating the same as interest income on re-purchase of 700 DDBs and, consequently (ii) confirming the disallowance of Rs.1.19 crores being the assessee s claim u/s 54EC of the Act. - decided in favour of assessee.

Summary

Issues Involved:
1. Method of Accounting
2. Treatment of Long Term Capital Gain (LTCG) as Interest Income
3. Non-Allowing of Claim u/s 54EC on LTCG
4. Treatment of LTCG as Short Term Capital Gains (STCG)
5. Non-Allowing of Deduction u/s 54EC on LTCG
6. Addition of Accrued Interest on Deep Discount Bonds (DDBs)
7. Addition of Notional Accrued Interest on Optionally Fully Convertible Premium Notes (OFCPNs)
8. Set-off of Brought Forward Capital Loss against LTCG
9. Adoption of Status as 'Trust' vs. 'Individual'
10. Disallowance of Interest and Service Charges u/s 14A

Issue-wise Detailed Analysis:

1. Method of Accounting:
The AO observed that the assessee was following the cash system of accounting but treated it as mercantile based on a block assessment order. The CIT (A) upheld this view, stating that the assessee cannot change the method of accounting for different assessment periods. However, the Tribunal, following its earlier decision in Kishan Discretionary Family Trust v. ACIT, ruled in favor of the assessee, allowing the cash method of accounting as a bona fide change.

2. Treatment of LTCG as Interest Income:
The AO treated the LTCG of Rs.1.19 crores from the repurchase of 700 DDBs by Nirma Limited as interest income, supported by a Board's Circular. The CIT (A) upheld this view. However, the Tribunal, referencing its decision in Karsanbhai K Patel (HUF) v. ACIT, ruled that the gains should be treated as LTCG, not interest income, and allowed the assessee's claim u/s 54EC.

3. Non-Allowing of Claim u/s 54EC on LTCG:
The AO disallowed the claim of Rs.1.19 crores u/s 54EC on the basis that the income was interest, not LTCG. The CIT (A) supported this view. The Tribunal reversed this decision, allowing the claim u/s 54EC, as the income was determined to be LTCG.

4. Treatment of LTCG as STCG:
The AO treated the LTCG of Rs.3,01,35,849/- from the sale of 1391 DDBs as STCG, arguing that the holding period was less than 12 months. The CIT (A) upheld this view. The Tribunal, following its earlier decision, ruled that the gains should be treated as LTCG, allowing the assessee's claim u/s 54EC.

5. Non-Allowing of Deduction u/s 54EC on LTCG:
Following the treatment of LTCG as STCG, the AO disallowed the deduction of Rs.3.01 crores u/s 54EC. The CIT (A) upheld this decision. The Tribunal allowed the deduction, treating the gains as LTCG.

6. Addition of Accrued Interest on DDBs:
The AO added Rs.48,83,858/- as accrued interest on 1250 DDBs - Series B, applying a Board's Circular. The CIT (A) upheld this addition. The Tribunal ruled in favor of the assessee, stating that the interest should not be added based on the earlier decision that treated similar gains as LTCG.

7. Addition of Notional Accrued Interest on OFCPNs:
The AO added Rs.1,13,123/- as notional accrued interest on OFCPNs, applying a Board's Circular. The CIT (A) upheld this addition. The Tribunal, following its earlier decision in Karsanbhai K Patel (HUF) v. ACIT, ruled that the interest cannot be assessed on an accrual basis for an assessee following the cash system of accounting, deleting the addition.

8. Set-off of Brought Forward Capital Loss against LTCG:
The AO and CIT (A) did not allow the set-off of brought forward capital loss against LTCG. The Tribunal ruled in favor of the assessee, referencing an earlier Tribunal decision that allowed the set-off.

9. Adoption of Status as 'Trust' vs. 'Individual':
The AO adopted the status of the assessee as 'Trust' instead of 'Individual'. The CIT (A) partly allowed this ground without clear reasoning. The Tribunal, referencing the Gujarat High Court rulings in CIT v. Deepak Family Trust No.1 and DCIT v. Harjivandas Juthabhai Zaveri, ruled in favor of treating the status as 'Individual'.

10. Disallowance of Interest and Service Charges u/s 14A:
The AO disallowed interest expenses and service charges u/s 14A, stating they were incurred against exempt income. The CIT (A) upheld this view. The Tribunal, referencing various judicial rulings, ruled in favor of the assessee, allowing the deduction of these expenses.

Conclusion:
The Tribunal ruled in favor of the assessees on most issues, allowing the method of accounting as cash, treating gains as LTCG, allowing claims u/s 54EC, deleting additions of notional interest, allowing set-off of brought forward losses, and treating the status as 'Individual'. The appeals were partly allowed.