2014 (12) TMI 300 - AT - Income Tax

Accrual of interest income on loans and advances doubtful or sticky loan. - interest income which is transferred to the suspense account - Held that - Following the decision in M/s. Maruti Securities Ltd. Versus Addl. Commissioner of Income-Tax 2014 (9) TMI 317 - ITAT HYDERABAD - to arrive at a real income, accrual basis cannot be a justifying factor and the commercial and business realties of the assessee, should be considered - The interest income has been recognized in the books of accounts only to the extent of actual collection, which is the recommended/ recognized method as per Accounting Standard 9 of ICAI which lays down that when uncertainties exist regarding the determination of the amount or its collectability, the revenue shall not be treated as accrued and hence shall not be recognized until collection - where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction - for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to ascertain the nature of business and character of the transaction and the realities and peculiarities of the situations. There was no inconsistency or contradiction between the circular so issued and section 145 of the Income-tax Act - In fact, the circular clarifies the way in which these amounts are to be treated under the accounting practice followed by the lender - The circular cannot be treated as contrary to section 145 of the Income-tax Act or illegal in any form - It is meant for a uniform administration of law by all the income-tax authorities in a specific situation and, therefore, validly issued under section 119 of the Income-tax Act - the circular would be binding on the Department the findings of CIT(A) is set aside Decided in favour of assessee. Validity of order of revision of u/s 263 - Revised valuation of closing stock accepted by without enquiry and application of mind - Held that - CIT was under an impression that assessee has deviated from the consistent accounting policy adopted by it while valuing the closing stock - as per the annual report and the consistent accounting policy, stock has to be valued at cost, but, in AY under consideration though originally assessee has valued the closing stock at cost as per accounting policy followed by it but, subsequently assessee has changed method while valuing of closing stock in the revised return without informing the AO - assessee has not changed the method of valuation of closing stock - assessee had valued the closing stock on the basis of weighted average cost price without taking into account the market price of the securities as on that - the allegation of CIT that assessee has changed the method of valuation is incorrect. What the assessee has done while revising the valuation of closing stock is consistent with accounting principle adopted by it for valuing the closing stock - assessee in the revised stock valuation has adopted the value of closing stock as per the cost or market price whichever is lower - AO has specifically enquired into the valuation of closing stock and the note submitted by assessee during the assessment proceeding, clearly explains the situation leading to revision in valuation of closing stock - it is established that AO has enquired into the matter and after examining the explanation/submissions of assessee along with other factual details submitted before him, he has accepted the revised valuation of closing stock - when the AO has enquired in to the matter and after proper application of mind to the facts and materials on record has passed the assessment order, it cannot be said that assessment order passed is erroneous and prejudicial to the interests of revenue merely because there is no reference in the assessment order with regard to the stock valuation. When the evidences on record show that AO has made enquiries and applied his mind to the issue and completed the assessment, only because the view taken by AO is not to the liking of ld. CIT, that will not make the assessment order erroneous and prejudicial to the interests of revenue so as to empower CIT to revise it u/s 263 - the note to clause 1 of AS- 13 clearly provides that it will apply to shares, debentures and securities held as stock-in-trade - Though they may not be treated as investment, but, AS-13 will apply to them as they are similar to current investments - Thus, as per AS-13 also, investments have to be valued at cost or fair market price whichever is lower - The finding of ld. CIT in this regard is also not based on proper appreciation of AS- 13 or the facts on record - assessment order on the issue cannot be held to be erroneous and prejudicial to the interests of revenue the revised order by the CIT is set aside. Expenses u/s 14A on exempted income - Whether AO has not disallowed the expenditure u/s 14A on the exempted income Held that - Though Rule 8D cannot be applied retrospectively to the AY as it came into the statute w.e.f. 24/03/2008, however, it cannot be overlooked that the provisions contained u/s 14A of the Act were existing in the statute which required disallowance of expenditure - CIT was correct in directing AO to examine the applicability of provisions of section 14A to the exempt income earned by assessee during the year - this issue has not at all been examined by AO while completing the assessment or at least nothing has been brought to our notice that AO during the assessment proceeding has examined this issue in assessee s own case also disallowance of expenditure u/s 14A at 10% of exempt income earned during the year is upheld the order of the CIT is upheld. Penalty u/s 271(1)(c) - Whether AO has failed to initiate proceeding u/s 271(1)(c) on the additions made while completing the assessment Held that - The addition of notional interest income of ₹ 58,10,000 was deleted, the direction of CIT to initiate proceeding u/s 271(1)(c) has become infructuous - the exercise of power u/s 263 of the Act in respect of issue relating to disallowance to be made u/s 14A of the Act, however, so far as the issue relating to valuation of closing stock and initiation of proceeding u/s 271(1)(c), exercise of power u/s 263 is invalid the order of the CIT is modified and the AO directed to confine himself to examine the issue relating to disallowance of expenditure u/s 14A of the Act Decided partly in favour of assessee.

Summary

Issues Involved:
1. Addition of Rs. 58,10,000 as notional interest income.
2. Revision of the assessment order under Section 263 of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Addition of Rs. 58,10,000 as Notional Interest Income:

The primary issue in ITA No. 1176/Hyd/12 was the addition of Rs. 58,10,000 made by the Assessing Officer (AO) as notional interest income on loans and advances where there were no written agreements. The AO followed the observation from the assessment order for AY 2006-07, which quantified notional interest income on such loans and advances. The CIT(A) confirmed this addition based on orders for AY 2005-06 and 2006-07.

The assessee argued that the additions for AY 2005-06 and 2006-07 were deleted by ITAT in ITA Nos. 468/Hyd/09 and 1111/Hyd/2011. The Tribunal in those cases held that for real income to accrue, it must be measurable and collectable with certainty. The interest income was recognized only on receipt basis as per Accounting Standard 9 of ICAI, which recommends not recognizing revenue until collection if uncertainties exist. The Tribunal concluded that notional interest income could not be taxed on a hypothetical basis.

Following the precedent set in the earlier years, the Tribunal deleted the addition of Rs. 58,10,000 for AY 2007-08, as the facts were materially the same. Thus, the assessee's appeal on this issue was allowed.

2. Revision of the Assessment Order under Section 263:

In ITA No. 841/Hyd/2012, the assessee challenged the order passed under Section 263 of the Income Tax Act, revising the assessment order for AY 2006-07. The CIT found the assessment order erroneous and prejudicial to the interests of revenue for three reasons:

a. Revised Valuation of Closing Stock:

The CIT observed that the AO accepted the revised valuation of closing stock without proper verification, leading to under-assessment of income by Rs. 4,86,95,344. The assessee contended that the revised valuation was based on the principle of cost or market price whichever is lower, and all relevant details were submitted during the assessment proceedings. The Tribunal found that the assessee consistently followed the accounting principle of valuing stock at cost or market price whichever is lower. The AO had enquired into the matter and accepted the revised valuation after examining the details. Therefore, the Tribunal held that the assessment order was not erroneous and prejudicial to the interests of revenue on this issue and set aside the CIT's direction.

b. Disallowance of Expenditure under Section 14A:

The CIT noted that the AO failed to examine the applicability of Section 14A regarding the exempt dividend income of Rs. 39,51,789. The Tribunal upheld the CIT's direction to the AO to examine and disallow expenditure incurred on earning exempt income under Section 14A, considering the assessee incurred interest expenditure of Rs. 4.84 crores. The Tribunal noted that Section 14A existed during the relevant AY, requiring disallowance of expenditure even if Rule 8D was not applicable retrospectively.

c. Initiation of Penalty Proceedings under Section 271(1)(c):

The CIT directed the AO to initiate penalty proceedings under Section 271(1)(c) for the addition of Rs. 58,10,000 towards unaccounted interest income. However, considering the Tribunal's decision to delete the addition of notional interest income, the direction to initiate penalty proceedings became infructuous.

Conclusion:

The Tribunal partly allowed the appeal in ITA No. 841/Hyd/12, upholding the CIT's direction regarding the disallowance under Section 14A but invalidating the exercise of power under Section 263 for the valuation of closing stock and initiation of penalty proceedings. The appeal in ITA No. 1176/Hyd/12 was allowed, deleting the addition of Rs. 58,10,000 as notional interest income.