2025 (5) TMI 97 - AT - Income Tax

Reopening of assessment u/s 147 beyond period of limitation - addition by disallowing a part of the interest u/s 36(1)(iii) by apportioning the same to WIP - HELD THAT - As in view of the decision of Ashish Agarwal 2022 (5) TMI 240 - SUPREME COURT it is clear that the time between the issue of original notice u/s 148 under the old regime and the time upto 30.06.2021 is the time limit available which needs to be added to the date on which the reply of the assessee was received. The Hon ble Supreme Court has referred to this time limit as the surviving time limit available. Applying the same principle as laid down in the case of Rajeev Bansal 2024 (10) TMI 264 - SUPREME COURT (LB) for A.Y. 2014-15 the Assessing Officer should have issued notice u/s 148 by 13.06.2022 and for A.Y. 2016-17 by 26.06.2022. However for both the assessment years the AO has issued notice u/s 148 subsequent to those dates i.e. 25.07.2022 and 26.07.2022 respectively. Therefore the notices issued u/s 148 in the new regime are barred by limitation for both years. We therefore hold that the notice issued u/s 148 of the Act being barred by limitation such re-assessment proceedings are not in accordance with law and have to be quashed. Even otherwise on merit also we find the assessee has debited the entire interest expenditure to the Profit and Loss Account and the AO has applied the provisions of ICDS IX which have been introduced w.e.f. assessment year 2016-17 and therefore are not applicable to the assessment year 2014-15. Since the ICDS provisions are not applicable to assessment year 2014-15 the Assessing Officer was not at all justified in making the disallowance in the hands of the assessee based on the same provisions. Assessee is following the Percentage of completion method for recognizing the revenue. Under this method the income is recognized on the basis of work completed and offered to tax. The interest is a period cost and the same would be incurred by the assessee even though there is no increase in work-in-progress and the assessee has to incur the interest expenses even when there is no sale in the project. Therefore such interest expenditure has to be allowed in the year in which such interest expenditure is incurred. A perusal of the above provisions show that once the borrowed funds are used for the purpose of business of the assessee interest is allowable as deduction. We find in the present case the funds borrowed were used for the business of the assessee and therefore such interest expenditure cannot be disallowed as deduction. The action of the AO for assessment year 2014-15 is clearly against the settled principle laid down in the case of Lokhandwala Construction Industries Ltd. 2003 (1) TMI 93 - BOMBAY HIGH COURT Further as per the provisions of section 36(1)(iii) there is no provision in the said section to apportion the interest cost between the work-in-progress and the sales. The interest expenditure being a period cost the same has to be allowed in the year in which it has been incurred. In our opinion when the provisions of ICDS conflict with the provisions of the Act the provisions of the Act would prevail. As per the ICDS IX it is clearly mentioned that in case of conflict between the provisions of the Income Tax Act 1961 and the ICDS IX the provisions of the Act would prevail to that extent. Thus we hold that the borrowed funds which are utilized for the purpose of business of the assessee has to be allowed as deduction in the year in which the interest expenditure has been incurred. Assessee had debited the entire interest expenditure to the Profit and Loss Account rather than apportioning it between sales and work-in-progress (WIP) as per ICDS IX relating to borrowing costs - When the development is undertaken after obtaining necessary approval from the local authorities the assessee can sell the units. Undisputedly the assessee is following the percentage of completion method according to which the revenue is accounted for in respect of units sold depending upon the percentage of work completed. Once the development plan is obtained the assessee is entitled to sell any unit in the building under construction even though the possession is given subsequently and the revenue of the units to the extent of work completed is accounted for. It is not necessary that the flat or unit is complete in every respect to sell the flat / unit. We find as per clause 8 of ICDS capitalisation of interest shall cease in case of an inventory when all the activities necessary to prepare such inventory for its intended sale are complete. Even in case of units that are under construction since the assessee is following the percentage completion method for recognizing the revenue the units do not fall within the definition of qualifying asset at all even though these are not complete in every respect. As per clause 8 of ICDS the borrowing cost is to be ceased to be capitalised when substantially all the activities necessary to prepare such inventory for its intended sale are complete. Since in the instant case at the time of passing the plan itself the said activities are complete therefore there is no question of capitalization of interest. Therefore we hold that even as per ICDS IX the assessee company was not required to capitalize the interest and has rightly debited the same to the Profit and Loss Account. Revenue appeal dismissed.

Summary

The core legal questions considered in the appeals concern the validity and legality of reopening income tax assessments under section 147 read with section 148 of the Income Tax Act, 1961 (the Act) for the assessment years 2014-15 and 2016-17. Specifically, the issues include whether there was fresh tangible material to justify reopening, whether the reopening was within the prescribed time limits under section 149, whether the Assessing Officer (AO) was justified in quantifying disallowance of interest expenditure at reopening, the applicability of Income Computation and Disclosure Standards (ICDS), and the allowability of interest expenditure under section 36(1)(iii) of the Act. Additionally, the appeals raised questions on the procedural validity of notices issued under section 148, including the authority issuing the notice.

Regarding the reopening of assessments, the legal framework mandates that reopening under section 147 can only be done if the AO has "reason to believe" that income chargeable to tax has escaped assessment, supported by fresh tangible material. The limitation period for issuing notices under section 148 is governed by section 149, which prescribes a three-year limit generally, extendable to ten years if income represented in the form of an asset exceeding Rs. 50 lakhs has escaped assessment. The Supreme Court's decision in Ashish Agarwal clarified procedural requirements for notices issued around the transitional period affected by the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (TOLA), including the concept of "surviving time limit" for issuance of reassessment notices under the new regime.

The AO reopened the assessment for AY 2014-15 on the ground that the assessee had debited the entire interest expenditure to the Profit and Loss Account rather than apportioning it between sales and work-in-progress (WIP), as per ICDS IX relating to borrowing costs. The AO contended that this resulted in escapement of income and disallowed Rs. 15,11,87,548/- of interest expenditure. The assessee challenged the reopening on grounds of absence of fresh tangible material, limitation, and the correctness of disallowance. The CIT(A)/NFAC quashed the reassessment proceedings, holding there was no fresh material and that the reopening was barred by limitation. It also deleted the addition on merit, relying on the decision of the Bombay High Court in Lokhandwala Construction Industries Ltd., which allows interest deduction under section 36(1)(iii) if borrowed funds are used for business purposes, regardless of capitalization under ICDS.

The Tribunal examined the reopening issue extensively, applying relevant precedents including the Bombay High Court's rulings in Siemens Financial Services and Knight Riders Sports, which emphasize that reopening based on mere change of opinion without fresh tangible material is invalid. The Tribunal found that the AO had relied on the same financial statements and facts available at the time of original assessment completed under section 143(3), evidencing no new material to justify reopening. The Tribunal further held that the reopening notice issued on 25.07.2022 was beyond the surviving time limit as per the Supreme Court's ruling in Rajeev Bansal and Ashish Agarwal, rendering it time-barred.

On the merit of the interest disallowance, the Tribunal analyzed the applicability of ICDS IX, which was introduced from AY 2016-17 onwards and thus not applicable to AY 2014-15. It noted that ICDS IX requires capitalization of borrowing costs only for qualifying assets, defined as tangible or intangible assets or inventories requiring 12 months or more to bring to saleable condition. The Tribunal found that the assessee's inventory included open land and units under construction, which did not qualify as qualifying assets since open land is saleable immediately and units were accounted on the percentage completion method allowing revenue recognition proportionate to work completed. The Tribunal held that capitalisation of interest ceases when substantially all activities necessary to prepare inventory for sale are complete, which was the case here.

Further, the Tribunal emphasized that under section 36(1)(iii) of the Act, interest paid on capital borrowed for business purposes is allowable as deduction in the year it is incurred, unless the borrowed capital is for acquisition of a capital asset not put to use, which was not the case here. The Tribunal relied on the binding decision of the Bombay High Court in Lokhandwala Construction Industries Ltd., which held that interest on loans for stock-in-trade (construction projects) is deductible in the year incurred, irrespective of capitalization or project completion method. The Tribunal also referred to various coordinate bench decisions of the Tribunal affirming this principle and rejecting the AO's attempt to disallow interest by apportioning it to WIP based on ICDS IX.

The Tribunal addressed the Revenue's contention that the CIT(A) erred in relying on the High Court decision in Hexaware Technologies regarding the authority to issue notices under section 148, but declined to decide this issue as the Supreme Court was seized of the matter and the reassessment was quashed on other grounds.

In conclusion, the Tribunal held that:

• There was no fresh tangible material to justify reopening; the AO merely changed opinion based on the same facts considered at original assessment.
• The reopening notice was issued beyond the surviving time limit prescribed under section 149 read with TOLA and Supreme Court rulings, thus barred by limitation.
• The disallowance of interest expenditure was not justified as ICDS IX was not applicable to AY 2014-15 and the assessee's method of accounting and use of borrowed funds for business purposes entitled it to deduction under section 36(1)(iii).
• The Revenue's grounds challenging the quashing of reassessment and deletion of addition were dismissed.

Significant holdings include the following verbatim excerpts and principles:

"If change of opinion concept is given a go by, that would result in giving arbitrary powers to the Assessing Officer to reopen the assessments. It would in effect be giving power to review which he does not possess. The Assessing Officer has only power to reassess not to review."

"No notice under section 148 shall be issued if three years have elapsed from the end of the relevant assessment year unless the Assessing Officer has in his possession books of account or other documents or evidence which reveal that the income chargeable to tax, represented in the form of asset, which has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year."

"The interest expenditure is allowable under section 36(1)(iii) in the year in which it is incurred provided the borrowed funds are used for the purpose of business of the assessee. The nature of expense whether on capital or revenue account is irrelevant as the section itself says interest paid on capital borrowed is an item of deduction."

"In case of conflict between the provisions of the Income-tax Act and the ICDS, the provisions of the Act shall prevail to that extent."

"Capitalisation of borrowing costs shall cease in case of inventory when substantially all the activities necessary to prepare such inventory for its intended sale are complete."

"The reopening of assessment on the basis of change of opinion from that held earlier during the course of assessment proceedings does not constitute justification to believe that income chargeable to tax has escaped assessment."

"The reassessment notices issued beyond the surviving time limit under Income-tax Act read with TOLA are time barred and liable to be set aside."

"The borrowed funds utilized for the business of the assessee have to be allowed as deduction in the year in which the interest expenditure has been incurred."

The Tribunal's final determinations on the issues are that the reopening of assessments for AYs 2014-15 and 2016-17 were invalid due to absence of fresh tangible material and being barred by limitation; the interest disallowance was unsustainable both on merits and law; and the notices issued under section 148 were invalid for being beyond the surviving time limit. Accordingly, the appeals filed by the Revenue were dismissed and the orders of the CIT(A)/NFAC were upheld in toto.