2007 (11) TMI 622 - ITAT AHMEDABAD

Taxability of income/interest from investment - Validity and applicability of Circular No. 2 of 2002 - family trust - Method of accounting - Cash Or Mercantile method - addition of notional interest on investment in optionally fully convertible premium note - income from business of manufacturing as well as from dividend and interest - Whether Circular No. 2 of 2002, was applicable retrospectively or prospectively - HELD THAT:- No dispute that till 28th March, 2000, the assessee was following mercantile system of accounting, but at the same time there is no dispute that the assessee had changed the system of accounting from mercantile to cash w.e.f. asst. yr. 2001-02 i.e. w.e.f. 1st April, 2000 and had furnished its return of income for asst. yr. 2001-02 on 31st July, 2001 showing income under the head "Income from other sources" which was consisting of interest on FDs and other interest. The system of accounting employed was clearly stated to be cash against column 11A of Form 3-CD which was required to be furnished along with return under the statutory provisions of Section 44AB of the Act.

It is also an admitted fact that the Revenue had not framed assessment for this assessment year, i.e. no assessment u/s 143(3) or u/s 147 of the Act has been made by the AO. This fact goes to show that the assessee's returned income shown on the cash system of accounting was accepted by virtue of provisions of Section 143(1)(a) of the Act and that being the case the assessee's preference to change the system of accounting from "mercantile" to "cash" for asst. yr. 2001-02 stood accepted.

To conclude, we, provisions relating to system of accounting, are of the opinion that:

(i) Return of income for asst. yr. 2001-02 showing income from other sources on cash system was filed on 31st July, 2001 which stood accepted, though under Section 145(1)(a) of the Act, and this conclusion is on the basis that Revenue had not preferred to make assessment under Section 143(3) of the Act.

(ii) Return of income for asst. yr. 2002-03 showing income from other sources and capital gain on cash system was filed on 9th Aug., 2002 which was again before the date of search and, therefore, system adopted by assessee was not effected by the assessment for block period.

(iii) Similarly, the return of income for asst. yr. 2003-04 showing income from "capital gain" and "other sources" on the basis of "mercantile system" was furnishing on 30th Sept., 2003 before completion of assessment u/s 158BC of the Act and, therefore, system adopted by the assessee for this year was also not effected by the assessment for block period.

(iv) Even otherwise, in our opinion, the change adopted by the assessee in the system of accounting was bona fide because the assessee had ceased to have income from business and has been following the changed system consistently in subsequent years.

Therefore, the assessee on its part; in our opinion, succeeded in establishing the change as bona fide because it has 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 No. 2 of 2002 on the statute. Since the assessee has followed the same system in all the subsequent years, we see no reason as to why assessee's choice/preference to adopt the changed system of accounting be not accepted. Thus, 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.

Since we have accepted the assessee's change in system of accounting as "cash system" from "mercantile system", there is no question of taxing the interest or any other income from so-called DDEs including on accrual basis and, therefore, direct the AO to delete all such additions. To be specific, we direct the AO to delete the addition of Rs. 77,95,691.

So far as Revenue's reliance on the Board Circular No. 409 dt. 12th Feb., 1985 which relates to taxability of interest on cumulative deposit schemes of private sector undertakings is concerned, we, after having gone through the same, are of the opinion that this Circular is of no help to the assessee because the issue involved in this circular is quite different than the issue involved in the appeal before us.

Validity of Circular No. 2 of 2002 - We are of the opinion that:

(1) So far as Circular No. 2 of 2002 vis-a-vis to the present assessee, who had subscribed to DDBs for holding the same as investment is concerned, was not applicable either for bonds purchased prior to this circular or purchased after this circular and the reasons for our view, are as under:

(i) In our opinion, results in changing the head of income, at least in case of those persons who were original subscribers to the bonds and were holding the same as investments and, therefore, creates problem instead of mitigating the same and this is supported by the stand of the Board itself whereby the Board has, in para No. 9 of this circular, tried to exempt the so-called small investors. There is no dispute as to the powers of Board to issue a benevolent circular for granting relief to a particular class of assessees, but when a circular is found to treat two assessees differently, then such a circular cannot be said to be circular as per law and at least cannot bind the assessees who are deprived of benefits as a result of such circular.

(ii) So far as binding nature is concerned, first of all, we are of the opinion that it is only benevolent circular which is binding on the authority, but so far assessee is concerned, the assessee can prefer not to take or seek benefits of the circular, irrespective of the fact as to whether the circular is benevolent or not and, therefore, if an assessee chooses not to seek benefit of a circular, the Revenue cannot impose the same.

(iii) So far as appellate authority, Tribunal and Courts are concerned, circulars issued by the Board even if benevolent are not binding.

(iv) So far as press note or release dt. 20th March, 2002 which has been issued by the Board only to clarify the scope of its earlier circular is concerned, is not a press note as understood in the normal parlances because as pleaded by the learned Departmental Representative, the press notes referred to by him are of nature which were released prior to issuance of a particular circular and not to clarify the scope or terms of any circular issued earlier. The press note being captioned as press note/release is nothing new but only a continuation of earlier circular, i.e. Circular No. 2 of 2002 and had just clarified the date of applicability of that circular.

(v) The Revenue's stand that the press note is contradictory to Circular No. 2 of 2002 is also misplaced.

(vi) Since we have held that the press note/release dt. 28th March, 2002 was in continuation of circular itself, it was also binding on the Revenue.

(vii) Even otherwise, even if Revenue's plea that press note/release was not in consonance with the intention of Circular No. 2 of 2002 or was contradictory then also the same, in view of the decision of Hon'ble Supreme Court in the case of CCE v. Dhiren Chemical Industries [2002 (2) TMI 115 - SC ORDER], was binding on the Revenue authorities and, therefore, Revenue authorities should have taken note of it.

(viii) The Revenue's stand that Circular No. 2 of 2002 is retrospective i.e. applicable to bonds purchased prior to this circular also cannot be sustained because this circular is silent with respect to chargeability of income earned prior to date of this circular; meaning thereby that in case where the bonds had been purchased prior to this circular, the income having been arisen (in the light of this circular) remained untaxed. The circular, therefore, speaks of different treatment to the income accrued for earlier years and to accrue in subsequent year. Consequently, this circular cannot be considered to be valid in the eyes of law.

(ix) Looking to the totality of the facts and circumstances of the case, we are, therefore, of the opinion that the Circular No. 2 of 2002 being contrary to the provisions of law providing different treatments to same type of income, providing different treatments to similar income in the hands of different persons, without there being any provisions of law on the point, cannot be held to be binding on the assessee and, hence, we are of the opinion that the income from DDBs was taxable as per first Board's letter dated 12th March, 1996. The additions made by following the Circular No. 2 of 2002 are, therefore, directed to be deleted.

Without prejudice to our aforesaid view, that the Circular No. 2 of 2002 was invalid and could not bind the assessee, we are, further of the opinion that in view of language of para No. 3 of this circular and the press note/release dt. 20th March, 2002, the Circular No. 2 of 2002 was not applicable to the DDBs purchased/subscribed before 15th Feb., 2002 and, therefore addition on account of income from such bonds is deleted.

This disposes of ground Nos. 1, 2 and 3 of the assessee's appeal.

We are of the opinion that the press note dt. 20th March, 1992 being for clarifying the date of applicability of Circular No. 2 of 2002 was not a normal press note, i.e. a press note which is generally issued prior to issuance of a circular, this press note being for clarifying the date of applicability of Circular No. 2 of 2002 was, in our opinion, a part of the circular itself and, therefore, the decision relied upon by the assessee are distinguishable on facts and, hence, not applicable.

Without prejudice to the aforesaid findings, we are, further of the opinion that there being no contract for payment of interest either on accrual basis or on periodical basis, the interest on DDBs could not be taxed on accrual basis and this proposition is supported by the decision of Hon'ble Gujarat High Court in the case of Mohit Marketing Ltd.[2005 (4) TMI 546 - GUJARAT HIGH COURT].

In the result, the appeal of the assessee is partly allowed.

SANJAY ARORA, A.M. - My only point of departure with my learned Brother's order is with "regard to the invalidity of Circular No. 2 of 2002 dt. 15th Feb., 2002 issued by the Central Board of Direct Taxes ('CBDT) u/s 119 of the IT Act, 1961 (the Act').

The circular has also been considered legally susceptible due to it carving out an exception for small investors, defined as one whose aggregate holding all such bonds (i.e., including those acquired prior to 15th Feb., 2002) does not exceed Rs. 1 lac. Once it is recognized, and which is the accepted legal position, that the CBDT has the power u/s 119 of the Act to remove or lessen the rigour of law, the objection would not survive, and becomes binding on the Revenue authorities, even though it may not be in agreement or consistent with the provision of law. Article 14 of the Constitution (equality before law) does not preclude drawing up of classifications; the only qualifying criteria being that the differentiation must be intelligible and, further justifiable on some reasonable and objective basis. The circular states of the same as being guided by the consideration of avoiding hardship to small Investors in benchmarking their investments to market on each valuation date, and has not been known even to be challenged for its validity in any Court of law to date. Also, it may be pertinent to state that the exclusion is only for investors, and not for those who hold the bonds as a trading asset and, further, is at their option. Example of such classification In law, as also under the Act, abound, viz., Section 44AA (maintenance of books of account); Section 44AB (compulsory audit of accounts); Section 44AD; Section 44AE, Section 44AF, etc., each of which has stood the test of time as well as of constitutional challenge in some cases.

Thus, I opine that the impugned Circular (No. 2 of 2002) dt. 15th Feb., 2002 issued by CBDT is a valid circular in the eyes of law. However, since the assessee's appeal would stand allowed on the ground of system of accounting followed by it, this issue, i.e., the validity Of the circular becomes academic in nature for the present appeal.