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2006 (11) TMI 242 - AT - Income TaxInterest income on FDRs - income from other sources or income from business - Rejection of books of account - Method of accounting - Surplus funds - award of the arbitrators for damages for breach of contract - deduction of interest paid to bank against interest received on FDRs - Estimation of income - net profit rate to the contract receipts - trucks on hire - Whether the A.O is justified in applying 8% net profit rate - HELD THAT:- Admittedly, the investment infixed deposits was made out of the surplus generated from the business and mainly out of the award of the arbitrators for damages for breach of contract. All the funds used for making the investments in FDRs were, therefore, surplus funds of the assessee. The assessee was free to utilize these funds in any manner. The assessee chose to invest these funds in fixed deposits. The fact that the fixed deposits were partly offered as security for the various facilities availed by the assessee from the banks would not make the income from the fixed deposits as business income. We would like to add here that as per scheme of the Act, interest is, generally speaking, income from "other sources" unless the assessee is carrying on money-lending business or some very special circumstance exists to hold interest income to be business income, such as interest on delayed payments of sale consideration or other receipts like contract receipts. However, onus to prove so will be on the assessee. Interest income is separate and independent of contract receipts. Apart from that interest income, by no stretch of imagination can be considered as contract receipts for estimation of income by applying net profit rate to the contract receipts. We, therefore, hold that the interest on FDRs with the bank continued to have their sources as the bank and the fixed deposits placed with it, and the fact that these FDRs were offered as security for financial facilities obtained by an assessee for the purpose of business would not change the character of the income as one from business. We are, however, faced with the fact that the Assessing Officer, in the order of assessment year 1997-98, has indirectly held interest income to be the business income. The ld. CIT (Appeals) also considered a major part of interest income to be the business income. The learned Counsel had argued that the texture of the order of the Assessing Officer cannot be altered at this stage. We tend to agree with him in this matter. We, however, hold that the interest income in assessment year 1997-98 also cannot form part of the contract receipts for estimation of income by applying net profit rate and have to be separately assessed. Interest expenses against interest income received on FDRs - HELD THAT:- In view of our conclusions that the interest income on FDRs is income from other sources, we are of the view that the entire interest income should be brought to tax as income from other sources after allowing deduction of expenses u/s 57(iii) of the Act. It cannot be said that interest paid to the bank was incurred for the purpose of earning the interest income on FDRs. The decision of the Hon'ble Supreme Court in the case of Dr. V.P. Gopinathan [2001 (2) TMI 10 - SUPREME COURT] clearly supports the stand taken on behalf of the Revenue. As observed, the funds in question were surplus funds, generated from the profits of business and the award money in the circumstances there is no expenses incurred by way of interest in earning the interest on FDRs. We, therefore, direct that the interest income in this assessment year be assessed as income from other sources. As far as question of interest income in assessment year 1997-98 is concerned, the Assessing Officer will only examine the plea of the assessee that actual interest income that accrued to the assessee was only Rs. 35,34,762. Thus, this matter will require a fresh decision from the Assessing Officer after hearing the assessee. Estimation of income - The books of the assessee suffered from a number of defects and sub-section (3) also provided that where the Assessing Officer is not satisfied about the correctness or completeness of accounts of the assessee, he may make an assessment in the manner provided in section 144. We have considered this matter. Sub-section (1) uses the word "shall", which means that from assessment year 1997-98, it is mandatory to compute the income under the head "Profits and gains of business or profession" in accordance with either cash or mercantile method of accounting. It is seen that from assessment year 1997-98, the assessee has not regularly followed any of these two methods. Therefore, we are of the view that the Assessing Officer was justified in rejecting the books of account. In view of the provisions of section 145(3) of the Act the Assessing Officer, therefore, had to proceed to make an assessment in the manner provided u/s 144 of the Act. The amendment in section 145 was brought in because the hybrid method of accounting was used by the assessees to postpone the tax liability. In this connection, we are of the view that only like things can be compared and there can be no comparison between unlike things. It was also argued by the learned Counsel that the gross receipts have significantly increased in those years vis-à-vis earlier years. Such increase will necessarily have the effect of depressing the net profit rate. The learned Counsel did not furnish any empirical data to support his argument. Having come to the conclusion that the assessment has to be made in the manner provided in section 144 of the Act, we may add that such assessment has to be reasonable and based on good faith and not arbitrary or capricious. It is the case of both the parties that past results, as assessed finally, form a reasonable basis for such an estimation, although other material on record can also be taken into account. If past results showed loss or nominal net profit rate, then, the Assessing Officer will not be justified in applying 8 per cent rate. The claim of the assessee for allowing depreciation separately will also be examined by the Assessing Officer in the light of various judicial pronouncements referred to by the learned Counsel for the assessee. However, it is clarified that if in the past estimation of income had been done before allowing depreciation then the Assessing Officer will be justified in allowing depreciation in these years also and not otherwise, because only like things can be compared. In the result, both the appeals by the Revenue and the cross objections by the assessee are treated as partly allowed, for statistical purposes.
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