TMI Blog2012 (11) TMI 756X X X X Extracts X X X X X X X X Extracts X X X X ..... Shri B. Ramakotaiah And Shri Amit Shukla, JJ. Assessee by: Shri Haresh G. Buch, Department by: Shri C.G.K. Nair, DR ORDER Per B. Ramakotaiah, A.M. These six appeals for various assessment years is on the issue of addition on account of notional interest of Rs.16,56,000/- in all the assessment years. The assessment was originally completed in assessment year 2005-06 and on the basis of that order, assessments were reopened for assessment years 2001-02 to 2004- 05 2006-07. 2. As the only issue in all the assessment years is with reference to addition of Rs.16,56,000/- in each of the AYs, all appeals were heard together. In the course of hearing, the learned Counsel withdrew Ground No.1 in appeals ITA Nos.1119 to 1122 and1124 pertaining to reopening of the assessment. It was also informed that the lead order was passed in AY 2005-06 and on that basis other assessments have been reopened and completed. The grounds raised by assessee in A.Y 2005-06 in ITA/ 1923/ M /2011 are extracted for the sake of record. Ground No.I 1. On the facts and circumstances of the case and in law the CIT (A) erred in confirming the action of AO in adding a sum of Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t still remains to be received. It seems as the said company M/s Sameta Exports (P) Ltd had been incurring heavy losses and was not in a position to pay interest assessee was not accounting any interest on the said deposit in the books of account from 1998-99 onwards. It is the contention of AO that since assessee is following the Mercantile system of accounting, the interest accrues to assessee and after observing that no attempts have been made to recover the interest or principal, AO made an addition of Rs.16,56,000/- as accrued interest in the relevant A.Y. 4. Before the CIT (A) it was the contention of assessee that the amounts were advanced between 3rd August, 1995 to 3rd October, 1995 to the said company M/s Sameta Exports (P) Ltd and even though interest has accrued and accounted upto the period 30.6.1996, it has received only an amount of Rs.1,75,000/- and the balance amount was outstanding. Further, it was submitted that the said company M/s Sameta Exports (P) Ltd vide letter dated 20.6.1996 requested assessee not to charge interest considering its adverse financial position. It was informed that the company was not recognizing the revenue and the Board has taken a cons ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt, it was decided that the interest would be waived further upto March 31, 2013. During the entire period from 2000 onwards, SEPL incurred losses even without providing for interest expense on the Appellant s deposits. Its net worth also continued to remain negative. 6. Further it was submitted that the observations of the CIT (A) that assessee has indeed earned income on Mercantile basis is not correct and relied on the following case laws: i) CIT vs. PC Media Systems Ltd (2009) 2 DTL Online 13 (Delhi). ii) CIT vs. Govind Agencies (P) Ltd (2007) 195 ITR 290 (All.) iii) Brahmaputra Capital Financial Services Ltd vs. Income Tax Officer (2009) 119 ITD 266 (Delhi) iv) TCI Finance Ltd vs. ACIT (2004) 91 ITD 573 (Hyd.) v) CIT vs. Vasisth Chay Vyapar Ltd (2011) 196 Taxman 169 (Delhi) vi) CIT vs. Woodward Governor India (P) Ltd, (2007) 162 Taxman 60 (Delhi) vii) Western Maharashtra Development Corpn. Ltd vs. DCIT (2008) 22 SOT 13 (Pune). viii) DCIT (Special Range) vs. Reliance Petroleum Ltd (2006) 5 SOT 164 (Mum.) ix) UCO Bank vs. CIT (1999) 104 Taxman 547 (SC) x) ACIT vs. Coromandal Investment (P) Ltd (2008) 174 Taxman 194 (Guj.) He also referred to the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome does not arise when assessee having recognized an amount of Rs..9,86,605/- as interest earlier could only recover an amount of Rs..1,75,000/-. 9. The principles on this issue of notional interest are decided by the following cases: i) CIT vs. PC Media Systems Ltd (2009) 2 DTL Online 13 (Delhi). Section 5 of the Income-tax Act, 1961 Income Accrual of Assessment year 2002-03 Assessing Officer computed certain notional interest income in hands of assessee On appeal, Commissioner (Appeals) opined that merely because assessee was following mercantile system of accounting, it could not be held that income had accrued to it Commissioner (Appeals) also concluded that from facts it was clear that no real income accrued to assessee and that it was evident from letters and correspondence with parties, to whom loans were advanced, that said persons had expressed their inability to pay interest Accordingly, Commissioner (Appeals) deleted notional interest added to assessee s income Tribunal upheld order of Commissioner (Appeals) Whether, no substantial question of law arose from Tribunal s order Held, yes ii) CIT vs. Govind Agencies (P) Ltd (2007) 195 IT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... verable, but should also be factual and practically realizable. Factual or practical unrealizibility thereof, may prevent its accrual, depending upon the facts and circumstances attending upon the transaction. No doubt, the Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of income or its receipts, but the substance of the matter is the income. If the income does not result at all, there cannot be a tax, even though the book keeping entry is made about hypothetical income which does not materialize. The instant case is on a better footing, wherein after realizing and establishing the bad financial position of debtors and no chance of realization of interest income, the assessee had not even passed any entry in the books of account for such interest. The guidance note on accrual of income on accounting issued by the ICAI lays down that where the ultimate collection with reasonable certainty is lacking, the revenue recognition is to be postponed to the extent of uncertainty involved. In terms of the guidance note, it is appropriate to recognize revenue in such cases only when it becomes reasonably certain that ultimate collecti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of accounting, as considered prudent by the RBI had been followed consistently for more than 4 years and that method had been accepted by the revenue in the earlier years. Such regularly employed method of accounting, could not be disturbed unless profits and gains could not be properly deduced there from, and unless the assessee had made such entries on a mere ipse dixit . AS-I notified by the Central Government in pursuance of section 145(2), mandates that consistency is a fundamental accounting assumption. Prudence and substance over form are the corner stones to the accounting policies to be adopted by an assessee. Accrual of income has to be judged from the realistic point of view. Nonrecognition of income on the ground that the income had not really accrued as the realisability of the principal outstanding itself was doubtful, is legally correct under the mercantile system of accounting, when the same is in accordance with ASI notified by the Government. The principle question that was to be considered whether the assessee s method of accounting violated Accounting Standards notified by the Central Government. The case of the revenue was not that AS-I had been viola ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e accounting principles, which the assessee was indubitably bound to follow, were AS- 9. Therefore, it could not be said that income in the form of interest, though not received, had still accrued to the assessee under the provisions of the Income-tax Act and was, therefore, exigible to tax. It was so for the reasons: (1)The assessee had not received any interest on the said ICDs placed with S since the assessment year 1996-97 as it had become NPA in accordance with the Prudential Norms, which was entered in the books of account as well. The assessee had further successfully demonstrated that even in the succeeding assessment years, no interest was received and the position remained the same until the assessment year 2006-07. Reason was adverse financial circumstances and the financial crunch faced by S . So much so, it was facing winding up petitions which were filed by many creditors. Those circumstances led to an uncertainty insofar as, recovery of interest was concerned, as a result of the aforesaid precarious financial position of S . What to talk of interest, even the principal amount itself had become doubtful to recover. In that scenario, it was legitimate move to i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the Central Government. The accounting standards prescribed by the ICAI are also required to be followed by the assessees. This has received recognition in several decisions of the High Courts and the Supreme Court. ACCOUNTING STANDARDS OF THE ICAI. The accounting standards issued by the ICAI require that accounting policies must be governed by the principle of prudence . In other words, Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only the basic estimate in the light of available information . Para 6 of Accounting Standard 1 defines accrual as the assumption that revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. What is required, therefore, is that all anticipated liabilities and foreseeable losses have to be provided for, while caution is to be exercised against accounting for unearned gains. Ultimately the emphasis is on presenting a true and correct state of affairs of the company as a going concern. This explains why, for in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... employed by the assessee has to give way to the accounting policies aimed at true and fair view of the affairs of the business. One of the major considerations for having such accounting policies is prudence . What follows is that the considerations of prudence have to be blended with the strict principles of mercantile or cash method of accounting, even when an assessee is following mercantile or cash method of accounting, and an improvised method of mercantile or cash method of accounting, which may result from such a blending of considerations of prudence with the strict principles of mercantile or cash method of accounting, meets the requirements of section 145. The concept of prudence as one of the basic considerations in deciding accounting policies is not of a recent origin. It is one of the fundamental principles of accounting that, as a measure of prudence and following the principle of conservatism, the incomes are not taken into account till the point of time that there is a reasonable degree of certainty of its realization, while all anticipated losses are taken into account as soon as there is a possibility, howsoever uncertain, of such losses being incurred. N ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n merits. Postamendment, it is also necessary for the assessee to demonstrate that even under the mercantile method of accounting, there are good reasons for not recognizing the revenues in question on accrual basis and that facts and circumstances of the case warrant that such revenues are recognized only when the same are received. That will essentially depend on facts of each case. The facts of the instant case did indeed justify that even under mercantile method of accounting revenue in question, i.e., accrued interest on seed money loans would be recognized only when, the same would actually be received by the assessee. There was no dispute to the fact that the assessee-corporation, was wholly owned by the Government of Maharashtra, and was engaged in various activities aimed at development of industries and promotion of industrialization in western region of the Maharashtra State. These activities were surely not on commercial lines and the predominant purpose of these activities was to promote growth and development in the target area. When seed money was given to an entrepreneur, the purpose of this advance was to enable him to start his business and even the repayment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to bring the same in conformity with the provisions of section 145(1). All that he could do in such a situation was to lean on section 145(3), which permits him to make a best judgment assessment under section 144. In the best judgment assessment, he had to take into account all such materials as he had gathered in the course of assessment proceedings. This material obviously included the Government of India notification which, despite the fact that all companies are required to follow accrual basis of accounting, specifically directed the assessee-corporation to book interest income on seed money loans only when the same would be actually received. A notification issued by the Government of India cannot be taken lightly nor can the Assessing Officer be simply dismissive about it. Therefore, Notification No. GSR 770(E), dated 10-9-1990 was sound basis to come to the conclusion that the revenues in question could be treated as income only when the revenues were realized. A best judgment assessment is also required to be a sound and rationale judgment about the income of the assessee. Therefore, the assessee could not be forced to pay tax on the interest accrued on seed money loans. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld that income had accrued to it. B) earning of the income, whether actual or notional, has to be seen from the viewpoint of a prudent assessee. If in given facts and circumstances the assessee decides not to charge interest in order to safeguard the principal amount and ensure its recovery, it cannot be said that he has acted in a manner in which no reasonable person can act. C) The guidance note on accrual of income on accounting issued by the ICAI lays down that where the ultimate collection with reasonable certainty is lacking, the revenue recognition is to be postponed to the extent of uncertainty involved. In terms of the guidance note, it is appropriate to recognize revenue in such cases only when it becomes reasonably certain that ultimate collection will be made. D) Non-recognition of income on the ground that the income had not really accrued as the realisability of the principal outstanding itself was doubtful, is legally correct under the mercantile system of accounting, when the same is in accordance with AS-I notified by the Government E) It is one of the fundamental principles of accounting that, as a measure of prudence and following the principle of conserv ..... X X X X Extracts X X X X X X X X Extracts X X X X
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