TMI Blog2007 (11) TMI 622X X X X Extracts X X X X X X X X Extracts X X X X ..... grossly erred in confirming the addition of notional interest of Rs. 77,95,691 on investment in optionally fully convertible premium note of Nirma Industries Ltd. 5. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has erred in not dealing with following additional ground: In law and in the facts and circumstances of the appellant's case, if addition of Rs. 24,03,33,662 made in respect of various investments is confirmed, either whole or in part, direction should be given that the same should not be taxed in the subsequent year in the year of receipt. 6. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has erred in confirming levy of interest under Sections 234A, 234B, 234C and 234D of the IT Act. 7. Your appellant craves leave to add, alter, amend, omit all or any of the above grounds of appeal, till the appeal is finally heard and decided. 2.1 The brief facts which are relevant for decision of all the issues and as have been revealed from the records are that the assessee, which is a family trust, was having income from business of manufacturing as well as from dividend and interest, etc. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inst the assessment for block period because assessed undisclosed income was 'nil', but thereafter, moved an application under Section 154 of the Act dt. 23rd March, 2005 stating therein that the assessee's system of accounting being cash system and the AO having mentioned the system as mercantile system without allowing the assessee an opportunity of being heard requires rectification, but the same was rejected by the AO as per his order dt. 20th Sep., 2005 (copy of which is available at page No. 61 of the assessee's paper-book) and reads as under: Order under Section 154 of the IT Act, 1961 The assessee has pointed out vide his application dt. 24th March, 2005 that in the block assessment order passed under Section 158BC of the Act, the method of accounting has been taken as mercantile though the assessee has followed cash method of accounting. Moreover, it has been pointed out that no opportunity of being heard has been granted to the assessee in the block assessment proceedings in this issue. 2. In this regard, the contention of the assessee that this is a mistake apparent from the records is not correct, therefore, the same cannot be rectified under Se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ra No. 3 of the assessment order which reads as under: 3. Method of accounting: From the notes forming part of the Rol, it has been found that the assessee has mentioned that it is following the 'cash' system of accounting. But from the block assessment order dt. 30th June, 2000, it has been found that the AO has considered the method of accounting in the case of the assessee as 'mercantile'. The assessee has not filed any appeal before learned CIT(A) against this order. In the asst. yr. 2002-03 the method of accounting was considered to be 'mercantile' due to the same. The appeal of the assessee is still lying before learned CIT(A), in this issue in asst. yr. 2002-03, therefore in this year also on consistent basis, method of accounting is considered as 'mercantile'. 3.4 The AO further proceeded to deal with the applicability of Circular No. 2 of 2002 [(2002) 173 CTR (St) 217] and after allowing the assessee an opportunity of being heard held the Circular No. 2 of 2002 to be valid in law and applicable retrospectively. Consequently, he computed the income from deep discount bonds (hereinafter referred to as DDBs ) of ICICI Ltd., DDBs of In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee it has been found that the assessee has shown brokerage income of Rs. 66,918 and claimed the consultancy of Rs. 10.30 lacs and accounting charges of Rs. 5.25 lacs against this income. In the notice dt. 25th Nov., 2005 the assessee was asked to explain as to why such huge expenses have been claimed which are not at all commensurate to the business income earned by the assessee, these can also not be claimed against the accrued income/ capital gains arising from the DDB/NCD REC bonds. The relevant part of this notice is as under. From the statement of income it has been found that you are earning brokerage income of Rs. 66,918 only. The expenditure on consultancy and accounting charges are Rs. 10.3 lacs and Rs. 5.25 lacs respectively. Justify that this expenditure is for brokerage income. So far as capital gain is concerned, no such deductions are allowed. Explain as to how accounting charges are related to the earning of brokerage income, as is so meager. If you fail to prove that these exp. have been incurred for earning the business income, the same will be disallowed. 7.1 In the submissions dt. 5th Jan., 2006, the assessee contended as under: This has refere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... making such expenditures arise out of commercial expediency and are definitely expenditures incurred for the purpose of making or earning of income. Further, the expenditure incurred is not in the nature of capital expenditure or in the nature of personal expenses. The same is laid out or expended in the relevant previous year and not in any prior or subsequent year and therefore the same is clearly allowable as per the provisions of Section 57(iii) of the IT Act. Your good office has referred to the meagerness of the income earned referring to brokerage income of Rs. 66,918. In this regard, we request reference to the computation of income attached to revised return of income filed on 31st March, 2004, from the perusal of which it is evident that your assessee has also offered interest of Rs. 77,95,691 on OFCPN of Nirma Industries Ltd. without prejudice to the validity of the Circular No. 2 of 2002 dt. 15th Feb., 2002 [(2002) 173 CTR (St) 217] issued by CBDT. The same appears to have been ignored by your good office. Further the short-term capital gain of Rs. 49,88,607 is also in respect of sale of OFCPN of Nirma Industries Ltd., which if would have been held till maturity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paid mainly for the income in matters for preparing return of income under IT Act and attending the assessment for the year ended on 31st March, 2002. In this regard it is reiterated that the brokerage income against which these charges have been claimed does not require such expenditure. Secondly the income from other sources which has been offered by the assessee in the revised return of the income is basically due to the Circular No. 2 of 2002 in respect of the OFCPN of Nirma Ind. Ltd. Therefore it is very clear that for earning such income there is no need of any consultancy for which Rs. 10,30,000 has been claimed. Moreover Nirma Ind. Ltd. is the group concern of the Nirma group and the assessee also is one of the entities of the Nirma group. Not only the assessee but most of the group concerns have purchased these OFCPNs, for purchasing the same there was no need to pay such a huge amount. Thirdly, no such expenditure can be claimed against the STCG/LTCG as per the provisions of the Act. 7.3 The claim of the assessee that out of these Rs. 10.30 lacs, Rs. 5 lacs pertain to attending the assessment proceedings for accounting year ended on 31st March, 2002, is actually incor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e has also tried to justify the claim of the expenditure Rs. 5,25 lacs paid to Nirma Management Services (P) Ltd. which is the group concern of the Nirma group for consultancy in the investment, taxation and other related services. This argument is misleading since from the careful perusal of the Rol, it is clear that there is no need of such expenditure. The income earned by the assessee is from brokerage of Rs. 66,918 and STCG and due to Circular No. 2 of 2002 these require no such expenditures. Thus again it is clear that these expenditures have not been incurred wholly and exclusively for the purpose of the business. 7.6 The assessee has tried to justify the claim of these expenditure under Section 57(iii) but it is noteworthy that this section requires stricter norms, since expenditure in the case must have been incurred for earning such income. It is needless to say that the incomes which have been earned under Section 57(iii) are the only incomes which are due to the Circular No. 2 of 2002. For the same the assessee need not incur these expenditure. Hence this contention is not tenable. 7.7 The reliance of the assessee in the decision of Hon'ble Supreme Court in ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the above observations, the additions of the these amounts are made in the hands of the assessee. 4. On appeal by the assessee, the CIT(A) decided the issue with respect to assessee's claim of system of accounting as per first para of 3.1 of the appellate order, which reads as under: 3.1 So far as the claim that the appellant's method of accounting is cash method and not mercantile method of accounting is concerned, I observe from the submissions of the appellant itself that as per order dt. 7th March, 2006 passed by the CIT(A)-I, Ahmedabad in appellant's own case for asst. yr. 2002-03 it has been held that the assessee was not justified in claiming that it follows cash system of accounting and, therefore, mercantile system of accounting cannot be applied. Though this order is claimed to be subject-matter of appeal before the Tribunal, at present the stand of assessee stands rejected by the above referred appellate order. Hence, this claim of the assessee about cash method of accounting to be adopted in its case is not accepted. 4.1 The issue with respect to taxability of income/interest from DDBs vis-a-vis the applicability of provisions of Circular No. 2 of 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... circular came into existence on 15th Feb., 2002. It is clearly stated in circular that the income is considered to be arising on 31st March every year for DDB holders. Therefore, the income in this case is also to be recorded by the assessee on 31st March, 2003 on the basis of the prevailing market value as on 31st March, 2003 on the DDB over the FV/PV as the case may be. Therefore the contention that the AO has applied the circular with retrospective effect is not correct as the circular was published before the date of accrual of income. Moreover, the press note nowhere exempts the DDB holders of such bonds which were issued prior to 15th Feb., 2002. The contention of the assessee that since the appellant is following cash method of accounting and therefore the Circular No. 2 of 2002 is not applicable is not correct as the Circular No. 2 of 2002 is applicable prospectively from 15th Feb., 2002 and is applicable from financial year 2002-03. It is clear from the circular that the interest should be offered by the assessee on accrual basis irrespective of the method of accounting adopted by it. The addition of Rs. 21,33,39,216 made by the AO on account of accrued interest is here ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Circular No. 2 of 2002 dt. 15th Feb., 2002 for the DDBs issued on or after 15th Feb., 2002 the inclusion of the said sum of Rs. 77,95,691 in the total income first by the assessee and then by the AO does not call for any interference. In other words, the corresponding claim made in the grounds of appeal is rejected. 3.3 As far as the reliance placed on the decision of the CIT(A) Mumbai is concerned, I am of the view that as discussed in the appellate order in the case of Nirma Chemical Works Ltd., the addition is to be confirmed and hence respectfully I disagree with the decision of CIT(A), Mumbai. 4.2 The issue relating to disallowance of assessee's claim of expenditure of Rs. 10.30 lacs and Rs. 5.25 lacs has been decided in favour of assessee and against the Revenue as per findings contained in para No. 4.2 of the appellate order, which are in the following terms: 4.2 I have considered the assessment order and the above submissions. Looking the fact that the appellant is not having any separate staff for accounting and administrative services, the appellant was required to obtain services of Nirma Management Services Ltd. and for that matter the payment is made. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ised Representative further submitted that for asst. yr. 2002-03, i.e. accounting year 2001-02, appellant filed its return of income (pp. 170-173) and in notes to its accounts (p. 173 note 4) it was categorically stated that it is following cash method of accounting. (iv) The Authorised Representative further submitted that in its return of income for the current asst. yr. 2003-04 (pp. 54-55 note 3) also, appellant stated that it is following cash method of accounting. The said return was revised (pp. 56-57) wherein also appellant stated that (p. 56 note 3) that it is following cash method of accounting. (v) According to him, the whole controversy arose because of a non-issue. Search took place on 27th Sep., 2001 as a result of which assessment for the block period ending on 27th Sep., 2001 was to be framed. Return of income for the block period at Rs. nil came to be filed which was assessed by the learned AO. at Rs. nil vide order dt. 30th June, 2004 (pp. 58-59). However, while mentioning method of accounting (p. 58), AO has stated the same to be mercantile , though, in the return of income for block period required to be filed, method of accounting is not required to be st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ruments. Majority [ICICI Bonds, Deep Discount Bonds (DDBs) of ILFS and Optionally Fully Convertible Premium Notes (OFCPNs) of Nirma Industries Ltd.] are of the nature where fixed amount is given at the beginning and for a specified period and at the end of the specified period, fixed amount is being paid by the issuer. The value at which the bonds are issued, period for which bonds are to be issued and price at which it would be redeemed are given in the table below: Nature of Bond Page Nos. Issue Price Tenure Redmption price Unsecured Bonds in the nature of Debentures (Capital Gains Deep Discounts Bonds)-Issued by ICICI Ltd. 11 to 14 Rs. 67,267.35 each 3 years and 6 months Rs. 1,00,000 each Deep Discounts Bonds in the nature of secured non-convertible debentures - Issued by LFS Ltd. 15 to 16 Rs. 1,000 each 42 months Rs. 1498.50 each Optionally Fully Convertible Premium Notes (OFCPNs)-issued by Nirma Industries Ltd. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th March, 2002 (pp. 44-45) that earlier Circular dt. 15th Feb., 2002 did not have retrospective effect and does not seek to impose modified treatment to existing bond holders. Present appeal involves the question of validity of the interpretation of these circulars. Some of the DDBs are acquired by the appellant after the second Circular dt. 15th Feb., 2002. Therefore, question would arise before the Tribunal as to the effect of 1st, 2nd and 3rd circular. 7.2 The learned Counsel thereafter, proceeded to argue his case-ground-wise. (i) Ground No. 1 : The learned Authorised Representative submitted that this being general, the same is not pressed. (ii) Ground No. 2 : Method of accounting The learned Authorised Representative submitted that the case of appellant is that for this assessment year i.e. for asst. yr. 2003-04 ; it followed cash method of accounting whereas the Department claims that appellant follows mercantile method of accounting. For this purpose the CIT(A) follows earlier year's orders which give three reasons on pp. 96-97; from pp. Nos. 96 and 97 which are as under: (a) With respect to above reasons, the learned Counsel submitted that from above, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... riod. Further the Revenue has not established even a single transaction which justifies its stand that appellant is following mercantile method of accounting. Barring the disputed items, not a single adjustment of either income or expenditure is made by the AO on the ground that appellant must follow mercantile method of accounting. In other words, what Revenue trying to do is to foist a mixed method of accounting; cash method of accounting for all transactions other than disputed transactions which, Revenue states, appellant must have followed mercantile method of accounting. This is impermissible under law. (c) Third finding given by the learned CIT(A) is that the payer Nirma Ltd. is following mercantile method of accounting. Before we proceed further in the matter, it may be rioted that in relation to other parties namely ILFS, ICICI and REC, neither appellant nor Revenue is aware as to the method of accounting followed by them. One cannot jump to the conclusion that they would have also followed the mercantile method of accounting and claimed the expenditure on a year to year basis. This aspect is without prejudice to the above contention of the appellant that, as stated her ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ised Representative submitted that the addition is made on account of interest alleged to have accrued to the appellant on three instruments as stated above. ICICI bonds Rs. 1,697.80 lacs, DDBs of ILFS Rs. 684.54 lacs and REC investment bonds Rs. 21 lacs. Of these three instruments, first two instruments were acquired prior to 15th Feb., 2002 whereas third instrument was acquired after 15th Feb., 2002. In view of this, the submissions are broken up in two parts (A) and (B). (A) Addition of Rs. 23,82,33,662 being alleged accrued interest on ICICI bonds and DDBs of ILFS, purchased prior to the date Circular No. 2 of 2002 came into being: (a) It was submitted that so far as this so-called income is concerned, the same cannot be taxed for following reasons: (i) Appellant is following cash method of accounting and therefore, no income is taxable. (ii) Assuming, without admitting, appellant's method of accounting is not cash, even then income cannot be taxed. No income has accrued on a year to year basis on such bonds. Bonds specified issue price, period and the redemption price. No interest on the bonds is being paid during the term of' the bonds. No rate of interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is, Revenue cannot argue that first circular cannot govern when the second circular is issued. Bombay Tribunal in the group case [Kulgam Holding (P) Ltd.) (pp. 49-53) has accepted appellant's contention that second circular cannot govern instrument prior to the date of second circular. In any case, it is well-settled that circular of CBDT can be withdrawn only prospectively and not retrospectively. We rely on the following decisions in this regard: (i) Unit Trust of India v. P.K. Unny, ITO [2001] 168 CTR (Bom) 99 : [2001] 249 ITR 612 (Bom); (ii) CIT v. BM. Edward, India Sea Foods [1979] 12 CTR (Ker)(FB) 278 : [1979] 119 ITR 334 (Ker)(FB); (iii) CIT v. Prasad Productions (P) Ltd. [1989] 76 CTR (Mad) 173 : [1989] 179 ITR 147 (Mad). (d) He, therefore, submitted that in the circumstances, it would not be correct to hold that by virtue of second circular, first circular disappears. (v) The learned Authorised Representative further submitted that even on the merits, the Revenue's arguments would be unsustainable. The 2nd circular is invalid for the reasons stated hereinafter. (B) Addition of Rs. 21,00,000 being alleged accrued interest on REC investment bo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pellant is right in its submission that second circular cannot be foisted upon the appellant the question arises under which provisions of law, the income of Rs. 21 lacs be taxed in the hands of the appellant ? First contention of the appellant that it is following cash method of accounting and therefore, in absence of receipt, it is not liable to pay tax. Assuming, without admitting that appellant is not permitted to follow cash method of accounting even then (there) is no accrual of Rs. 21 lacs in favour of the appellant during the year. Bonds do not contain any term as to the right of the appellant to receive interest on a year to year basis. As held by Hon'ble Gujarat High Court in the case of Mohit Marketing (supra) Revenue cannot rewrite the terms of contract. Under the circumstances, even on this basis, amount of Rs. 21 lacs is not taxable. (iii) One more aspect would show that circular is invalid. It not only seeks to tax income on a year to year basis even when it does not accrue, it seeks to convert long-term capital asset into short-term capital asset. Short-term capital asset and long-term capital asset defined in Clause 2(29A) and under Clause 2(42A) re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng given by the CIT(A) namely the acquisition being subsequent to 15th Feb., 2002 the case of the appellant is governed by the second circular, the appellant has already submitted earlier as to why second circular is invalid, illegal and contrary to law. Appellant has also given reason as to why assessment is to be framed independently i.e. income is not required to be taxed. (iii) Coming to the first finding that after offering income in the revised return, which was not withdrawn by the appellant, it is respectfully submitted that the fact that appellant has offered income in the revised return of income cannot preclude and appellant can raise such contentions before learned CIT(A) or before Hon'ble Tribunal. At the outset it is submitted that the income was offered in the revised return on a without prejudice basis. Further as a matter of fact, the case of Goetze India Ltd. (supra) carves out exception whereby appellant is entitled to raise such contention under Section 254 before this Hon'ble Tribunal. On merits also this aspect is noted in two decisions as stated below: (i) Universal Subscription Agency (P) Ltd. v. Jt. CAT (2007) 207 CTR (All) 62 : (2007) 159 T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tative says is correct, but the assessee has to state the reasons for the change and justify the change in method of accounting. Even otherwise as per the CBDT Circular dt. 15th Feb., 2002, the assessee has to account interest income on DDBs on accrual basis. Similar types of income for e.g. interest on cumulative deposit schemes of private sector undertakings is taxable on accrual basis annually as per Circular No. 409 dt. 12th Feb., 1985 [(1985) 46 CTR (St) 4 : (1985) 153 ITR (St) 4]. 9.1 With respect to validity and applicability of Circular No. 2 of 2002: It was further submitted that, as has been rightly held by CIT(A) in the case of the assessee for the asst. yr. 2002-03 (please refer pp. 91 to 98 of paper book of the assessee) the assessees in Nirma group including the assessee have interpreted the letter of Board and Circular dt. 15th Feb., 2002 and press release dt. 20th March, 2002 in different manners, while claiming deduction of interest on these Deep Discount Bonds (hereinafter referred as DDBs); the company Nirma Ltd. has followed mercantile method and claimed deduction on accrual basis and in cases of holders of DDBs while offering income of interest on DDBs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essary that the party who presses that into service shall establish that copies of the said letter/document have been sent to the CITs in the various States and that unless copies of the circulars are addressed to the other authorities mentioned in Section 116, the letter/document which is said to be circular cannot be treated as such, (p. 257) (d) In the case of Bharat Vijay Mills Ltd. v. ITO [1985] 45 CTR (Guj) 60 : [1985] 154 ITR 786 (Guj), wherein the Hon'ble Court has held that Benevolent circulars issued by the CBDT, even if they deviate from the legal position, are required to be followed by the ITO since the circulars would go to the assistance of the assessee . (e) In the case of Chotubhai Anr. v. Union of India [1998] 147 CTR (Del) 83 : [1998] 230 ITR 416 (Del), wherein the Court held that communication from Board/Ministry does not amount to an order, instruction or direction under Section 119 of the Act. 9.3 Binding nature of Circular No. 2 of 2002, dt 15th Feb., 2002 The learned Departmental Representative further submitted that the Circular No. 2 dt. 15th Feb., 2002 has been issued to mitigate hardships to the taxpayers as otherwise as per Circular d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rein it has been held that the CBDT has power to tone down the rigours of the law and ensure a fair enforcement of its provisions by issuing circulars. Such circulars are binding on the authorities in the administration of the Act. 9.4 With respect to the effect of press note dt. 20th March, 2002, the learned Departmental Representative submitted that the learned Authorised Representative has submitted that third letter or clarification dt. 20th March, 2002 clearly classifies the prospective nature of the circular; the learned Departmental Representative submitted that it is neither a circular nor it was issued by CBDT. It is a press release issued by PIB (Press Information Bureau), hence, has no binding force as circulars. Press releases cannot override basic intention of a circular. To support the above submission, reliance was placed on the following: (a) In the case of CAT v. Anjum M.H. Ghaswala [2001] 171 CTR (SC) 1 : [2001] 252 ITR 1 (SC), wherein it has been held that press releases do not have statutory force like circulars and a clarificatory note or press release issued by the CBDT does not have statutory force like circulars issued by the Board under Section 119 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dification. Reliance was placed on the decision in following cases: (i) CAT v. Geeva Films [1983] 141 ITR 632 (Ker), wherein it has been held that modifications of the above circular during the pendency of the assessment were not relevant. (ii) Shakti Roj Films Distributors v. CAT [1995] 124 CTR (Bom) 243 : [1995] 213 ITR 20 (Bom), wherein it has been held that if a circular is in force on 1st of April, of relevant assessment year, benefit obtained under it by the assessee cannot be withdrawn on the basis of another circular which was issued before completion of assessment and superseding earlier circular. (iii) CAT v. Prasad Productions (P) Ltd. [1989] 76 CTR (Mad) 173 : [1989] 179 ITR 147 (Mad). 9.6 Effect of circular vis-a-vis provisions of Act The Departmental Representative, further submitted that various Courts have held that CBDT circular cannot enlarge the scope of the statutory provision. [CAT v. Ramchandra Poddar Charitable Trust. [1987] 164 ITR 666 (Cal). The circular being executive in character cannot alter the provisions of the Act. The circulars cannot detract from the Act. State Bank of Travancore v. CAT [1986] 50 CTR (SC) 290 : [1986] 158 ITR 102 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w were established. The Tribunal has also observed that decision of apex Court in Goetze India Ltd. (supra) is binding. 10.2 In view of the above submission, it was submitted that the decision of CIT(A) should be sustained. 11. The learned Counsel for the assessee, in rejoinder, submitted that so far as decision relied upon by the learned Departmental Representative is concerned, there is no dispute as to the proposition of law laid down by them, but since the facts and circumstances of the present case are different, so applicability of those propositions of law should be seen in the context of facts and circumstances of the present case. He, therefore, submitted that assessee's claim of following cash system of accounting be accepted. The learned Counsel, further, submitted that if assessee's this claim is accepted, then its submission with respect to validity and applicability of Circular No. 2 of 2002 will be academic only and so far as issue relating to the taxability of income from OFCPN of Nirma Industries Ltd, shown by the assessee in revised return on accrual basis is concerned, the same will automatically be decided in assessee's favour. 11.1 With res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accounting ? B. (i) The second issue for our decision is the validity of Board's Circular No. 2 of 2002 dt. 15th Feb., 2002. (ii) The third issue for our decision is as to whether Circular No. 2 of 2002 (supra), was applicable retrospectively or prospectively, i.e. whether the DDBs purchased prior to date of this circular i.e. prior to 15th Feb., 2002, were covered by this circular or DDBs purchased after 15th Feb., 2002 only were covered by this Circular ? C. Whether, the assessee having once disclosed some income in the return is barred from claiming that income to be exempt during the assessment or appellate proceedings ? 13. We have considered the rival submissions, facts and circumstances of the case, provisions of law relating to the issues involved in this appeal as well as various decisions relied upon by the parties with utmost care. 13.1 The first issue as we have already spelt out for our consideration and decision is the system of accounting adopted by the assessee. The assessee's case is that it was following the cash system of accounting w.e.f. asst. yr. 2001-02 and has been following the same consistently till now. The Revenue's case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n accordance with either cash or mercantile system of accounting regularly employed by the assessee. (2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. (3) Where the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in Sub-section (1) or accounting standards as notified under Sub-section (2), have not been regularly followed by the assessee, the AO may make an assessment in the manner provided in Section 144. 158BB Computation of undisclosed income of the block period-(1) The undisclosed income of the block period shall be the aggregate of the total income of the previous years falling within the block period computed, (in accordance with the provisions of this Act, on the basis of evidence found as a result of search or requisition of books of account or other documents and such other materials or information as are available with the AO and relatable to such evidence), as reduced by the aggregate of the total income, or as the case may be, as increased by the ag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Section 32: Provided that in computing deductions under Chapter VI-A for the purposes of the said aggregation, effect shall be given to set off of brought forward losses under Chapter VI or unabsorbed depreciation under Sub-section (2) of Section 32; (b) of a firm, returned income and total income assessed for each of the previous years falling within the block period shall be the income determined before allowing deduction of salary, interest, commission, bonus or remuneration by whatever name called (to any partner not being a working partner): Provided that undisclosed income of the firm so determined shall not be chargeable to tax in the hands of the partners, whether on allocation or on account of enhancement; (c) assessment under Section 143 includes determination of income under Sub-section (1) or Sub-section (IB) of Section 143. (2) In computing the undisclosed income of the block period, the provisions of Sections 68, 69, 69A, 69B and 69C shall, so far as may be, apply and references to 'financial year' in those sections shall be construed as references to the relevant previous year falling in the block period including the previous year ending with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax payable by him on the basis of such assessment; (d) the assets seized under Section 132 or requisitioned under Section 132A shall be dealt with in accordance with the provisions of Section 132B. 14.3 After having gone through the Chapter XTV-B, it is observed that the legislature has not provided anywhere in the provisions of Chapter XTV-B as to which of the system of accounting is to be followed for computing the assessee's undisclosed income for the purpose of this chapter. However, we are of the opinion that some help can be sought from the provisions of Section 158BB of the Act which prescribe the way out for computation of undisclosed income of the block period and also from provisions of Section 158BC which prescribe the procedure for completing block assessment and that is why that we have preferred to reproduce these two sections. Section 145 of the IT Act, 1961 14.4 After the analysis of provisions of Section 145, reproduced here in above, effective from asst. yr. 1997-98, we are of the opinion that these provisions clearly lead one to understand that income chargeable under the head Profits and gains of business or profession or Income from other sou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ' instead of mercantile, e.g. assessable under Section 56; he cannot be assessed for that income on accrual basis [Juggilal Kamlapat Bankers v. CIT [1975] 101 ITR 40 (All)}. Similarly, if the assessee follows mercantile system of accounting, it. is not open to the AO to make the assessment on cash basis [Mrs. B.N. Pinto v. CIT [1972] 85 ITR 448 (Mysore)]]. 14.7 We are further of the opinion that since choice to adopt a particular system of accounting one of two is with the assessee, the choice to change the system of accounting is also with the assessee, but this changeover from one system to another system; choice is subject to the following: (i) The changeover is bonafide. (ii). The second condition to be satisfied is that the assessee is to establish that the method of accounting employed (originally or on change) is being followed regularly in the subsequent years and this fact can be established by showing the regularity from accounts of subsequent years. This view of ours finds support from decision of Hon'ble Madras High Court in the case of Sundaram Co. Ltd. v. CIT [1959] 36 ITR 162 (Mad). 15. So far as AO is concerned, we have already observed that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nting. He can only compute the income in the manner provided under Section 144 of the Act. This view of ours supported by the decision in the case of CIT v. K. Sankarapandia Asari Sons (1980) 19 CTR (Mad) 264 : (1981) 130 ITR 54.1 (Mad), 544) 18. If we consider the case of the present assessee in the light of above proposition of law and the provisions, first of all. we are of the opinion that: (i) Choice to employ any one of the two methods of accounting, subject, however, to the fact that such a method should be followed regularly in subsequent years, is with the assessee. (ii) It is the assessee who has the choice even to change the system of accounting, but again subject to the fact that it is for him to establish that change was bona fide and changed system was being followed regularly. 19.1 Coming to the facts of the present case, there is 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. 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee cannot change the same. According to AO, the assessee is bound to follow the same system of accounting on continuous basis and is not permitted to change the same. The relevant part of the assessment order appearing at page Nos. 2 and 3 for asst. yr. 2002-03 placed at page No. 65 of the assessee's paper book, reads as under: From the notes forming part of the Rol, it has been found that the assessee has mentioned that he is following the cash system of accounting. But from the block assessment order dt. 30th June, 2004 it has been found that the AO has considered the method of accounting in the case of the assessee as 'mercantile'. The assessee has not filed any appeal before learned CIT(A) against this order. Therefore it is clear that the assessee has no objection with this finding of the AO and it has accepted that it is following the mercantile system of accounting. The assessee was given the show-cause notice dt. 18th March, 2005 to explain as to why in the light of the Section 145 of IT Act the method of accounting should be considered as 'mercantile' in the case of the assessee in this year also. The relevant portion of this show-cause notice is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hange the same. Hence the method of accounting is considered in the case of the assessee as 'mercantile'. (iii) The assessee had appealed the assessment order for asst. yr. 2002-03 and the issue relating to assessee's claim of system of accounting was rejected by the CIT(A) by observing as under: I have considered the above submissions of the appellant and do not find any force in them for the following reasons: (i) it is, no doubt, true that the method of accounting cannot be thrust on the assessee by the AO. But it is also incorrect to state that the appellant can change the method of accounting arbitrarily and without proper and adequate justification. In the present case, no reasons or adequate justification for adopting the cash method of accounting is given by the appellant. (ii) The AO's reasoning that the mercantile method of accounting has been adopted in the block period assessment proceedings and the appellant has not filed an appeal against such an adoption by the AO, cannot be faulted on legal or logical grounds. The method of accounting in both the block period and regular assessment proceedings has to be the same. If the appellant has miss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. 2003-04 was completed on 2nd Feb., 2006 after adopting the method of accounting as mercantile on the same reasonings as were for asst. yr. 2002-03 and read as under: 3. Method of accounting: From the notes forming part of the Rol, it has been found that the assessee has mentioned that it is following the 'cash' system of accounting. But from the block assessment order dt. 30th June, 2000, it has been found that the AO has considered the method of accounting in the case of the assessee as 'mercantile'. The assessee has not filed any appeal before learned CIT(A) against this order. In the asst. yr. 2002-03 the method of accounting was considered to be 'mercantile' due to the same. The appeal of the assessee is still lying before learned CIT(A), in this issue in asst. yr. 2002-03, therefore in this year also on consistent basis, method of accounting is considered as 'mercantile'. 21. If we consider the above case in the light of settled principles of law, first of all, we are of the opinion that the AO's decision to adopt the method of accounting in regular assessment for asst. yr. 2003-04 as mercantile simply because the AO had mentione ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B and 158BC of the Act. Had the AO proceeded to make the assessment for block period as per the provisions of the Act, he would have definitely not taken the system of accounting for the period 1st April, 2000 to date of search, i.e. upto 27th Sept., 2001 as mercantile, because, assessee had, by that time, furnished its return of income for asst. yrs. 2001-02, 2002-03 and 2003-04 disclosing the system of accounting as cash . (v) In addition to above, the undisclosed income for the block period having been assessed at NIL, it is quite clear that the income retained or assessed as per returns filed by the assessee or as per regular assessments, as the case may be, stood accepted as it is and since the income for regular assessments for the asst. yr. 2001-02 was declared on cash system, the system adopted by the assessee stood accepted. (vi) The block assessment being for the period ending on the day of search, i.e. 27th Sept., 2001, cannot bind the assessee for all times to come because not only the assessee had right to change the system of accounting but the provisions for assessment for block period and for regular assessment are quite different; meaning thereby that if aft ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. 24.1 If we consider the Section 145 of the Act, it will be revealed that all that Section 145(1) lays down is that if an assessee regularly employs any of the method of accounting mentioned therein, i.e. cash system or mercantile system; his income under two specified heads, i.e. business or profession or other sources should be computed in accordance of law therewith. The section, in its terms, does not require any enquiry into the bona fides of the assessee in following regular method and it is so because following any one of the methods specified therein regularly would necessarily result in a proper computation of assessee's real income. Even if one regular method of accounting is substituted by another regular method, the same result will follow. Only in a case where the assessee changes his regular method of accounting by another method and does not follow the changed method regularly thereafter, it might be possible for the assessee by introducing successive changes in his method of accounting to exclude items of its income from being included in the computation of his total income, otherwise not. Therefore, when an assessee changes his regular method of accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that too to apply Circular No. 2 of 2002 which was not available on 1st Oct., 2000 when the assessee had preferred to change its system of accounting from mercantile to cash and, therefore, the Revenue's reliance on the decision in block period being not only illegal and unjustified but unwarranted also cannot be allowed to penalize the assessee for not following it. 24.4 Revenue has not alleged non-compliance of any of the requirements of Sub-section (1) or Sub-section (2) of Section 145 of the Act and, therefore, in absence of clear findings on this account, i.e. it being not the Revenue's case; the action of the AO adopting the method of accounting as mercantile for asst yr. 2003-04, in our opinion, is illegal and bad in law for want of jurisdiction and, therefore, cannot be sustained. 24.5 Without prejudice to the above, in the given circumstances, what the AO could at the most do was to make the assessment in the manner as provided under Section 144 of the Act and nothing else, but could not, in any case change the system of accounting independent of these proceedings. Therefore, that fact cannot snatch away the assessee's right to claim during regular asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ected 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 under Section 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. 27. 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. In view o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofit or loss. The decision on other issues, referred to in your letter shall be communicated in due course. 29.3 The second document is to be considered is Circular No. 2 of 2002 copy of which is placed at page No. 39 of the assessee's paper-book and reads as under: CBDT Circulars Circular No. 2 of 2002, dt. 15th Feb., 2002. To, All the Chief CITs/Directors-General of IT. Subject: Tax treatment of deep discount bonds and STRIPS- reg. A review of the tax treatment of income arising from Deep Discount Bonds has been under consideration in the Board for sometime. The Board had earlier clarified by way of certain letters issued to the Reserve Bank of India and others that the difference between the bid price (subscription price) and the redemption price (face value) of such bonds will be treated as interest income assessable under the IT Act. On transfer of the bonds before maturity, the difference between the sale consideration and the cost of acquisition would be taxed as income from capital gains where the bonds held as investment, and as business income where the bonds were held as trading assets. On final redemption, however, no capital gains will arise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income (where the bonds are held as investments) or business income (where the bonds are held as trading assets). 4.2 In a case where the bond is acquired during the year by an intermediate purchaser (a person who has acquired the bond by purchase during the term of the bond and not. as original subscription) the difference between the market value as on the valuation date and the cost for which he acquired the bond, will be taxed as interest income of business income, as the case may be, and no capital gains will arise as there would be no transfer of the bond on the valuation date. 5. Transfer before maturity Where the bond is transferred at any time before the maturity date, the difference between the sale price and the cost of the bond will be taxable as capital gains in the hands of an investor or as business income in the hands of a trader. For computing such gains, the cost of the bond will be taken to be the aggregate of the cost of which the bond was acquired by the transferor and the income, if any, already offered to tax by such transferor (in accordance with para 4 above) upto the date of transfer. 5.1 Since the income chargeable in this case is only the ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... between the bid price of a Deep Discount Bond and its redemption price, which is actually paid at the time of maturity, will continue to be subject to tax deduction at source under Section 193 of the IT Act. Under the existing provisions of that section, no tax is deductible at source on interest payable on Government securities. Further, the Central Government is empowered to specify any such bonds issued by an institution, authority, public sector company or co-operative society by way of notification, exempting them from the requirement of tax deduction at source. 9. Option to investors Considering the difficulties which might be faced by small non-corporate investors in determining market values under the RBI guidelines and computing income taxable in each year of holding, it has further been decided that such investors holding Deep Discount Bonds upto an aggregate face value of rupees one lakh may, at their option, continue to offer income for tax in accordance with the earlier clarifications issued by the Board referred to in para 1 above. 10. The contents of this Circular may be brought to the notice of all the officers working in your region. (Sd.) Batsala J ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ized at any time by selling the bond. Taxing income from such bonds on accrual basis annually is, in fact, a practice followed worldwide. It is also an established principle that a circular issued by CBDT cannot have a retrospective tax effect. The present circular on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified, treatment on existing bond-holders. Further, non-corporate persons who invest small amounts in new issues (face value upto Rs. 1 lakh) can still opt for the old system. Valuing the bonds every year on the basis of RBI guidelines will not pose any problem as such values can be obtained from the issuers themselves, who will invariably be the RBI or a public financial institution. The amount received on redemption would always be liable to tax deduction at source as per normal provisions of the IT Act. However, no TDS is required on interest payable on Government securities, and bonds issued by an institution, authority, public sector company or cooperative society can also be exempted from the requirement by notification. [Source : PIB Press ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxed as interest income, there was no question of giving rise to any capital gain or loss. (e) This circular further states that the earlier view expressed by the Board has created some problems, which according to the Board were as under: (i) According to Board, taxing the entire income received in the year of redemption as interest income was to give rise to sudden and huge tax liability in one year irrespective of the fact that value of the bond was progressively increasing over the period of holding. (ii) The second problem according to the Board's was that where the bond was redeemed by a person other than the original subscriber i.e. by a person who had purchased the bond, before the date of redemption, such person was to pay the tax on the entire difference between the subscribed price and bond (bid price) and the redemption price as interest income. According to the Board such person was not able to deduct his cost of acquisition from such income. (iii) The third problem according to Board, likely to be faced was that the company issuing such bonds and following the mercantile system of accounting might have evolve a system of accounting of actual accrual ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n date. (iv) It was further provided that in case the bond was to be redeemed by the original subscriber, the difference between the redemption price and the valuation on the last valuation date which was 31st March falling just prior to the date of redemption was to be taxed as interest income in the case of investor and business income in the case of trader. (3) So far as press note dt. 20th March, 2002 is concerned, we are of the opinion that this press note issued by the Board has simply clarified the applicability of Circular No. 2 of 2002 and is not a press note spelling out any proposed action likely to be taken by the Board. 31. The parties have been heard and the respective arguments have been incorporated in para Nos. 7 to 12 of this order. 32. The assessee's case is that: (i) The Circular No. 2 of 2002 is not applicable to the persons who have subscribed to DDBs for the purpose of keeping the same as investment because Board has no power to tax any income taxable under a particular head as income under any other head. (ii) In any case, para No. 3 of this circular read with press note dt. 20th March, 2002 clarifies beyond doubt that this circular is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad and that too only by way of so-called circular. Even if the circular is claimed to have been issued to mitigate the hardship to someone, the present circular, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 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. 33.1 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 view is supported by the decision of Tribunal Mumbai Bench C Mumbai in the case of ITO v. M/s Kulgam Holdings (P) Ltd. for asst. yr. 2001-02 in ITA No. 3785/Mum/2004, dt. 25th April, 200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad relied upon the decisions mentioned in para No. 10.2 (a), (b) (c) and (e) in support of his submission that the letter issued by Board to IDBI on 12th March, 1996 was not a circular which could be issued in exercise of Board's powers available under Section 119 of the Act. 35.1 Having gone through the decision and the letter in question, we are of the opinion that even if it is taken that the Board's letter dt. 12th March, 1996 written to IDBI was not a circular under Section 119 of the Act, then also the assessee's case is not effected and it is so because if this letter is excluded, then there being no contract for payment of interest on DDBs on yearly basis, the Board had no jurisdiction to make the interest payable at the time of redemption is taxable on accrual basis, more so in a case where the accounts were maintained as cash system or the bonds were kept as investment. These decisions, therefore, in our opinion, do not. support the Revenue's case. The learned Departmental Representative had, further relied on the decisions referred to in para Nos. 10.2(d) and 13.3 (a) and (b) in support of his submission that benevolent circulars issues by the CBDT w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f withdrawing or altering the terms of the circular during the course of financial year 2002-03. 36.3 The learned Departmental Representative had relied on the decisions referred to in para No. 10.6 in support of its submission that CBDT's circular cannot enlarge the scope of statutory provision. 37. After having gone through the decision, we are of the opinion that this decision, instead of helping the Revenue's case supports the assessee's case and, therefore, is of no use to the Revenue. Decisions relied upon by the learned Counsel for the assessee 38. The various decisions relied upon by the learned Counsel for the assessee have been referred to in para Nos. 9(ii)(a), (c), para Nos. 9(A)(a)(iii) and (iv), para Nos. 9 (iii)(B)(a)(i), para Nos. 9(iii)(3)(i) and (iii) of this order. 38.1 After having gone through all the aforesaid decisions, we are of the opinion that some of the decisions support the assessee's relevant plea directly, whereas some of the decisions support the decisions indirectly, but since we have allowed the assessee's various grounds after going through these decisions, consideration of the same separately, in our opinion, is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... than by filing a revised return. The assessment year in question was 1995-96. The return was filed on 30th Nov., 1995, by the appellant for the assessment year in question. On 12th Jan., 1998, the appellant sought to claim a deduction by way of a letter before the AO. The deduction was disallowed by the AO on the ground that there was no provision under the IT Act to make amendment in the return of income by modifying an application at the assessment stage without revising the return. This appellant's appeal before the CIT(A) was allowed. However, the order of the further appeal of the Department before the Tribunal was allowed. The appellant has approached this Court and has submitted that the Tribunal was wrong in upholding the AO's order. He has relied upon the decision of this Court in National Thermal Power Co. Ltd. v. CIT [1999] 157 CTR (SC) 249: [1998] 229 ITR 383 (SC), to contend that it was open to the assessee to raise the points of law even before the Tribunal. The decision in question is that the power of the Tribunal under Section 254 of the IT Act, 1961, is to entertain for the first time a point of law provided the facts on the basis of which the issue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... earned Departmental Representative being distinguishable on facts is not applicable to the present case. (b) In a nutshell, both the decisions relied upon by the learned Departmental Representative (supra) are not applicable to the present case. 40.1 (b) Decisions relied upon by the assessee: (i) Decision of Hon'ble High Court of Gujarat in the case of Mohit Marketing Ltd. (Tax Appeal No. 157 of 2000). In this case, the question for decision of Hon'ble High Court in Tax Appeal No. 157 of 2000 (supra) was as under: Whether in the facts and circumstances of the case, the Tribunal was right in law in holding that the assessee was not entitled to the deduction of interest paid by it on the debentures issued by it ? 40.2 The relevant part of the decision of Hon'ble High Court in Tax Appeal No. 157 of 2000 (supra) contained in para Nos. 8 to 17, reads as under: Tax Appeal No. 157 of 2000 8. As the facts narrated hereinbefore go to show the case of the respondent -assessee in Tax Appeal No. 328 of 2000 and the appellant assessee in Tax Appeal No. 157 of 2000 is primarily based on the debenture issued by the company; namely, tax treatment of interest whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ween the parties. As already reproduced hereinbefore the company had agreed and undertaken to duly and punctually pay, observe and perform the financial covenants and conditions endorsed on the debenture certificate. It was done so. The limited question that would then survive is whether the company is entitled to deduction of such amount while computing its taxable income. 11. Section 36(1) of the Act lays down that the deduction provided in the clauses that follow shall be allowed in respect of the matters dealt with in the respective clauses while computing the income referred to in Section 28 i.e. income from profits and gains of business or profession. Clause (iii) of Sub-section (1) of Section 36 reads, 'the amount of interest paid in respect of capital borrowed for the purposes of the business or profession. The proviso and the Explanation thereunder are not reproduced as they are not relevant for the present. Therefore, on a plain reading for an assessee to become entitled to deduction under Section 36(l)(iii) of the Act while computing income under the head 'Profits and gains of business and profession' the assessee has to establish that it has paid interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9; if it is laid out or expended wholly and exclusively for the purposes of business. Therefore, once it is shown that an expenditure is of the nature described in any of the specified sections i.e. Sections 30 to 36, the same cannot fall within Section 37(1) of the Act. In the circumstances, the assessee's claim being under Section 36(l)(iii) of the Act, there is no question of applying principles on the basis of which deduction of an expenditure is permissible under provisions of Section 37(1) or the Act. There is one more aspect of the matter. The company issuing the debenture, under which the borrowing is made, has entered into a contract with the debenture holder. It is nobody's case that the contract is sham or not acted upon. In the circumstances, the parties are bound by the terms of the contract and it is not open to any third party, including Revenue or the Court, to rewrite the terms of the contract. During course of hearing, on behalf of Revenue, attention was invited to observation made by the AO regarding applicability of ratio of McDowell Co. Ltd. v. CTO, [1985] 47 CTR (SC) 126 : [1985] 154 ITR 148 (SC) to contend that there was a transaction entered int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company that pursuant to the impugned order of Tribunal if any claim is made by each of the payer companies in any of the subsequent years on the basis of proportionate payment in accordance with the order of the Tribunal, the respective assessee companies shall have no objection if the claims which might have been allowed are withdrawn and additions made to the said extent considering that the entire claim of deduction of interest paid is allowed in asst. yr. 1995-96. 40.3 From the aforesaid order of the jurisdictional High Court what we have been able to understand is that income from DDBs is taxable on the basis of contract between the parties; meaning thereby that if the contract provides the payment of interest in a particular way i.e. either at the time of transaction or quarterly or half-yearly or yearly or at the time of squaring of the transaction the interest income is to be taxed accordingly. The Hon'ble jurisdictional High Court has distinguished the decision of Madras High Court in the case of Madras Industrial Investment Corporation Ltd. (supra) in para No. 29 of its order. 41. After careful consideration of the decision (supra), we are of the opinion that s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e devoted to other important issues. This situation has compelled us to look into the duties of the assessing authorities rather than powers of assessing authorities because Government is entitled to collect only the tax legitimately due to it otherwise the tax not so collected would be violative of the Article 265 to the Constitution of India. In such pursuit we have found that the CBDT as back as in 1955 issued Circular No. 14 (XI,-35), dt. 11th April, 1955 as to what should be a Departmental attitude towards refund and reliefs to the assessees. The subject circular is reproduced below for the purpose of ready reference: V. Miscellaneous - Refund and reliefs due to assessees - Departmental attitude towards - The Board have issued instructions from time to time in regard to the attitude which the officers of the Department should adopt in dealing with assessees in matters affecting their interest and convenience. It appears that these instructions are not being uniformly followed. 2. Complaints are still being received that while ITOs are prompt in making assessments likely to result into demands and in effecting their recovery, they are lethargic and indifferent in granting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... substitution, if not time-barred, must be brought to the notice of taxpayer. (d) Section 26A : The benefit to be obtained by registration should be explained in appropriate cases. Where an application for registration presented by a firm is found defective, the officer should point out the defect to it and give it an opportunity to present a proper application. (e) Section 33A : Cases in which the ITO (now AO) or Asstt. CIT (now Dy. CIT) thinks that an assessment should be revised, must be brought to the notice of the CIT. (f) Section 35 : Mistakes should be rectified as soon as they are discovered without waiting for an assessee to point them out. (g) Section 60(2) : Cases where relief can properly be given under this subsection should be reported to the Board. In this circular, the Board has recognised the fact that responsibility for claiming refunds and reliefs rests with the assessee. As imposed by law even then the Board has directed the officers to draw the attention of the assessees in respect of any refunds or reliefs to which they are eligible, which they have not claimed for some reason or the other. The Board has also given few examples in this regard and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing authorities. As stated earlier, CBDT is the apex body for tax administration and it can also issue directions which are for the benefit of the assessees though such directions may not be in consonance with the provisions of law, hence, if a circular is now issued directing the assessing authorities to grant reliefs/refunds while completing the assessment proceedings, even though such circular may be at variance with the law, as pronounced by the Hon'ble Supreme Court, but the same would be binding on the subordinate IT authorities. In our opinion, therefore, circulars of same nature which have been already issued would not become irrelevant or can be ignored. Admittedly, the circular issued in 1995 has not been withdrawn, hence, it has got binding force on the subordinate authorities even as on date. Accordingly, we hold that the AO is bound to assess the correct income and for this purpose, the AO may grant reliefs/refunds suo motu or can do so on being pointed out by the assessee in the course of assessment proceedings for which assessee has not filed revised return, although, as per law, the assessee is required to file the revised return. Having stated so, in our view, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relief to the assessee, in such circumstances, he would be acting de hors the powers under the Act and the provisions of the Act and, therefore, is duty-bound to give relief to an assessee, where due, in accordance with the. provisions of the Act. 22. A word of caution. The authorities under the Act are under an obligation to act in accordance with law. Tax can be collected only as provided under the Act. If an assessee, under a mistake, misconception or on not being properly instructed, is over-assessed, the authorities under the Act are required to assist him and ensure that only legitimate taxes due are collected. This Court, in an unreported decision in the case of Vinay Chandulal Satia v. NX). Parekh, CIT Special Civil Application No. 622 of 1981, rendered on 20th Aug., 1981, has laid down the approach that the authorities must adopt in such matters in the following terms: The Supreme Court has observed in numerous decisions, including Ramlal v. Rewa Coalfields Ltd. AIR 1962 SC 361; State of West Bengal v. Administrator, Howrah Municipality, AIR 1972 SC 749 and Babhutmal Raichand Oswal v. Laxmibal R. Tarte AIR 1975 SC 1297, that the State authorities should not raise te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cash system has been followed consistently in subsequent years, the system of accounting for asst. yr. 2003-04 was, cash system and we uphold it. (ii) In view of our conclusion, as aforesaid and the facts and circumstances of the present case as well as various decisions discussed hereinabove , we are of the opinion that income/interest from DDBs, admittedly, being held by the assessee as investment, was not taxable on accrual basis and, therefore, income of Rs. 24,03,33,662 having been assessed on accrual basis is deleted. (iii) The income on account of so-called notional interest on investment in OFCPN of Nirma Industries Ltd. amounting to Rs. 77,95,691, which was declared by the assessee in the revised return, is also deleted. (iv) The: Circular No. 2 of 2002 is an invalid circular and, therefore, income/interest from DDBs, in assessee's case who has held the same as investments, cannot be taxed on accrual basis as proposed by this circular. (v) Without prejudice to our findings at Sl. No. (iv) above, even if the circular is considered to be valid, then also the same being, in our opinion, applicable only to the DDBs purchased after 15th Feb., 2002, the income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be useful to recount, in brief, what the circular posits in the main: (a) It envisages that the Deep Discount Bonds (DDBs) could be held both as trading assets or by way of investment and that, therefore, the same may warrant a differential tax treatment on the income arising therefrom. (b) The second principle it seeks to emphasize is that the bonds, being essentially a debt instrument, could yield income to the holder thereof in two ways, i.e., on its mere holding (lapse of time), and on its transfer. (c) The third principle that the circular iterates is that there could be a difference in the head of income under which the income arising on holding and on transfer would be assessable and, further, also on whether the same is held as a trading asset or by way of an investment. With regard to the operationalization of the aforesaid principles, the circular suggests the following mechanism: (i) DDBs, being actively traded securities in the debt/money market, the valuation as declared by the RBI and/or the participating institutions (in consonance with the RBI guidelines) would form the basis of their valuation as at each (financial) year end. The difference in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on to the value of the bond is construed as accrual of income over the intervening period. Now, therefore, the only question would be whether the same thus represents an accrual of income to that extent, or not, and if so, there can be no doubt that the same would, subject to the other provisions of the Act, form part of taxable income in terms of Section 5 of the Act, which defines the scope of income assessable for a particular year, reading as under: 5. Scope of total income-(1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which: (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year: Provided that, in the case of a person not ordinarily resident in India within the meaning of Sub-section (6) of Section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the end of the term, say five years, being contracted to be redeemed at Rs. 1,000. As such, what all the holder of the bond is to do, i.e., after investing, in the performance of his part of the contract, is to wait for a period of five years; so that the contract stands performed (from his stand-point) by the lapse of time. The right to receive Rs. 333 (taking the figure of our example) would mature only at the end of the said term. However, the said maturity, or the fructification of the right, is only on account of the performance of the contract, and which, as seen, stands satisfied by the lapse of time. The right vested at the time of the execution of the contract, gets matured to the proportionate extent, so that there is accretion in value to the proportionate extent, say one-fifth, after a lapse of a year on a five year term. Again, it could be argued that this amount (Rs. 66.60 or Rs. 333 x 1/5) is only to be received after four years, so that its present value could not be in linear proportion, i.e., at Rs. 66.60, and the same would also be subject to discounting. It is for this reason that the concept of compound rate (of interest) gains ground, so that income accrue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccrual of income, which can only be on its realization on actual sale (transfer) or redemption. The argument is misconceived. There is no underlying contract in the case of shares or real estate, so that increase (or decrease) in market value thereof is notional, unless realized, even though the price may be real (and not hypothetical). However, in the case of instruments as DDBs, the price increase is only or principally on account of the reduction in the time period outstanding for the redemption. There could be incidental factors, as say decline in the fundamentals of the issuer company, so that the attendant risk (on the bonds) increases, resulting in a higher expected ytm thereon (and consequent depression in bond value). However, the market value is a composite value, factoring all such concern/issues. In fact, the bond (contract) itself specifies the ytm. In some case, the interest rate is specified, with the bond holder given an option to exercise the same and receive annual (periodical) interest, rather than deferring it to the end of the term, and getting cumulative interest, so as to suit varying liquidity needs of different constituent groups. It is in this context that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diture were held by the Hon'ble Court to have been realized and, thus, subject to assessment in the year of realization itself; the instrument in that case (debenture) being structured opposite to the DDBs, so that the payment of interest was made upfront, i.e., at the beginning of the contract period, as against its end in the case of DDBs. Further, the decision is also supportive of the fact that the valuation, of the DDBs, as per the circular, and thus the accrual of income, is bench-marked to the market value i.e., that realizable in the open market; the Hon'ble Court in that case being moved by the fact of realization, so that the question of accrual did not outstand. The market value, it must be emphasized, is only a valuation model, though a robust, comprehensive and real one at that, to capture the change in the intrinsic value of the bond due to lapse of time on account of the underlying contract. 65. The next infirmity pointed in the circular is that the bond, a capital asset (where held as an investment), though held for 36 months, yet would yield short-term capital gains on its transfer. However, this again flows directly from the cost of the bond being there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 68. In view of the foregoing, 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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