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Tax Publishers Red Fort Shahjahan Properties (P) Ltd. v. ACIT [ITA No. 742/DEL/2020, dt. 20-8-2020] : 2020 TaxPub(DT) 3294 (Del-Trib) Notional addition of interest on sticky loan to related party *Facts:* Assessee had given loan amounting to Rs. 21.40 crores to its group entity for a project with interest at prime lending rate + 3.5%. The said project did not crystallize in the hands of the group entity due to certain litigious aspects inherent to the project due to which the interest income was not accounted by the assessee. It was subsequently in FY 2018-19 the entire loan was also written off by the assessee factually. The assessing officer notionally added the interest in the hands of the assessee for assessment year 2016-17 which was upheld by the Commissioner (Appeals). The prime reason for the addition being one would not give money free of cost besides the fact that the non-accounting of the interest itself was more of a hogwash to divert amounts to group entity. On higher appeal by the assessee - Held in favour of the assessee that the notional addition of interest could not be done. The principles of uncertainty in revenue recognition as per AS-9 was canvassed by the assessee. *Applied:* CIT v. Motor Credit Co. (P) Ltd. (1981) 127 ITR 572 (Mad-HC) : 1981 TaxPub(DT) 0587 (Mad-HC) ".......Where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following the mercantile system of accounting. Even if the assessee makes a debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialised there can be no liability to tax a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account but, what should be considered is, whether the income has really materialised or resulted to the assessee. The question whether real income has materialised to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to the system of accounting. When the facts and the circumstances of the case clearly indicated that there is not even the remotest possibility of any interest income materialising in favour of the assessee in respect of the outstanding for the accounting year relevant to the assessment year in question, no liability to tax can be imposed on the ground that interest has accrued because of the mercantile system of accounting employed by the assessee. The mercantile system of accounting can be only relevant only to determine the point of time at which tax liability is attracted and it cannot be relied on to determine whether income has, in fact, resulted or materialized in favour of the assessee merely because the assessee has been maintaining his accounts on the basis of mercantile system of accounting, the interest income on the outstanding in the two firms cannot be held to have accrued at the end of the accounting year. Viewed against the background of commercial business realities of the situation in which the assessee was placed, the Tribunal came to the conclusion that it would be very unrealistic on the part of the assessee to take credit for a highly illusory interest." CIT v. Goyal M.G. Gases (P) Ltd. (2008) 303 ITR 159 (Del-HC) : 2008 TaxPub(DT) 508 (Del-HC) "10. The principle that the Supreme Court applied was that even if the accounts are maintained in the mercantile system, what has to be seen is whether income can be said to have really accrued to the assessee. In support of this principle, reliance was placed upon CIT v. Birla Gwalior (P) Ltd., (1973) 89 ITR 266 (SC) : 1973 TaxPub(DT) 0469 (SC) which approved the view taken by the Bombay High Court in H.M. Kashiparekh and Co. Ltd. v. CIT, (1960) 39 ITR 706 (Bom) : 1960 TaxPub(DT) 0158 (Bom-HC), Morvi Industries Ltd. v. CIT, (1971) 82 ITR 835 as well as Poona Electric Supply Co. Ltd. v. CIT, (1965) 57 ITR 521 (SC) : 1965 TaxPub(DT) 0316 (SC). In the penultimate paragraph of the judgment, the Supreme Court held as follows :-- "The question whether there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity has to be considered by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light, it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the Income Tax Officer while passing the assessment orders in respect of the assessment years under consideration." 11. Applying the law laid down by the Supreme Court, what has to be seen in the present case is whether there was any real accrual of interest to the assessee. Both the Commissioner (Appeals) as well as the Tribunal came to the conclusion that there was no real accrual of interest. It has been noted that the interest had not even been recorded by the assessee in its books of accounts. ..................................... The debts were written off as bad debts and were also allowed by the assessing officer in subsequent years. These facts lead to the inescapable conclusion that realisation of even the principal amount was in jeopardy and, therefore, there cannot be said to be any real accrual of income by way of interest. We find no fault in this view taken by the Tribunal and are of the opinion that no substantial question of law arises for our consideration." *Editorial Note:* The landmark decision of UCO Bank v. CIT (1999) 237 ITR 889 (SC) : 1999 TaxPub(DT) 1303 (SC) may also be referred to where it was held that the mercantile system alone does not decide the taxability of the interest on sticky loans but it is the actual right to receive the same.

Tax Publishers

Red Fort Shahjahan Properties (P) Ltd. v. ACIT [ITA No. 742/DEL/2020, dt. 20-8-2020] : 2020 TaxPub(DT) 3294 (Del-Trib)

Notional addition of interest on sticky loan to related party

Facts:

Assessee had given loan amounting to Rs. 21.40 crores to its group entity for a project with interest at prime lending rate + 3.5%. The said project did not crystallize in the hands of the group entity due to certain litigious aspects inherent to the project due to which the interest income was not accounted by the assessee. It was subsequently in FY 2018-19 the entire loan was also written off by the assessee factually. The assessing officer notionally added the interest in the hands of the assessee for assessment year 2016-17 which was upheld by the Commissioner (Appeals). The prime reason for the addition being one would not give money free of cost besides the fact that the non-accounting of the interest itself was more of a hogwash to divert amounts to group entity. On higher appeal by the assessee -

Held in favour of the assessee that the notional addition of interest could not be done.

The principles of uncertainty in revenue recognition as per AS-9 was canvassed by the assessee.

Applied:

CIT v. Motor Credit Co. (P) Ltd. (1981) 127 ITR 572 (Mad-HC) : 1981 TaxPub(DT) 0587 (Mad-HC)

".......Where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following the mercantile system of accounting. Even if the assessee makes a debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialised there can be no liability to tax a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account but, what should be considered is, whether the income has really materialised or resulted to the assessee. The question whether real income has materialised to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to the system of accounting.

When the facts and the circumstances of the case clearly indicated that there is not even the remotest possibility of any interest income materialising in favour of the assessee in respect of the outstanding for the accounting year relevant to the assessment year in question, no liability to tax can be imposed on the ground that interest has accrued because of the mercantile system of accounting employed by the assessee. The mercantile system of accounting can be only relevant only to determine the point of time at which tax liability is attracted and it cannot be relied on to determine whether income has, in fact, resulted or materialized in favour of the assessee merely because the assessee has been maintaining his accounts on the basis of mercantile system of accounting, the interest income on the outstanding in the two firms cannot be held to have accrued at the end of the accounting year. Viewed against the background of commercial business realities of the situation in which the assessee was placed, the Tribunal came to the conclusion that it would be very unrealistic on the part of the assessee to take credit for a highly illusory interest."

CIT v. Goyal M.G. Gases (P) Ltd. (2008) 303 ITR 159 (Del-HC) : 2008 TaxPub(DT) 508 (Del-HC)

"10. The principle that the Supreme Court applied was that even if the accounts are maintained in the mercantile system, what has to be seen is whether income can be said to have really accrued to the assessee. In support of this principle, reliance was placed upon CIT v. Birla Gwalior (P) Ltd., (1973) 89 ITR 266 (SC) : 1973 TaxPub(DT) 0469 (SC) which approved the view taken by the Bombay High Court in H.M. Kashiparekh and Co. Ltd. v. CIT, (1960) 39 ITR 706 (Bom) : 1960 TaxPub(DT) 0158 (Bom-HC), Morvi Industries Ltd. v. CIT, (1971) 82 ITR 835 as well as Poona Electric Supply Co. Ltd. v. CIT, (1965) 57 ITR 521 (SC) : 1965 TaxPub(DT) 0316 (SC). In the penultimate paragraph of the judgment, the Supreme Court held as follows :--

"The question whether there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity has to be considered by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light, it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the Income Tax Officer while passing the assessment orders in respect of the assessment years under consideration."

11. Applying the law laid down by the Supreme Court, what has to be seen in the present case is whether there was any real accrual of interest to the assessee. Both the Commissioner (Appeals) as well as the Tribunal came to the conclusion that there was no real accrual of interest. It has been noted that the interest had not even been recorded by the assessee in its books of accounts.

.....................................

The debts were written off as bad debts and were also allowed by the assessing officer in subsequent years. These facts lead to the inescapable conclusion that realisation of even the principal amount was in jeopardy and, therefore, there cannot be said to be any real accrual of income by way of interest. We find no fault in this view taken by the Tribunal and are of the opinion that no substantial question of law arises for our consideration."

Editorial Note: The landmark decision of UCO Bank v. CIT (1999) 237 ITR 889 (SC) : 1999 TaxPub(DT) 1303 (SC) may also be referred to where it was held that the mercantile system alone does not decide the taxability of the interest on sticky loans but it is the actual right to receive the same.