Income Tax Appellate Tribunal - Ahmedabad
Kisan Discretionary Family Trust vs Assistant Commissioner Of Income Tax on 2 November, 2007
Equivalent citations: (2008)113TTJ(AHD)918
ORDER
I.S. Verma, J.M.
1. In this appeal, the assessee has objected to the order of the CIT(A)-II, Ahmedabad dt. 26th Feb., 2007 passed for asst. yr. 2003-04, by way of following grounds:
1. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has grossly erred in points of law and facts.
2. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has grossly erred in holding that the appellant is not following cash method of accounting.
3. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has erred in confirming addition of Rs. 24,03,33,662 being artificial accrual of interest on various investments.
4. In law and in facts and circumstances of the appellant's case, the learned CIT(A) has 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, 2340 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. till 28th March, 2000. On 28th March, 2000, the assessee sold away its running business as a going concern and this fact was duly disclosed by way of note No. I of Annex.-B to its audited accounts for asst. yr. 2000-01.
2.2 The return of income for asst. yr. 2001-02 declaring income from other sources only, along with tax audit report was furnished on 31st July, 2001 (acknowledgements, computation of income and notes forming part of return of income) placed at page Nos. 167, 168 and 169 of assessee's paper-book. In audit report in Form No. 3-CB (copy placed at page Nos. 157 to 166 of assessee's paper-book) for asst. yr. 2001-02, the assessee has duly disclosed the method of accounting employed by it, against column 11-A as "cash". No assessment under Section 143(3) was made.
2.3 The return of income for asst. yr. 2002-03 accompanied with audited accounts was furnished on 9th Aug., 2002 (page Nos. 170 to 173 of the assessee's paper-book).
2.4 The sources of income shown in this return were 'long-term capital gain' and 'income from other sources'.
2.5 Note No. 4 of notes forming part of return of income duly showed the system of accounting followed by the assessee for asst. yr. 2002-03 as "cash system". The note in question, reads as under:
4. The assessee trust is following cash method of accounting.
2.6 The return of income for asst. yr. 2003-04 (copy placed at page Nos. 54 and 55 of the assessee's paper-book) declaring an income of Rs. 36,02,080 from 'short-term capital gain' and 'income from other source' on cash basis was furnished on 30th Sep., 2002.
2.7 Note No. 3 of notes forming part of return of income appended just below the computation of total income for asst. yr. 2003-04, which is reproduced hereunder, showed the system of accounting followed by the assessee as "cash system".
Note No. 3 : The assessee trust is following cash method of accounting.
2.8 As a result of search and seizure action under Section 132 having been carried on in Nirma group of cases on 27th Sep., 2001, the assessee's assessment for block period from 1st April, 1995 to 27th Sep., 2001 under Chapter XTV-B of the Act was completed on 30th June, 2004, assessing the undisclosed 'income at nil, and the method of accounting was mentioned the AO as "mercantile".
2.9 The assessee did not appeal against 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 Section 154 of the Act and the application is treated as filed and disposed.
Sd (Sheodan Singh Bhadoriya) Asstt. CIT, Central Circle-1(1), Ahmedabad
3. The assessee went in appeal before the CIT(A), but failed. The relevant part of the order of the CIT(A) (from copy placed at page Nos. 62 and 63), reads as under:
2. The appellant had by way of rectification claimed that its method of accounting was cash method whereas in the block assessment, it was taken as mercantile method. The AO has rejected this application stating that it is not rectifiable mistake.
2.1. In the course of hearing before me, the appellant vide letter dt. 13th Nov., 2006 stated that it does not want to press this ground as the total income assessed is nil. This ground is therefore, dismissed.
3. In the result, the appeal stands dismissed.
3.1 The assessee revised its return for asst. yr. 2003-04 on 31st March, 2004, wherein interest on OFCPN of Nirma Industries Ltd. was offered for taxation with the following note:
Note No. 6:
The return of income is revised to offer interest income of Rs. 77,95,691 on investment in OFCPN of Nirma Industries Ltd. held as on 31st March, 2003 to avoid litigation. The said revision is without prejudice to the validity of the Circular No. 2 of 2002 F. No. 149/235/2001-TPL dt. 15th Feb., 2002 [(2002) 173 CTR (St) 217] issued by CBDT.
During the year 3925 OFCPN has been sold on which capital gain of Rs. 49,88,607 has been offered. The interest income offered in earlier year has been correspondingly reduced from the said capital gain offered in original return.
3.2 The assessee had further given a note with respect to taxability of income from Bonds of Rural Electrification Corporation (hereinafter referred to as "REC") against note No. 4 which is in the following terms:
Note No. 4 : "Investment of the assessee trust includes Rs. 352.20 lacs in bonds of Rural Electrification Corporation made in financial yr. 2002-03. The assessee is advised that income from such notes/bonds is taxable only on actual realization and consequently the income therefrom will be offered for tax upon actual realization at the time of redemption thereof.
3.3 The assessment for asst. yr. 2003-04 was completed on 2nd Feb., 2006, wherein the AO, first of all, adopted the method of accounting as "mercantile" as per his observations contained in para 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 Infrastructure Leasing and Financial Services Ltd. and bonds of REC on accrual basis, at Rs. 16,97,80,160, Rs. 6,84,53,848 and Rs. 20,99,654 respectively, totalling to Rs. 24,03,33,662 and taxed the same.
3.5 So far as taxability of interest from investment in OFCPN of Nirma Industries Ltd. is concerned, the assessee had offered the interest on OFCPN amounting to Rs. 77,95,691 in its revised return furnished on 31st March, 2004 subject, however, to its right to challenge the validity and applicability of Circular No. 2 of 2002 as is evident from note No. 6 appended to the revised statement of income furnished along with the revised income (copy placed at page No. 56 of the assessee's paper-book) and reproduced in para No. 4.1 of this order. During the course of assessment proceedings, the assessee had objected to the taxability of this income by objecting to the validity and applicability of a Circular No. 2 of 2002, but the AO taxed the same as per his findings contained in para No. 4 of assessment order, which read as under:
4. The assessee filed revised return of income dt. 31st March, 2004 in which the interest income of Rs. 77,95,691 from investment in OFCPN of Nirma Ind. Ltd. has been offered. In a note written in the revised Rol, it has been mentioned that the revised return is filed without prejudice to the validity of the Circular No. 2 of 2002. But the validity of circular is reiterated in this regard and the revision is accepted. It is also clarified that the nature of OFCPN is similar as that of DDB therefore this Circular dt. 15th Feb., 2002 is applicable in the OFCPN also.
3.6 The CIT(A) decided this issue against the assessee as per his findings contained in para No. 3.2 of his order after relying on the decision of Hon'ble Supreme Court in the case of Goetze (India) Ltd. v. CIT which will be reproduced at the appropriate place of this order.
3.7 The AO further disallowed the assessee's claim of an expenditure of Rs. 10.30 lacs claimed on account of consultancy charges and another expenditure of Rs. 5.25 lacs claimed on account of accounting charges as per his findings contained in para Nos. 7 to 7.9 of the assessment order:
7. Claim of consultancy of Rs. 10.30 lacs and accounting charges of Rs. 5.25 lacs against brokerage income of Rs. 66,918.
From the Rol filed by 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 reference to the on-going assessment proceedings, and your notice dt. 25th Nov., 2005 received by us on 29th Nov., 2005. over and above the information furnished so far, we furnish hereunder the following information as desired:
Your goodself have referred to the brokerage income of Rs. 66,918 and consultancy and accounting charges of Rs. 10.30 lacs and Rs. 5.25 lacs respectively and required us to explain as to how these expenses are related to the earning of brokerage income.
We request reference to our letter dt. 19th Oct., 2005 wherein we have furnished the details as regards to consultancy charges. The same have been paid mainly for consultation fees for asst. yr. 2002-03 in respect of income-tax matters, for preparing return of income under IT Act and attending assessment for the year ended on 31st March, 2002. The expenditure has been incurred to meet with statutory obligations, which is very essential for earning income under the head income from other sources.
Your good office have referred to accounting charges of Rs. 5.25 lacs. In this regard, we would like to clarify that the expenses of Rs. 5.25 lacs are not only in respect of accounting services but also includes for investment, taxation and other related services as well. The same have been paid to Nirma Management Services (P) Ltd. by account payee cheque and are reasonable in view of the services availed.
Your good office have required us to prove that these expenses have been incurred to earn business income, otherwise the same will be disallowed.
As is evident from the computation of income attached to return of income, that the said expenses have been claimed against income from other sources and are allowable under Section 57(iii) of the Act. These expenses have been incurred for the purpose of making or earning of income and for protecting the assets of the trust.
We request reference to Section 57{iii) of the IT Act, which reads as under:
57. The income chargeable under the head 'Income from other sources' shall be computed after making the following deductions namely:
(iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.
To sum up, we submit that the expenditure incurred for the purpose of protecting the assets of the trust and necessity of 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 would have resulted into interest income. The assessee has other investments like bonds of ICICI Ltd. of Rs. 125 crores, NCDs of Infrastructure Leasing and Financial Services Ltd. of Rs. 50 crores, which if would have been held till maturity would have resulted into interest income.
From these details, it is evident that the referred expenses have been incurred wholly and exclusively for the purpose of making or earning of income.
We request reference to the decision of the Supreme Court in CIT v. Rajendra Prasad Moody in this regard. While quoting the judgment, and its reasoning, para 3 of the order, a relevant portion reads as under:
What Section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of Section 57(iii) and that purpose must be making or earning of income. Section 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of Section 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of Section 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure. It may be pointed out that an identical view was taken by this Court in Eastern Investments Ltd. v. CIT, where interpreting the corresponding provision in Section 12(2) of the IT Act, 1922 which was ipsissima verba in the same terms as Section 57(iii). Bose, J., speaking on behalf of the Court observed : 'It is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned'. It is indeed difficult to see how, after this observation of the Court, there can be any scope for controversy in regard to the interpretation of Section 57(iii).
In view of above, the expenses claimed are allowable.
7.2 It has been contended that the consultancy charges of Rs. 10.30 lacs have been 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 incorrect, since from the records it has been found that Kaushik Jayendra & Co. has represented the assessee for the accounting year ended on 31st March, 2002 and not the concern to which this amount has been paid. It has been claimed that Rs. 30,000 have been paid to M/s S.N. lnamdar, advocate High Court for attending IT appeals for asst. yr. 1999-2000. This cannot be allowed as per the provisions of the Act since the same is not related for conduction of the business of this year. Another Rs. 5 lacs have been paid to M/s Rajendra D. Shah & Co. for consultation fee for asst. yr. 2002-03 in respect of income-tax matters. This is again misleading since such a huge payment cannot be justified to have been wholly and exclusively incurred for the business purposes. The assessee has earned the incomes as STCG, interest on OFCPN/DDB/NCD offered due to the Circular No. 2 of 2002 and the meager brokerage income of Rs. 66,918 against these incomes, it is claiming Rs. 10.30 lacs as consultancy and Rs. 5.25 lacs as accounting charges. As has been observed above, no such expenses can be claimed against STCG/LTCG and also against interest on OFCPN/DDB/NCD offered due to the Circular No. 2 of 2002 because there is no need of such expenditure for the same. The remaining income is Rs. 66,918 which has been earned as brokerage. There is no justification of incurring such unrelated expenditure against this income. Thus it is very clear that these expenses have not been incurred wholly and exclusively for the purpose of the business.
7.4 The assessee has tried to justify its claim of Rs. 10.30 lacs by saying that these are in the form of statutory expenditure as the same are relating to the income-tax proceedings, preparing Rol and attending assessment but this contention is incorrect since the claim of Rs. 5 lacs for consultancy in the income-tax matters is also factually incorrect since as per the nature of the incomes earned by the assessee there is no need to pay such huge expenses for earning no income out of consultancy or for conducting any business activities. Basically whatever income has been earned is from the investment and that is due to the assets already owned by the assessee. From the activities of the assessee also, it is clear that these expenditure have not been incurred wholly and exclusively for the purpose of the business of the assessee.
7.5 The assessee 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 case of CIT v. Rajendra Prasad Moody (supra) is incorrect since the question before Hon'ble Supreme Court in that case was as to whether interest paid on money borrowed for investing in shares is deductible when no dividends are received in the year under consideration; in this issue the decision was given in favour of the assessee. But here the issue is different, these expenses are not wholly, exclusively relatable to any business or any income generation activities earned in this year or to be earned in the future years. In the relied case there was possibility of income generation in the future years though the same could not be earned in the year under consideration but in the instant case, no activity, in which income has been offered as income from other sources, in this year or later year, requires such expenses. The assessee has sufficient funds and income which has been earned, is due to the Circular No. 2 of 2002, there is no role of these consultants to earn the income in this regard. Therefore it is clear that the claim of the assessee that its case is covered by the relied case is incorrect.
7.8 To substantiate its claim the assessee could not give any written agreement based on which the payments have been made to these persons. It has been tied to give these exp. the name of statutory exp. but the same is not connect. There is no requirement to pay such huge amounts without any commercial expediency. The assessee cannot claim the expenditure which are not wholly and exclusively for the purpose of the business. By giving the expenses statutory names the same cannot become justifiable and without commercial justification the same cannot be allowed as business expenditure.
7.9 When the expenditure is not incurred wholly and exclusively for the purpose of the business and when there is no commercial expediency to incur such expenditure the same is not allowable at all. In this regard, reliance is placed on the following decisions:
(i) Andrew Yule & Co. Ltd. v. CIT ;
(ii) CAT v. Globe Theatres (P) Ltd. ;
(iii) Smt Sushila Devi Rampuria v. CIT ;
(iv) Rambilas Chandram v. CAT ;
(v) Pratap Cotton Trading Co. v. CIT .
In the light of 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 2002 and consequential taxability of income on accrual basis has been dealt with by the CIT(A) in second paras of 3.1, 3.2 and 3.3 of his order, which are in the following terms:
3.1...Insofar as the interest on DDBs of REC, ICICI and 1 LFS Ltd. is concerned, the appellant's further submission is that the interest is not to be taxed in view of the Circular dt. 15th Feb., 2002 and subsequent press release. Similar question had arisen in the case of Nirma Chemical Works Ltd. for asst. yr. 2003-04 wherein vide appellate order passed recently on 8th Feb., 2007, I have not accepted the contentions of the assessee and the addition made by the AO on account of accrued interest was confirmed. As discussed on pp. 4 and 5 of the said appellate order the addition in the present case also deserves to be confirmed. Hence, ground Nos. 3 and 4 raised by the appellant are dismissed. For the sake of ready reference the relevant paras from the said decision are reproduced as under:
The appellant submitted before the AO that since the investments in DDBs/OFCPNs is done prior to the date of issue of Circular dt. 15th Feb., 2002, the question does not arise of applying the provisions of the circular in the assessee's case and offering income on the basis of valuation at the end of the year as stipulated in the Circular dt. 15th Feb., 2002. The appellant also placed reliance on the Board's press release dt. 20th Feb., 2002.
I have carefully considered the contentions of the appellant as well as gone through the records available on file. The AO has discussed various aspects of Boards Circular No. 2 of 15th Feb., 2002 followed by CBDT's press release dt. 20th March, 2002.
The contention of the appellant that the interests have not been actually received during the year and they have no right to receive the income during the year, there is no question of offering any interest income is not acceptable as the value of the DDB increases automatically in the market depending on the current PLR and the appellant can recover the accrued value of interest by selling the same at any time. CBDT's Circular No. 2 of 15th Feb., 2002 explains in detail the method for arriving at the discounted value or maturity value of bonds and determining the accrued income. Therefore the contention of the assessee, that there is no income which has accrued is not correct. The 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 hereby confirmed. In a result, the 1st ground of appeal is dismissed.
(2) The 3rd and 4th ground of appeal contended by the appellant is that:
In law and in the facts and circumstances of the appellant's case, the learned AO has erred in making addition of Rs. 2,58,44,224 by way of notional interest on investment in OFCPN of Nirma Industries Ltd.
In law and in the facts and circumstances of the appellant's case, the learned AO has erred in ignoring the intimation given by the appellant vide letter 11th Aug., 2004 and during submissions in the assessment proceedings, that in the computation in revised return, excess income offered of Rs. 8,50,000 in the revised return of income filed on 31st March, 2004 and requested to exclude the excess income offered. The income now assessed is more by Rs. 8,50,000.
The AO has clearly stated in his assessment order that the sum of Rs. 21,33,39,216 is arrived by the AO by a method as discussed in Circular No. 2 of 2002 of CBDT and after giving effect of excess interest of Rs. 8,50,000. Therefore, ground Nos. 3 and 4 raised by the appellant are hereby dismissed.
3.2 With reference to interest of Rs. 77,95,691 in respect of the bonds of Nirma Ltd., I further observe that the AO has not discussed this in the assessment order presumably because in the revised return the assessee had herself offered it for tax. Presumably, claim for exclusion of this sum from the total income was not made before the AO. At any rate, another revised return was not filed for claiming exclusion of that sum from the total income offered for tax in the revised return on 31st March, 2004. Be as it may, it is clear that as per the latest revised return available with the AO this amount stood offered for taxation by the assessee. Even if a claim for exclusion of the same was made before the AO without filing correspondingly a revised return of income the AO would be entitled not to entertain any such claim in view of the Supreme Court decision in Goetze (India) Ltd. v. CIT . Apart from this, from the papers whose copies are filed with the assessee's submissions dt. 13th Feb., 2002 to this office the said DDBs were issued on or about 7th June, 2002 and certainly after 15th Feb., 2002. On the basis of information and papers furnished by the assessee even by applying the principles of 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. The disallowance of Rs. 5.25 lakhs is therefore, not justified. So far as the fees for the income-tax matters are concerned, it is well known that for income-tax consultancy the assessee has to incur professional fees. The claim is supported by the bills of professionals and hence the disallowance is not justified. The disallowance of Rs. 15.55 lakhs is therefore, deleted.
4.3 The issue relating to interest under Sections 234A, 234B, 234C and 234D was held to be consequential as per CIT(A)'s observation contained in para No. 5 of his order, which reads as under:
5. Ground No. 5 relates to interest charged under Sections 234A, 234B, 234C and 234D. The levy of interest being consequential these grounds of appeal are dismissed.
5. The assessee is aggrieved with the order of the CIT(A) with respect to issues relating to:
(i) System of accounting,
(ii) Validity of Circular No. 2 of 2002.
(iii) The applicability of Circular No. 2 of 2002 to the DDBs purchased prior to this circular and taxing of interest/income from DDBs on accrual basis.
5.1 Whereas Revenue is in appeal against deletion of addition of Rs. 15.55 lacs having been made by the AO by disallowing the assessee's claim of expenditure of Rs. 10.30 lacs on account of consultation charges and claim of expenditure of Rs. 5.25 lacs on account of account charges.
6. Learned Counsel for the assessee's arguments:
(i) As per the learned Counsel for the assessee, the appellant, a family trust, was till 28th March, 2000 engaged in the business of manufacturing and for the said business, it was following mercantile method of accounting. On 28th March, 2000, appellant sold away the said business as a going concern (reference was made to Note No. 1 on p. 129 which is notes to accounts for asst yr. 2000-01 filed along with the return of income). Thereafter, it has no business and the only income is from investments.
(ii) It was, further, submitted that for the year ending on 31st March, 2001 i.e. asst. yr. 2001-02, appellant filed its return of income (pp. 167-169) along with tax audit report (pp. 155-166) where on p. 157, it was clearly stated that its method of accounting was cash. Since no order of assessment was passed on this return therefore, the return and system of accounting stand accepted by virtue of the provisions of Section 143(l)(a) of the Act.
(iii) The Authorised 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 stated. In any case, description "mercantile" would be partly correct inasmuch as upto asst. yr. 2000-01, appellant was admittedly following mercantile method of accounting, but not for the period 1st April, 2000 to 27th Sep., 2001-the date of search, because after 1st April, 2000 the appellant has started following cash method of accounting.
(vi) It was further submitted that since the block assessment was framed at Rs. nil, appellant originally did not prefer any appeal. However, as controversy to the method of accounting, followed by the appellant, was sought to be raised by the Revenue on the so-called finding of the AO. In the block assessment order which was not challenged in the appeal by the appellant, the appellant moved rectification application (p. 60). The same came to be rejected by the AO on 20th Sept., 2005 (p. 61). The same was challenged in appeal. However, in view of the fact that total income was Rs. nil and in view of the fact that for substantial period of the block, the appellant had, in any case followed mercantile method of accounting, the same was not pressed by the appellant and accordingly the same has been dismissed by CIT(A) (pp. 62-63).
(vii) The learned Counsel for the assessee further submitted that the appellant's assessment for asst. yr. 2002-03 was taken up for hearing. The appellant's argument that it is following cash method of accounting came to be rejected on the ground that in the block assessment, it is found that appellant has been following cash method of accounting (pp. 64-66). The said order was challenged before learned CIT(A) who vide his order dt. 7th March, 2006 (pp. 91-98) dismissed appellant's appeal, partly on the ground that in the block assessment, the same has been accepted as mercantile method of accounting (pp. 94-97). The appellant has preferred appeal against this order which is pending before Hon'ble Tribunal.
(viii) Apart from the controversy as to the method of accounting, controversy pertains to the question as to whether appellant is liable to pay tax on interest alleged to have accrued to it. This issue is in two parts and therefore, considered separately. However, before discussing controversy in two parts, cause of controversy needs to be stated. The Authorised Representative, therefore, submitted that the appellant has invested amounts in the purchase of financial instruments. 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 Issue Price Tenure Redmption
Nos. price
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Unsecured Bonds in the nature 11 Rs. 67,267.35 3 years Rs. 1,00,000 of Debentures (Capital to 14 each and 6 each Gains Deep Discounts Bonds)- months Issued by ICICI Ltd.
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Deep Discounts Bonds in the 15 Rs. 1,000 42 Rs. 1498.50 nature of secured non- to 16 each months each convertible debentures - Issued by ILFS Ltd.
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Optionally Fully Convertible 30 Rs. 25,000 5 years Rs. 33,750 Premium Notes (OFCPNs)-issued to 37 each each by Nirma Industries Ltd.
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(ix) For the sake of convenience, these bonds are being referred as DDBs. As per the terms and conditions for issuing these documents, no return/interest/dividend was to be paid during the tenure of bonds and whosoever would hold DDBs on the date of maturity would get redemption price.
(x) As opposed to this, appellant has invested the amount in bonds issued by capital tax exemption bond issued by REC Ltd. on which return will be either to be paid on year to year basis or to be accumulated and be paid on the date of maturity (see p. 22). For the sake of convenience, this instrument is referred to as Investment Bonds (IB).
Facts relating to Circulars of CBDT:
7.1 In relation to the tax treatment of DDBs, three circulars/press notes have been issued by CBDT and the same are detailed below:
(i) On 12th March, 1996, a letter came to be issued (p. 48) by CBDT wherein it was clarified that when an appellant transfers such bonds before maturity, difference between sale consideration and issue price will be treated as capital gain/loss if the appellant purchased them by way of investment. In other words, till the date of transfer or maturity, as the case may be, question of taxing difference between redemption price/sale price and cost price did not arise at all.
(ii) On 15th Feb., 2002, Circular No. 2 of 2002 came to be issued by the CBDT (p. 39-42) wherein firstly it was confirmed that law did prevail till that date as per the earlier letter dt. 12th March, 1996 (pp. 39 and 40 para 1). It further stated that the Board have decided to change the system and such income may hereafter be treated as follows, (p. 40 para 3). Briefly stated, according to this new system DDBs which would not carry any interest on a year to year basis, would have to be valued on a year to year basis and difference between cost/value at the beginning of the year and value at the end of the year would be treated as income of the appellant on a year to year basis. In the year of maturity of bonds, the same would be treated as short-term capital asset irrespective of period of holding as income on a year to year basis till 31st March prior to the date of redemption has already been taxed as interest income.
(iii) It was clarified by a press note dt. 20th 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, it is gathered that the CIT(A) accepts in principle that method of accounting cannot be thrust upon on the appellant by the AO but then he proceeds to state that the appellant cannot change the method of accounting arbitrarily or without proper and adequate justification. In saying so, he completely ignores the fact that upto asst. yr. 2000-01 appellant was doing business. It was, therefore, following mercantile method of accounting. On 28th March, 2000, it sold away business. Thereafter, the only income with the appellant was in the nature of interest/dividend income. Under the circumstances, appellant would be justified in changing the method of accounting and such a change cannot be faulted. The appellant relies upon Hon'ble Gujarat High Court decision in the case of CIT v. Ganga Charity Trust Fund . Further, in the year of change i.e. asst. yr. 2001-02, Department has given no reason to dispute the change. As a matter of fact, no assessment order is passed in that year. If that be situation, question of raising the issue in later year cannot arise.
(b) Second ground given by the learned CIT(A) for following mercantile method of accounting is that in the block assessment proceedings the AO had held that appellant has followed mercantile method of accounting against which appellant did not prefer appeal and that method of accounting in the block assessment and regular assessment has to be same. Firstly this finding is irrelevant and secondly finding is partially incorrect. In the block assessment order, income was assessed at Rs. nil. The question of preferring appeal therefore, did not arise. In any case, for the block period, for substantial part, such finding would be correct inasmuch as upto asst. yr. 2000-01, appellant was following mercantile method of accounting. Second finding that method of accounting for the normal and the block period has to be same is irrelevant finding for the simple reason that the two methods have to be same for the same period. There is nothing in law that, after the block period is over till eternity appellant has to follow the same method of accounting which is found in the block period. Block period ended on 27th Sep., 2001. We are concerned with asst. yr. 2003-04. There is nothing to show that appellant has to follow the same method of accounting in subsequent period. 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 hereinafter method of accounting followed by the issuer is thoroughly irrelevant for deciding the method of accounting in the hands of the appellant. On merits it is submitted that this consideration is thoroughly irrelevant. Law does not oblige in relation to any transaction, both parties to the transaction must follow the same method of accounting. If that were the rule, there can never be transaction between the two parties following two different methods of accounting because as per the logic of learned CIT(A) one of the two parties is obviously incorrect. This is absurd proposition. The question can be examined from one more angle. Say an assessee holds two or more instruments, some issuer follows cash method and others follow mercantile method of accounting. If the argument of CIT(A) is allowed, appellant must accept cash method vis-a-vis first set of instrument and mercantile method vis-a-vis second set of instrument. He must therefore, follow mixed method of accounting which is impermissible. Thus it is absurdity of the argument of learned CIT(A). In any case, the issue stands concluded by the decision of Hon'ble Supreme Court in the case of Empire Jute Co. Ltd. v. CIT (1980) 17 CTR (SC) 113 : (1980) 124 ITR 1 (SC) where Revenue desired the Supreme Court to treat the particular receipt as capital receipt as in hands of payer it was treated as capital expenditure. The Supreme Court rejected that argument specifically stating that "The fact that certain payment constitutes income or capital receipt in the hands of the recipient is not material in determining whether payment is revenue or capital disbursement qua the payer. Whether it is capital expenditure or revenue would have to be determined having regard to the nature of transaction and other relevant factors." (124 ITR 1 at 7).
(d) It was, therefore, pleaded that in view of (sic) also, even third finding given by the learned CIT(A) is not correct. In the circumstances, appellant submits that it be held that appellant is following cash method of accounting.
(e) If this ground is accepted, rest of the grounds 3 and 4 would become academic inasmuch as undisputedly, the appellant has received nothing during the year and therefore, question of making any addition on the basis of accrual of interest would not arise.
(iii) Ground Nos. 3 and 5 : Addition of Rs. 24,03,33,662 The learned Authorised 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 is specified. Under the circumstances, during the term of the bond, no interest accrues to the appellant. When the contract between the parties does not specify obligation to pay interest much less the rate of interest, Revenue cannot rewrite the contract for considering interest and that too at a particular rate. For this purpose, appellant relies upon Hon'ble Gujarat High Court decision in Tax Appeal No. 157 of 2000 and in particular para 14 thereof.
(iii) In any case the issue is squarely covered by the Board's 1st circular in favour of the appellant. This position is in fact reiterated by the Board in first para of second circular also. Therefore, one cannot dispute that position at least till 15th Feb., 2002. The matter was settled by Board's circular in favour of the appellant. If that be so, in view of the following decisions where a view is taken that benevolent circular of the CBDT binds on the Revenue, even if it is inconsistent with the Act, appellant should succeed.
(i) Navnit Lal C. Javeri v. K.K. Sen, Appellate Asstt. CIT ;
(ii) K.P. Varghese v. ITO ;
(iii) UCO Bank v. CIT ;
(iv) Keshavji Ravji & Co. v. CIT ;
(v) Rajan Ramkrishna v. CWT ;
(vi) Nirmal Udyog Co. v. Asstt. CIT (1998) 62 TTJ (Mumbai)(TM) 101 : (1998) 65 ITD 73 (Mumbai)(TM); (Minority view) (Difference on some other issue)
(vii) 254 ITR 534 (SC)(sic);
(viii) Comm. of Customs v. Indian Oil Corporation Ltd. ;
(ix) Vidit Kumar Ram Krishan Agarwala, Deepak Kumar Agarwala (AOP) v. Dy. CAT (2005) 95 TTJ (Agra) 117;
(x) 278 ITR 536 (Del)(sic);
(xii) CCE v. Dhiren Chemical Industries .
(iv) According to the Revenue, first circular would not apply because of second circular, but the learned Authorised Representative was of the view that for the following reasons, the said argument of the Revenue is incorrect:
As stated in the second circular, the same is to be applied prospectively. See para 4. Third circular itself clarifies that 2nd circular would apply to the instalments issued after the date of second circular. In view of this, 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 ;
(ii) CIT v. B.M. Edward, India Sea Foods ;
(iii) CIT v. Prasad Productions (P) Ltd. .
(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 bonds.
(a) With respect to this addition, the learned Authorised Representative submitted that inasmuch as REC investment bonds were acquired by the appellant after 15th Feb., 2002, appellant cannot argue its case on the basis of first circular. Under the circumstances, the appellant submits that in spite of the second circular on the basis of principle of law, so-called income of Rs. 21 lacs of REC investment bonds cannot to be taxed because of the following reasons:
(i) It is well-settled law that circulars of CBDT would be binding on the Revenue but not appellant. It is always open to the appellant to claim that his case should be covered by the provisions of the Act and not by the circular. As a matter of fact, following decisions have taken a view that CBDT circular cannot make the case of the appellant worse off and appellant would have right to be assessed under the scheme of the Act and not under a circular:
(i) Gestetner Duplicators (P) Ltd. v. CAT ;
(ii) Keshavji Ravji & Co. v. CIT .
This aspect is discussed with great clarity by Patna Tribunal in the case of ITO v. Dilip Shirodkar (2004) 82 TTJ (Panaji) 869 where Tribunal held as under:
Law is trite that a circular, even under Section 119, cannot be thrust upon the assessee. The assessee can derive advantage from a circular but it does not bind the assessee in any way nor can it impose any taxability on the assessee. The assessee is entitled to ignore a circular if its terms are beyond the provisions of the Act. It is only a benevolent circular which is binding, and that too on the Revenue.
...As the Hon'ble Supreme Court has observed in the case of Keshavji Ravji & Co. v. CIT (supra), Board cannot preempt a judicial interpretation of scope and ambit of a provision of the Act by issuing a circular on the subject. It is also well-settled in law that Tribunal is not bound to take judicial notice of the circulars, issued by the Board, as is held in the case of Motor Industries Co. Ltd. v. CIT (1986) 55 CTR (Kar) 36 : (1987) 163 ITR 659 (Kar) by the Hon'ble jurisdictional High Court.
It was, therefore, submitted that in view of the above, the second circular is invalid and should not be relied upon.
(ii) The Authorised Representative, further, submitted that if the appellant 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) respectively are sought to be amended by a circular that long-term capital asset can be converted into short-term capital asset. It may be argued that, that part of the circular is invalid. However, such argument is also incorrect inasmuch as once a view is taken that the holding period of asset is given in the Act determines, as to whether an asset is a short-term or long-term asset and once part of the circular which converts a long-term into short-term asset fails, automatically other part of the circular would fail because then taxability of income on a year to year basis so as to assume the holding also on a year to year basis would also fail. Therefore, the whole circular is illegal.
(iv) The matter can be examined from one more angle. Say an assessee acquired bonds of 5 years. First four years have already gone by the time second circular is issued. As the appellant would not have paid on the so-called accrual of interest for the first four years on the basis of first circular. If the Revenue is right then on the basis of second circular tax would be paid by the said appellant only for the income of the fifth year. Under the circumstances, income of the first four years would go scot-free. This could not be done or commitments cannot be undone by a Board's circular.
(iv) Ground No. 4 : Addition of notional interest of Rs. 77.96 lacs on OF CPNs of Nirma Industries Ltd.
(i) With respect to this addition, it was submitted that the appellant had acquired Optionally Fully Convertible Premium Note (OFCPNs) of Nirma Industries Ltd. after 15th Feb., 2002. Originally it did not offer income on the same to tax. However, later on appellant filed revised return of income (pp. 56-57) offering to tax this income on a "without prejudice" basis to avoid litigation. When the matter was carried to learned CIT(A), specific ground was raised before him for exclusion of such income. However, learned CIT(A) in para 3.2 of his order holds that inasmuch as appellant had offered this income in the revised return of income, which was not subsequently revised, following the decision of the Supreme Court in the case of Goetze (India) Ltd. v. CIT (supra) appellant is not entitled to plead for its exclusion. He further held that as the investments were subsequent to 15th Feb., 2002, appellant's case is governed by the second circular.
(ii) Insofar as second finding 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 Taxman 64 (All);
(ii) (2006) 10 SOT 715 (Del);
However, now appellant finds a detailed order of Mumbai Tribunal in the case of Chicago Pneumatic India Ltd. v. Dy. CAT (2007) 15 SOT 252 (Mumbai) where whole law on the aspect is discussed and the Tribunal has taken a view that even if appellant has offered the income, he has a right to challenge the same, if it is found that income is not otherwise liable to be taxed. (See discussion on pp. 271-275 para 49). That apart, the judgment of the Hon'ble Gujarat High Court in the case of S.R. Koshti v. CAT also supports the case of the appellant.
(iv) Under the circumstances, appellant cannot be denied to raise such contention once the same is permitted to be raised. The issue is identical to ground No. 4 and for the reasons stated therein, this ground is also required to be allowed.
(v) Ground No. 6 : Leuy of interest under Sections 234A, 234B, 234C and 234D of IT Act The learned Authorised Representative submitted that the issue involved in this ground be treated as consequential.
(vi) Ground No. 7 : General No separate argument is necessary.
8. Learned Departmental Representative's arguments:
8.1 With respect to the issue relating to the method of accounting followed by the assessee:
Regarding method of accounting followed by the assessee, the Departmental Representative submitted that the assessee was following mercantile method of accounting till 28th March, 2000 for the business of manufacturing carried on by it. The assessee has not given reasons as to why it has changed method of accounting to cash. It has never stated before the AO that it has changed the method of accounting. Even originally the assessee did not challenge the finding of the AO in the block assessment order about the method of accounting followed by the assessee as being mercantile. As has been rightly held by the CIT(A) while deciding appeal of the assessee for the asst. yr. 2002-03 (kindly refer p. 96 of assessee's paper book) the appellant cannot change the method of accounting arbitrarily and without proper and adequate justification. The learned Authorised Representative has argued that there is nothing in law that after the block period, till eternity the assessee has to follow the same method of accounting. What the learned Authorised Representative 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 have claimed to offer the same on cash basis.(please refer to p. 97 of paper book filed by assessee at top few lines). Offering of interest income on cash basis postpones the incidence of tax which has not been approved by CBDT Circular dt. 15th Feb., 2002. This clearly shows that assessee has tried to reduce tax liability on interest income and postpone the same to a later year.
9.2 Effect of letter issued by Board dt. 12th March, 1996 The contention of the learned Authorised Representative is that the issue is covered by Board's 1st circular issued on 12th March, 1996 in favour of the assessee. It is submitted that letter issued by the Board on 12th March, 1996 is not a circular. Even in para 1 of Circular No. 2nd, dt. 15th Feb., 2002 reference is made to letters issued by Board to IDBI and others clarifying the issue of tax treatment of income arising from DDBs The letter issued by the Board dt. 12th March, 1996 relied upon by the assessee is not a circular, rather it is a clarification given to IDBI. Clarifications issued by the Board have no binding force as circulars. Reliance was placed on the decision in following cases:
(a) In J.K. Synthetics Ltd. v. CBDT , the assessee wrote to the CBDT to give directions to the AG to allow relief under Section 80J to the assessee for a particular year. The Board rejected the request. The assessee filed a writ.
The apex Court held that the communications sent by the Board were replies to the letters written by the assessee. They could not bind the taxing authorities who had to decide the questions in issue on its own merits, unaffected by extraneous considerations.
(b) In the case of CIT v. Kerala Financial Corporation , whereas it was held that a letter clarification of the Board in reply to a communication from the assessee or any other person who is not an authority within the meaning of Section 116 cannot be treated as a circular within the meaning of Section 119 and will not be binding on the Revenue authorities.
(c) In the case of CIT v. Kerala Financial Corporation Ltd. it was discussed as to which document can be regarded as a circular. It was held that, To say that a particular document or letter is a circular issued by the Board, it is necessary 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 , 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 , 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 dt. 12th March, 1996 the taxpayers were faced with sudden and huge tax liability. In para 2 of the said circular it has been stated that such tax treatment of DDBs, i.e. taxing on maturity, however, has posed the following problems:
(i) Taxing the entire income received from such a bond in the year of redemption as interest income gives rise to a sudden and huge tax liability in one year whereas the value of the bond has been progressively increasing over the period of holding.
(ii) Where the bond is redeemed by a person other than the original subscriber, such person becomes taxable on the entire difference between the bid price and the redemption price as interest income, since he is not able to deduct his cost of acquisition from such income.
(iii) A company issuing such bonds and following the mercantile system of accounting may evolve a system for accounting of annual accrual of the liability in respect of such a bond and claim a deduction in its assessment for each year even though the corresponding income in the hands of the investor would be taxed only at the time of maturity.
(iv) Taxing the entire income only at the time of maturity amounts to a tax deferral.
The Circular No. 2 dt. 15th Feb., 2002 was issued to remove above anomalies and to be in line with international taxation policy.
As per this circular interest income on DDEs is to be taxed on accrual basis irrespective of cash or mercantile method followed by a taxpayer.
It was, therefore, submitted that since the Courts have held that the circulars issued to mitigate hardship to the taxpayers are binding on the Department, the authorities have rightly applied the circular. To support the submission, reliance was placed in the following decisions:
(a) In the cases of UCO Bank v. CIT and Paper Products Ltd. v. CCE , wherein it was held that CBDT has power to issue circulars to tone down the rigours of the law and ensure fair enforcement of its provisions. In view of the provisions of Section 119 of the Act, so long as such a circular is in force it would be binding on the Departmental authorities to ensure a uniform and proper administration and application of the IT Act.
(b) In the case of CIT v. Jain Construction Co wherein 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 , 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 of the Act.
(b) In the case of Ved Prakash Gupta v. CAT , wherein it was held that, "The press notifications issued by the Ministry of Finance, Government of India, on 19th May, 1951 and 18th July, 1951 dealing with a concessional scheme for the payment of arrears of tax and disclosure of income have not been passed under the provisions of IT Act or any other law and have no legal force. Court held that assessees taking advantage of the press notification and acting in accordance therewith are not entitled to any relief by way of mandamus directing the officers of the IT Department to enforce the provisions of the press notification."
(c) On Circular No. 783 of 1999, dt. 18th Nov., 1999 [(1999) 157 CTR (St) 107], wherein it was clarified by the CBDT that, "It is hereby clarified that making any claim for waiver of interest based on the press note dt. 21st May, 1996 is not sustainable. A press note is basically intended to give a broad idea in advance to the public at large regarding a policy/step under formulation. To treat a press note as a final legal document and to make any claim on the basis of it as against the contents of the final document is not maintainable."
(d) In the case of J.K. Synthetics Ltd. v. CBDT (supra), wherein it was held that "Opinion expressed by the CBDT in response to communications received from assessee cannot be considered as 'directions' under Section 119. Any such opinion cannot bind the IT authorities who have to decide the question on its own merits uninfluenced by extraneous considerations."
(e) In the case of National Thernval Power Corporation Ltd. v. Union of India , wherein it was held that opinion of the Central Board of Direct Taxes (CBDT) expressed in its administrative capacity, could, under no circumstances, be binding on the CIT(A) or the Tribunal or the High Court on a reference.
9.5 Effect of circular vis-avis assessment year : With respect to applicability of the Circular No. 2 of 2002, the learned Departmental Representative submitted that Circular No. 2 of 2002 dt. 15th Feb., 2002 is on force as on 1st April., 2002, so it is valid for asst. yrs. 2002-03 and 2003-04. According to him, the circular issued by the CBDT as it stands at beginning of assessment year will be applicable, notwithstanding its subsequent modification. Reliance was placed on the decision in following cases:
(i) CAT v. Geeva Films , 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 , 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. .
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. .
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 .
9.7 It was further submitted that the assessee cannot challenge the validity of Circular No. 2 dt. 15th Feb., 2002 when it is issued for the benefit of taxpayers. By challenging the validity of Circular No. 2 dt. 15th Feb., 2002 the assessee has challenged the power of CBDT under Section 119 to issue such circulars to mitigate hardship to the taxpayers, which in my submission assessee can challenge only in writs.
In view of the above submissions and the case law, it is submitted that the AO and the CIT(A) have rightly held that interest income on DDBs is to be taxed on accrual basis in the concerned years on the basis of Circular No. 2 dt. 15th Feb., 2002 which is in force on the 1st day of asst. yr. 2003-04 irrespective of method of accounting followed by the assessee.
10. Ground No. 4 Addition of notional interest of Rs. 77.96 lakhs on OFCPNs of Nirma Industries Ltd.
With respect to this addition, the learned Departmental Representative submitted that the assessee has offered the said income in the revised return and raised a ground before CIT(A) for exclusion of such income. Reliance has been rightly made by CIT(A) on decision of the Supreme Court in Goetze (India) Ltd. v. CIT (supra). Reliance is made on the decision of Hon'ble Tribunal Ahmedabad 'C Bench, in the case of Infmium Communication (P) Ltd. in ITA Nos. 3489 and 3490/Ahd/2004 dt. 3rd Nov., 2006 for the submission that after passing of assessment order the assessee cannot make any claim for deduction from income (copies of the said order are placed on record).
10.1 It was further submitted that the learned Authorised Representative has relied upon the decision of Chicago Pneumatic India Ltd. v. Dy. CIT (supra). In the cited case of Chicago Pneumatic India Ltd. (supra), the assessee had revised its claim of deduction under Sections 80HH and 801 during course of assessment proceedings which was not accepted by AO but in case of the assessee the facts are different as here assessee had consciously offered the income and thereafter at appellate stage changed its mind and claimed exclusion. Further it is not a statutory deduction as in the case cited by the learned Authorised Representative. Further the Hon'ble Tribunal has held at p. 274 in the cited case that the CIT(A) should have entertained the claim of the assessee if other conditions of the provisions of the law 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 respect to Departmental Representative's arguments, that it was for the assessee to establish that change in system of accounting was bona fide and that the changed system was being followed regularly, the learned Authorised Representative has submitted that, first of all, this is not the case of the Revenue. According to learned Authorised Representative, neither the AO nor the CIT(A) has raised this issue and even if, for the sake of arguments, the issue is considered from this point of view, then also it was for the Revenue first to allow the assessee an opportunity of being heard, which was never allowed. According to learned Authorised Representative, otherwise, the change was bonafide because the assessee had ceased to carry on the business and has been following the changed system consistently thereafter.
12. Before proceeding further, we consider it necessary to find out the issues involved in this appeal and after going through the totality of the facts and circumstances of the case, are of the opinion that the issues involved in this assessee's appeal are as under:
A. (i) The first issue for our decision relates to the system of accounting followed by the assessee, i.e. whether the assessee was following 'mercantile system of accounting' or 'cash system of accounting' ?
(ii) The other connected issues to be decided are as under:
(a) Whether, choice to follow a system of accounting, mercantile system or cash system is with the assessee or can the Revenue enforce the assessee to follow a particular system of accounting ?
(b) Whether the system of accounting adopted by the Revenue in assessment framed under Chapter XTV-B of the Act, which is the assessment of undisclosed income only upto the date of preparation of last 'Panchnama', in the case in which action under Section 132 of the Act has been taken, can be enforced for future years in regular assessments also, or does the assessee has option to adopt a change in system of accounting ?
(c) Whether the Revenue can change the system of accounting disclosed by the assessee in the return of income suo motu without complying with the requirement of the law that the change adopted by the assessee was not bona fide or that the assessee was not following the changed system regularly ?
(d) Can the Revenue impose its choice of following a particular method of 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 is that the system of accounting, in assessment for block period under Chapter XTV-B of the Act completed on 30th June, 2005 (for the period 1st April 1995 to 27th Sept., 2001), having been taken as "mercantile system" and assessee having not appealed against that order and the method of accounting for asst. yr. 2002-03 also having been taken as "mercantile system" : (on the basis of method of accounting taken in block assessment), method of accounting for asst. yr. 2003-04 considered as mercantile is quite justified. In other words, the Revenue's stand is that method of accounting for this assessment year is to be taken as mercantile because of the Revenue having taken the assessee's system of accounting in block assessment.
14.1 First: of all we are of the opinion that Revenue's stand for adopting the system of accounting as "mercantile" being solely on the basis of its having adopted the system of accounting in assessee's block assessment, which was for the block period 1st April, 1995 to 27th Sept., 2001. and assessee's failure to appeal against that order, the issue is to be decided only on the basis as to whether Revenue's this stand is legal or not, i.e. whether adoption of system of accounting as "mercantile" mentioned in block assessment which, admittedly, was upto the period ending on 27th Sept., 2001, was binding on the assessee for future times to come and is also binding in regular assessment, but since Departmental Representative has advanced some arguments, though after admitting that the assessee has right to change the system of accounting at any time, with respect to the change in system by saying that it was assessee to establish that change was bona fide and was being followed consistently, we would like to deal with these arguments also and, therefore, we proceed to decide all these issues.
14.2 To decide the aforesaid issue, we are of the opinion that it is desirable for us to consider the provisions of Section 145 of the Act as they stood at the relevant time as well as the provision of block period vis-avis the system of accounting for that purpose and, therefore, the same are reproduced as under:
Section 145 (1) Income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources' shall, subject to the provisions of Sub-section (2), be computed in 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 aggregate of the losses of such previous years, determined:
(a) where assessments under Section 143 or Section 144 or Section 147 have been concluded (prior to the date of commencement of the search or the date of requisition), on the basis of such assessments;
(b) where returns of income have been filed under Section 139 (or in response to a notice issued under Sub-section (1) of Section 142 or Section 148) but assessments have not been made till the date of search or requisition, on the basis of the income disclosed in such returns;
(c) where the due date for filing a return of income has expired, but no return of income has been filed:
(A) on the basis of entries as recorded in the books of account and other documents maintained in the normal course on or before the date of the search or requisition where such entries result in computation of loss for any previous year falling in the block period; or (B) on the basis of entries as recorded in the books of account and other documents maintained in the normal course on or before the date of the search or requisition where such income does not exceed the maximum amount not chargeable to tax for any previous year falling in the block period;
(ca) where the due date for filing a return of income has expired, but no return of income has been filed, as nil, in cases not falling under Clause (c);
(d) where the previous year has not ended or the date of filing the return of income under Sub-section (1) of Section 139 has not expired, on the basis of entries relating to such income or transactions as recorded in the books of account and other documents maintained in the normal course on or before the date of the search or requisition relating to such previous years;
(e) where any order of settlement has been made under Sub-section (4) of Section 245D, on the basis of such order;
(f) where an assessment of undisclosed income had been made earlier under Clause (c) of Section 158BC, on the basis of such assessment.
Explanation-For the purposes of determination of undisclosed income:
(a) the total income or loss of each previous year shall, for the purpose of aggregation, be taken as the total income or loss computed in accordance with the provisions of this Act without giving effect to set off of brought forward losses under Chapter VI or unabsorbed depreciation under Sub-section (2) of 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 the date of search or of the requisition.
(3) The burden of proving to the satisfaction of the AO that any undisclosed income had already been disclosed in any return of income filed by the assessee before the commencement of search or of the requisition, as the case may be, shall be on the assessee.
(4) For the purpose of assessment under this Chapter, losses brought forward from the previous year under Chapter VI or unabsorbed depreciation under Sub-section (2) of Section 32 shall not be set off against the undisclosed income determined in the block assessment under this Chapter, but may be carried forward for being set off in the regular assessments.
158BC. Procedure for block assessment.-Where any search has been conducted under Section 132 or books of account, other documents or assets are requisitioned under Section 132A in the case of any person, then:
(a) the AO shall:
(i) in respect of search initiated or books of account or other documents or any assets requisitioned after the 30th day of June, 1995, but before the 1st day of January, 1997, serve a notice to such person requiring him to furnish within such time not being less than fifteen days;
(ii) in respect of search initiated or books of account or other documents or any assets requisitioned on or after the 1st day of January, 1997, serve a notice to such person requiring him to furnish within such time not being less than fifteen days but not more than forty-five days, as may be specified, in the notice a return in the prescribed form and verified in the same manner as a return under Clause (i) of Sub-section (1) of Section 142, setting forth his total income including the undisclosed income for the block period:
Provided that no notice under Section 148 is required to be issued for the purpose of proceeding under this Chapter:
Provided further that a person who has furnished a return under this clause shall not be entitled to file a revised return;
(b) the AO shall proceed to determine the undisclosed income of the block period in the manner laid down in Section 158BB and the provisions of Section 142. Sub-sections (2) and (3) of Section 143, Section 144 and Section 145 shall, so far as may be, apply;
(c) the AO, on determination of the undisclosed income of the block period in accordance with this chapter, shall pass an order of assessment and determine the tax 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 sources", subject however, to the provisions of Sub-section (2) of Section 145, has to be computed in accordance with 'cash system' or 'mercantile system' of accounting regularly employed by the assessee; meaning thereby that choice with the assessee to maintain its accounts is only limited; i.e. the assessee is bound to maintain accounts for 'business or profession' or for income liable to be taxed under the head "Income from other sources" either on "cash system" or on "mercantile system" whichever he is regularly employing, subject, however, to the provisions of Sub-section (2) of Section 145 which authorizes the Central Government to notify the accounting standards to be followed by class of assessees or in respect of any class of income and also subject to the provisions of Sub-section (3) of Section 145, which authorizes the AO, in case of assessee's failure to comply with Sub-sections (2) and/or (3), to make the assessment in the manner as provided by Section 144 of the Act.
14.5 So far as the question as to which of the two systems; "cash system" or "mercantile system" should be followed is concerned, there is no dispute because the language of the Sub-section (1) r/w Sub-section (3) of Section 145 of the Act clearly goes to show that it is the assessee who is to follow one of the given two methods, which in turn makes it clear that the choice of the method to be adopted for maintaining the accounts for the income chargeable under the head "Business or profession" or for the income chargeable under the head "Other sources" lays with the assessee and the Revenue has, absolutely, no part to play and this proposition now stands settled by various Courts including the apex Court. The Hon'ble Supreme Court in the case of Investment Ltd. v. CIT in the case of CIT v. A. Krishnaswami Mudaliar and in the case of CIT v. McMillan & Co. has held that the choice of the method of accounting lies with the assessee. In other words, Revenue cannot enforce its choice for system of accounting to be followed.
14.6 It is also gathered from the aforesaid provisions that the method of accounting adopted by the assessee (subject to the condition that the same is followed regularly) cannot be disturbed by the Revenue, i.e. if an assessee adopts 'cash system' instead of mercantile, e.g. assessable under Section 56; he cannot be assessed for that income on accrual basis [Juggilal Kamlapat Bankers v. CIT }. 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 ].
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 .
15. So far as AO is concerned, we have already observed that he has no power either to change the system of accounting followed or preferred by the assessee or to thrust upon the system of his choice.
15.1 The only power given to the AO is of the nature to the extent as provided by provisions of Sub-section (3) of Section 145 of the Act and if we analyse, these provisions, it will be clear that the AO has been clothed with the power to make an assessment in the manner provided in Section 144, if he is not satisfied about the correctness or completeness of the accounts of the assessee or the assessee is not employing any of the method of accounting provided in Sub-section (1) regularly or is not following the accounting standards, if any, notified by the Government (under) Sub-section (2) of Section 145 of the Act regularly.
15.2 In other words, if the AO finds that the assessee's accounts are not correct or complete or assessee is not following either of the two systems, i.e. "cash system" or "mercantile system" regularly; or is not following the accounting standards notified by the Government regularly the AO can proceed to compute the assessee's income in the manner provided under Section 144 of the Act, but he, in no case, can substitute the one system by another system.
16.1 In other words, if the assessee has complied with the requirement of provisions of Sub-sections (1) and (2) of Section 145, then AO has no power /jurisdiction to disturb the method of accounting. Similarly, if the AO has accepted the method of accounting in one year and the assessee has followed the same method in subsequent years, the AO shall not be justified in refusing to accept such method as the basis of assessment in subsequent year. This view is supported by the decision of Hon'ble High Court of Gujarat in the case of Balapur Vibhag Jungle Karndar Mandcdi Ltd. v. CIT
17. We are further of the opinion that while Sub-section (3) of Section 145 enables the AO to compute the assessee's income in the manner provided under Section 144 if he is of the opinion that accounts of the assessee are not correct or complete or the assessee has not followed any one of the two system of accounting [provided Sub-section (i) regularly or has not followed the accounting standard notified by the Government regularly], but has not been given power to impose his own method of accounting. 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. 2001-02 on 31st July, 2001 showing income under the head "Income from other sources" which was consisting of interest on FDs and other interest. The system of accounting employed was clearly stated to be cash against column 11A of Form 3-CD which was required to be furnished along with return under the statutory provisions of Section 44AB of the Act.
19.2 It is also an admitted fact that the Revenue had not framed assessment for this assessment year, i.e. no assessment under Section 143(3) or under Section 147 of the Act has been made by the AO. This fact goes to show that the assessee's returned income shown on the cash system of accounting was accepted by virtue of provisions of Section 143(1) (a) of the Act and that being the case the assessee's preference to change the system of accounting from "mercantile" to "cash" for asst. yr. 2001-02 stood accepted. (The copy of computation of income, acknowledgement for having furnished the return of income for asst. yr. 2001-02 on 31st July, 2001 and audit report along with Form Nos. 3-CB and 3-CD find placed at page Nos. 168, 167 and 155 to 1663 of the assessee's paper book respectively).
19.3 (a) Coming to the facts relating to asst. yr. 2002-03. it is again an admitted fact that the return of income declaring income from "long-term capital gain" and income from "other sources", which was consisting of interest income only, computed on cash system of accounting was furnished on 9th Aug., 2002. The system of accounting was duly specified in a note No. 4 of notes forming part of return of income in the following language. (These details find placed at page Nos. 171, 170 and 172 respectively of assessee's paper-book).
The assessee trust is following cash method of accounting.
(b) The assessment for asst. yr. 2002-03 was completed under Section 143(3) of the Act on 24th March, 2005, wherein the system of accounting was adopted by the AO as "mercantile system" because of the following two reasons as have been gathered from the AO's findings which will be reproduced hereinafter.
(i) Because the assessee had not filed any appeal before the CIT(A) against assessment for block period dt. 30th June, 2000, wherein the AO had taken the method of accounting as mercantile.
(ii) As per Section 145 of the Act, the assessee can adopt only one system of accounting on the regular basis, the assessee 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 produced as under:
Please refer to the block assessment order dt. 30th June, 2004. In this order the AO has decided that the method of accounting in your case is mercantile; you have not tiled any appeal before learned CIT{A), this means that you have accepted the same. But in the Rol of this year, on the notes forming part of the Rol, you have stated that the assessee is following the cash system of accounting. This Rol was filed on 9th Aug., 2002, and therefore it is clear that the AO has passed the block order after this date.
Explain as to why as per Section 145 of IT Act the system of accounting should not be considered as mercantile since it has to be taken on continuous basis and it cannot be changed.
In his submissions the representative of the assessee tried to justify that the same should be considered as 'cash' but the contentions and the submission of the assessee are not tenable since as per Section 145 of IT Act, the assessee can adopt only one system of accounting on the regular basis. This Section 145 of the Act is produced as under:
145. Method of accounting-(1) Income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources' shall, subject to the provisions of Sub-section (2), be computed in accordance with either case 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.
Since in the block assessment order the AO has decided the method of accounting in the case of the assessee as 'mercantile' and the assessee has not challenged the same on appeal, the learned CIT(A) has also passed the order dt. 16th Dec, 2004, it is concluded that as per the provisions of the Act, the assessee cannot change the same. The assessee is bound to follow the same method of accounting on continuous basis and he is not permitted to change 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 missed the bus by not filing an appeal, the AO's action cannot be faulted.
(iii) If such an interpretation of the appellant is accepted, it would make the provisions of Section 145 of the IT Act unworkable. In this regard the Nirma Group has tried to interpret the Section 37(1) in such a way that the claim of interest on these DDBs is available to Nirma Ltd. on accrual basis but in case of the holders of the DDBs the same group has interpreted the letter of Board dt. 12th March, 1996, Circular of the Board dt. 15th Feb., 2002 and press release dt. 20th March, 2002 in different manner. In this regard, the reliance is placed in case of C.W.S. (India) Ltd. v. CAT in which it has been observed that when a literal interpretation leads to an absurd or unintended result, even the language of the statute can be modified to accord with the intent of legislation and to avoid absurdity. In the case of Indian Hotels Co. Ltd. v. 1T0 a similar view has been affirmed. In the cases of K. Govindan & Sons v. CIT (2000) 164 CTR (SC) 490 : (2001) 247 ITR 192 (SC) and Oxford University Press v. CIT , the Hon'ble Supreme Court has held that interpretation must avoid absurdity and if literal construction leads to unreasonable or absurd consequences, the same should not be adopted.
Hence, the AO's action is upheld and ground of appeal No. 2 is dismissed.
(iv) Assessee's appeal against order of the CIT(A) is pending before the Tribunal.
20. (a) So far as facts relating to asst. yr. 2003-04 (under appeal) are concerned, it is again an admitted fact that the assessee had furnished the return of income for asst. yr. 2003-04 declaring income from "capital gain" and "other sources" computed on cash system and the system of accounting was specifically disclosed as per note No. 3 of the notes forming part of the return of income and appended just below the computation of income (p. No. 54 of assessee's paper book).
(b) This return was revised by the assessee and the system of accounting was again disclosed as cash as per para No. 3 of notes forming the part of the revised return and appended just below the computation (copy placed at page No. 56 of the assessee's paper-book).
(c) The assessment for asst. yr. 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 mentioned the system of accounting in block assessment, which was for the period (block period 1st April, 1995 to 27th Sept., 2001), as mercantile and for non-filing of appeal by the assessee against that action, not only in law, but on facts also, the Revenue's reliance on the method of accounting mentioned in the assessment order for block period cannot be held to be legal or justified, because:
(i) As submitted by the assessee, the assessee did not file appeal against the assessment order for block period because the undisclosed income computed by the AO in assessment for block period was computed at NIL, the assessee has to be given the benefit of bona fide belief for not having any grievance against such an assessment and, consequently, for entertaining a belief that there was no necessity to file an appeal also.
(ii) Still, the assessee having objected to the system of accounting taken in the assessment order for block period by way of petition under Section 154 of the Act, the Revenue's plea that the assessee did not appeal against AO's action is unfounded and, therefore, gets rejected.
(iii) Further, block period being from 1st April, 1995 to 27th Sept., 2001 and the assessee having changed the system of accounting from "mercantile system" to "cash system" w.e.f. 1st April, 2000 i.e. w.e.f. asst. yr. 2001-02, the AO should not have taken the system of accounting as mercantile for the period 1st April, 2000 to the date of search, i.e. 27th Sept., 2001 and, therefore, Revenue's action for mentioning the system of accounting in the assessment for block period (for the period 1st April, 2000 to 31st March, 2001 and 1st April, 2001 to 27th Sept., 2001) was not only arbitrary but illegal also and, therefore, such an order cannot be relied upon.
(iv) Further, in block assessment also, the assessee had neither computed the undisclosed income on mercantile system nor had claimed the system of accounting as mercantile and, therefore, the AO had no power to adopt a particular system of accounting as per his whims and fancies. According to the provisions of Section 158BB, the AO was bound first to compute the total income for each assessment year falling within the block period as well as for the period 1st April, 2001 to 27th Sept., 2001 and then to arrive at the undisclosed income adopting the procedure prescribed under Sections 158BA, 158BB 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 after the date of search, one prefers to change the system of accounting. Revenue has no jurisdiction to impose the system of accounting adopted till the date of search, upon the assessee for subsequent years.
22. So far as assessee's right to change the system of accounting is concerned, the assessee's obligation, as has been discussed in the earlier part of this order, was only to show that the change was bonafide and that could be established by showing that changed system of accounting was being followed regularly in the subsequent years. In the case of Sundaram Ltd. v. CIT wherein the Hon'ble High Court of Madras has held that the fact that the assessee was following the constant method of accounting can be established by showing that it was following the same system in subsequent years. So far as present case is concerned, the assessee succeeds in establishing, from the documents on record, i.e. its return of income and accompanying accounts; that it was following the changed system of accounting (cash system) w.e.f. 1st April, 2000 consistently, i.e. in all subsequent years upto asst. yr. 2004-05.
23. The Department, in our opinion, could reject the assessee's change in system of accounting only after it was found that the change was not bona fide, but so far as present case is concerned, it is not the Department's case as can be seen from the order for block period as well the reasoning for adopting mercantile system for asst. yr. 2002-03 and asst. yr. 2003-04. The Department has nowhere alleged that the assessee's choice to change the system of accounting from mercantile system to cash system w.e.f. 1st April, 2000 was not bonafide one.
24. The learned Departmental Representative during the course of his arguments had pleaded that the assessee should have established that the change was bonafide. This argument of the learned Departmental Representative, in our opinion, is devoid of any merit because it had never been the Revenue's case. The Revenue had never raised the issue relating to bona fide of the change. So far as block assessment and regular assessments for asst. yrs. 2001-02 and 2002-03 are concerned, it is Department which has acted arbitrarily and illegally for adopting a system of accounting which was never adopted by the assessee and was not borne out even from the facts on record.
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 accounting by another regular method, the question of his bona fides has a little relevance. Even otherwise, it is only in the year in which a change in method of accounting is introduced, for the first time, that the change is to be examined by the Revenue authorities to find out whether the change introduced is meant to be regularly followed or not. It is in this context only that the expressions, 'good faith' and 'bona fide' occur in the observation of the Hon'ble Bombay High Court in the judgment in the case of Sarupchand v. CIT and of Hon'ble Madras High Court in the case of Indo Commercial Bank Ltd. v. CIT .
24.2 In this view of the matter, where it is found that an assessee has changed his regular method of accounting by another recognized method and has followed the regular method thereafter, it is not open to the Revenue authorities to go into the question of bona fide of the introduction and continuously following the change and this proposition is supported by the decision of Calcutta High Court in the case of Snow White Food Products Co. Ltd. v. CIT . In other words, the Revenue cannot contend that a change has to be supported by cogent reasons showing the bona fides of the assessee in so changing the method as has been held by the Hon'ble High Court Calcutta in the case of Snow White Food Products Co. Ltd. (supra).
24.3 Without prejudice to the above, if we analyse the Section 145 of the Act little further, it will be revealed that w.e.f. 1st April, 1997, the AC) has been divested of the powers to change the system of accounting. He can do and that too in the case of violation of requirements mentioned in Sub-sections (1) and (2) of Section 145 of the Act is that he can make the assessment in the manner provided in Section 144 of the Act.
So far as present case is concerned, the Revenue has nowhere alleged or taken a stand that the assessee has violated any of the provisions of Sub-sections (1) and (2) of Section 145 of the Act and, therefore, the Revenue's stand to take the system of accounting as mercantile cannot be upheld.
The Revenue's case for taking the system of accounting of mercantile is on the basis of system of accounting mentioned in the assessment order for block period completed under Chapter IX-B of the Act only and 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 assessment proceedings that he was following cash system of accounting.
24.6 So far as assessee is concerned, it having sold its running business on 28th March, 2000 and was left with the source of income from dividend, capital gain and interest only and, therefore, it had a justifiable reason to change the system of accounting from mercantile to cash. Here, it is important to highlight that by the time, the assessee opted to change the system of accounting, i.e. from 1st April, 2000, even Circular No. 2 of 2002 was not on statute and, therefore, Revenue cannot allege that the assessee had changed the system to avoid applicability of Circular No. 2 of 2002. Changeover in the system of accounting by the assessee was, therefore, in our opinion, lawful and bonafide.
24.7 In view of above facts and circumstances of the case, we are of the opinion that objection of the learned Departmental Representative that the assessee has not established the change in method of accounting which he was adopting w.e.f. 1st April, 2000, as a bonafide one, has no force and, therefore, is rejected.
25. Further, even if for the sake of arguments, the Revenue's stand that the issue relating to system of accounting had become final because of the block assessment then also, the block assessment being upto i.e. 27th Sept., 2001 it can at the most, be said that mercantile system of accounting continued till 27th Sept., 2001 and not thereafter. This fact cannot debar the assessee to change its system of accounting for the future years; meaning thereby that still the assessee could adopt a changed system of accounting w.e.f. 28th Sept., 2001 or from any subsequent date.
26. To conclude, we, in view of the facts and circumstances of the case, provisions relating to system of accounting, case law and above discussion, are of the opinion that:
(i) Return of income for asst. yr. 2001-02 showing income from other sources on cash system was filed on 31st July, 2001 which stood accepted, though under Section 143(l)(a) of the Act, and this conclusion is on the basis that Revenue had not preferred to make assessment under Section 143(3) of the Act.
(ii) Return of income for asst. yr. 2002-03 showing income from other sources and capital gain on cash system was filed on 9th Aug., 2002 which was again before the date of search and, therefore, system adopted by assessee was not effected by the assessment for block period.
(iii) Similarly, the return of income for asst. yr. 2003-04 showing income from "capital gain" and "other sources" on the basis of "mercantile system" was furnishing on 30th Sept., 2003 before completion of assessment 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 of the totality of the facts and circumstances of the case as well as settled provisions of law discussed hereinbefore, we are of the opinion that the assessee had right to adopt the changed system of accounting and by changing the system of accounting from mercantile to cash was a bona fide change.
In other words, we are of the opinion that so far as assessee's case is concerned, it has to be held to have followed cash system of accounting w.e.f. 1st April, 2001.
28. Since we have accepted the assessee's change in system of accounting as "cash system" from "mercantile system", there is no question of taxing the interest or any other income from so-called DDEs including on accrual basis and, therefore, direct the AO to delete all such additions. To be specific, we direct the AO to delete the addition of Rs. 77,95,691.
28.1 So far as Revenue's reliance on the Board Circular No. 409 dt. 12th Feb., 1985 which relates to taxability of interest on cumulative deposit schemes of private sector undertakings is concerned, we, after having gone through the same, are of the opinion that this Circular is of no help to the assessee because the issue involved in this circular is quite different than the issue involved in the appeal before us.
29. Validity of Circular No. 2 of 2002 29.1 For considering the issue relating to validity of Circular No. 2 of 2002 as well as its scope of applicability, we are of the opinion that it is desirable to consider all the circulars/press notes/letters/clarification, etc. in connection with this issue.
29.2 The first document to be taken note of is circular issued to IDBI (copy of which is placed at page No. 48 of assessee's paper book) which reads as under:
Clarification regarding taxability of income relating to Deep Discount Bonds.
Letter F. No. 225/45/1996-ITA. II, dt. 12th March, 1996 of IDBI It is clarified that the difference between the issue price and the redemption price of Deep Discount Bonds will be treated as interest income assessable, under the IT Act. On transfer of bonds before maturity, the difference between the sale consideration and issue price will be treated as capital gains/loss if the assessee purchased them by way of investment. However, in the case of an assessee who deals in purchase and sale of bonds, securities, etc., the profit or loss shall be treated as trading profit 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. It was further clarified that tax would be deducted at source on the difference between the bid price and the redemption price at the time of maturity.
2. Such tax treatment of Deep Discount Bonds, however, has posed the following problems:
(i) Taxing the entire income received from such a bond in the year of redemption as interest income gives rise to a sudden and huge tax liability in one year whereas the value of the bond has been progressively increasing over the period of holding.
(ii) Where the bond is redeemed by a person other than the original subscriber, such person becomes taxable on the entire difference between the bid price and the redemption price as interest income, since he is not able to deduct his cost of acquisition from such income.
(iii) A company issuing such bonds and following the mercantile system of accounting may evolve a system for accounting of annual accrual of the liability in respect of such a bond and claim a deduction in its assessment for each year even though the corresponding income in the hands of the investor would be taxed only at the time of maturity.
(iv) Taxing the entire income only at the time of maturity amounts to a tax deferral.
3. The matter has now been examined in consultation with the RBI and the Ministry of Law. The practice followed in several countries outside India has also been examined. With a view to remove the anomalies in the existing system of taxation of income from Deep Discount Bonds, and to formulate a system which is more in line with international practice, the Board have decided that such income may hereafter be treated as follows.
4. General Treatment:
Every person holding a Deep Discount Bond will make a market valuation of the bond as on the 31st March of each financial year (hereafter referred to as the valuation date) and mark such bond to such market value in accordance with the guidelines issued by RBI for valuation of investments. For this purpose, market values of different instruments declared by the RBI or by the Primary Dealers Association of India jointly with the Fixed Income Money Market and Derivatives Association of India may be referred to.
4.1 The difference between the market valuations as on two successive valuation dates will represent the accretion to the value of the bond during the relevant financial year and will be taxable as interest 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 accretion to the value of the bond over a specific period, for the purposes of computing capital gains, the period of holding in such cases will be reckoned from the date of purchase/subscription, or the last valuation date in respect of which the transferor has offered income to tax, whichever is later. Since such period would always be less than one year, the capital gains will be chargeable to tax as short-term capital gains.
6. Redemption Where the bond is redeemed by the original subscriber, the difference between the redemption price and the value as on the last valuation date immediately preceding the maturity date will be taxed as interest income in the case of investors, or business income in the case of traders.
6.1 Where the bond is redeemed by an intermediate purchaser, the difference between the redemption price and the cost of the bond to such purchaser will be taxable as interest or business income, as the case may be. For this purpose, again, the cost of the bond will mean the aggregate of the cost at which the bonds were acquired and the income arising from the bond which has already been offered to tax by the person redeeming the bond.
7. Strips Apart from original issue of Deep Discount Bonds, such bonds can also be created by 'stripping', i.e., the process of detaching the interest coupons from a normal coupon bearing bond and treating the different coupons and the stripped bond as separate instruments or securities ('strips') capable of being traded in independently. Such a mechanism, referred to as STRIPS (Separate Trading of Registered Interest and Principal of Securities) creates instruments which are in the nature of Deep Discount or Zero Coupon Bonds from out of the normal interest bearing bonds. Accordingly, the tax treatment of the different components of principal and interest created by such stripping will be on the same lines as clarified in the preceding paragraphs in respect of Deep Discount Bonds.
7.1 The reasons of stripping of a normal interest bearing bond into its various components will not amount to a transfer within the meaning of the IT Act as it merely involves the conversion of the unstripped bond into the corresponding series of STRIPS. Similarly, the reconstitution of STRIPS to form a coupon bearing bond will not amount to a transfer.
8. Tax deduction at source The difference 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 Jha Yadav, Under Secretary (TPL-IV)] (Notification No. F. 149/235/2001 -TPL) 29.4 The third document is to be considered as the press note/release from the CBDT on 20th March, 2002 (copy of which placed at page No. 44 of the assessee's paper-book) and reads as under:
Press Notes/Releases Tax Treatment of Deep Discount Bonds and Strips.
There have been certain reports in the press recently, suggesting that the tax treatment of deep discount bonds as specified in the Circular dt. 15th Feb., 2002 [published at (2002) 173 CTR (St.) 217] issued by the CBDT is anomalous, as it provides for taxation of income from such bonds on an annual basis, even though no income is received by the bond-holder before maturity. It has been opined that a heavy tax burden is being placed on persons who have been holding such bonds for a while, and a cumbersome obligation of valuing the bonds every year on the basis of RBI guidelines is being cast on small investors. The reports are misconceived and based on an incorrect understanding and inadequate knowledge of facts and law. The modified tax treatment now specified in fact corrects the anomalies in the existing system by providing a mechanism for taxing income accruing from year to year on deep discount bonds, on the same lines as income from normal coupon bearing bonds is taxed. Transfer of the bonds before maturity will attract capital gains tax, as in the existing system.
The earlier system of taxing the entire income received from such bonds in the year of redemption as interest income was anomalous in that it gave rise to a sudden and huge tax liability in one year whereas the value of the bond has been progressively increasing over the period of holding. Further, where the bond was redeemed by a person other than the original subscriber, such person was taxed on the entire difference between the bid price and the redemption price as interest income. Such a system also created tax-induced distortions in the debt market, and was an impediment to the development of a market in STRIPS, which are essentially zero coupon instruments derived from normal coupon bearing bonds.
Taxation of income on accrual basis is an established principle of law and always results in taxing income that has not yet been received. Income from deep discount bonds accrues continuously over the period of holding and can be realized 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 Release, dt. 20 March, 2002.]
30. We have considered the aforesaid circulars/press notes/releases and would, first of all, like to comment on the issues involved in these circulars/press notes/releases.
(1) So far as letter issued by the Board to IDBI on 12th March, 1996, i.e. letter No. 225 (copy at page No. 48 of the paper-book) is concerned, we are of the opinion that as per this clarification the taxability of interest income from DDBs was to be treated as under:
(a) In case, the DDBs were transferred before maturity, i.e. if the subscriber to these bonds was to transfer the same in the name of anybody else, by way of sale before the date of maturity, the difference between sale consideration and issue price was to be treated as capital gain or loss, if the subscriber had purchased them by way of investment and if the subscriber had purchased the same in the capacity of a dealer in purchase and sale of bonds, securities, etc. then the profit or loss was to be treated as trading profit or loss
(b) This letter was silent as to the treatment of surplus amount at the time of maturity which in the normal course would have been taxable as income from other sources (interest in case of subscriber who was dealing in purchase and sale of bonds and securities and as capital gain in the hands of subscribers who had purchased them by way of investment.
(2) Circular No. 2 of 2002 : After having none through the circular carefully, first of all, we are of the opinion that this circular was intended to mitigate certain hardships, which, in view of the Board the subscribes were likely to face.
(a) This circular, first of all, refers to the treatment of difference between subscription price and the redemption price i.e. bid price and the face value of DDBs; on the basis of Board's earlier view according to which the difference at the time of redemption was to be treated as income taxable under IT Act as interest income.
(b) On transfer of bonds before maturity, the difference between the sale consideration and the cost of acquisition was to be taxed as income from capital gains in case of assessees who had subscribed these bonds for holding them as investment, and
(c) As business income, in case of assessees who had subscribed these bonds for carrying on trading in bonds.
(d) Since the difference itself, at the time of redemption, was to be 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 of the liability in respect of interest on such bond and claim of deduction year after year, though the corresponding income in the hands of the subscriber was to be taxed only at the time of maturity.
(iv) The fourth problem according to the Board, which would have arisen was that the taxing the entire income at the time of maturity only amounted to a tax deferral.
The Board to mitigate the aforesaid problems prescribed a fresh formula for treatment of surplus on such bonds and as is evident from para No. 3 of the circular wanted the public to follow that formula in future.
Formula : General Terms:
(i) As per this formula, every person holding DDBs was put under obligation to make market valuation of such bond as on 31 March of each financial year in accordance with the guidelines issued by the RBI for valuation of investment and made the difference between market value as on 31 March of the first year of holding and subscribed price as taxable under the head "Interest income" in cases where bonds were held investment and as "business income' where the bonds were held as trading assets. This system was to be followed year after year; meaning thereby that in the second and subsequent years, the difference between valuations on two dates, i.e. on the first day of the financial year and the last day of financial year was to be taxed as above.
(ii) It was further provided that where the bond was acquired during the year by an intermediate purchaser, i.e. by a person who had acquired the bond by way of purchase at any time during the term of the bond from the original subscriber, the difference between the market value as on the following 31st March and the cost for which bond was acquired would be taxable as interest income or business income, as the case may be, and there was no question of any capital gain arising in the hands of original subscriber or the seller, as the case may be.
(iii) The circular further prescribes that where the bond was transferred at any time before the maturity date the difference between the sale price and the cost of bond was to be taxed as capital gain in the hand of investor or as business income in the hands of the trader and for computing of such gains, the cost of the bond was to be taken to be the aggregate of the cost for which the bond was acquired by the transferror and interest upto the last valuation 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 applicable only to the DDBs purchased on or after the date of this circular which was 15th Feb., 2002 and, therefore, so far as DDBs purchased before 15th Feb., 2002 were not covered by this circular.
In support of the aforesaid proposition put forward by the learned Counsel for the assessee, detailed arguments were advanced which have been reproduced by us in earlier part of this order. Decisions relied upon have also been listed in earlier part of this order especially the decision of Bombay Bench [see para No. 9 (iii)(A)(a)(iv) of this order].
32.1 Revenue's case, on the other hand, is that circular issued by (to) IDBI on 12th March, 1996 and the press note issued by the Board of 21st March, 2002 were not binding on the Revenue authorities because these were not circulars as envisaged in the provisions of Section 119 of the Act. According to Revenue authorities, it is the Circular No. 2 of 2002, which having been issued in exercise of Board's power available under Section 119 of the Act and has been issued to mitigate the various hardships likely to be faced by the subscribers or purchasers of DDBs is binding on the Revenue authorities and, therefore, Revenue authorities were right in taxing the income on these DDBs as per this circular. The next stand of the Revenue is that this circular is retrospective in nature, i.e. applicable to bonds purchased before or after the circular. In support of the aforesaid stands, the learned Departmental Representative advanced detailed arguments along with various quotes from various Court's decisions which have been reproduced in para No. 9 of this order.
33. After having considered the rival submissions, facts and circumstances of the case, various decisions relied upon by the parties and law relating to applicability/validity/scope of circulars, we are of the opinion that:
(1) So far as Circular No. 2 of 2002 vis-a-vis to the present assessee, who had subscribed to DDBs for holding the same as investment is concerned, was not applicable either for bonds purchased prior to this circular or purchased after this circular and the reasons for our view, are as under:
(i) The Board has no jurisdiction to change the head of income, i.e., if any income is to be taxed under a particular head of income specified under Section 14 of the Act, the Board cannot make the same as taxable under any other head 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 to whether the circular is benevolent or not and, therefore, if an assessee chooses not to seek benefit of a circular, the Revenue cannot impose the same.
(iii) So far as appellate authority, Tribunal and Courts are concerned, circulars issued by the Board even if benevolent are not binding.
(iv) So far as press note or release dt. 20th March, 2002 which has been issued by the Board only to clarify the scope of its earlier circular is concerned, is not a press note as understood in the normal parlances because as pleaded by the learned Departmental Representative, the press notes referred to by him are of nature which were released prior to issuance of a particular circular and not to clarify the scope or terms of any circular issued earlier. The press note being captioned as press note/release is nothing new but only a continuation of earlier circular, i.e. Circular No. 2 of 2002 and had just clarified the date of applicability of that circular.
(v) The Revenue's stand that the press note is contradictory to Circular No. 2 of 2002 is also misplaced.
(vi) Since we have held that the press note/release dt. 28th March, 2002 was in continuation of circular itself, it was also binding on the Revenue.
(vii) Even otherwise, even if Revenue's plea that press note/release was not in consonance with the intention of Circular No. 2 of 2002 or was contradictory then also the same, in view of the decision of Hon'ble Supreme Court in the case of CCE v. Dhiren Chemical Industries , was binding on the Revenue authorities and, therefore, Revenue authorities should have taken note of it.
(viii) The Revenue's stand that Circular No. 2 of 2002 is retrospective i.e. applicable to bonds purchased prior to this circular also cannot be sustained because this circular is silent with respect to chargeability of income earned prior to date of this circular; meaning thereby that in case where the bonds had been purchased prior to this circular, the income having been arisen (in the light of this circular) remained untaxed. The circular, therefore, speaks of different treatment to the income accrued for earlier years and to accrue in subsequent year. Consequently, this circular cannot be considered to be valid in the eyes of law.
(ix) Looking to the totality of the facts and circumstances of the case, we are, therefore, of the opinion that the Circular No. 2 of 2002 being contrary to the provisions of law providing different treatments to same type of income, providing different treatments to similar income in the hands of different persons, without there being any provisions of law on the point, cannot be held to be binding on the assessee and, hence, we are of the opinion that the income from DDBs was taxable as per first Board's letter dated 12th March, 1996. The additions made by following the Circular No. 2 of 2002 are, therefore, directed to be deleted.
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, 2007, wherein the Hon'ble Mumbai Bench had occasion to consider the date of applicability of Circular No. 2 of 2002 and after considering the circular and the press note dt. 20th March, 2002 has held that Circular No. 2 of 2002 was applicable to DDBs purchased after 15th Feb., 2002 and the relevant part as contained in para No. 7 of the appellate order (copy placed at page No. 49 of the assessee's paper book) reads as under:
7. We heard the rival submissions. Circular of CBDT No. 2 of 2002 dt. 15th Feb., 2002 and press notes have been placed on record by the assessee at pp. 38 to 47 of the paper book. Clause 3 of Circular No. 2 of 2002 reads as under:
3. The matter has now been examined in consultation with the RBI and the Ministry of Law, The practice followed in several countries outside India has also been examined. With a view to remove the anomalies in the existing system of taxation of income from Deep Discount Bonds, and to formulate a system which is more in line with international practice, the Board have decided that such income may hereafter be treated as follows.
makes it clear that the clarification is applicable and could be applied only subsequent to the issue of this circular and not before. Learned Counsel for the assessee submitted that in the subsequent year the assessee sold the bonds and whatever surplus was offered to tax and it was accepted as well. Learned Counsel again brought our attention to p. 43 of the paper-book, which is the press notes/releases for tax treatment of Deep Discount Bonds and strips. This press note dt. 20th March 2002, makes it clear that the amount received on redemption would be offered to tax as per the guidelines of the RBI or a public financial institution. It is not disputed that the assessee had offered it and accepted by the Revenue. Under these circumstances, we are of the view that there is no scope to disturb the order of the learned first appellate authority. Hence, the appeal by the Revenue fails and dismissed.
33.2 This disposes of ground Nos. 1, 2 and 3 of the assessee's appeal.
34. Before ending with the issue as aforesaid, we are of the opinion that it is useful to consider the various decisions relied upon by the parties in favour and against this issue.
The decision relied upon by the learned Departmental Representative
35. The learned Departmental Representative had 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 were binding on the Revenue authorities.
35.2 Having considered the decisions, we are of the opinion that there; cannot be any dispute as to the binding nature of benevolent circulars on the Revenue authorities, but it is also settled that the assessee and Courts including the Tribunals are not bound by such requirements and, therefore, in the present case the assessee having disputed the very validity and applicability of Circular No. 2 of 2002, the Revenue authorities' reliance on these decisions is only academic.
35.3 The learned Departmental Representative had further relied on the decisions stated in para Nos. 10.4(1), (b) and (e) in support of his submission that press note dt. 28th March, 1992 being not a circular had no binding force and, therefore, cannot change the terms and conditions of Circular No. 2 of 2002.
36. Alter careful consideration of the decisions in question, we are of the opinion that the press note dt. 20th March, 1992 being for clarifying the date of applicability of Circular No. 2 of 2002 was not a normal press note, i.e. a press note which is generally issued prior to issuance of a circular, this press note being for clarifying the date of applicability of Circular No. 2 of 2002 was, in our opinion, a part of the circular itself and, therefore, the decision relied upon by the assessee are distinguishable on facts and, hence, not applicable.
36.1 The learned Departmental Representative had further relied on the decisions stated in para Nos. 10.5(i), (ii) and (iii) in support of his submissions that Circular No. 2 of 2002 being available on the first day of financial year 2002-03, i.e. on 1st April, 2002, it could not be withdrawn by any subsequent press note or circular issued during the financial year 2002-03.
36.2 After having considered the decisions, we are of the opinion that Revenue's plea being based on incorrect facts, the decisions are of no help to it. To clarify the Circular No. 2 of 2002 was issued on 15th Feb., 2002, whereas the press note clarifying the date of applicability of this circular was issued on 20th March, 2002, i.e. within the financial year 2001-02. In other words, the clarification pronounced by dt. 20th March, 2002 had become part of the circular in question meaning thereby that this clarification was a part of circular as on 1st April, 2002 and, therefore, there was no question of 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 not required.
Ground No. 439. So far as ground No. 4 of assessee's appeal is concerned, we have considered the rival submissions, facts and circumstances of the case and various decisions relied upon by the parties.
First of all, we prefer to consider the various decisions relied upon by the parties.
(a) So far as Revenue is concerned, it has relied on the decision of Hon'ble Supreme Court in the case of Goetze (India) Ltd. v. CIT (supra) and order of Tribunal Ahmedabad Bench "C" in the case of Injinium Communication (P) Ltd. (supra).
(b) The learned Counsel for the assessee, on the other hand, in support of its claim that the assessee has right to plead exclusion of any income shown in the return of income, during the course of assessment proceedings, as well as, later on, before the appellate authorities and has relied on the decision in following cases:
1. Chicago Pneumatic India Ltd. v. Dy. CAT (supra);
2. S.R. Koshti v. CIT (supra);
3. Decision of Gujarat High Court in the case of Mohit Marketing Ltd. v. Dy. CIT in Tax Appeal No. 157 of 2000 and Tax Appeal No. 328 of 2000, dt. 21st April, 2005.
39.1 (a) Decisions relied upon by the learned Departmental Representative:
(i) Decision in the case of Goetze (India) Ltd, v. CIT (supra) In this case, the assessee had its return of income for asst. yr. 1995-96 on 30th Nov., 1995. Thereafter, the assessee, by way of a letter addressed to AO on 12th Jan., 1998 claimed a deduction. The AO disallowed the assessee's claim on the ground that there was no provision in the IT Act, 1961 allowing an amendment in the return without a revised return. The Tribunal as well as High Court confirmed this. The assessee went in appeal before the Hon'ble apex Court contenting that it was open to the assessee to raise points of law before the Tribunal.
The Hon'ble Supreme Court dismissed the appeal, making it clear that the decision was restricted to the power of assessing authority to entertain a claim for deduction, otherwise than by a revised return, and did not impinge on the power of Tribunal under Section 254 of the IT Act, 1961. The decision of Delhi High Court was affirmed. The order of the Hon'ble Supreme Court reads as under:
Leave granted.
The question raised in this appeal relates to whether the appellant assessee could make a claim for deduction other 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 , 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 of law can be raised are before the Tribunal. The decision does not in any way relate to the power of the AO to entertain a claim for deduction otherwise than by filing a revised return. In the circumstances of the case, we dismiss the civil appeal. However, we make it clear that the issue in this case is limited to the power of the assessing authority and does not impinge on the power of the Tribunal under Section 254 of the IT Act, 1961. There shall be no order as to costs.
39.2 After giving our thoughtful consideration to the decision of Hon'ble Supreme Court in the case supra what we have been able to understand is what the Hon'ble Supreme Court has held is that it is the AO who is barred to entertain a claim for deduction, made otherwise than by a revised return, and has also held that, this decision does not impinge on the power of the Tribunal under Section 254 of the IT Act. In other words, in our opinion, the Hon'ble apex Court has held that the Tribunal has the power to entertain such claim.
We are, therefore, of the opinion that so far as Tribunal's power to entertain the assessee's claim that interest on OFCPN of Nirma Industries Ltd. was not taxable on accrual basis can be entertained by the Tribunal and we do so.
(ii) Decision in the case of Injinium Communication (P). Ltd. (supra).
(a) The facts of this case were that the assessee had withdrawn its claim of deduction under Section 80-HHE in its statement given during survey action, had confirmed the withdrawal by furnishing a valid revised return under Section 139(5} of the Act, had paid the tax due on the basis of such revised return and never raised any grievance or reiterated the statement till completion of the assessment But, so far as present ease is concerned, it is not so because the assessee, while furnishing revised return had specifically mentioned by way of note that the income was shown on accrual basis subject to its challenge to validity of Circular No. 2 of 2002.
Not only this, the assessee has, in fact, objected to the applicability of Circular No. 2 of 2002 with respect to income from OFCPN of Nirma Industries Ltd. as has been duly noted by the AO in para No. 4 of the assessment order which we have already reproduced in the earlier part of this order.
We are, therefore, of the opinion that this decision of Tribunal relied upon by the learned Departmental Representative being distinguishable on facts is not applicable to the present ease.
(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 which is payable by the company and receivable by the individual debenture holder under the debenture. The relevant portion of the debenture certificate shows that debentures are issued in terms of the debenture trust deed dt. 31 March, 1995 in pursuance of resolutions passed by the board of directors of the company on 24th March, 1995 as well as by the general body at the; extraordinary general meeting held on 24th March, 1995. Accordingly, the company has issued secured redeemable non-convertible debentures each of Rs. 100 and as the specimen certificate available on record shows amount paid up per debenture is Rs. 100. It is further stated in the certificate that "The debentures are issued subject to and with the benefit of the financial covenants and conditions endorsed hereon which shall be binding on the company and the debenture holders and all persons claiming by, through or under any of them and shall ensure for the benefit of the trustees and all persons claiming by, through or under any of them and shall ensure for the benefit of the trustees and all persons claiming by, through or under them. The company hereby agrees and undertakes to duly and punctually pay, observe and perform the financial covenants and conditions endorsed thereon.
9. As per financial covenants and conditions, condition No. 2 relatable to 'Interest rate and manner of payment' and condition No. 3 relatable to 'Redemption' read as under:
2. Interest rate and manner of payment Each debenture shall carry interest @ Rs. 62 payable upfront on the date of allotment.
3. Redemption The company agrees and undertakes to redeem the debentures at par in one instalment at the end of 6th year from the date of allotment.
10. On plain reading it becomes apparent that each debenture was to carry interest @ Rs. 62 payable upfront on the date of allotment. Therefore, on each debenture having face value of Rs. 100, interest of Rs. 62 was payable on the date of allotment, which is admittedly 24th March, 1995. There is no dispute that the company has in fact made payment of interest to the debenture holder on the date of allotment, deducted tax at source on such payment in accordance with the provisions of the Act, and paid over such tax to the credit of Central Government. Therefore, the payer company has fulfilled its part of obligation arising from the contract between 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 in respect of capital borrowed for the purposes of business. In the present case, it is an admitted position between the parties that, the payer company is carrying on business, it had borrowed capital by way of debenture issued for such business, and it had paid interest in respect, of such capital borrowing. The payer company, therefore, has satisfied all the conditions necessary for involving Section 36(l)(iii) of the Act and is thus, entitled to deduction of interest paid while computing its income from profits and gains of business.
12. As rightly contended on behalf of the payer company, Section 43(2) of the Act which defines the term 'paid' would take within its sweep as per the definition both 'actual payment' as well as 'incurring of a liability' according to method of accounting on the basis of which profits and gains of business are computed. The said definition is applicable wherever the term 'paid' is used in Sections 28 to 41 of the Act, unless the context otherwise requires. In the circumstances, the term 'paid' as used in Section 36(l)(iii) of the Act would have the same meaning and as per method of accounting regularly employed, on the basis of terms of contract, the payer company had incurred the liability and discharged the same during the accounting period. In other words, not only was there an incurring of liability but there was actual payment of interest. In these circumstances, it is not possible to accept the stand of Revenue that despite the total amount of interest having been paid during the relevant accounting period as per the terms of the contract between the parties, only proportionate amount should be deducted while disallowing the balance which would be allowable in subsequent years.
13. The apex Court decision in case of Madras Industrial Investment Corporation Ltd. (supra) cannot be pressed into services by Revenue because, admittedly, the Court was called upon to decide the controversy in light of the provisions of Section 37(1) of the Act. Section 37(1) of the Act specifically states that any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee) shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession' 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, to contend that there was a transaction entered into between the parties so as to take double advantage. Whether the transaction is entered into with the object of tax planning or not is an entirely different matter than the contract being sham or not being acted upon by parties. At the cost of repetition it requires to be stated that both the assessees, namely, the payer company as well as the recipient on one side and Revenue on the other side have relied upon the terms of the contract so as to suit their convenience while bringing to tax the interest income or while denying the deduction in the hands of the payer; in bringing to tax the entire amount or while seeking spread over of such interest, but none of the parties to the dispute has stated that the contract has not been acted upon. In the circumstances, in absence of any contrary provisions under the Act, the parties are required to be governed by the terms of the contract and the transaction in question is required to be appreciated in context of the same. Hence, it is apparent that the payer company has made payment of entire amount of interest on the date of allotment and sought deduction thereof in the year of payment. There is no question of the same being denied in light of the fact that as per terms of the contract no other mode of interest payment is stipulated by the covenants which form part and parcel of the debenture certificate.
The contention raised on behalf of Revenue that interest would accrue only on a day-to-day basis does not merit acceptance in the light of the fact that the parties have specifically provided for a particular rate of interest as well as the manner of payment. Once that is so, it is not possible to rewrite the same and state that interest would accrue, or liability to pay interest would accrue over the entire period of debenture i.e. six years. If this is not possible, the entire interest payment made in the initial year of allotment cannot be artificially spread over the period of six years for the purposes of allowing deduction.
In these circumstances, the question raised in Tax Appeal No. 157 of 2000 is answered in the negative. The Tribunal was not right in holding that the assessee i.e. the payer company was not entitled to deduction of interest paid by it on the debentures issued by it in the assessment year under consideration.
14. At this stage, it is stated by learned advocate for the appellant 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 so far interest on OFCPN of Nirma Industries Ltd. is concerned, admittedly, there being no agreement for payment of interest on yearly basis, the same was not taxable either on mercantile basis or on cash basis.
(ii) Decision Tribunal Mumbai Bench "K" in the case of Chicago Pneumatic India Ltd. v. Dy. CIT (supra).
42. The facts in this case were that the assessee claimed deduction under Sections 80HH and 80HHI in the original return of income. Thereafter, the assessee filed revised return of income, but the claim of Sections 80IIH and 80HHI was not revised. Subsequently, during the course of assessment proceedings, the assessee revised its claim of deduction under Sections 80HH and 80HHI of the Act. The AO did not take cognizance of this claim made by the assessee under Sections 80IIH and 80HHI as the assessee has not filed revised return to this effect. On appeal, the CIT(A) confirmed the action of the AO. On appeal before the Tribunal, the Tribunal has allowed the assessee's claim and the relevant part as contained in para No. 49 of the order, reads as under:
49. The assessee claimed deduction in the original return of income. Though the assessee revised its original return, however, claim under Sections 80HII and 80-1 was not revised. Subsequently, during the course of assessment proceedings, the assessee revised its claim, which the AO did not take into cognizance as the assessee had not filed revised return to this effect. The learned CIT(A) also confirmed the action of AO. Prima facie, the ratio of the decision of the Hon'ble Supreme Court in the ease of Goetze (India) Ltd. (supra) is squarely applicable to the facts of the case because as per the law, the onus lies on the assessee to make right claim and such claim must be made within the framework of provisions of Act. However, this situation, though, it is perfectly in consonance with the position of law may result into genuine hardship to the assessees as the assessees would be left with the option only to proceed under Section 264 that too in case they have not gone into appeal before the learned CIT(A) on the same issue or the learned CIT(A) has not admitted those issues. Other option would be to approach CBDT under Section 119 of the Act for getting the specific relief. Both these options involve time as well as engagement of other administrative authorities which can be otherwise 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 refunds and giving reliefs due to assessees under the Act. Dilatoriness or indifference in dealing with refund claims (either under Section 48 or due to appellate, revisional, etc. orders) must be completely avoided so that the public may feel that the Government are actually prompt and careful in the matter of collecting taxes and granting refunds and giving reliefs.
3. Officers of the Department must not take advantage of ignorance of an assessee as to his rights. It is one of their duties to assist a taxpayer in every reasonable way, particularly in the matter of claiming and securing reliefs and in this regard the officers should take the initiative in guiding a taxpayer where proceedings or other particulars before them indicate that some refund or relief is due to him. This attitude would in the long run benefit the Department for it would inspire confidence in him that he may be sure of getting a square deal from the Department. Although, therefore, the responsibility for claiming refunds and reliefs rests with assessees on whom it is imposed by law, officers should:
(a) draw their attention to any refunds or reliefs to which they appear to be clearly entitled but which they have omitted to claim for some reason or other;
(b) freely advise them when approached by them as to their rights and liabilities and as to the procedure to be adopted for claiming refunds and reliefs;
(c) Public Relation Officers have been appointed at important centres, but by the very nature of their duties, their field of activity is bound to be limited.
The following examples (which arc by no means exhaustive) indicate the attitude which officers should adopt:
(a) Section 17 (1) : While dealing with the assessment of a non-resident assessee the officer should bring to his notice that he may exercise the option to pay tax on his Indian income with reference to his total world income if it is to his advantage.
(b) Sees. 18 (3), (3A), (3B) and (3D) : The officer should in every appropriate case bring to the assessee's notice the possibility of obtaining a certificate authorising deduction of income-tax at a rate less than the maximum or deduction of super tax at a rate lower than the flat rate, as the case may be.
(c) Sees. 25 (3) and 25 (4) : The mandatory relief about exemption from tax must be granted whether claimed or not; the other relief about 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 has specifically clarified that these examples are not exhaustive. Further, the Board also issued Circular F. No. 81/27/65-IT(B), dt. 18th May, 1965 defining the duties of P.R.Os. in providing assistance to the public. In this circular, the Board has also advised the P.R.Os. to visit the Government/commercial establishments to provide them assistance in filing correct returns and making eligible claims. These circulars issued by the Board almost 4-5 decades before cast a duty on the assessing authorities to collect only the legitimate tax. Starting from late 1980s, the Government has focussed as voluntary compliance by the assessees and, therefore, Government has reduced the number of cases selected for compulsory scrutiny and has also reduced the tax rates. This policy of the Government has resulted into higher tax revenues and simplification of laws. It is a settled position that the circulars issued by the Board are binding on the subordinate IT authorities and if CBDT issues directions which are beneficial to the assessees although the same may not be directly in consonance with the provisions of law, even then these instructions have to be given effect and adhered to by the concerned authorities. Thus, there is a strong case for reciprocity to be shown by the Revenue authorities while completing assessments and to avoid administrative hardships to the assessees. As far as the decision of the Hon'ble apex Court in the case of Goetze (India) Ltd. (supra) is concerned, there is no dispute that the same is binding on everybody concerned. In the said decision, the Hon'ble apex Court has also ruled that Tribunal may adjudicate the issue if a claim is made by any party subject to satisfaction of prescribed rules, hence, even the Hon'ble apex Court has not barred the assessee raise its legal claim before appellate authorities. However, such process would result into undue hardships, delay and multiplicity of proceedings. The Hon'ble apex Court, on numerous occasions has laid down the proposition that the assessing authorities are bound to compute the correct income only and collect only legitimate tax, hence, merely for a procedural lapse or technicalities, in our opinion, the assessee should not be compelled to pay more tax than what is due from him. Therefore, this situation has necessarily to be looked upon from the angle of duties of assessing 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, the learned CIT(A), having coterminous powers with the powers of AO and the fact that appellate proceedings are the continuation of original proceedings, should have entertained the claim of assessee and allowed if other conditions of the provisions of the law were satisfied. In this view of the matter, we accept both the grounds of the assessee and direct the learned CIT(A) to consider the claim of the assessee at the revised figures on merits and decide the same according to the provisions of Sections 80HH and 80-1 of the Act after hearing the assessee. Thus, this ground of the assessee stands accepted.
43. Having considered the aforesaid decision, we are of the opinion that the proposition of law held in this decision is squarely applicable to the facts and circumstances of the case before us. Moreso because, the Hon'ble Tribunal has discussed and distinguished the decision of Hon'ble apex Court in the case of Goetze (India) Ltd. (supra) which has been relied upon by the Revenue before us also.
44. Respectfully following this decision, we are of the opinion that the assessee had right to claim exclusion interest on OFCPN of Nirma Industries Ltd. on the basis of that the same was not taxable on accrual basis.
(iii) Decision of Hon'ble Gujarat High Court in the case of S.R. Koshti v. CIT (supra).
45. (a) So far as this decision is concerned, the reliance by the learned Counsel for the assessee was to the effect that authorities under the IT Act are under an obligation to action in accordance with law and if an assessee under a mistake or misconception or on not being properly instructed or by reserving its right to claim any deduction or any part of income to be exempt, the authorities under the Act are required to assess him and ensure that only the lawful tax due from the subject is collected. Our attention in this respect was drawn to para Nos. 20 and 22 at page No. 175 of the report, which read as under:
20. The position is, therefore, that, regardless of whether the revised return was filed or not. Once an assessee is in a position to show that the assessee has been over-assessed under the provisions of the Act, regardless of whether the over-assessment is as a result of the assessee's own mistake or otherwise, the CIT has the power to correct such an assessment under Section 264(1) of the Act. If the CIT refuses to give 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 arc 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. ; State of West Bengal v. Administrator, Howrah Municipality, and Babhutmal Raichand Oswal v. Laxmibal R. Tarte , that the State authorities should not raise technical pleas if the citizens have a lawful right and the lawful right is being denied to them merely on technical grounds. The State authorities cannot adopt the attitude which private litigants might adopt.
45.1 (b) After careful consideration of the aforesaid extract of the decision, we are of the opinion that there is no doubt about the proposition of law that IT authorities are under obligation to charge, levy and collect only the legitimate tax and if an assessee due to any reason fails to claim deduction/exemption available to it under the law or commits a mistake in showing any income which is otherwise not taxable or shown any income in the return reserving its rights to claim the same as exempt during the course of assessment proceedings, the authorities are bound to assess the assessee and, in case the authorities failed to do so, then the appellate authorities or Tribunal should take note of the same and assess the assessee.
46. After having cumulative understanding of aforesaid three decisions relied upon by the learned Counsel for the assessee, we are of the opinion that the assessee was not precluded from claiming the income from OFCPN of Nirma Industries Ltd. having been shown in its revised return on mercantile basis as exempt, during the course of assessment proceedings, or before the appellate authorities including the Tribunal and also before the Courts.
47. We are further of the opinion that admittedly, there being no contract between the parties for payment of interest on accrual basis, the assessee was justified in claiming the same to be exempt as has been held by the Hon'ble jurisdictional High Court in the case of Mohit Marketing Ltd. (supra), however the interest will be taxable in Loto in the year of receipt.
48. Respectfully following the aforesaid three decisions, we uphold the assessee's claim and direct the deletion of income of Rs. 77,95,691,
49. In view of our decision with respect to Ground No. 3 (supra), which is in assessee's favour, this ground does not survive.
50. To reiterate, we in view of aforesaid facts and circumstances of the case, are of the opinion that:
(i) Since assessee's option to changeover to "cash system" of accounting from "mercantile system" of accounting has been found to be bona fide because of facts and circumstances of the assessee's case and the fact that "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 ease as well as various decisions discussed hereinabovc, 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/interest from DDBs purchased prior to 15th Feb., 2002, in assessee's case who has held the same as investment, was not liable to be taxed on accrual basis.
(vi) The income/interest from OFCPN of Nirma Industries Ltd. could not be taxed only because the assessee had declared the same in the revised return because once the assessee's system of accounting has been held to be "cash system", the income, even if shown by the assessee in the return on accrual basis, has to be excluded and to be taxed on cash basis, because Circular No. 2 of 2002, so far as assessee's case is concerned, is not applicable to the DDBs purchased even after 15th Feb., 2002, because, the assessee's system of accounting has been held to be "cash system". The income of Rs. 77,95,691 also, therefore, stands deleted.
51. Without prejudice to the aforesaid findings, we are, further of the opinion that there being no contract for payment of interest either on accrual basis or on periodical basis, the interest on DDBs could not be taxed on accrual basis and this proposition is supported by the decision of Hon'ble Gujarat High Court in the case of Mohit Marketing Ltd. (supra).
52. The levy of interest under Sections 234A, 234B, 234C and 234D was pleaded to be consequential, by both the parties and, therefore, we direct the AO to re-compute the interest chargeable under Sections 234A, 234B, 234C and 234D of the Act, if any, in consequence upon giving effect to the Tribunal's order.
53. In the result, the appeal of the assessee is partly allowed.
Sanjay Arora, A.M.
54. I have carefully gone through the proposed order by my learned Brother. However, I am unable to bring myself in agreement with some parts thereof, even as the same would not impact the final result as declared by the said order. As such, I proceed to write my separate consenting order.
My only point of departure with my learned Brother's order is with "regard to the invalidity of Circular No. 2 of 2002 dt. 15th Feb., 2002 issued by the Central Board of Direct Taxes ('CBDT for short) under Section 119 of the IT Act, 1961 (the Act' hereinafter).
The criticism of the said circular is enumerated at paras 30 to 33, with the latter enlisting the infirmities as found therein. Prior to that, the discussion in the matter begins with para 29 of the proposed order.
55. It would 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 value of a particular bond between two successive valuation dates would represent the accretion to the value of the bond during the intervening financial year, and would be taxable as interest income (where held as investment) and as business income (where held as a trading asset).
(ii) Where acquired during the year, the difference in the value between the cost of acquisition and the value as at the ensuing valuation date would be interest or business income, as the case may be.
(iii) Where the bond is transferred prior to the maturity date, the difference between the sale value and the cost of the bond would be a capital gain or business income, in the case of an investor or traders, as the case may be. The cost of the bond would be the sum of the price for which the bond is acquired and the aggregate of income, if any, already offered to tax as accrued on the said bond since. As the cost of the bond includes the income accrued upto the last valuation date prior to the transfer date, its period of holding, for the purpose of computation of capital gains, would be reckoned from the said (last) valuation date, so that the said period would be always less than twelve months and the capital gains, resultantly, a short-term capital gain.
(iv) On redemption, the difference between the face value and the accumulated value upto the last valuation date, i.e., immediately preceding the redemption date, would be interest or business income, as the case may be.
(v) Due to practical problems associated with the determination of market value, which may be faced by small investors (defined as those holding such bonds upto an aggregate value of Rs. 1 lac), at their option, could continue to offer income to tax as the erstwhile, i.e., on realized basis and, therefore, as capital gains or business income, where held as investment or trading asset respectively.
(vi) Lastly, it stands clarified that the circular would be applicable only to bonds issued on or after 15th Feb., 2002, i.e., the date of the circular.
56. As such, it may be observed that the principles (a) and (c) (supra) are only a reiteration inasmuch as the same were applicable under the existing regime/practice as clarified by the CBDT's letter No. 225 dt. 12th March, 1996 to IDBI (refer para 29). The only difference, therefore, is with regard to the principle No. (b), whereby the accretion 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 India.
(2) ...
57. A DDB is a bond i.e., issued at a price (issue price), i.e., discounted vis-a-vis its par value at which it is to be redeemed at a future date. For example, a bond of face value of Rs. 1,000, to be redeemed five years from the issue date, is issued at a discounted price of Rs. 667 (say). Conceptually, therefore, it would not be any different from a bond (or any debt instrument) which is issued at par (say for Rs. 1,000), redeemable five years hence at Rs. 1,500 (say).
58. As such, two questions would arise. Whether the difference between the redemption and the issue price (Rs. 333 in our example) can be said to be interest income, and if so, can it be taxed under separate heads of income. To answer the second question first, it is well-settled that interest income acquires the character from the nature of the underlying transaction [C1T v. Govinda Choudhury & Sons ], so that it could, and does, in the present case, represent yield/period income (where held as an investment) and trading income (where held as a trading asset), so that its being assessable under the head 'Income from other sources' or 'Business income', is apposite.
59. As regards the first question, interest, by definition, is a time value of money and represents the opportunity cost of fund in the hands of the payer, often referred, thus, as a period cost. Funds (monies), which is itself a store of value, are required for any economic activity. The purveyors thereof may not necessarily have the requisite funds, so that the same are accessed by various modes, borrowal, at a price, being one of them, which is termed as 'interest' in common parlance. The word stands comprehensively defined under the Act [s. 2 (28A)], as under, and is generally reckoned in per cent terms (for a defined period), again, generally, a year, viz., 15 per cent per annum (p.a.):
2 (28A) 'interest' means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized;
60. Coming to the terms of the contract (of DDB) an investment of Rs. 667 (say) is to yield Rs. 333 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 accrues at a uniform rate over the defined time period, implying a greater proportion of accrual with the, approach of the maturity date, and thus, addresses the aforesaid concern. In the context of our example, it could mean an accrual of (say) Rs. 55, Rs. 60, Rs. 65.50, Rs. 72.50 and Rs. 80, for the five consecutive years. Further, true, in practice, other factors, such as the going rate of interest in the debt (money) market would also influence the rate which the bond may fetch on its transfer, so that it is not necessary that the value of the bond increases in these steps. If the yield to maturity ('ytm') of a bond is (say) 15 per cent per annum, an investment of Rs. 100 therein would fetch Rs. 115 after a year, only if the going interest rate on the relevant debt instrument (the market being also segmented ever the terms-time horizon-of the debt security) is still 15 per cent per annum. If it is less, say 14 per cent per annum, the bonds ytm being fixed (at 15 per cent per annum), it is likely to fetch over Rs. 115 (so that the ytm of the investment over the remainder term is aligned to 14 per cent per annum). On the other hand, if the interest rate has increased to 16 per cent per annum, the bond* is likely to fetch less than Rs. 115 in the open market. However, this would only exemplify or explain the valuation process/dynamics involved, and not detract from the fact that the increase in the bond's value is only on account of lapse of time and the proportionate performance of the contract as regards the bond holder, so that the right to that extent enures. Further, as explained by the apex Court in the case of A.R. Krishnamurthy and Anr. v. CIT , valuation is a product of both science and art, and though may not be very precise, yet is significant in that it attempts to quantify the underlying variables. In the present case, however, the valuation being market (and which would represent the sum total of the expectations of the market participants) linked, so that the same could be realized (through sale), it is to say that income to that extent has arisen during the relevant period.
61. The learned Authorised Representative had, while arguing his case, cited the example of other properties, as shares, real estate, to drive home the fact that the existence of a market price (quote) cannot imply accrual 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 the CBDT's earlier Circular No. 409 (on Cumulative Deposit Scheme) dt. 12th Feb., 1985 becomes relevant, and its applicability is also emphasized, being only harmonious with the impugned circular. Of the portfolio held by the assessee, some bonds, viz., REC Ltd., ILFS Ltd., ICICI Ltd., as it appears, also specify the interest rate, even as the same, being a matter of fact, could be subject to verification.
62. The comparison with shares, however, is illustrative and clarifying, inasmuch as it demonstrates that both the regular income and capital gain can arise on a particular property; the same yielding both dividend income and capital gains. Also, real estate could give both the regular (rental) income as also capital gains on its transfer. As such, the receipt of more than one type of income, or of the said incomes being assessable under different heads of income, would be of no consequence insofar as assailing the DDBs (or the circular for that matter) is concerned.
63. Concluding the discussion on accrual of income, what better proof thereof could be than that the bond issuer (Nirma Industries Ltd.) accounts for the interest liability on annualized basis, on the ground of it having accrued. Clearly, if no right to receive enures, over time, as contended, there can be no corresponding obligation to pay, so that no expense accrues under the contract. The learned Authorised Representative has pressed into service, to my mind incorrectly, the ratio of the decision in the case of Empire Jute Co. Ltd. v. CIT (supra), and in the case of Mohit Marketing Ltd. (in Tax Appeal Nos. 157 and 328 of 2000) to canvass his point In Empire Jute Co. Ltd. (supra), the apex Court has held that a capital expenditure in the hands of the payer could be revenue receipt for the payee, and vice versa, an entirely different ratio, and which would depend on the nature of the asset obligation qua which the income/expense is received/laid out, i.e., a trading asset or capital asset. In Mohit Marketing Ltd. (supra), the observations of the jurisdictional High Court are in a case where the income stands realized up front, so that it was held not to be a case where the same accrues over a period of time. In fact, the said decision supports the view of a consistency of treatment to a particular sum in the hands of the payer and the payee inasmuch as both the income and the expenditure 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 thereon upto the last valuation date, or its valuation upto the last valuation date. Once it is recognized that the variation in the intrinsic value (at any point of time) of the bond, which (i.e., value) is sought to be realized by way of transfer, is only on account of the underlying contract (of which time is of essence), the said argument would fail; the transfer, or the accrual of interest, being only the different mode per which the value of the bond is realized. A ready example would be of a capital asset employed in business and subject to depreciation allowance; its transfer would, though held over 36 months prior to the transfer date, always yield a short-term capital gain; the economic rationale being that the investment in asset (which is what is sought to be realized per its transfer) stands already realized to the extent of depreciation allowance, so that the (depreciated) asset sold/transferred is not the same as that acquired. Likewise, the bond sold cannot be compared with that acquired, it being impregnated with value over time, and which stands recognized in view of the underlying contractual relationship.
66. The next detraction of the circular is of it being silent as regards the taxability of the income accrued after 15th Feb., 2002 on DDBs purchased prior to that date. This is invalid, being inconsistent with the finding, and which I wholly concur, being a matter of fact, that the circular is applicable only to DDBs acquired on or after 15th Feb., 2002. As such, there is or can be no question of any income, in terms of the said circular, escaping its framework. The circular would either be applicable or inapplicable qua a particular bond, so that the stated anomalousness does not exist.
67. The circular has also been considered legally susceptible due to it carving out an exception for small investors, defined as one whose aggregate holding all such bonds (i.e., including those acquired prior to 15th Feb., 2002) does not exceed Rs. 1 lac. Once it is recognized, and which is the accepted legal position, that the CBDT has the power under Section 119 of the Act to remove or lessen the rigour of law, the objection would not survive, and becomes binding on the Revenue authorities, even though it may not be in agreement or consistent with the provision of law. Article 14 of the Constitution (equality before law) does not preclude drawing up of classifications; the only qualifying criteria being that the differentiation must be intelligible and, further justifiable on some reasonable and objective basis. The circular states of the same as being guided by the consideration of avoiding hardship to small Investors in benchmarking their investments to market on each valuation date, and has not been known even to be challenged for its validity in any Court of law to date. Also, it may be pertinent to state that the exclusion is only for investors, and not for those who hold the bonds as a trading asset and, further, is at their option. Example of such classification In law, as also under the Act, abound, viz., Section 44AA (maintenance of books of account); Section 44AB (compulsory audit of accounts); Section 44AD; Section 44AE, Section 44 AF, 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, i.e., the validity Of the circular becomes academic in nature for the present appeal.