Income Tax Appellate Tribunal - Delhi
Deputy Commissioner Of Income Tax vs Allied Construction on 30 November, 2006
Equivalent citations: [2007]291ITR16(DELHI), (2007)106TTJ(DELHI)595
ORDER
1. Income-tax Appeal Nos. 3458 and 3459/Del/2001 are the appeals by the Revenue against the order dt. 30th May, 2001 of the CIT(A), Ghaziabad, relating to the asst. yrs. 1997-98 and 1998-99 respectively. The assessee has filed CO Nos. 143 and 144/Del/2005 against the aforesaid orders of the CIT(A).
2. The facts and circumstances under which these appeals as well as cross-objections arise are as follows:
The assessee is a partnership firm. It is engaged in the business of execution of civil construction works for U.P. State Government and Rajasthan State Government. For asst. yr. 1997-98, a return of income was filed declaring total income of Rs. 1,41,930. The return was accompanied by audited trading account, P&L a/c, balance sheet and report of auditor. During the previous year the assessee derived receipts from three sources, namely, contract receipts, hire charges and interest. Contract receipts were shown in the trading account and other receipts were shown in P&L a/c. Gross receipts were Rs. 2,73,48,503 from execution of civil construction contracts, Rs. 47,65,609 by way of interest on FDRs with bank and Rs. 40,000 from the business of plying a TATA 409 truck on hire. As far as contract receipts were concerned, the GP after deducting direct expenses like purchases, labour expenses, carriage and cartage, fuel and lubricants, tools and plant and machinery repairs and spares was Rs. 7,90,811, which gave a GP rate of 2.89 per cent. The assessee had claimed further expenses in the P&L a/c. The major items of expense so claimed were:
Bank interest and charges Rs. 19,59,994 Depreciation Rs. 11,55,260 Salary to partners Rs. 1,82,120 Interest to partners Rs. 1,45,093 General expenses Rs. 5,05,769 (Mess expenses, entertainment expenses, medical, postage etc.)
2.1 The net profit declared after adding interest and hire charges and deducting the expenses to and from the GP was Rs. 1,41,931.
2.2 The AO examined the auditor's report and other evidence and noted the following defects in the books of account maintained by the assessee:
(a) with effect from 1st April, 1997 an assessee was obliged to follow either cash or mercantile method of accounting while maintaining his books of account. Earlier to asst. yr. 1997-98, an assessee could also follow hybrid method of accounting. The change with effect from asst. yr. 1997-98 was due to the amendment in the provisions of Section 145 of the IT Act, 1961 (hereinafter referred to as the Act). The AO noticed that the auditors, in their report under Section 44AB of the Act, have reported that the assessee continued to maintain its books of account by following the hybrid method of accounting. The AO, therefore, held that the method of accounting followed by the assessee was not in consonance with the provisions contained in sub-section (1) of Section 145 of the Act;
(b) stock register was not maintained by the assessee and, therefore, the opening and closing stock value as well as incoming and outgoing were not verifiable;
(c) a part of purchases was not verifiable as it was not supported by vouchers;
(d) labour expenses of Rs. 95,16,702, claimed by the assessee, were not verifiable as the wages register produced in this regard contained only thumb impression of labourers. The percentage of labour expenses to the total contract receipt was 34.8 per cent, which was on the higher side compared to similar percentages of earlier years viz., Asst. yr. 1994-95 12.49 per cent;
Asst. yr. 1995-96 12.79 per cent; Asst. yr. 1996-97 20. 9 per cent;
(e) carriage cartage, fuel, tool, machinery repairs expenses were also not properly verifiable as they were supported by self-made vouchers. These expenses were also excessive compared to the earlier years;
(f) the GP rate of 2.89 per cent declared in this year was lower compared to the past GP rates which were between 17.20 per cent to 30.98 per cent;
(g) expenses debited in the P&L a/c were excessive compared to the past and were supported by self-made vouchers;
(h) even in the auditors' report there was a comment that petty expenses were not supported by vouchers; and
(i) in asst. yr. 1996-97 books of account were rejected and a net profit rate of 10 per cent was applied to gross contract receipts which was later on reduced to 8 per cent by the CIT(A).
2.3 The AO, after making references to the above defects, called upon the assessee to show cause as to why the income of the assessee be not determined in the following manner:
(a) income from civil contracts be estimated at 10 per cent of the gross contract receipts;
(b) the interest on bank deposits received be not separately assessed to tax as income, separate and apart from the income from civil contracts;
(c) income from plying of trucks also be estimated.
2.4 In reply the assessee pointed out that its turnover was more than Rs. 40 lakhs and brought to the notice of the AO that in asst. yr. 1996-97, similar action by the AO was not approved by the Tribunal in its order dt. 15th Feb., 2000 in ITA No. 1746/Del/1999. In asst. yr. 1996-97 the AO had rejected the book results in absence of the stock register, unvouched purchases, unvouched expenses and for the reason that wages paid were not verifiable. The Tribunal held that the above reasons, assigned by the AO for rejecting the book results, were not sufficient. It was further held that the circumstances of the case warranted only disallowance of the unverifiable expenses, and estimation of income by application of a net profit rate was not justified. Finally, the Tribunal remanded the matter to the AO for making assessment on the aforesaid lines i.e. after making disallowances as directed.
2.5 After considering the facts and arguments of the assessee, the AO held that he was not satisfied that the assessee followed cash or mercantile method of accounting. He was also not satisfied about the completeness and correctness of the books of account maintained by the assessee. Therefore, he proceeded to make estimate of assessee's income from civil construction contract to the best of his judgment.
2.6 The AO thereafter computed the income of the assessee under three heads, viz., (a) income from the business of civil construction; (b) income in the form of interest from banks; (c) income from the business of plying truck on hire. The method employed by him is indicated below:
(a) Income from civil construction business-The AO applied a net profit rate of 8 per cent on the contract receipts of Rs. 2,73,48,503 and estimated the income at Rs. 21,87,880. He held that this income would be deemed to be the income from this business computed under the head 'Profits and gains of business or profession', as if all permissible deductions under this head had been allowed. Thus, depreciation on assets used in the civil construction business, excluding TATA 407 truck, which was used in the business of giving on hire and salary and interest to partners were deemed to have been allowed;
(b) Interest income on FDRs-The AO was of the view that the interest on FDRs was an income separate and apart from the income from civil construction business. The plea of the assessee before the AO was that the FDRs, on which interest income accrued to the assessee, were taken out of the funds of the contract business and that they had been offered as security for obtaining CC limit, some FDRs had also been used against bank guarantees given to various Departments for due execution of contracts or given to the Government Departments themselves as security for due performance of contracts. The assessee, therefore, pleaded that the interest income on FDRs related to business and formed part and parcel of contract receipts. The AO held that the fact that the FDRs were offered as security for obtaining CC limits/guarantees would not make the interest income as income from business of civil construction. He, however, held that it would be fair to allow bank charges and interest of Rs. 19,59,994 as expenditure against interest income. He, thus, brought to tax a sum of Rs. 28,05,615 (Rs. 47,65,605 minus Rs. 19,59,994).
(c) Income from plying of truck TATA 407-The TATA truck in question was purchased during this previous year for Rs. 3,44,479. Depreciation of Rs. 68,896 was claimed on the same and the depreciation of Rs. 11,55,260 claimed in the P&L a/c included this depreciation also. The AO applied the provisions of Section 44AE of the Act and adopted income @ Rs. 1,800 per month. Thus, income from the business of plying on hire TATA 407 truck, under the said provisions was computed at Rs. 21,000.
2.7 The AO thus computed the income of the assessee as follows:
1. income from contract work, as discussed above Rs. 21,87,880
2. interest income Rs. 28,05,615
3. income from TATA 407 Rs. 21,600 Rs. 50,15,095 say Total income : Rs. 50,15,100
3. The facts as far as asst. yr. 1998-99 is concerned are more or less identical. In this year, the AO has detailed the items of various materials used in construction, their opening stock, purchases effected during the year and their closing stock. The AO has given details of various projects executed by the assessee and the quantum of work and the period within which they were to be completed by the assessee. He has thereafter concluded that the stock of materials used in construction was not commensurate with the nature of work done. The AO called upon the assessee to produce running bills project-wise issued by the authorities from time to time to verify the assessee's accounts. The assessee took a stand that the claim of the AO was not based on any technical report and if there be any, the same be communicated to him. Besides the above, the following other defects were also pointed out by the AO that : (a) the assessee followed mixed or hybrid method of accounting as mentioned in the report of the auditors, which was contrary to the provisions of Section 145 of the Act, as it stood amended with effect from asst. yr. 1997-98; (b) no voucher was maintained for petty expenses; (c) no stock register was maintained hence, opening/closing stock of materials, etc. were not verifiable; (d) fuel, lubricants expenses, machinery repair expenses were higher compared to earlier years and were not verifiable as they were not supported by proper vouchers; (e) dates of cash payment for purchase of steel and cement as per the cash memo and ledger accounts did not tally. This discrepancy was in respect of purchase of cement for Rs. 1 lakh and steel for Rs. 1,16,820; (f) purchase of steel for Rs. 3,41,768 on 10th Feb., 1998 was not supported by any document evidencing its transportation; (g) labour expenses of Rs. 1,40,79,074 were not verifiable since names and addresses of the persons to whom they were paid were not available.
3.1 For asst. yr. 1998-99, the assessee had maintained only P&L a/c. It had declared a total income of Rs. 46,71,997. The interest received on FDRs with banks of Rs. 45,45,850 and the interest paid to banks of Rs. 44,69,262 were included in the P&L a/c in arriving at an income of Rs. 46,59,693 as per accounts. The AO excluded the interest income on FDRs from the income as per P&L a/c and found that the profit on contract work was only Rs. 1,90,431 (Rs. 46,59,693 minus Rs. 44,69,262), giving a net profit rate of 0.29 per cent. This, in his opinion, was on the lower side. The AO was of the view that the interest on FDRs was not business income, but income from other sources. He, therefore, brought to tax Rs. 44,69,262 being interest on FDRs as income from other sources. The AO also applied 8 per cent net profit rate on total contract receipts of Rs. 6,55,39,260 and estimated income at Rs. 52,43,140. He gave credit for income of Rs. 1,90,431 already shown by the assessee as income from contract business and made an addition of Rs. 50,52,709. Thus, the income for asst. yr. 1998-99 was computed by the AO as follows:
Net profit from contract work as computed Rs. 50,52,709 in para (A) above Add : Income from other sources as Rs. 44,69,262 discussed in para (B) above Rs. 95,21,971 (It appears that the AO should have taken net profit from contract work at Rs. 52,43,140 as against Rs. 50,52,709).
4. In the appeal for asst. yr. 1997-98, the learned CIT(A) upheld the rejection of books of account by the AO. He referred to the order of the Hon'ble Tribunal in asst. yr. 1996-97, but was of the view that the facts in asst. yr. 1997-98 could not be compared with the facts of asst. yr. 1996-97 because hybrid method of accounting was not permissible due to amendment of Section 145, operative w.e.f. 1st April, 1997. He also held that the other reasons given by the AO for rejecting book results were proper.
5. On the question of application of net profit rate on gross contract receipts to determine the income from contract business, the CIT(A) posed the question as to whether interest received on FDRs could form part of the business income of the assessee. He found that the FDRs were purchased out of surplus funds lying with the assessee and mainly out of funds received during the asst. yr. 1996-97, pursuant to award of arbitrators towards damages for breach of contract by the State Government. He also found that these FDRs were partly given to the banks as security for furnishing bank guarantee to contractee Departments in connection with contracts entered into by the assessee. The FDRs were partly used as security for obtaining overdraft facilities for the business. Some FDRs were also offered as security for loans availed of by the assessee from the bank for purchase of machinery. The CIT(A), therefore, concluded that the investment in FDRs was inextricably linked with the contract business and, therefore, the interest income on FDRs had to be considered as business income. The corresponding interest paid to banks had also to be treated as business expenditure. He also held that the interest on FDRs which have not been offered as security to the banks or the Departments, had to be considered as income from other sources. The interest on such FDRs was quantified at Rs. 8,78,563.
6. Before the CIT(A) the assessee pleaded that the interest income on FDRs was only Rs. 35,34,762 and not Rs. 47,65,609 as shown in the P&L a/c and that this was due to mistake in the TDS certificates issued by the banks. The CIT(A) did not give any definite findings in the matter, probably because it was not necessary to do so in the scheme of his order. He, however, held that out of the whole interest, an amount of Rs. 8,78,563, being interest on FDRs which were not offered as security, had to be treated as 'Income from other sources'.
7. The findings of the CIT(A) in respect of business income were as follows:
... taking an overall view of the case, considering the interest income on FDRs and interest paid to the banks, considering the income on bank FDRs which has to be taken as income from other sources and that this was the first year of the contract business of construction of dams, it would be reasonable and fair to apply a net profit rate of 8 per cent on the total gross receipts of Rs. 2,73,88,303. These receipts also include the receipts in respect of hiring charges of Tata Truck 407 for two months because thereafter it has been utilized in own business of the assessee. This would result in an income of Rs. 21,91,080. No further deduction including depreciation is admissible thereafter. The deduction for interest and salary to partners is also not allowable because it has not been allowed even in earlier years.
7.1 The CIT(A) also held that the income determined as above would cover income from the business of truck plying and no separate addition was required to be made. The CIT(A) computed income of the assessee thus:
Income from contract work Rs. 21,91,080
Add : Income from other sources on bank
FDRs on hand Rs. 8,78,563
Rs. 30,69,643
7.2 For asst. yr. 1998-99 the CIT(A) followed his order in asst. yr. 1997-98. The income from contract business was estimated at 8 per cent of the gross contract receipts. Interest on FDRs, which were not pledged with the bank, was Rs. 2,35,606. This was held to be 'Income from other sources'. The CIT(A) computed the income for asst. yr. 1998-99 thus:
Contract income of 8 per cent of gross receipts Rs. 52,42,340
at Rs. 6,55,29,260
Add : Income from other sources on bank FDRs Rs. 2,35,606
in hand
Rs. 54,77,746
8. Aggrieved by the order of the CIT(A), the Revenue has preferred the present appeals and the assessee has filed cross-objections in both the assessment years.
9. These appeals as well as the cross-objections were originally heard by a Division Bench. Before the Division Bench, the assessee brought to the notice the decision of the Tribunal in its own case for asst. yr. 1996-97. We have seen earlier that, the issue regarding rejection of books of account was set aside by the Tribunal to the AO for fresh consideration (vide order in ITA No. 1748/Del/1999). The Tribunal held that the facts warranted only disallowance of expenses which were not verifiable and rejection of accounts was not proper. The AO was directed to consider the expenses to be disallowed after allowing opportunity of being heard to the assessee.
10. The AO heard the assessee and framed fresh assessment. On the issue of interest on FDRs, the AO again held that they were to be considered only as 'Income from other sources'. The AO also disallowed certain expenses. On appeal by the assessee, some expenses were directed to be allowed. On the issue of treating interest income as income from business, the CIT(A) found that some FDRs purchased were given as security for various purposes connected with the business of the assessee. He, therefore, held that the interest income on these FDRs was income from business. In respect of interest on FDRs, which were not offered as security, the CIT(A) held that the same was taxable as income from other sources. The Revenue preferred appeal before the Tribunal in ITA No. 3009/Del/2003. reported as Asstt. CIT v. Allied Construction (2007) 106 TTJ (Del) 616-Ed. The Tribunal upheld the order of the CIT(A). It is this order of the Tribunal that was relied upon by the learned counsel for the assessee before the Division Bench in support of his argument that interest income on FDRs, which were offered as security to bank, had nexus with the business and, therefore, has to be considered as 'Income from business'.
11. The Division Bench felt that the view of the Tribunal in ITA No. 3009/Del/2003 in assessee's own case for asst. yr. 1996-97 required reconsideration and hence the Division Bench made a reference to the President to constitute a Special Bench to hear and decide the appeals and cross-objections including the following question:
Whether, in the facts and circumstances of the case, the net interest income earned by the assessee on bank FDRs having nexus to its contracting business can be added separately to its income from the said business computed on estimated basis by applying a net profit rate ?
12. Accordingly a Special Bench was constituted. The learned Departmental Representative sought to contend that the question framed as above does not bring out the real controversy at hand. Therefore, the Bench expressed the opinion that the grounds raised in the appeals as well as the grounds raised in the cross-objections would be taken up for adjudication. The learned Departmental Representative as well as the learned counsel for the assessee agreed to the suggestion. Accordingly the following grounds raised by the Revenue (which are common in both the assessment years) and the following grounds raised by the assessee in its cross-objections (which are common in both the assessment years except for the quantum of interest received on FDRs) are taken up for consideration.
13. Grounds reased by the Revenue in its appeals:
1. The learned CIT(A) has erred in law and on facts in directing to take net profit rate of 8 per cent of gross receipts takes care of the interest paid by holding that interest received on FDRs amounting to Rs. 28,05,615 have been mainly taken for the purpose of obtaining overdraft facility and bank FDRs has direct nexus with the business activities of the firm ignoring the facts that the assessee has excess fund which were initially utilized for taking FDRs interest income earned on all the FDRs is interest income chargeable under the head 'Income from other sources'.
2. As the learned CIT(A) has erred in law and on facts, therefore, order of learned CIT(A) be set aside and that of the AO restored on this issue.
14. Grounds raised by the assessee in cross-objections:
1. For that on the facts and circumstances of the case the learned CIT(A) was not justified in estimating the net profit @ 8 per cent after rejecting the books of account, the method of the accounting has been followed as regularly employed in the preceding years.
2. For that on the facts and circumstances of the case the learned CIT(A) was not justified in not allowing the depreciation on fixed assets used for the business, in estimating the income.
3. For that on the facts and circumstances of the case the learned CIT(A) was not justified in not adjudicating the ground No. 3 taken before him, in levying the interest any charge of interest, which is vague, is untenable and unwarranted in law.
15. The learned Departmental Representative, at the outset, submitted that the interest on FDRs ought to have been added separately as 'Income from other sources' and that it could not be part of income from the business of civil construction. He pointed out that the FDRs in question were purchased out of surplus funds generated in business by the assessee in the form of profits but mainly by way of damages awarded by the arbitrators in the course of performing civil construction work. According to him, the latter sum received would not be in the nature of profits of business. He submitted that if a person earns agricultural income and deposits that income in FDRs and receives interest thereon, the character of such interest income will not be that of agricultural income. According to him, the source of the interest income is alone relevant and that source is traceable only to the fixed deposits and not business. Therefore, interest income cannot be income from business.
16. On the action of the AO in asst. yr. 1998-99 in allowing deduction on account of interest paid to bank against interest income from FDRs, strong reliance was placed on the decision of the Hon'ble Supreme Court in the case of CIT v. Dr. V.P. Gopinathan . The facts of the case were that that assessee put moneys into fixed deposit and earned interest thereon. On security of such fixed deposits, the assessee availed of loan from bank. The interest paid on the loan was claimed as a deduction against the interest income earned. The Hon'ble Supreme Court held that the interest income received by the assessee was income in his hands and would stand reduced only if there was a provision in law, which permits such diminution. Further reliance was placed on the decision of the Hon'ble Madras High Court in the case of South India Shipping Corpn. Ltd. v. CIT . The facts of the case were that the assessee received interest income on short-term deposits, which was treated as income from other sources by the AO rejecting the claim of the assessee that it had to be assessed as business income. The assessee had paid interest on overdraft facility it enjoyed with the bank. The interest so paid was claimed as a deduction against interest received on term deposit. Such claim of the assessee was also rejected. The Hon'ble Madras High Court upheld the stand of the Revenue. The following observations of the Court were highlighted by the learned Departmental Representative:
Under the IT Act, 1961, the distinct heads under which the income of an assessee are to be classified are set out in Section 14 of the IT Act, 1961. The income received by an assessee has to be fitted under one or other head-having regard to the source from which that income is derived. The fact that a person carries on business does not lead to the inference that all income received by such a person is business income. The same assessee can have income, which may require to be classified under more than one head. It is the manner in which the income is derived that is relevant and not merely the fact that the person is engaged in a business or in a profession.
Interest received by a company which carries on business, from bank deposits and loans could only be taxable as 'Income from other sources' and not as 'business income'.
Interest paid on overdraft obtained for the purpose of business cannot be deducted from the interest earned on monies kept in fixed deposits as such income derived by way of interest on fixed deposits has to be taxed under the head 'Income from other sources'.
17. The learned Departmental Representative submitted that in the present case interest received on FDRs and interest paid to bank on credit facilities were two distinct transactions and, therefore, the assessee cannot claim deduction of interest paid even under Section 57(iii) of the Act against interest received on FDRs. Reliance was placed on the decision of the Hon'ble Supreme Court in the case of Pandian Chemicals Ltd. v. CIT wherein the Hon'ble Supreme Court had laid down that the words "derived from" in Section 80HH of the Act have to be understood as something which has a direct or immediate nexus with the assessee's industrial undertaking. According to him there is no nexus direct or immediate between the interest income on FDRs and the business of the assessee.
18. On the question whether interest income should enter into the computation of business income from civil construction, the learned Departmental Representative submitted that once interest income is held not to be a part of business income from civil construction, then it follows that the same has to be added separately and not correlated to business income. According to him, once rejection of book results of an assessee is found to be correct, then one has to adopt a reasonable estimate of income from business. He drew our attention to the provisions of Section 44AD of the Act, which lay down a presumptive rate of profit in the case of business of civil construction. He submitted that though these provisions are applicable only for contractors whose gross receipts are less than Rs. 40 lakhs, yet the spirit behind these provisions has to be applied to the case of the assessee in estimating income from business of civil construction. According to him, therefore, the percentage of profit has to be applied on the gross receipts excluding interest received on FDRs.
19. On the question of rejection of books of account, the learned Departmental Representative submitted that the facts in the present assessment year are different from the facts which prevailed in the asst. yr. 1996-97, wherein the Tribunal held that the rejection of books of account was not proper. In this regard the learned Departmental Representative pointed out that in asst. yr. 1997-98 there was a change in the provisions of Section 145 of the Act by virtue of which the assessee was required to maintain books of account either on the cash method or mercantile method of accounting and it could not have followed hybrid method of accounting. On this ground alone, according to the learned Departmental Representative, the rejection of books of account by the AO was fully justified. Apart from the above he also relied on the other reasons given by the AO for rejecting the books of account in the asst. yrs. 1997-98 and 1998-99.
20. On the question of the estimation of income from the business of civil construction, the learned Departmental Representative submitted that the AO had applied the presumptive rate as envisaged under Section 44AD of the Act. Though this was applicable only in the case of assessees having gross receipts of less than Rs. 40 lakhs, yet the principle behind the enactment of the said provisions will equally apply to civil construction contractors, more so, in the case of an assessee, who has not maintained proper books of account. According to him the estimate made by the AO cannot be questioned so long as it is not arbitrary. According to him, the estimate in the present case by the AO was a bona fide estimate and is based on the rational basis and, therefore, the same has to be upheld. Reliance was placed by the learned Departmental Representative on the decision of the Hon'ble Supreme Court in the case of CST v. H.M. Esufali H.M. Abdulali .
21. On the question regarding the AO not allowing depreciation and interest and salary paid to partners against the income estimated by applying a net profit percentage, the learned Departmental Representative submitted that once an estimate of income is made, all deductions are deemed to have been allowed and there is no question to allow separate deduction. In this regard the learned Departmental Representative placed reliance on the decision of the Hon'ble Andhra Pradesh High Court in the case of Indwell Constructions v. CIT (. In the aforesaid decision the AO for making estimate of income after rejecting the books of account made a further addition towards interest and remuneration paid to partners. The Hon'ble Andhra Pradesh High Court held that separate addition cannot be so made when books are rejected and income estimated. The learned Departmental Representative submitted that the same analogy will be applicable in the present case and no further deduction towards the interest, depreciation and salary to partners has to be allowed.
22. The learned counsel for the assessee firstly submitted that in the assessment the interest income on FDRs was treated as part of the business income. The CIT(A) considered a major portion of the interest income as business income, but only in respect of a portion of the interest income held that the same was income from other sources. According to him, in this appeal by the Revenue the grievance projected by the Revenue was that the interest received on FDRs should be separately considered as business income apart from the income estimated by applying net profit percentage on the gross contract receipts. According to him it is not possible for the Tribunal at this stage to render a finding that the interest received on FDRs is income from other sources. According to him doing so would be changing the very basis of assessment made by the AO and the Tribunal does not have such a power.
23. Without prejudice to the aforesaid submissions, the learned counsel for the assessee further submitted that the interest earned on the bank FDRs had a nexus with the contract receipts as the assessee had offered these FDRs as security for obtaining cash credit limit and other facilities in connection with its business from the banks. According to him, therefore, the interest income forms part and parcel of the business income. The only business of the assessee was that of civil contract business and, therefore, interest income has also to be considered as part of the income from contract business. In this regard reliance was placed on the decision of the Delhi Bench of the Tribunal in the case of Mrs. Saroj Dassani v. Asstt. CIT (2006) 99 TTJ (Del) 345 wherein the Tribunal has held that once FDRs were utilized by the assessee for the purpose of business in placing them with the bank as margin money, they cease (to be) a commercial asset, therefore, interest on fixed deposits is liable to be assessed as business income. Further, reliance was placed on the decision of the Hon'ble Bombay High Court in the case of CIT v. Puneet Commercial Ltd. in support of the contention that interest income is also income from business.
24. The further submission of the learned counsel for the assessee was that once interest income is considered as business income, no separate addition on account of net interest income can be made. Reliance was placed by the learned counsel for the assessee on the decision of the Jabalpur Bench of the Tribunal in the case of HO v. Tahir All (2001) 116 Taxman 226 (Jab)(Mag) the case of a contractor, where books were rejected and income determined by applying net profit percentage rate. The Tribunal held that where bank interest was directly relatable to contract business, the same has to be considered as part of the business receipts and net profit rate has to be applied including such interest as part of the contract receipts and that no separate addition could be made for the interest received from bank.
25. On the question of allowing deduction of interest paid to bank against interest received on FDRs, the learned counsel submitted that in asst. yr. 1997-98 the AO himself has allowed such a deduction and in this appeal by the Revenue the Tribunal is not competent to modify the original basis of assessment. On the issue of rejection of books of account and applying a net profit rate of 8 per cent on the gross receipts from contracts, the learned counsel for the assessee firstly pointed out that this ground, which was raised in the cross-objections filed by the assessee, was originally not pressed before the Division Bench under the impression that the findings of the CIT(A) regarding not making a separate addition on account of interest on FDRs would be upheld by the Tribunal as done in asst. yr. 1996-97. Since this issue is now subject to adjudication, he clarified that he was entitled to advance arguments on this issue. His submission on merits on this issue was that as decided by the Tribunal in asst. yr. 1996-97, there was no basis for rejecting the book results and the circumstances at best only warranted making of disallowance of expenses, which were found to be excessive or not verifiable. His further submission on the application of a net profit rate of 8 per cent was that the past history of the assessee's case does not justify such an approach by the AO. In this regard he drew our attention to pp. 1 and 2 of the assessee's paper book wherein the net income from contract receipts excluding other receipts was a negative figure from asst. yrs. 1994-95 to 1997-98 and was a paltry 0.29 per cent in asst. yr. 1998-99. According to him, once the book results are rejected what becomes germane is the past history of the assessee's own case, which does not justify the rate of 8 per cent adopted by the CIT(A). In para 17 of his written submissions, filed before the Tribunal, it has been specifically stated that the assessee has no objection if interest earned is separately assessed and income from contract business is separately estimated. It has, however, been clarified that the estimate of income from contract business ought to be made on the basis of past history in the assessee's own case. The further submission was that if income from contract business is to be estimated, deductions from such income towards depreciation and interest and salary paid to partners have to be allowed. Reliance in this regard was placed on the decision of the Hon'ble Chandigarh Bench of the Tribunal in the case of Chopra Bros. (India) (P) Ltd. v. ITO (1993) 46 TTJ (Chd)(TM) 523 : (1993) 45 ITD 85 (Chd)(TM) wherein the Tribunal has made references to the CBDT Circular No. 29-D (XIX-14), dt. 31st Aug., 1985. Further reliance was also placed in the decision of Hon'ble Rajasthan High Court in the case of CIT v. Jain Construction Co. & Ors. .
26. In reply the learned Departmental Representative submitted that it is no doubt true that when the books of account are rejected, past history in assessee's own case becomes a relevant factor, but the same has to be taken into consideration in the light of all the facts and circumstances. In this regard he pointed out that in the past i.e. prior to asst. yr. 1997-98, the assessee was following a hybrid method of accounting and, therefore, the past history in the assessee's own case may not be as worthwhile guide. On this submission the learned counsel for the assessee pointed out that even if an average of the past five years prior to asst. yr. 1997-98 is considered, still, the past history of the case would not justify making an estimation of 8 per cent. The average of the past five years, if adopted, would eliminate effect of hybrid method of accounting followed by the assessee.
27. We have considered the rival submissions. The issue to be decided in the Revenue's appeal is as to whether the interest income on FDRs has to be considered as income from other sources or income from business and as to whether such interest income can be treated as part of contract receipts on which estimation of income can be made by applying net profit rate. Admittedly, the investment in fixed deposits was made out of the surplus generated from the business and mainly out of the award of the arbitrators for damages for breach of contract. All the funds used for making the investments in FDRs were, therefore, surplus funds of the assessee. The assessee was free to utilize these funds in any manner. The assessee chose to invest these funds in fixed deposits. The fact that the fixed deposits were partly offered as security for the various facilities availed by the assessee from the banks would not make the income from the fixed deposits as business income. The taking of the FDRs and pledging them as securities for taking loans are two different transactions. Hon'ble Supreme Court, in the case of Pandian Chemicals Ltd. (supra), held that interest earned on deposit with the Electricity Board for supply of electricity could not said to flow from the undertaking and, therefore, it was not income derived from the undertaking. Further, in the case of CIT v. Raja Bahadur Kamakhaya Narayan Singh and Ors. (1948) 16 ITR 325 (PC), the Privy Council held interest on arrears of rent payable in respect of agricultural land was not agricultural income. The decision of the Hon'ble Madras High Court in the case of South India Shipping Corpn. Ltd. v. Addl. CIT (supra) supports the plea of the learned Departmental Representative in this regard. The Hon'ble Madras High Court relied on the decision of the Hon'ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT . Hon'ble Allahabad High Court in IT Ref. No. 219 of 1992 in the case of CIT v. Kisan Sahakari Chini Mills Ltd. by order dt. 7th April, 2005 [reported at (2005) 197 CTR (All) 385-Ed.] also came to the same conclusion by relying on the decisions in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT (supra). The decision in the case of Puneet Commercial Ltd. (supra) as well as in the case of Mrs. Saroj Dassani (supra) were rendered in the context of provisions of Section 80HHC of the Act where the "profits of business" have to be computed on the basis of express provisions of Section 80HHC of the Act. Source of interest income is FDRs, which is different (and) separate from contract receipts. Even if contract business is stopped, the assessee can continue to receive interest and vice versa. Thus, it follows that interest received cannot be considered as part of the contract receipts while estimating income from the business of civil construction contracts.
We are also of the view that in asst. yr. 1996-97, the Tribunal had not dealt with this issue in proper perspective. The reason seems to be that this issue was not material as the Tribunal directed the computation of income on the basis of the book. Once that is done, it is immaterial whether a particular amount is taxed under this or that head. Therefore, the Tribunal had come to the erroneous conclusion from the mere fact that the FDRs were utilized for business purposes, that interest thereon has to be considered as business receipts of the assessee. We would like to add here that as per scheme of the Act, interest income is, generally speaking, income from "other sources" unless the assessee is carrying on money-lending business or some very special circumstance exists to hold interest income to be business income, such as interest on delayed payments of sale consideration or other receipts like contract receipts. However, onus to prove so will be on the assessee. Interest income is separate and independent of contract receipts. Apart from that interest income, by no stretch of imagination can be considered as contract receipts for estimation of income by applying net profit rate to the contract receipts. Therefore, we are of the view that the net profit percentage has to be applied only on the gross receipts from the business of civil construction to estimate income from the said business, and interest on FDRs cannot be said to be a part of the receipts from civil construction works. In this regard we also notice that the Jabalpur Bench of the Tribunal in the case of Tahir Ali (supra) has taken a view that if the bank interest was directly relatable to contract business, the same would be deemed to have been considered while applying net profit rate and no separate addition could be made. We are of the view that this decision of the Jabalpur Bench runs contrary to the principles as laid down in the decision of the Hon'ble Madras High Court in the case of South India Shipping Corpn. Ltd. (supra) and the decision of the Privy Council in the case of CIT v. Raja Bahadur Kamakhaya Narayan Singh and Ors. (supra) and the Hon'ble Supreme Court in the cases of Pandian Chemicals Ltd. (supra) and Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). We, therefore, hold that the interest on FDRs with the bank continued to have their sources as the bank and the fixed deposits placed with it, and the fact that these FDRs were offered as security for financial facilities obtained by an assessee for the purpose of business would not change the character of the income as one from business. We are, however, faced with the fact that the AO, in the order of asst. yr. 1997-98, has indirectly held interest income to be the business income. The learned CIT(A) also considered a major part of interest income to be the business income. The learned counsel had argued that the texture of the order of the AO cannot be altered at this stage. We tend to agree with him in this matter. We, however, hold that the interest income in asst. yr. 1997-98 also cannot form part of the contract receipts for estimation of income by applying net profit rate and has to be separately assessed.
28. On the question of allowing the interest expenses against interest income received on FDRs, as far as asst. yr. 1997-98 is concerned, the AO had allowed such a deduction and has brought to tax only the net interest income. That basis cannot be altered by the Tribunal. Before the CIT(A), the assessee submitted that the actual interest income that accrued to the assessee for asst. yr. 1997-98 was only Rs. 35,34,762 as against Rs. 47,65,609 declared by the assessee. Out of this interest income, interest paid to bank of Rs. 19,59,944 was to be allowed as a deduction. The CIT(A) directed that Rs. 8,78,563 should be assessed as income from other sources.
29. In asst. yr. 1998-99, the AO considered the interest paid to the bank as not the expenses incurred for earning the interest income. In view of our conclusions above that the interest income on FDRs is income from other sources, we are of the view that the entire interest income should be brought to tax as income from other sources after allowing deduction of expenses under Section 57(iii) of the Act. It cannot be said that interest paid to the bank was incurred for the purpose of earning the interest income on FDRs. The decision of the Hon'ble Supreme Court in the case of Dr. V.P. Gopinathan (supra) clearly supports the stand taken on behalf of the Revenue. As already observed, the funds in question were surplus funds, generated from the profits of business and the award money. In the circumstances there are no expenses incurred by way of interest in earning the interest on FDRs. We, therefore, direct that the interest income in this assessment year be assessed as income from other sources. As far as question of interest income in asst. yr. 1997-98 is concerned, the AO will only examine the plea of the assessee that actual interest income that accrued to the assessee was only Rs. 35,34,762. Thus, this matter will require a fresh decision from the AO after hearing the assessee.
30. As far as estimation of income in asst. yr. 1997-98 from plying of trucks on hire is concerned, the same will have to be determined separately as was done by the AO. The fact that these trucks were subsequently used in the business of civil construction will not render the said income as one from business of civil construction. Estimation of such income by applying the provisions of Section 44AD of the Act as done by the AO is, therefore, upheld. The depreciation on this vehicle will, however, be allowed to the extent provided in Section 38(2) of the Act against business income.
31. The issue which remains to be considered now is about the estimation of income of the assessee from the business of contract works. However, before proceeding with that, we may deal with the provisions of Section 145 of the Act, as applicable to asst. yr. 1997-98 and onwards. In this connection, it may be pointed out that Finance Act, 1995, substituted this section w.e.f. 1st April, 1997. Therefore, the provisions of the substituted section are applicable to the proceedings of asst. yr. 1997-98 and thereafter. Sub-section (1) of the substituted section, inter alia, provides that the income chargeable under the head "Profits and gains of business or profession" shall, subject to provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. The assessee had been employing hybrid method of accounting for and upto asst. yr. 1996-97. Therefore, in view of the provision contained in the aforesaid sub-section, he was required to change his method of accounting and maintain books either on mercantile method or on cash method. However, such a change was not made and the assessee continued to follow the hybrid method of accounting for recognizing income and expenditure in the books of account. The case of the learned counsel before us was that in spite of the aforesaid substitution of the section, the assessee was justified in continuing to maintain the books of account on hybrid method of accounting basis. However, he was not able to cite any authority in support of his case. On the other hand, the case of the learned Departmental Representative was that provision contained in sub-section (1) was mandatory and the assessee ought to have switched over either to cash or mercantile method of accounting, which was not done. In view thereof, provision contained in sub-section (3) became applicable on the facts of the case, which provides that where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee, the AO may make an assessment in the manner provided in Section 144. Therefore, it was agitated that the AO was justified in rejecting the books of account by following the provision in sub-section (3) of Section 145. Apart from that, the books of the assessee suffered from a number of defects and sub-section (3) also provided that where the AO is not satisfied about the correctness or completeness of accounts of the assessee, he may make an assessment in the manner provided in Section 144. We have considered this matter. Sub-section (1) uses the word "shall", which means that from asst. yr. 1997-98, it is mandatory to compute the income under the head "Profits and gains of business or profession" in accordance with either cash or mercantile method of accounting. It is seen that from asst. yr. 1997-98, the assessee has not regularly followed any of these two methods. Therefore, we are of the view that the AO was justified in rejecting the books of account. In view of the provisions of Section 145(3) of the Act the AO, therefore, had to proceed to make an assessment in the manner provided under Section 144 of the Act.
32. The case of the learned Departmental Representative in regard to estimation of income was that Section 44AD, regarding "Special provision for computing profits and gains of business of civil construction etc.", provides a statutory guideline for estimating the income at 8 per cent of the receipts. It was fairly conceded by him that the provision contained in the aforesaid section shall not apply in the case where gross receipts payable exceed an amount of 40 lakh rupees. That, however, will not detract from the conclusion that estimation at the rate of 8 per cent of the gross receipts payable would not be fair in a case where such receipts exceed Rs. 40 lakhs and the income is to be estimated. On the other hand, the case of the learned counsel of the assessee was that his receipts far exceeded the aforesaid sum of Rs. 40 lakhs and, therefore, the provisions contained in Section 44AD were not applicable at all. It was contended by him that on the facts of the case, it would be most appropriate if the past results accepted by the Revenue in the case of the assessee, are used as guidelines for estimating the income. The learned Departmental Representative did not contest this proposition seriously, but pointed out that in the past the books were maintained on hybrid method, while in this year the income is to be computed on mercantile or cash method of accounting and, therefore, suitable amendments will have to be made to the results accepted in the past to bring them in line with the mercantile method of accounting. The case of the learned counsel on this issue was that if results of past five years are taken into consideration aberration arising on account of hybrid method of accounting would even out, giving true picture of the results of the operations of the assessee as a civil contract.
33. We have considered this matter also. The amendment in Section 145 was brought in because the hybrid method of accounting was used by the assessees to postpone the tax liability. In this connection, we are of the view that only like things can be compared and there can be no comparison between unlike things. It was also argued by the learned counsel that the gross receipts have significantly increased in those years vis-a-vis earlier years. Such increase will necessarily have the effect of depressing the net profit rate. The learned counsel did not furnish any empirical data to support his argument.
34. Having come to the conclusion that the assessment has to be made in the manner provided in Section 144 of the Act, we may add that such assessment has to be reasonable and based on good faith and not arbitrary or capricious. It is the case of both the parties that past results, as assessed finally, form a reasonable basis for such an estimation, although other material on record can also be taken into account. Our view finds support from the decision of the Hon'ble Chief Court of Oudh in the case of Abdul Qayum & Co. v. CIT (1933) 1 ITR 375 (Oudh), wherein it was held that although the AO was not bound by strict judicial principles, he should be guided by rules of justice, equity and good conscious. In the case of State of Orissa v. Maharaja Shti B.P. Singh Deo (1970) 76 TTR 690 (SC), Hon'ble Supreme Court held that the power of levy on best judgment was not an arbitrary power. The assessment had to be made on relevant material. Hon'ble Calcutta High Court, in the case of CIT v. Ranichena Tea Co. Ltd. , also held that although the AO is not bound by strict judicial principles, in making best judgment assessment, he does not possess absolutely arbitrary authority to assess any figure as he likes. He should be guided by the rules of justice, equity and good conscious. Looking to the ratio of these cases, if past results showed loss or nominal net profit rate, then, the AO will not be justified in applying 8 per cent rate. The claim of the assessee for allowing depreciation separately will also be examined by the AO in the light of various judicial pronouncements referred to by the learned counsel for the assessee. However, it is clarified that if in the past estimation of income had been done before allowing depreciation then the AO will be justified in allowing depreciation in these years also and not otherwise, because only like things can be compared.
35. The issue with regard to charging of interest is consequential and the AO is directed to give consequential relief.
36. In the result, both the appeals by the Revenue and the cross-objections by the assessee are treated as partly allowed, for statistical purposes.