ITO Vs Pallon Shapoorji Mistry ( ITAT Mumbai)

ITAT Mumbai held that change of method of accounting from mercantile to cash system for recording interest income on loan due to financial distress at the end of borrower is justifiable and legitimate.

Facts- Assessee is an individual and belongs to the promoter family of Shapoorji Pallonji and Co. Pvt. Ltd. (SPCPL) and Roxanna Consultancy Services Pvt. Ltd. (Roxanna). In the course of assessment proceedings, AO on perusal of Form 26AS of the assessee for the year under consideration noted an entry towards interest income of Rs.8,81,35,246/- from Roxanna with a corresponding TDS of Rs.88,38,525/-. He observed that this income has not been offered to tax so also TDS has not been claimed by the assessee. After considering the submissions made by the assessee, AO passed the assessment order making an addition towards interest income not accounted on accrual basis.

CIT(A) deleted the additions. Being aggrieved, revenue has preferred the present appeal.

Conclusion- Change in method of accounting is not prohibited when warranted by situations which has been justifiably explained by the assessee. Assessee had demonstrated that once changed, he has regularly followed the method in the subsequent years. Assessee has affirmed to offer the income as and when he receives it. Keeping all the above discussions in juxtaposition, in our considered view, change of method of accounting from mercantile to cash by the assessee in the year under consideration is a legitimate exercise. Assessee has explained that it is a genuine and bonafide exercise arising out of compelling reasons of financial distress at the end of borrowers.

Held the change in method of accounting from mercantile to cash system justifiable and legitimate. Having held so, non-receipt of interest income during the year from both the parties, namely, in the case of SPCPL where assessee has waived the interest which has not even been accrued by it in its books of account to claim it as an expense and Roxanna having accrued the interest expense in its books of account has not paid the same to the assessee, cannot be added in the hands of the assessee on accrual basis as done by the ld. Assessing Officer.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

This appeal filed by the Revenue is against the order of Ld. CIT(A), National Faceless Appeal Centre (NFAC), Delhi vide order no. ITBA/NFAC/S/250/2023-24/1060304458(1), dated 31.01.2024 passed against the assessment order by the Assessment Unit, u/s. 143(3) of the Income-tax Act (hereinafter referred to as the “Act”), dated 09.09.2022 for Assessment Year 2020-21.

2. Grounds taken by the Revenue are reproduced as under:

1. “Whether on the facts and Circumstances of the case and in law, the Ld. CITA) has erred in deciding the case in favour of assessee without appreciating the provisions of sec 145 of the Income Tax act in “totality” ignoring the sub section 3 of sec. 145 of the IT Act?”

2. “Whether on the facts and circumstances of the case and in law the Ld. CITA) has erred in ignoring sub section. 3 of sec. 145 of the IT Act and relied only upon the sub sec (1) and (2) of section 145 which states that the income of the assessee has to be computed on the basis of cash or mercantile system of accounting regularly employed by the assessee?”

3. Whether on the facts and circumstances of the case and in law the Ld. CITA) has erred in ignoring the sub section. 3 of sec. 145 of the IT Act which states that where the Assessing Officer 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 subsection (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144?”

4. “Whether on the facts and Circumstances of the case and in law, the Ld. CITA) has erred in ignoring the finding of AO in assessment order that the assessee had taken a free run to decide an accounting system/policy which suits him to evade paying taxes?”

5. Whether on the facts and in the Circumstances of the case and in law, the Ld CILIA) has erred in allowing the conduct of the assessee which clearly indicates that where the group company was required to pay taxes ie. M/s Roxanna Consultancy Services Pvt Ltd (SPLICER) they have debited such claim of interest expenses and where the assessee in his own case was required to offer the interest income in the same manner they had offered in the previous year they have changed their method of accounting stating that they have followed the cash system of accounting?”

6 “Whether on the facts and in the Circumstances of the case and in law, the Ld CIT(A) has erred in ignoring the word (regularly) stated in sub section (3) of sec. 145 which does not permit such free will to change accounting method?”

3. Assessee belongs to the promoter family of Shapoorji Pallonji and Co. Pvt. Ltd. (SPCPL) and Roxanna Consultancy Services Pvt. Ltd. (Roxanna). Assessee as an individual, filed his return of income, reporting total income at Rs.1,45,71,240/- with source of income from salary and from other sources. In the course of assessment proceedings, ld. Assessing Officer on perusal of Form 26AS of the assessee for the year under consideration noted an entry towards interest income of Rs.8,81,35,246/- from Roxanna with a corresponding TDS of Rs.88,38,525/-. He observed that this income has not been offered to tax so also TDS has not been claimed by the assessee. Necessary details and explanations were called for from the assessee. Details of interest accrued, interest received, total TDS deducted, TDS claimed and corresponding income offered for taxation in respect of loan given by the assessee to SPCPL and Roxanna is tabulated below. It may be noted that owing to financial stress faced by these companies, assessee had extended loan to SPCPL during the Assessment Year 2019-20 and 2020-21 amounting to Rs.677 Crores and to Roxanna in Assessment Year 2020-21 amounting to Rs.150 Crores.

3.1. After considering the submissions made by the assessee, ld. Assessing Officer passed the assessment order making an addition of Rs.63,91,85,245/- towards interest income not accounted on accrual basis. Details of addition made by the ld. Assessing Officer is tabulated as under:

3.2. In the first appeal before the ld. CIT(A), additions so made are deleted. While giving relief to the assessee, ld. CIT(A) in para 6.5.5 made certain factual notings. He noted that SPCPL group was passing through financial stress because of which assessee did not receive interest income from SPCPL and Roxanna. Also, SPCPL had not accrued interest expense in its books of account as interest payable for which copy of notes forming part of the financial statement of SPCPL was submitted whereby in note No.8, it was disclosed and reported that SPCPL had received letter of waiver of interest from the assessee and other persons to whom it owed payment of interest. On this account, assessee also submitted copy of resolution passed by the Board of Directors of SPCPL on the decision of the assessee to waive off the interest. Ld. CIT(A), thus concluded in para 6.5.6 that assessee being a non-corporate assessee is legally allowed to change method of accounting from mercantile to cash. Since no income is received by the assessee during the year under consideration by following cash system of accounting, no interest income from SPCPL and Roxanna could be brought to tax in the year under consideration.

4. We have heard both the parties and perused the material on record. Considering the submissions made before us and upon going through the orders of the authorities below as well as synopsis filed by the ld. Counsel of the assessee, we give our observations and findings hereunder.

4.1. It is an undisputed fact that assesse belongs to promoter family of SPCPL and Roxanna. In order to bail out the group which was under financial stress, assessee had extended loans to both the companies. Assessee extended the loans out of funds received from his father as gift. This fact is stated in impugned assessment order at para 12(a) forming part of the submissions made by the assessee in compliance to notice u/s.142(1) dated 17.08.2022. In this respect, assessee furnished copy of bank account statement and income-tax return to corroborate this fact. Ld. Assessing Officer has not doubted this explanation furnished by the assessee on the source of funds for granting loans to SPCPL and Roxanna. In this context, it is important to note that there is no interest cost incurred by assessee on the fund so made available to both the companies by extending loans to meet their financial crisis.

4.2. Due to the financial difficulties at the end of both the companies, they did not pay interest to the assessee on the loans so extended by him. Since assessee adopted cash system of accounting, he did not record the interest income during the year by including it in the total income reported in the return filed by him. Stand taken by the assessee is that he neither received the interest income nor this interest income accrued to him during the year. Contrary to this, ld. Assessing Officer completed the assessment by holding that interest income had accrued in the hands of the assessee and added it to the total income. Details of loans given by assessee and component of interest thereon are already tabulated above and therefore not reiterated.

4.3. We first take up the transaction of loan with SPCPL in respect of which addition of interest income of Rs.55,10,49,999/- is made by ld. Assessing Officer. In relation to the loan granted to SPCPL, it had requested assessee for waiver of interest on account of severe financial stress, there being little or no possibility of interest payment by it. Being a promotor, Director, assessee extended his waiver of interest which was accepted by SPCPL in its Board of Directors meeting. This fact was disclosed in the financial statements of SPCPL included in its Annual Report for the year. The note contained in the financial statement of SPCPL is reproduced as under:

“5. We draw attention to Notes 2(b), 53(ii) and 55 to the standalone financial statements which indicate material uncertainty in the timing of the cashflows on account of the One Time Restructuring (OTR) application dated September 17, 2020 made by the company to its lenders and cash flows from monetization of assets; the constraints in the promoter fund infusion and the commitment of the company towards its subsidiaries, joint ventures, and associates. Consequently, companies ability to continue as a going concern is essentially dependent on approval of the resolution plan by the lenders of the company as well as the lenders of the respective group entities, timing of cashflows from monetization of assets and infusion of funds by the promoters to bridge any further shortfall with regards to its obligations and other matters as described in the said Notes. Our opinion is not modified in respect of this matter.”

4.4. Accordingly, SPCPL did not accrue interest expense in its books of account as interest payable and correspondingly there was no deduction of tax at source done by it. Since there was no interest accrued at the end of SPCL and no TDS thereon, this transaction did not reflect in Form 26AS of the assessee for the year under consideration.

4.5. On these facts, ld. Assessing Officer observed in para 16 of his order that SPCPL did not furnish any documentary evidence in support of request for waiver of interest made by it to the assessee and its acceptance in the Board meeting. He also noted that audited financials of SPCPL does not mention any such event of waiver of interest from the assessee during the year under consideration. He thus, concluded that it is nothing but an afterthought, done to avoid immediate financial burden of depositing required TDS on interest accrual.

4.6. However, we note that ld. CIT(A) has taken cognizance of the documentary evidences in request of waiver of interest duly accepted by the company in its Board meeting and the disclosure made by it in its audited financial statement. It is also important to note that ld. Assessing Officer had issued notice u/s.133(6) to SPCPL which was duly complied by it, by uploading the details along with corroborative documents on the portal of the Department. On observation of ld. Assessing Officer, that possibility cannot be ruled out that assessee might have taken benefit equal to the amount of accrued interest from SPCPL either directly or indirectly, it was submitted that SPCPL had earned significant capital gain on sale of Sterling and Vincent Solar Pvt. Ltd. (monetization of assets) during the year and if it had to take any benefit, it could have done so by accruing the interest expense to reduce the capital gain to that extent, which was in fact not done by SPCPL.

4.7. Ld. Assessing Officer has given significant thrust to the fact that assessee was following accrual basis of accounting in the immediately preceding year, i.e., Assessment Year 2019-20, wherein he had included interest income from SPCPL on accrual basis in his return and also claimed credit towards TDS done thereon. However, in the year under consideration, i.e., Assessment Year 2020-21, assessee claims to change the method of accounting from accrual basis to cash basis which he did not accept. He observed referring to provisions of section 145(1) that the said section explicitly mandates to follow method accounting on regular basis. Rejecting the contention of assessee of not including the interest income on account of change in method of accounting from accrual basis to cash basis, ld. Assessing Officer included interest income on accrual basis in respect of loans given to SPCPL and added it to the total income of the assessee even though there was no such accrual at the end of SPCPL in its books of account.

4.8. On the aspect of change in method of accounting, we note that assessee did change the method of accounting in respect of interest income on loan given to SPCPL which was on accrual basis in the immediately preceding Assessment Year and changed to cash basis in the year under consideration. We refer to provisions contained in section 145 which are reproduced as under:

“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 [income computation and disclosure standards] to be followed by any class of assessees or in respect of any class of income.

3.Where the Assessing Officer 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) “[has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under.9. Sub-section 1 inter alia requires that in respect of income from other sources, the method of accounting could be either cash or mercantile system regularly employed by the assessee subject to income computation and disclosure standards notified by Central Government which are to be followed by any class of assessee or in respect of any class of income. Sub-section 3 requires that where Assessing Officer is not satisfied about the method of accounting prescribed in sub-section 1, not followed regularly by the assessee then, Assessing Officer may make an assessment in the manner provided in section 144.

4.9. Choice of employing system of accounting of either cash or mercantile is with the assessee as contained in section 145(1). Under Section 145(3), Assessing Officer may make an assessment in the manner prescribed in section 144 after recording his satisfaction as to method of accounting not regularly followed by the assessee. In our view, provisions stated above cannot be interpreted to mean that once a system of accounting is adopted, it can never be changed. It must be appreciated that ‘regular’ does not mean ‘permanent’. It must be noted that method of accounting adopted by assessee cannot be disregarded, merely because tax will be deferred and paid in the year of receipt of interest income by following cash basis of accounting. What is material for the purpose of section 145 is that method of accounting should be such as to enable the real income to be properly deduced therefrom. What can be taxed, is only real income. If income does not result at all, there cannot be a tax, even though in book keeping an entry is made about a hypothetical income which does not materialize. This observation find force from various judicial precedents of Hon’ble Supreme Court including in the case of Shoorji Vallabhdas and Co. [1962] 46 ITR 144 (SC), Excel Industries Ltd., [2014] 358 ITR 295(SC). Change in method of accounting is not impermissible or barred, more particularly when assessee explains the situations which warrants such a change. Hon’ble High Court of Punjab and Haryana in the case of CIT vs. Punjab State Industrial Development Ltd. [2002] 255 ITR 351 (P&H) held that –

“Reliance is placed on the decision of Punjab and Haryana High Court in the case of CIT v. Punjab State Industrial Development Corp Ltd [2002] 255 ITR 351 (Pun) & Har) (Refer page no. 197-198) wherein it was held that on perusal of section 145, the income could be computed “in accordance with the method of accounting regularly employed by the assessee”. It is undoubtedly correct that the statute stipulates that the income shall be computed on the basis of the system of accounting ‘regularly’ followed by the assessee. It should mean during the period under consideration. However, the provision cannot be interpreted to mean that once a system of accounting is adopted, it can never be changed.”

4.10. In the present case, assessee has changed the method of accounting from mercantile system to cash system in the year under consideration. In this respect justifiable reasons and corroborative actions taken have been explained by the assessee. Assessee is a non-corporate assessee who is permitted to follow either of the cash or mercantile system of accounting for recognizing his income. In the case of companies, they are mandatorily required to follow accrual basis of accounting. In respect of loans given to SPCPL, assessee had waived interest which was accepted by the company by way of resolution in its Board of Director’s meeting with appropriate disclosure in its audited financial statements. Company did not claim any interest expense in its profit and loss account nor provided for TDS in that respect. Thus, there was no occasion for the company to accrue interest expense and for the assessee to include the same in his return of income. In the given set of facts, whether assessee followed accrual or cash system, amount of interest on loan to SPCPL cannot be taxed in the hands of assessee. Owing to waiver by the assessee, interest on loan did not accrue and was not accounted in the books of SPCPL. Under the cash system also, interest which was waived was never received in the hands of the assessee nor paid by SPCPL. Further, on the aspect of system of accounting being regularly followed by the assessee, he submitted that in the subsequent years, after the change in the year under consideration, cash system of accounting has been regularly followed for which he placed the necessary material before the ld. CIT(A) and considered by him.

4.11. Now, we take up the second transaction of loan given by the assessee to Roxanna which arose in the year under consideration alone. In this respect, ld. Assessing Officer made an addition of interest income of Rs.8,81,35,246/-. Ld. Assessing Officer had issued notice u/s.133(6) to Roxanna also, who had complied with the same. In this case, Roxanna had accrued interest expense in its books of accounts and done TDS on the same. However, the same was not paid to the assessee during the year under consideration. This transaction reflected in Form 26AS of the assessee for the year under consideration. Since assessee having adopted cash system of accounting in this year and having not received the interest income from Roxanna, accrued by it in its books of account, assessee did not include this interest income in his total income reported in the return filed by him. He carried forward the TDS credit to the subsequent year. In this respect, assessee claimed before the authorities below that this will be offered to tax in the year in which the same is received by him. Accordingly, in this case, a timing difference has occurred on the taxability of the interest component since Roxanna had accounted for it in its books of account by following mercantile system of accounting whereas assessee has deferred it owing to non- receipt, by adopting cash system of accounting.

5. On the above stated observations on the two transactions of assessee with SPCPL and Roxanna, the issue at hand is to adjudicate whether change in method of accounting from mercantile to cash basis undertaken by assessee is valid in accordance with section 145 and whether assessee is liable to tax on an income which he has not received during the year.

5.1.On the issue relating to change in method of accounting from mercantile to cash basis by the assessee, as observed by us in above paragraphs, ‘regular’ cannot in the present context mean ‘permanent’. Change in method of accounting is not prohibited when warranted by situations which has been justifiably explained by the assessee. Assessee had demonstrated that once changed, he has regularly followed the method in the subsequent years. Assessee has affirmed to offer the income as and when he receives it. Keeping all the above discussions in juxtaposition, in our considered view, change of method of accounting from mercantile to cash by the assessee in the year under consideration is a legitimate exercise. Assessee has explained that it is a genuine and bonafide exercise arising out of compelling reasons of financial distress at the end of borrowers.

5.2. On the second aspect of subjecting assessee to tax on interest income which he has not received, we have held the change in method of accounting from mercantile to cash system justifiable and legitimate. Having held so, non-receipt of interest income during the year from both the parties, namely, in the case of SPCPL where assessee has waived the interest which has not even been accrued by it in its books of account to claim it as an expense and Roxanna having accrued the interest expense in its books of account has not paid the same to the assessee, cannot be added in the hands of the assessee on accrual basis as done by the ld. Assessing Officer.

6. accordingly ,we do not find any infirmity in the finding arrievd at by id.CIT(A)in diline the additoin made by id. assering officer towords interest income on long give to the two companies in the result ,grounds raised by the revenue are dismissed .

7. in the result ,appeal of the revenue is dismissed .