2007 (12) TMI 473 - AT - Income Tax

Construction company wins appeal against assessed income for AY 2003-04 due to project unviability

The Tribunal allowed the appeal of the construction company against the CIT(A)'s order confirming the assessed income at Rs. 4,99,260 for the assessment ... - ISSUES PRESENTED AND CONSIDERED 1. Whether interest specified in a development agreement, but not received or payable due to impossibility of project completion, is taxable on accrual under the mercantile system as a notional income. 2. Whether interest under section 234B (interest for default in payment of advance tax) is payable where the assessing addition for accrued interest is disallowed because the income is notional and not realized. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Taxability of contractual interest on accrual (notional income) under mercantile accounting Legal framework: The revenue treated accounts on mercantile basis and assessed interest income on the basis that contractual interest accrued on deposits made under a development agreement; taxation generally follows accrual where income has 'arisen' or 'accrued' under the relevant accounting system unless the law requires receipt basis treatment or some other disqualification. Precedent Treatment: No specific judicial precedents were invoked or relied upon by the Tribunal in the judgment; the Tribunal addressed the issue on statutory and factual grounds rather than by following or distinguishing reported decisions. Interpretation and reasoning: The Court examined the terms of the development agreement which provided for a refundable security deposit and payment of interest at 12% per annum 'from the date of payment ... until completion of construction.' The Tribunal found that although deposits were made, the statutory authorities refused consent/FSI rendering the project legally unfeasible and preventing completion. As a result the contractual condition (payment of interest 'until completion') could not be satisfied; in substance no interest was realized or paid. The Tribunal treated the claimed accrual as purely notional because the legal impossibility of the project meant there was no income in fact arising or becoming due to the taxpayer in the year under consideration. Ratio vs. Obiter: Ratio - The Tribunal held that where contractual interest depends on performance/continuation of a development project and the project becomes legally unviable so that interest is neither due nor paid, such interest cannot be treated as taxable accrual merely because the assessee follows mercantile accounting. This enunciates the principle that notional/unrealized income, which has not accrued or arisen in fact, is not subject to assessment. Conclusions: The addition made by the assessing officer treating the undeclared interest as income on accrual basis was deleted. The Tribunal concluded there was no material on record to show the interest income was realized or that it had in fact accrued given the legal impossibility of project completion; therefore the assessable income cannot include the notional interest. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Consequence for interest under section 234B Legal framework: Section 234B imposes interest for default in payment of advance tax where tax payable is not fully covered by advance tax; such interest is consequential upon there being tax payable on returned/assessed income. Precedent Treatment: The Tribunal applied the statutory operation of section 234B as consequential to the primary assessment decision rather than relying on case law. Interpretation and reasoning: Because the primary addition for accrued interest was set aside (no taxable income), there was no resultant tax liability arising from that addition. Consequently, the foundational basis for imposing section 234B interest - tax liability on the disallowed accrual - did not exist. Ratio vs. Obiter: Ratio - Where an addition is deleted because the income was notional and did not accrue, any consequential interest under section 234B predicated on that deleted addition must also fall away. Conclusions: Interest under section 234B was held not payable insofar as it related to the deleted addition for notional interest; the issue was decided in favour of the assessee. Cross-reference The decision on section 234B directly follows from and is contingent upon the conclusion on taxability of the contractual interest: deletion of the assessed notional interest drives the finding that consequential interest under section 234B is not leviable.