2021 (7) TMI 440 - AT - Income Tax

Tribunal clarifies hybrid accounting, related party status, and income accumulation under section 13(3).

The Tribunal upheld the Assessing Officer's principle regarding the impermissibility of the hybrid accounting system but provided a method to avoid double ... Assessment of trust - assessment of interest on accrual basis - assessee is following mercantile system of accounting as per its audit report and accounts - assessee's claim of exemption being the interest income accrued but not received during the previous year as the assessee followed the mixed system of accounting i.e. cash system for receipts and mercantile system for expenses - HELD THAT:- We are of the considered opinion that the system followed by the assessee of only accounting interest income on receipt basis is not sustainable. Assessing Officer is correct principally in holding that the assessee is required to account for the interest on accrual basis - Assessee is accounting for the interest on receipt basis. Hence, assessee must have accounted for the interest of earlier year which has been received during the year on receipt basis. Hence, by this change of method of accounting the assessee’s income would include interest income of earlier year received during this year as well as interest income accrued for the year. This will amount to taxing more interest income than that what is legitimately taxable for this year. Hence we are of the opinion that from the interest accrued for the year the interest income of earlier year which had accrued in earlier year but were accounted for on receipt basis during this year should be reduced. The resultant figure should be added to the income of the assessee. Transaction between the related concerns - After examining shareholding pattern of the person specified, learned CIT(A) has given a finding that clause (a) to (d) of section 13(3) of the Act are not applicable - CIT(A) has given a finding with respect to section 13(3)(e) of the Act the said clause is not applicable here. CIT(A) has given a finding that he has examined the shareholding pattern of ABHSL and also compared the same with the list of the trustees of the appellant trust. He has found that Mrs. Rajshree Birla, Mr. B.L. Shah and Mr. Ashwin Kothari are the three people who are the Trustees of the Appellant Trust and shareholders of ABHSL. Total shares held by these three persons collectively are 30 shares as compared to the total share capital of 50,000 shares of ABHSL. Even collectively, the shareholding of the Trustees in ABHSL is far below the threshold of 20%. Hence CIT(A) held that in view of specific provisions of section 13 of the Act he held that ABHSL is not a related party under section 13(3) of the Act and thus addition made by the Assessing Officer is deleted. Apparently there is no error in the finding of learned CIT(A). Learned CIT(A)-DR could not cogently rebut the learned CIT(A)’s finding but tried to make out of the case that the shareholder list of ABHSL may be obtained and thereafter further examination can be done. In this regard we are of the opinion that there is no such case made out by the Assessing Officer in the assessment order. He has simply made a presumption without actually analyzing the facts. It is settled law that mere presumption is not sustainable. Quantification of rent - We find that once the assessee is not falling the ambit of section 13(1) of the Act this issue does not arise. Application for accumulation of income in Form 10 for the previous year - HELD THAT:- CIT(A) has passed a correct order as held that it is not disputed that the Appellant had filed Form No. 10 along with its return of income. Thus, after giving effect to the appellate order if there is any surplus income for the current year for set off of past deficit, if any, then the AO is directed to consider Form No. 10 filed by the Appellant and compute the income as per law. Issues Involved:1. Exemption of interest income accrued but not received.2. Hybrid system of accounting.3. Addition under section 13(3) due to lower rent from a related party.4. Accumulation of income under section 11(2).Detailed Analysis:Issue 1 & 2: Exemption of Interest Income Accrued but Not Received & Hybrid System of AccountingThe primary issue revolves around the assessee's claim for exemption of Rs. 3,96,94,179/- as interest income accrued but not received during the previous year, due to the assessee following a mixed system of accounting. The Assessing Officer (AO) argued that the assessee, being a company registered under section 25 of the Companies Act, 1956, was statutorily required to follow the mercantile system of accounting. The AO reworked the interest income using section 144, stating that the hybrid system of accounting was not permissible under section 145 of the Income Tax Act.The CIT(A) deleted the addition, noting that the assessee had consistently followed the cash system for interest income and that this practice had not been disputed in earlier years. The CIT(A) also referenced a similar case where the addition was deleted.Upon appeal, the Tribunal noted that while the assessee followed the mercantile system for other income and expenses, it accounted for interest income on a cash basis. This hybrid system was deemed impermissible under section 145. The Tribunal agreed with the AO's principle but acknowledged that including both accrued interest for the current year and received interest from previous years would result in double taxation. Therefore, it directed that the interest income of earlier years received during the current year should be reduced from the accrued interest for the year before making the addition.Issue 3: Addition under Section 13(3) Due to Lower Rent from a Related PartyThe AO added Rs. 8,78,94,440/- under section 13(3), alleging that the assessee charged lower rent to a related party, ABHSL, which was not at arm's length. The AO used third-party websites to determine fair rental value and later revised the addition to Rs. 2,61,17,501/- based on the DVO's report.The CIT(A) deleted the addition, holding that ABHSL was not a related party under section 13(3) as the trustees' collective shareholding was far below the 20% threshold. The CIT(A) also noted that the rent was approved by the Charity Commissioner and was revisable every five years.The Tribunal upheld the CIT(A)'s decision, stating that the AO's presumption was not supported by evidence. It emphasized that mere presumption is not sustainable and that the AO's reliance on notional addition or DVO's valuation was not tenable under the law. The Tribunal found no error in the CIT(A)'s findings and concluded that the assessee was not a related party under section 13(3).Issue 4: Accumulation of Income under Section 11(2)The AO failed to give effect to the assessee's application for accumulation of income in Form 10. The CIT(A) directed the AO to consider Form 10 and compute the income as per law if there was any surplus income after giving effect to the appellate order.The Tribunal upheld the CIT(A)'s order, agreeing that it was a consequential issue and that the CIT(A) had passed a correct order.Conclusion:The Tribunal's judgment addressed multiple issues, primarily focusing on the permissibility of the hybrid accounting system and the relationship between the assessee and ABHSL. The Tribunal upheld the AO's principle regarding the hybrid system but provided a method to avoid double taxation. It also confirmed that ABHSL was not a related party under section 13(3) and directed the AO to consider the accumulation of income as per Form 10. The Revenue's appeal was partly allowed.