2025 (9) TMI 1568 - AT - Income Tax

Notional interest on interest-free mobilization advances disallowed under Section 37 where income not accrued and costs capitalized.

ITAT MUMBAI (AT) directed deletion of the AO's addition of notional interest on interest-free mobilization and other advances given to the principal EPC ... Addition towards notional interest received by assessee - assessee had given interest free advance to the principal EPC contractor when the assessee had obtained short-term and long-term advances from Bank/Financial Institutions, which carried interest @ 11% p.a. - AO has computed the notional interest on the advances given to the principal EPC contractor @ 10.35% which is added as income u/s 37 of the Act. HELD THAT:- A plain reading of Clause 6 indicates that the assessee was obliged to pay 15% of the contract price as interest free mobilization advance upon signing of the agreement, which mobilization advance was recoverable on pro-rata basis from the bills of the Principal EPC Contractor. The Concessioner shall provide advance to Principal EPC Contractor in addition to the mobilization advance as and when required to complete the work within scheduled time and the same shall be recovered on prorata basis from subsequent bills of the Principal EPC contractor. It is trite that no tax can be levied on hypothetical or notional income or the income which is not actually earned or accrued. CIT(A) has found on facts that substantial portion of the mobilization advance has been recovered and upon completion of the project 95% of the mobilization as well as additional advance has been recovered by 30.09.2017. He has found on the basis of the ledger account produced by the assessee, that subsequently the balance amount has also been settled by 01.12.2019. Assessee has not claimed any interest expenditure for the interest paid on the short-term/long-term advances from the banks/financial institutions. Interest expenditure has been capitalized as a part of the project cost, which would be amortized over the concession period post the completion of the EPC contract. CIT(A) has found, and in our view rightly so, that the impugned addition cannot be sustained. ISSUES PRESENTED AND CONSIDERED 1. Whether the reassessment notice under section 147 read with section 144B was validly issued where the assessment had earlier undergone complete scrutiny under section 143(3) without any addition on the subject matter. 2. Whether the Assessing Officer was justified in making an addition by imputing notional interest income on interest-free mobilization and other advances granted to the principal EPC contractor, assessed as income under section 37 (or otherwise chargeable to tax). 3. Whether contractual obligation to provide interest-free mobilization advances, recovery of such advances during the project, and capitalization of borrowing costs preclude the levy of tax on notional interest. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Validity of Reopening under section 147 read with section 144B Legal framework: Reopening under section 147 requires tangible material/evidence indicating income has escaped assessment; a mere change of opinion is not permissible. Section 143(3) scrutiny culminates in an assessment which, if complete on the subject matter, raises the bar for subsequent reopening. Precedent treatment: The Court treated prior scrutiny under section 143(3) as a relevant factor; well-established principle that reopening must be based on fresh tangible material and not a mere change of opinion was applied (the Court followed that principle rather than citing or distinguishing specific authorities in the text). Interpretation and reasoning: The record showed an earlier full scrutiny assessment dated 19.07.2019 with no addition on the advances issue. The Assessing Officer later relied on unspecified 'material and information' to assert escaped income but did not point to any particular new material which was not available or considered during the scrutiny. The Tribunal found absence of specific fresh material to justify reopening. Ratio vs. Obiter: Ratio - Reopening held invalid where no new tangible material was identified and the issue had already been examined in scrutiny assessment; conclusion forms part of the operative decision. Obiter - Remarks on the CIT(A)'s refusal to examine reopening challenge are incidental. Conclusions: The reassessment was a mere change of opinion and thus unjustified. The cross-objection challenging reopening succeeds; assessment reopened under section 147 read with section 144B is quashed to that extent. Issue 2 - Legitimacy of imputing notional interest on interest-free advances Legal framework: Tax cannot be levied on hypothetical or notional income that is not actually earned or accrued. The characterisation of receipts/advances depends on contractual terms and actual receipt/settlement; taxation requires real accrual or receipt unless specific statutory provision imputes income. Precedent treatment: The Court relied on the settled proposition that notional income is not taxable unless law provides; prior treatment at first assessment (no addition) supported that approach. No authority was expressly overruled or followed by name in the judgment, but the Tribunal applied established principles regarding notional income. Interpretation and reasoning: Clause 6 of the EPC contract expressly provided for an interest-free mobilization advance (15% of contract price) and additional recoverable advances as and when required, recoverable pro rata from contractor bills. The Tribunal held that such contractual obligation establishes the nature of payments as advances recoverable through project billing rather than income-bearing transactions. Further factual findings showed substantial recovery of mobilization and additional advances (95% recovered by 30.09.2017 and balance settled by 01.12.2019), undermining any claim of ongoing income accrual. Ratio vs. Obiter: Ratio - Notional interest cannot be added where advances are contractually interest-free, are recoverable under the contract, and were in fact recovered; addition on the basis of hypothetical interest is unsustainable. Obiter - Ancillary observations on normal industry practice and obligation under the EPC contract are supportive but not dispositive beyond the facts. Conclusions: The addition of Rs. 8,46,66,000 as notional interest is unsustainable on merits because (a) the advances were contractually interest-free and recoverable, (b) the bulk of the advances were actually recovered within the project timeline, and (c) tax cannot be levied on notional income not actually earned or accrued. The Tribunal affirmed deletion of the addition by the CIT(A). Issue 3 - Effect of capitalization of interest expense and absence of interest claim on deductions Legal framework: Interest on borrowings used for project finance can be capitalized as part of project cost and amortized over the concession period; capitalization affects the deductibility and timing of interest costs and interacts with claims of imputing income against related-party non-interest advances. Precedent treatment: The Tribunal considered the factual position that the assessee capitalized interest and did not claim interest expenditure as a current deduction, treating capitalization as proper treatment for project-related borrowing costs. Interpretation and reasoning: The assessee did not claim interest paid to banks/financial institutions as an expense in the relevant year; instead such interest was capitalized as project cost and to be amortized post-completion. Given capitalization, there was no contemporaneous interest benefit claimed that could be matched by imputing income from interest-free advances. This factual posture reinforced the conclusion that no taxable notional income arose in the year under consideration. Ratio vs. Obiter: Ratio - Capitalization of borrowing costs and non-claim of interest as an expense are relevant factual circumstances that negate the basis for assessing notional interest in the year; incorporated into the decision on merits. Obiter - Observations about broader industry practice remain illustrative. Conclusions: Capitalization of interest and non-claim of interest deduction in the relevant year materially supported the deletion of the notional interest addition; these facts contributed to the Tribunal's conclusion that the impugned addition could not be sustained. Cross-references and Interplay between Issues 1. Issue 1 (reopening) and Issue 2 (notional interest) are interlinked: absence of fresh material to justify reopening impacted the legitimacy of the subsequent notional interest addition; independently on merits Issue 2 also failed. 2. Issue 3 supports Issue 2: accounting treatment (capitalization) and actual recovery of advances corroborated the factual basis that no notional income had accrued, reinforcing both the merits decision and the conclusion that reopening was unnecessary. Final Conclusions The Tribunal dismissed the Revenue appeal on merits by upholding deletion of the notional interest addition and allowed the assessee's cross-objection to the extent that the reassessment under section 147 read with section 144B was a mere change of opinion and therefore invalid. The order of the lower authority deleting the addition is sustained.