TaxTMI 
TaxTMI 
2005 (9) TMI 231
X X X X Extracts X X X X
X X X X Extracts X X X X
....ng year and the AO had rightly pierced the corporate veil and found that the assessee's claim of non-accrual of interest did not appear to be bona fide and correct. It is also the case of the Revenue that the CIT(A) ought to have ignored the agreement between the assessee and Reliance Industries Ltd. (RIL), Reliance Industrial Infrastructure Ltd. (RIIL) and Lavanya Holdings and Trading (P.) Ltd. (Lavanya), as the only purpose of so-called agreement was to transfer funds from the assessee-company to the above three companies all belonging to Reliance group of companies and these agreements were not at arms length. 4. The facts leading to the dispute, briefly, are as under: Assessee filed the return on 28th Nov.,1994, declaring taxable income at Nil. Assessee-company was incorporated on 3rd Sept., 1991, previously known as 'Reliance Refinery (P) Ltd.' Subsequently, its name was changed to 'Reliance Petroleum Ltd.' (RPL) from 16th April, 1993 onwards. 5. In the statement of income attached with the assessee's return for the asst. yr. 1994-95, income was shown at Nil, subject to notes. The notes read as under:- --------------------------------------------------- "(1) a. ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ead "Miscellaneous Expenses". This treatment is in consonance with the decision of Andhra Pradesh High Court in the case of CIT vs. Nagarjuna Steels Ltd. (1988) 71 CTR (AP) 118 : (1988) 171 ITR 663 (AP). Andhra Pradesh High Court in the above decision has considered the guidelines issued by the Institute of Chartered Accountants of India in their compilation called "Study on expenditure during construction period" and held that the difference between the pre-operative expenses and the income earned during construction period has to be capitalised. Andhra Pradesh High Court in the case of CIT vs. Andhra Farm Chemicals Corporation (1988) 171 ITR 660 (AP) and Delhi High Court in the case of Snam Progetti vs. Addl. CIT (1981) 132 ITR 70 (Del) have also held that the income during the construction period is to be capitalised:" 6. During the course of assessment proceedings, AO noticed, assessee has credited as income received/accrued, among other, the following three items: ---------------------------------------------- Interest accrued on deposit Rs. given to Reliance Industries Ltd. 42,60,92,054.79 Interest ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ted any interest in their accounts to the assessee. Confirmation letters were filed from all the three companies by the assessee, requesting not to treat the interest of Rs. 46,74,87,123 credited in assessee's accounts and reversed subsequently as income for the year under consideration. Assessee also pointed out that no interest is receivable on debentures as well, as per the terms of issue. 8. AO noted that it is actually surprising-first the assessee-company credited the interest in its books of account during the relevant assessment year and reversed the same in the subsequent year, claiming that no interest has accrued or receivable at all. AO further noted, as on the last day of the previous year, i.e. on 31st March, 1994 and in fact even upto September, 1994, i.e., the date of signing of the final accounts, the whole group along with the auditors, were clear in their minds and there was no doubt that interest had accrued to the assessee. AO further notes that even in the audit report dt. 24th Nov., 1994, against the column "Method of accounting employed", the auditor stated as under: "The company generally follows accrual system of accounting both as to income and expe....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sessee made the claim of interest vide their letter dt. 20th Oct., 1994 from RIL, it was immediately rejected by RIL vide their letter dt. 21st Oct., 1994. Similar was the case with Lavanya and RIIL. It was again repeated that none of these parties (three companies) claimed deduction for interest in their books of account. It was stated, various specifications required from the assessee-company for the purpose of finalisation of the orders for purchase of materials with various parties were also not provided by the assessee-company. Thus the delay in execution of the contract was due to assessee's fault. On account of this, the matter of interest was considered by the board of directors and was decided to reverse the charge of interest made in the books for the year ended on 31st March, 1994. Entries were reversed on 31st Oct., 1994. It was also stated that the board of directors, while considering the contract, also had taken note of the fact that charging of interest was not specifically permitted. It was submitted, the action of the AO in not accepting the above facts was wrong, as such liable to be reversed. 11. The assessee relied upon the following decisions in support of ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rewrite the agreement. It was further submitted, with regard to Lavanya and RIIL, that even if it were to be assumed that the funds were diverted for non-business purposes, the maximum that could be done is to disallow the interest paid but it was not open to the AO to compute the interest. It was further submitted, in the case of the assessee, RIL never agreed to pay interest. Therefore, there is no accrual. Merely because RIL agreed to pay to some other party, it does not mean that interest also accrued to the assessee. 14. The CIT(A), taking note of the fact of the agreement entered into between the parties, particularly cl. 9(a) of the agreement dt. 29th Sept., 1993, wherein the question of interest was specifically ruled out and also considering the purchase orders placed with Lavanya and letter of intent issued to RIIL for supply of project material required for SBM project of Gulf of Kutch, wherein there was no provision of interest, he held that the claim of the assessee is on the right direction. He also noted that inspite of non-charging interest clause, assessee tried to charge interest and made entries in its books of account to that effect. A letter was written on 2....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n the case of Beni Prasad Sidh Gopal, CIT(A) held that 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 materialise. The Hon'ble High Court held that the amount shown in the account as due from a particular person cannot be treated as merely assessee's income because he has shown it, unless the other party also admits it. Further, for the above proposition, the CIT(A) also relied upon the decision of the Hon'ble Supreme Court in the case of Hindustan Housing and Land Development Trust Ltd. He held that in the instant case of the assessee there is no dispute that the other parties repudiated the claim for interest made on them by the assessee. In the light of the above facts, the CIT(A) held that the assessee has no right to charge interest on the advances made to RIL, Lavanya and RIIL. 17. With reference to the AO' s stand that the assessee is bound by the entries made in the books of account and it is not open for the assessee to take a contrary position from that of the entries made in the books of account, CIT(A) held that this is incorrect. Particularly relying upon the decision ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... that the assessment made in the case of RPEL and RPPL provides guidelines as to the assessment to be made in the case of the assessee also, he held, is wholly misplaced. The most important distinguishable fact in both the cases of these companies, i.e., in the case of RPEL and RPPL is that it was accepted by RIL that interest would be paid and it was actually paid. 19. Coming to the AO's observation that it is permissible to lift the corporate veil, CIT(A) held that this is also incorrect. He held that in the case of RIL more than 50 per cent of the shares are held by the public and close to 75 per cent of the shares held by financial institutions/banks, mutual funds and the public. There are nominee directors of the financial institutions on the board of RIL and also of the assessee. Only four of the Directors are common in both the companies. In these circumstances, he held, it appears that the suggestion made by the AO is far-fetched. He held that RIL is the promoter of the assessee, but that by itself does not lead to a conclusion that the assessee is a front company of RIL. He records, the Courts have often lifted the corporate veil for the benefit of members of the compan....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... of the auditors. Commenting on auditors' duty, he submitted, if there is any cause or reason to doubt in the mind of the auditor as to the accuracy of certain entries in the balance sheet or they are such that, if disclosed they would show the balance sheet in a different light, those facts must be conveyed to the shareholders and it is the duty of the auditor to make a full, careful and truthful report, in default of which he must be held to have failed to discharge his obligation. If any auditor certifies contrary to the above they are liable to be treated as unqualified and unfit to be a member of the Institute. Thus the learned senior Departmental Representative submitted, once the auditor certified and board of directors ratified the accounts, the company cannot go back from its responsibility. The learned senior Departmental Representative, getting support from the decision of the Tribunal, Mumbai Bench, in the case of ITO vs. Shreyas Shipping Ltd. (2002) 76 TTJ (Mumbai) 11 : (2003) 86 ITD 556 (Mumbai), submitted that the method of accounting followed by the assessee in writing his books of account has to be compulsorily taken as basis of computation of income in assessment ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....aging director of the company. Therefore, the credibility of the explanation given by the assessee with regard to the dispute between the assessee and three companies, as also the, agreement with RIL is highly suspected. Rs. 796 crores, Rs. 100 crores and Rs. 175 crores were advanced to RIL, RIIL and Lavanya during the year and RIL refunded substantial amount and only a net amount of Rs. 115 crores was standing at the close of the accounting year. He further submitted, though similar agreements entered into by two other group companies with RIL, RIL agreed to pay interest at the rate of 9 per cent on advances, which shows that the stand of the Revenue is very reasonable. 22. The learned senior Departmental Representative objected to the finding of the CIT(A) and contended that the agreement dt. 29th Sept., 1993 itself is suspicious. CIT(A) was not correct in holding that no right to receive interest vested in the assessee and, therefore, it cannot be said that there was a legally enforceable right to claim interest from RIL and the other two companies. He held, CIT(A)'s reliance in the case of E.D. Sasson & Co. Ltd., Nadiad Electric Supply Co. Ltd., Bharat Petroleum Corpn. Ltd.'....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r, envisages assessee providing funds to RIL significantly without any written agreement and sub-cl. (c) states that RIL shall pay to contractors and suppliers. If the orders for contract are to be executed by the assessee directly with the contractors and vendors in terms of cl. 3 of the agreement, the provision of assessee making funds available to RIL for making payment in respect of such contract is inexplicable. Further, in this clause, it is stated that monies paid to contractor/vendor by RIL will be deducted from advances made by the assessee to RIL. Thus, the agreement itself envisages payment of moneys to RIL by the assessee in excess of and without reference to the amounts due to contractors/vendors, which is to be paid to RIL on behalf of the assessee. Finally, sub-cl. (d) of cl. 9 requires that advances made by the assessee to RIL be secured through deposit of marketable securities. Throughout the assessment and appellate proceedings, the assessee has not given the details of the securities deposited by RIL with the assessee. The learned senior Departmental Representative further submitted, there is no independent evidence on record to prove that the agreement was indee....
X X X X Extracts X X X X
X X X X Extracts X X X X
....IL to the assessee and at the same time, advances by the assessee to RIL. Further, it is to be noted that the amount advanced to RIL does not have any relationship or proportion to the scope of work envisaged under the agreement. It is also to be noted that claims of interest on RIL (as also on RIIL and Lavanya) was made on 20th Oct., 1994 and replies of the three parties denying any liability to pay interest was received within a few days thereafter. The assessee did not take any further action with regard to its claim. The letters addressed by the assessee to the three companies are curt as are the replies received thereto, clearly indicating that the claims and the denials were merely subterfuge to demonstrate to authorities a situation that did not exist in reality. Therefore, no reliance can be placed on this agreement to contend that the assessee had no enforceable right to interest particularly when the annual accounts unequivocally treated it as an income in its final accounts on temporary deployment of funds. For similar reasons, reliance placed by the assessee on other case laws is misplaced. (e) It has been held by a number of judgments of Hon'ble Supreme Court and Hi....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... was also provided, in the case of temporary deficiency or inadequacy of funds, then RIL was to assist in arranging temporary accommodation to meet such deficiency, RIL was to arrange funds in foreign exchange to meet assessee's requirements. In consideration of the above services as well which RIL is to discharge their obligations in respect of the assessee's project, assessee agreed to make certain funds available to RIL, But there was a stipulation that no interest will accrue or will be payable by RIL to the assessee on such funds. It is further the case of the assessee that RIL was not supposed to charge the fees in respect of making available various services, the assessee was also not to charge interest on the money made available, by virtue of cl. 9 of the agreement with RIL, This was beneficial agreement to both the sides and in the best interest of both the parties. 29. Assessee also placed a purchase order for supply of various materials on 2nd March, 1994 with Lavanya, Supply contemplated included structural steel, steel plates, enforcement steel and pipes etc, The value of the total purchase order was about Rs, 590,16 crores, In the purchase order issued to Lavanya,....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e amount so received as share capital as well from the calls received in advance, the assessee has given project advances to RIL, Lavanya and RIIL; also made investments in convertible debentures of Reliance Filaments Ltd.; units of UTI and bonds of various public sector undertakings. 31. In the return filed, the assessee submitted that the above interest income of Rs. 46,74,87,123 is not liable to be taxed and filed the return declaring Nil income. Assessee submitted, interest has not accrued as the same is not in accordance with the agreement/purchase order/letter of intent and is disputed by other parties; hence, it was mentioned as not offered for tax. 32. As mentioned above, the facts were not accepted by the AO for the reason that the accounts were signed by the managing director and approved by the auditors as well. He held, assessee belongs to Reliance Group and the same set of persons decided that interest accrued first and subsequently held not accrued; which is not acceptable. The rate of interest was pre-determined. The interest foregone was an afterthought. 33. When the matter was carried before the CIT(A), the CIT(A) accepted assessee's contention. He agreed ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ned counsel submitted, that the claims for interest were preferred by the assessee after the balance sheet was signed on 23rd Sept., 1994, though the entries in the assessee's books of account were passed at the time of finalisation of accounts. When the claim was rejected, the entries were reversed in the subsequent financial year. 36. Relying upon the decision of the Hon'ble Supreme Court in the case of E.D. Sasoon & Co. Ltd., learned counsel submitted, unless and until assessee's contribution or parenthood is effective in bringing into existence a debt or right to receive the payment or in other words a debitum in presenti, solvendum in futuro, it cannot be said that any income has accrued to him. 37. Relying upon the decision of the Hon'ble Supreme Court in the case of Godhra Electricity Co. Ltd., learned counsel submitted, the question whether there is real accrual income or not need to be considered by taking the probability or improbability or realisation in a realistic manner. Again relying upon the decision of the Hon'ble Supreme Court in the case of Hindustan Housing & Land Development Trust Ltd., learned counsel submitted, there is a clear distinction between the c....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rs, according to the Revenue, the assessee cannot go back and say that it was a mere entry in the books without accrual. Learned counsel submitted, another stand of the Revenue is that clauses of agreement are contradictory and due to common management much reliance cannot be placed on the clauses of agreement with RIL. He further objected learned senior Departmental Representative's pointing of various anomalies in the agreement. Learned counsel submitted, neither the AO nor the learned senior Departmental Representative could give any evidence in support of their argument that interest income on advances given to these three companies accrued to the assessee inasmuch as it has created a debt or right to receive in assessee's favour. 42. Learned counsel submitted, it is well settled principle that the entries made in the books of account is not final and determinative factor and it alone cannot be the basis for taxing an amount. He submitted, Companies Act lays down provisions for maintaining books of account based on norms and standards and cast a responsibility on the board of directors and the auditors to disclose the trading results truly and fairly; but the provisions of C....
X X X X Extracts X X X X
X X X X Extracts X X X X
....not consider it as a valid piece of evidence with regard to interest; we are unable to accept this proposition. RIL finalised their accounts on 18th July, 1994, prior to the finalisation of accounts by the assessee. In their audit report they had made no provision for interest as payable to the assessee. In the light of these facts, assessee's claim that interest not accrued on the advances is to be accepted, as any unilateral steps will not give assessee a legally enforceable right to receive interest. 45. Now the question is once after claiming it as accrued, can the assessee go back from the stand? First we have to note that the other parties have specifically denied their responsibility. In RIL's accounts, which was finalised prior to the claim of the assessee as mentioned above, no interest is provided as payable to the assessee. This crucial fact has to be kept in mind while considering whether unilateral claim of the assessee of interest will amount actually accrual of interest to the assessee only because the auditors certified it and the board of directors approved it. As rightly contended by the assessee, in the case reported in Godhra Electricity Co. Ltd. the Hon'ble ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....se to any legally enforceable right. It is not so. In the case of Nadiad Electric Supply Co. Ltd., the Hon'ble jurisdictional High Court held that sending the bills amounts to making a claim. It did not create a legally enforceable right nor a corresponding legally enforceable obligation on the other party. The same principle applies in the instant case of the assessee. Even, if we accept, the Revenue's contention that the agreement is sham and cannot be taken cognizance of because the parties in fact are the same being a family controlling the companies; we are afraid it does not further the case of the Revenue. In the absence of agreement there is no legally enforceable right on the part of the assessee to charge interest either. The Revenue, in such a case, at the the most can treat this amount as advance made for non-business purposes. There is no such case for the Revenue. The case of the Revenue is that since all the companies are controlled by (late) Shri Dhirubhai Ambani, Shri Mukesh Ambani and Shri Anil Ambani; the credibility of the explanation advanced by the assessee with regard to dispute between the assessee and the three companies is also to be highly suspected. This....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t is enforceable in law, does not amount to accrual of income. 48. We also find that the Hon'ble Supreme Court dealt with similar issue in the case of Bakaro Steel Ltd. In this case the assessee had shown in its books of account a sum as income from interest received from Hindustan Steel Ltd. for the eight locomotives supplied by the assessee-company to them. The entry in this regard was reversed in the next year since Hindustan Steel Ltd. had replaced the eight locomotives lent by the assessee-company to it by new ones. The entire nature of the transaction was changed between the parties. There was a resolution of the assessee-company in this regard and the income from interest did not result at all as the original agreement ceased to be operative ab initio. The entry in the books, which was made, was about a hypothetical income, which did not materialise and the entry was reversed in the next year. Both the Tribunal as well as the Hon'ble High Court have held that since this entry reflected only hypothetical income, it could not be brought to tax as income. Only real income can be brought to tax. The Hon'ble Supreme Court held "in the present case also the entry which was init....