By TIOL News Service

HYDERABAD, APRIL 09, 2018: THE issue is - Whether actual receipt and not mere accrual of interest on unsecured loans, makes it a taxable event, even while following mercantile system of accounting. YES IS THE ANSWER.

Facts of the case:

The assessee-company, engaged in the business of investment in capital markets, filed its return declaring loss of Rs. 5,35,493/-. During assessment proceedings, the AO observed that there were unsecured loans to the extent of Rs. 19.25 Crs under 'advances recoverable in cash or kind'. The AO verified the advances recoverable in cash or credit and found that assessee did not charge interest on three parties. Neither assessee-company had entered into any agreements for charging interest @ 8% on the various outstanding loans. The AO therefore was of the view that the company had entered into agreement for receipt of interest from such companies @ 8% per annum during the previous year relevant to the A.Y 2009-10. At the end of the years, the assessee-company again entered into agreements for not charging interest or waiver of the interest stating that all the three parties suffered losses. This practice of entering and cancellation of agreements, was found not acceptable to the AO, since the assessee-company was following mercantile system of accounting, according to which the interest accrues and subsequent relinquishment of interest after expiry of accounting year was of no consequence. Accordingly, the AO held that interest was not a notional interest and it constitutes interest income not offered to tax and hence computed the rate of interest @ 8% on amounts advanced by the assessee-company during the FY under consideration and brought to tax the same which amounts to Rs.1,26,86,509/-.

On appeal, the FAA held that no notional income could be brought to tax on loans and advances. Accordingly, he deleted the addition and directed the AO to verify whether the interest had been actually received by the assessee and tax the same on receipt basis.

Tribunal held that,

++ the issue of notional interest is squarely covered by the order of this Tribunal in the assessee’s own case for the AYs 2005-06 & 2006-07 in ITA Nos. 468/H/2009 and others, and for the A.Y 2007-08 in ITA Nos. 841 & 1176/Hyd/2012, wherein it was held that: "....to arrive at a real income, accrual basis cannot be a justifying factor and the commercial and business realties of the assessee, should be considered. The interest income has been recognized in the books of accounts only to extent of actual collection, which is the recommended/ recognized method as per Accounting Standard 9 of ICAI which lays down that when uncertainties exist regarding the determination of amount or its collectability, the revenue shall not be treated as accrued and hence shall not be recognized until collection. The interest income has been admittedly recognised only on receipt basis. The contention of Revenue that the loan agreements have interest clause permitting the assessee to charge interest at the rate of 14% is not tenable. The terms of the agreements, which enabled the assessee company to demand interest were only enabling provisions and those enabling provisions did not guarantee the collection of overdue interest. The method of accounting, as followed by the assessee, does not create any income; but the method of accounting only recognizes income. There is some merit in the submission of assessee that when the principal itself is overdue and not collected, there is no basis for making out a case that interest income would be collectable with certainty. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction....";

++ since the facts are identical and the FAA has rightly allowed the appeal of assessee following the order of this Tribunal for the earlier years, therefore respectfully following the view taken by this Tribunal in the assessee’s own case, this Tribunal holds that the notional interest on advances cannot be charged on accrual basis and the AO is directed to verify the interest actually received and assess the same on actual receipt basis.

(See 2018-TIOL-519-ITAT-HYD)