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PR COMMISSIONER OF INCOME TAX ALWAR v. BAJARGAN TRADERS

Rajasthan High Court

Sep 12, 2017

Judgment

Subsequent
References

CaseIQ

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Structured Summary of the Opinion

Factual and Procedural Background

This is an order dated 12/09/2017, delivered by Hon'ble Mr. Justice Vijay Kumar Vyas (with K.S. Jhaveri, J. also noted), arising from an appeal in which the appellant challenged the judgment and order of the Tribunal. The Tribunal had allowed the appeal of the assessee (i.e., the revenue's assessment additions had been deleted by the Tribunal). The appellant contested the Tribunal's reversal of findings of the Commissioner of Income Tax (Appeals) [CIT(A)] relating to additions made by the Assessing Officer (AO) following a survey.

The contested items included: (a) deletion of an addition of Rs. 70,04,814/- which the assessee had "surrendered" as an unrecorded investment in stock (rice); (b) the characterization by the Tribunal of that surrendered investment as business income rather than income from other sources; and (c) deletion of an addition of Rs. 1,39,366/- (and related issues on interest disallowance) arising from alleged notional interest/less interest charged by the firm from the wife of one of the partners.

Legal Issues Presented

Whether the Tribunal was legally justified in reversing the findings of the CIT(A) and deleting the addition of Rs. 70,04,814/- (surrendered by the assessee) by holding that such amount was included in purchases and was reflected in sales and closing stock, particularly when the assessee allegedly failed to show that the said amount was included in the sales and closing stock?
Whether the Tribunal was legally justified in treating the investment in excess stock of Rs. 70,04,814/- (found during the course of survey) as business income instead of income from other sources?
Whether the Tribunal was legally justified in reversing the findings of the CIT(A) and deleting the addition of Rs. 1,39,366/- made on account of less interest charged by the firm from the wife of one of the partners, especially when interest was allegedly paid at higher rates on loans taken?

Arguments of the Parties

Appellant's (Revenue's) Position — as reflected in the substantial questions of law

The Tribunal erred in reversing the CIT(A) and deleting the addition of Rs. 70,04,814/- which was surrendered by the assessee, because the assessee had allegedly not shown that the surrendered amount was included in sales and closing stock.
The Tribunal erred in treating the investment in excess stock of Rs. 70,04,814/- as business income rather than income from other sources and/or as income taxable under the provisions for unexplained investments (section reference not specified in the provided text).
The Tribunal erred in deleting the addition of Rs. 1,39,366/- relating to notional/less interest charged by the firm from the wife of a partner, particularly given higher rates paid on loans.

Assessee's Arguments (as presented to the Tribunal and noted in the opinion)

The assessee (through its learned Authorized Representative) contended that the AO's addition on account of notional interest (Rs. 1,39,366/-) cannot stand because only real income can be taxed; hypothetical or notional income cannot be taxed. The AR relied on the authority of E.D. Sassoon & Co. & Ors. vs. CIT (1954) 26 ITR 27 and Godhra Electricity Co. Ltd. vs. CIT (1997) 225 ITR 746 to support this proposition.
The AR further submitted that the advance to Smt. Rita Gupta (wife of a partner) was given in earlier years for construction of a godown and was given on rent by the assessee; commercial expediency existed for making the advance, so interest disallowance was not justified. The AR relied on S.A. Builders 288 ITR 1 and Hero Cycles Pvt. Ltd. vs. CIT 379 ITR 347 to argue that revenue cannot substitute its own view for that of a prudent businessman or board of directors.
On the quantification/extent of disallowance, the AR argued that partners were paid interest at 12% and the partners' account balance exceeded the amount advanced to Smt. Rita Gupta, so the disallowance made (figures variously referenced in the opinion) was excessive and should be limited (the AR proposed restriction to 2% in one passage). The AR also placed reliance on Rajastan High Court decisions: CIT vs. Ram Kishan Verma (2016) 132 DTR 107/132 Taxman 107 (Raj) and CIT vs. Vijay Solvex Ltd. (2015) 113 DTR 382 (Raj) in support of limiting disallowance.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court / Tribunal (as described in the opinion)
Shri Ramnarayan Birla (Coordinate Bench, ITA No. 482/JP/15 dated 30.09.2016)	Used as a coordinating decision supporting the proposition that when excess stock/investment is part of regular business stock and its source is identifiable, it should be treated as business income.	The Tribunal relied on this Coordinate Bench decision to support the assessee's position that the surrendered investment in rice stock should be treated as business income.
Fakir Mohd. Hazi Hasan — 247 ITR 290	Stands for the principle that unaccounted income ought to be categorized under the residuary head "Income from other sources" where the investment/expenditure is not identifiable and no nexus with any head of income is established.	The Tribunal noted there was no conflict with this decision because Fakir Mohammed applies where the asset/expenditure is not identifiable; in contrast, the excess stock in the present case was identifiable and part of trading stock.
Choksi Hiralal Mangnlal vs. DCIT — 131 TTJ (Ahd.) 1	Holds that where the source of investment/expenditure is clearly identifiable and the alleged undisclosed asset has no independent physical existence (is inseparable/mixed with declared assets), the undisclosed business receipt should first be taxed as business income rather than under section 69 as unexplained investment.	The Tribunal cited this decision for the principle that when undeclared investment is integral to declared trading stock (no independent identity), it should be treated as undeclared business income. The Tribunal applied that reasoning to the excess rice stock.
E.D. Sassoon & Co. & Ors. vs. CIT — (1954) 26 ITR 27	Authority for the proposition that only real income can be taxed; notional or hypothetical income cannot be taxed.	The assessee relied on this Supreme Court authority (as noted in the opinion) to argue that the AO's addition of notional interest was impermissible; the Tribunal/bench accepted the legal position that notional income cannot be taxed as such in assessing the notional interest addition.
Godhra Electricity Co. Ltd. vs. CIT — (1997) 225 ITR 746	Also cited for the principle that hypothetical income cannot be taxed — only real income is taxable.	The assessee relied on this decision in support of deleting the notional interest addition; the opinion records this reliance when summarizing the assessee's submissions.
S.A. Builders — 288 ITR 1	Principle that revenue authorities must not substitute their own commercial judgment for that of a prudent businessman; authorities should view matters from the assessee's commercial perspective.	The assessee relied on this authority to argue commercial expediency for the advance to Smt. Rita Gupta and to resist disallowance of interest; the opinion records this reliance in the assessee's submissions.
Hero Cycles Pvt. Ltd. vs. CIT — 379 ITR 347	Used to support the proposition that tax authorities must consider commercial expediency and not act as business managers when judging reasonableness of expenditure.	The assessee relied on this decision in its submissions; the opinion notes reliance on the case in arguing against the interest disallowance.
CIT vs. Ram Kishan Verma — (2016) 132 DTR 107 / 132 Taxman 107 (Raj) (HC)	Cited by the assessee (specific principle not detailed in the provided opinion) in support of restricting disallowance.	The opinion records that the assessee placed reliance on this decision to support the contention that disallowance should be restricted; the exact application in reasoning is not elaborated beyond reliance.
CIT vs. Vijay Solvex Ltd. — (2015) 113 DTR 382 (Raj) (HC)	Cited by the assessee (specific principle not detailed in the provided opinion) in support of restricting disallowance.	The opinion notes the assessee's reliance on this High Court decision; the opinion does not set out further detail of application beyond recording the reliance.

Court's Reasoning and Analysis

The court recorded and expressed agreement with the Tribunal's analysis. The Tribunal's step-by-step reasoning as reflected in the opinion is summarized below, strictly as stated in the text:

Facts from survey and subsequent accounting: During the course of survey the assessee surrendered an amount of Rs. 70,04,814/- as investment in unrecorded stock of rice. The assessee later brought this transaction into its books by debiting the purchases account and crediting "income from undisclosed sources." In the annual accounts, the purchases figure included Rs. 70,04,814/- as part of total purchases, and this amount was also part of closing stock since that stock was unsold. The amount was therefore reflected both in purchases/closing stock and as income from undisclosed sources in profit and loss account.
Legal approach to classification: The Tribunal applied the principle, drawn from Coordinate Bench decisions (including Choksi Hiralal and Shri Ramnarayan Birla), that where excess investment is integral to declared trading stock and has no independent physical identity, the first attempt should be to link the undeclared investment with the known head of income (i.e., business income). Only if such a nexus cannot be satisfactorily established should the investment be taxed as unexplained investment under section 69 or treated as income from other sources.
Application to present facts: Given that the assessee's business was dealing in foodgrains, rice and oil seeds, and the excess stock found was rice (i.e., part of the trading stock), the investment in procurement of such stock was "clearly identifiable and related to the regular business stock of the assessee." The Tribunal therefore concluded that the surrendered investment ought to be brought to tax as business income, not as income from other sources.
On the accounting treatment: The Tribunal observed that by recording the transaction (debited to purchases and credited to income from undisclosed sources) the assessee regularised its books of account. This double-entry accounting treatment (bringing stock onto books and offering the unreconciled investment to tax by crediting profit and loss account) provided a credible base for the Revenue to tax subsequent profit/loss on sale of such stock as normal business transactions.
On notional interest/disallowance: The assessee's AR argued, relying on authoritative decisions, that notional or hypothetical income cannot be taxed and that commercial expediency justified the advance to Smt. Rita Gupta; accordingly, the addition/disallowance relating to notional interest was not permissible. The Tribunal's decision (as accepted by the court) led to deletion of the contested additions (the opinion records that the court is in "complete agreement with the view taken by the Tribunal").

Holding and Implications

Holding: The court stated that it is in complete agreement with the view taken by the Tribunal and held that no substantial question of law arises. Accordingly, the appeal is DISMISSED.

Implications:

The immediate practical effect is that the Tribunal's order in favour of the assessee stands: the additions challenged by the appellant (including the Rs. 70,04,814/- surrendered investment and the notional interest/disallowance issues summarized in the opinion) remain deleted as per the Tribunal's decision.
The opinion records reliance on several coordinate-bench and higher court authorities for legal principles, but the court concluded that the Tribunal's application of those principles to the facts did not raise a substantial question of law warranting interference. The opinion does not purport to lay down any novel legal principle; it upholds the Tribunal's fact-specific application of established authorities.
The opinion does not expressly state any broader legal or precedential shift beyond affirming the Tribunal's fact-based conclusion that identifiable excess trading stock should be taxed as business income rather than under the residuary head where a nexus to the business exists.

Judicial panel and administrative note as recorded in the provided opinion: (VIJAY KUMAR VYAS), J.; (K.S. JHAVERI), J. Order date: 12/09/2017. Report notation: A.Sharma/23.

Show all summary ...

HON'BLE MR. JUSTICE VIJAY KUMAR VYAS Order 12/09/2017

1. By way of this appeal, the appellant has assailed the judgment and order of the Tribunal whereby the Tribunal has allowed the appeal of the assessee.

2. Counsel for the appellant has framed the following substantial questions of law:-

i) Whether the Tribunal was legally justified in reversing the findings of the CIT(A) and deleting the addition of Rs. 70,04,814/- which was surrendered by the assessee by holding that such amount was included in the purchases and was reflected in the sales and closing stock, specifically when the assessee failed to show that the said amount was included in the sales and closing stock? ii) Whether the Tribunal was legally justified in treating the investment in excess stock for Rs. 70,04,814/- found during the course of survey (2 of 5) [ITA-258/2017] as business income instead of income from other sources which was to be liable to tax u/s iii) Whether the Tribunal was legally justified in reversing the findings of the CIT(A) and deleting the addition of Rs. 1,39,366/- made on account5 of less interest charged by the firm from the wife of one of the partner specifically when the interest was paid at higher rates on the loans taken?

3. The Tribunal while considering the matter has observed as under:- 2.7. It is further submitted that the real issue in this case is whether the excess stock surrendered should be made as a part of business income or not and if so, assessee can claim deduction on account of payment of remuneration to partners on account u/s 40b(v). In this regard, our reference was drawn to the decision of Co-ordinate Bench in case of Shri Ramnarayan Birla (in ITA No. 482/JP/15 dted 30.09.2016). In that case, the question before the Coordinate Bench was whether the CIT(A)-2, Udaipur has erred in directing the AO to assess the unexplained investment surrendered by the assessee under the head income from Business ignoring the decision of the Honble Gujarat High Court in the case of Fakir Mohd. Hazi Hasan 247 ITR 290 that unaccounted income ought to be categorized under the residuary head of Income from other sources. In respect to the said issue, the findings of the Coordinate Bench are as follows:

We have heard the rival contentions and perused the material available on record. Undisputed facts emerged from the record that at the time of survey excess stock was found. It is also not disputed that assessee is engaged in the business of jewellery. During the course of survey excess stock valuing Rs. 77,66,887/- was found in respect of gold and jewellery. The Coordinate Bench in the case of Choksi Hiralal Mangnlal vs. DCIT 131, TTJ (Ahd.) 1 has held that in a cases where source of investment/expenditure is clearly identifiable and alleged undisclosed asset has no independent existence of its own or there is no separate physical identity of such investment/expenditure then first what is to be taxed is the undisclosed business receipt invested in unidentifiable unaccounted asset and only on failure it should be considered to be taxed u/s 69 on the premises that such excess investment is not recorded in the books of account (3 of 5) [ITA-258/2017] and its nature and source is not identifiable. Once such excess investment is taxed as undeclared business receipt then taxing it further as deemed income under section 69 would not be necessary. Therefore, the first attempt of the assessing authority should be to find out link of undeclared investment/expenditure with the known head, give opportunity to the assessee to establish nexus and if it is satisfactorily established then first such investment should be considered as undeclared receipt under that particular head. It is observed that there is no conflict with the decision of Honble Gujarat High Court in the case of Fakir Mohd. Jajihasan (supra) where investment in an asset or expenditure is not identifiable and no nexus was established then with any head of income and thus was not available for set off against any loss under any other head. Therefore, the Honble Coordinate Bench held that where asset in which undeclared investment is sought to be taxed is not clearly identifiable or does not have independent identity but is integral and inseparable (mixed) part of declared asset falling under a particular head, then the difference should be treated as undeclared business income explaining the investment. In the present case the excess stock was part of the stock. The revenue has not pointed out that the excess stock has any nexus with any other receipts. Therefore, we do not find any fault with the decision of the ld. CIT(A) directing the AO to treat the surrendered amount as excess stock qua the excess stock found.

2.10. We have heard the rival contentions and perused the material available on record. During the course of survey, the assessee has surrendered an amount of Rs. 70,04,814/- towards investment in stock of rice which had not been recorded in the books of accounts. Subsequently, in the books of accounts, the assessee has incorporated this transaction by debiting the purchase account and crediting the income from undisclosed sources. In the annual accounts, the purchases of Rs. 70,04,814/- were finally reflected as part of total purchases amounting to Rs. 33,47,19,658/- in the profit and loss account and the same also found included as part of the closing stock amount to Rs. 1,94,42,569/- in the profit/loss account since the said stock of rice was not sold out. In addition to the purchase and the closing stock, the amount of RS. 70,04,814/- also found credited in the profit and loss account as income from undisclosed sources. The net effect of this double entry accounting treatment is that firstly the unrecorded stock of rice has been brought on the (4 of 5) [ITA-258/2017] books and now forms part of the recorded stock which can be subsequently sold out and the profit/loss therefrom would be subject to tax as any other normal business transaction. Secondly, the unreco4rded investment which has gone in purchase of such unrecorded stock of rice has been recorded in the books of accounts and offered to tax by crediting the said amount in the profit and loss account. Had this investment been made out of known source, there was no necessity for assessee to credit the profit/loss account and offer the same to tax. Accordingly, we do not see any infirmity in assessees bringing such transaction in its books of accounts and the accounting treatment thereof so as to regularise its books of accounts. In fact, the same provides a credible base for Revenue to bring to tax subsequent profit/loss on sale of such stock of rice in future. 2.11. Having said that, the next issue that arises for consideration is whether the amount surrendered by way of investment in the unrecorded stock of rice has to be brought to tax under the head business income or income from other sources. In the present case, the assessee is dealing in sale of foodgrains, rice and oil seeds, and the excess stock which has been found during the course of survey is stock of rice. Therefore, the investment in procurement of such stock of rice is clearly identifiable and related to the regular business stock of the assessee. The decision of the Co-ordinate Bench in case of Shri Ramnarayan Birla (supra) supports the case of the assessee in this regard. Therefore, the investment in the excess stock has to be brought to tax under the head business income and not under the head income from other sources. In the result, ground No. 1 of the assessee is allowed. 3.2. The ld. AR of the assessee submitted that at the outset, it may be noted that the AO has made addition on account of notional interest of Rs. 1,39,366/-. There cannot be any addition on account of notional income as held by the Honble Supreme Court in case of E.D. Sassoon & Co. & Ors. vs. CIT (1954) 26 ITR 27 and Godhra Electricity Co. Ltd. vs. CIT (1997) 225 ITR 746 where it was held that only real income can be taxed, hypothetical income cannot be taxed nor income can be taxed in vacuum. Therefore, the addition made by the AO is not as per law and the same be deleted. The ld. CIT(A) has confirmed the addition by stating that it is the disallowance of interest. It is submitted that the lower authorities have not disputed about the commercial expediency about the advance given to Smt. Rita Gupta. In fact, the advance was given to (5 of 5) [ITA-258/2017] Smt. Rita Gupta in earlier years for construction of godown and the same was given on rent by the assessee. Therefore once commercial expediency for giving the advance is established, no part of the interest expenditure can be disallowed in view of the decision of Honble Supreme Court in case of S.A. Builders 288 ITR 1 and Hero Cycles Pvt. Ltd. vs. CIT

379 ITR 347 where it was held that the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. If further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman. Further, in past, no such disallowance/addition was made. Therefore, neither the addition of notional interest made by the AO or disallowance of interest as held by the ld. CIT(A) is Rs. 1,96,73,637/-. Partners are paid interest @ 12% the balance in the partners account is much more than the amount advanced to Smt. Rita Gupta who is a wife of one of the partner. Therefore, even the disallowance made @ 4% is not justified and the same should be restricted @ 2% only. Reliance is also placed on the following cases. .CIT vs. Ram Kishan Verma (2016) 132 DTR 107/132 Taxman 107 (Raj.)(HC) . CIT vs. Vijay Solvex Ltd. (2015) 113 DTR 382 (Raj.) (HC)

4. We are in complete agreement with the view taken by the Tribunal. No substantial question of law arises.

5. Hence, the appeal stands dismissed. (VIJAY KUMAR VYAS),J. (K.S. JHAVERI),J. A.Sharma/23