Facts of the Case

The assessee, Sitac Re Pvt. Ltd., is engaged in the business of installation and sale of windmill projects and providing consultancy services related to wind energy projects. The company also makes investments in companies engaged in similar activities.

For Assessment Year 2015-16, the assessee filed its return declaring a loss of ₹7,26,558.

The case was selected for limited scrutiny under Section 143(2) for verification of specific issues including:

  • Contract receipt / fees mismatch
  • Sales turnover mismatch
  • Receipt of foreign remittance
  • Low income with high loans/advances/investments
  • Low income with high investments
  • Loss from currency fluctuations

However, during the assessment proceedings, the Assessing Officer examined additional issues beyond the scope of limited scrutiny and made the following additions:

  1. Addition of ₹11,25,00,000 under Section 41(1) for alleged cessation of liability relating to advance received from a foreign customer.
  2. Disallowance of transmission charges amounting to ₹1,46,58,592.
  3. Addition of notional interest income of ₹1,91,70,000 on investment in 9% Compulsorily Convertible Debentures (CCDs).

Issues Involved

  1. Whether the Assessing Officer can make additions beyond the scope of limited scrutiny without obtaining approval from the Principal Commissioner of Income Tax (PCIT).
  2. Whether notional interest income on investment in Compulsorily Convertible Debentures (CCDs) can be taxed when interest was waived before the end of the year.
  3. Whether addition under Section 41(1) for alleged cessation of liability was justified. 

Petitioner’s Arguments (Assessee)

  • The case was selected for limited scrutiny, and therefore the Assessing Officer could examine only the issues specified in the notice.
  • The additions relating to cessation of liability and transmission charges were outside the scope of limited scrutiny and were made without prior approval of PCIT, which is mandatory under CBDT instructions.
  • The alleged liability had not ceased, as the advance received from the customer was under dispute before the Company Law Board / NCLT, and subsequently the dispute was settled.
  • No deduction had been claimed earlier in respect of the said amount, hence Section 41(1) was not applicable.
  • The addition of notional interest on CCDs was unjustified since the assessee had waived the interest before the end of the year, and therefore no real income accrued.

Respondent’s Arguments (Revenue)

  • The issues examined during assessment were connected with the parameters identified for limited scrutiny, such as low income with high investments or advances.
  • Therefore, the Assessing Officer was justified in examining the transactions and making the additions.
  • The CIT(A) upheld the additions made by the Assessing Officer. 

Court Findings

The ITAT observed that:

  • The additions relating to cessation of liability under Section 41(1) and disallowance of transmission charges were not part of the issues identified for limited scrutiny.
  • The Assessing Officer did not obtain mandatory approval from the PCIT before expanding the scope of scrutiny.
  • CBDT Instructions No. 20/2015 and 5/2016 clearly require such approval before examining additional issues.

The Tribunal held that the additions were made in violation of CBDT instructions, which are binding on tax authorities.

Accordingly:

  • The additions under Section 41(1) and disallowance of transmission charges were deleted.

With respect to notional interest on CCDs, the Tribunal held:

  • Interest was waived before the end of the year, and therefore no income had accrued to the assessee.
  • Income tax can be levied only on real income and not on hypothetical income.

The Tribunal relied on judicial precedents which held that notional interest cannot be taxed in the absence of actual accrual of income. 

Important Clarifications by ITAT

  1. CBDT instructions are binding on Income Tax authorities.
  2. The Assessing Officer cannot travel beyond the scope of limited scrutiny without proper approval.
  3. Hypothetical or notional income cannot be taxed unless it actually accrues to the assessee.
  4. Interest waived before the end of the year cannot be treated as accrued income. 

Court Order

  • Additions under Section 41(1) and disallowance of transmission charges were invalid as they were beyond the scope of limited scrutiny.
  • Addition of notional interest on CCDs was also deleted as no real income accrued to the assessee.

Important Case Laws Referred

  • CIT vs Shoorji Vallabhdas & Co. (46 ITR 144, Supreme Court) – Only real income is taxable.
  • Shivlaxmi Exports Ltd vs CIT (Calcutta High Court) – Interest waived during the year does not accrue as income.
  • Shiv Nandan Buildcon Pvt. Ltd vs CIT – Notional interest cannot be taxed without statutory provision.
  • CIT vs Best Plastics Pvt. Ltd (Delhi High Court) – CBDT circulars are binding on tax authorities.
  • Commissioner of Customs vs Indian Oil Corporation Ltd (267 ITR 272, Supreme Court) – Departmental authorities are bound by circulars.

Link to download the order - https://itat.gov.in/public/files/upload/1735627392-WNCkJU-1-TO.pdf 

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