Facts of the Case

The assessee company, Sitac Re Pvt. Ltd., was engaged in the business of installation and sale of windmill projects, consultancy services related to windmill projects, and investment in other companies engaged in similar activities. The assessee filed its return of income for Assessment Year 2015-16 declaring a loss of ₹7,26,558.

The case was selected for limited scrutiny under section 143(2) of the Income-tax Act, 1961 for examining certain specific issues such as mismatch in contract receipts, sales turnover, foreign remittance receipts, low income with high investments/advances, and loss from currency fluctuations.

During assessment proceedings, the Assessing Officer went 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).

The assessee challenged these additions before the Tribunal. 

Issues Involved

  1. Whether the Assessing Officer could make additions beyond the scope of limited scrutiny without obtaining prior approval from the Principal Commissioner of Income Tax (PCIT).
  2. Whether notional interest on Compulsorily Convertible Debentures (CCDs) could be taxed when the assessee had waived its right to receive interest before the end of the year.

Petitioner’s Arguments

  • The assessment was selected only for limited scrutiny, and therefore the Assessing Officer had no jurisdiction to examine issues beyond the specified parameters.
  • Additions relating to cessation of liability under Section 41(1) and disallowance of transmission charges were completely outside the scope of limited scrutiny.
  • The Assessing Officer did not obtain mandatory approval from the PCIT before expanding the scope of scrutiny as required under CBDT instructions.
  • Regarding CCDs, the assessee argued that it had waived its right to charge interest before the end of the financial year, and therefore no income had accrued.
  • Since interest was neither received nor accrued, taxation of notional or hypothetical income was not permissible under the Income-tax Act.

Respondent’s Arguments

  • The issues examined by the Assessing Officer were connected to the parameters of limited scrutiny such as low income with high investments and advances.
  • Therefore, the additions made during assessment were justified.
  • In respect of CCDs, the Revenue contended that the assessee was following the mercantile system of accounting, and therefore interest should be treated as accrued during the year regardless of the waiver. 

Court Order / Findings

1. Additions Beyond Limited Scrutiny Invalid

The Tribunal observed that the additions made under Section 41(1) and the disallowance of transmission charges were clearly outside the scope of limited scrutiny.

The Assessing Officer had not obtained prior approval from the PCIT for converting the case from limited scrutiny to complete scrutiny, which was mandatory under CBDT Instruction No. 20/2015 and Instruction No. 5/2016.

Since CBDT instructions are binding on the Income Tax authorities, any assessment made in violation of these instructions cannot be sustained.

Accordingly, the Tribunal deleted the additions relating to cessation of liability and disallowance of transmission charges.

2. Notional Interest on CCDs Not Taxable

  • The assessee had waived its right to receive interest before the close of the year.
  • The borrower companies had no financial capacity to pay interest.
  • The investment was made out of the assessee’s own funds, not borrowed funds.
  • There is no provision under the Income-tax Act for taxation of notional interest income.

The Tribunal reiterated the principle that only real income can be taxed, not hypothetical income.

Therefore, the addition of ₹1,91,70,000 towards notional interest was also deleted.

Finally, the appeal of the assessee was allowed. 

Important Clarification

  1. Assessing Officers cannot travel beyond the scope of limited scrutiny without prior approval of PCIT.
  2. Income tax is levied only on real income and not on hypothetical or notional income, especially when the right to receive such income has been waived before the end of the relevant financial year.

Link to download the order - https://itat.gov.in/public/files/upload/1735624910-Yy3paX-1-TO.pdf 

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