Interest on bank fixed deposit not credited to account taxable on mercantile basis. It is no defense that TDS was not deducted by bank and hence accrual did not arise -High Court
Prelude:
Taxation of interest on fixed deposits made with banks have often been seen the litigation. One of the primary issues of contention is with respect to point of taxation of interest income i.e., is the interest taxable when actually received or at the time of credit/accumulation by the bank.
Under section 145 of the Income Tax Act, 1961 (the Act) the income chargeable under the head “Income from other Sources” is to be computed in accordance with either “cash” or “mercantile/accrual” basis of accounting regularly employed by the assessee.
The present case law involves a controversy as to taxation of FDR interest at the hand of the respondent assessee which was a Publoc Sector Undertaking (PSU) following mercantile system of accounting.
Interest on bank fixed deposit not credited to account taxable on mercantile basis
ABCAUS Case Law Citation:
ABCAUS 2153 (2017) (12) HC
The Challenge/Grievance:
This income tax appeal was filed under Section 260-A of the Income Tax Act, 1961 (the Act) by the Income Tax Department (ITD/Revenue) against the order passed by the Income Tax Appellate Tribunal (Tribunal/ITAT) deleting the addition made by the Assessing Officer (AO) and upheld by the First Appellate Authority (FAA/CIT-A) with respect to interest on Fixed deposits with bank.
Important Case Laws Cited/relied upon by the parties:
Tuticorin Alkali Chemicals and Fertilizers Ltd. v. Commissiner of Income Tax (1997) 227 ITR 172 (SC)
Keshav Mills Ltd. v. Commissioner of Income Tax (1953) 23 ITR 230 (SC)
Commissioner of Income Tax v. Excel Industries Ltd. (2013) 358 ITR 295 (SC)
Brief Facts of the Case:
The original assessment of the assessee was completed under Section 143(3) of the Act. Thereafter, the assessment was reopened by issuing notice under Section 148 of the Act. The re-assessment was completed under Section 143(3) read with Section 147 by making an addition towards interest receivable on fixed deposits which the assessee had showed as accrued but excluded it from taxation contending the same was not received and was only a hypothetical income to which right to receive had not accrued.
The Commissioner of Income Tax (Appeals) confirmed the action of the AO. On appeal before the ITAT, it was held that income accrues only when the right to receive is accrued and the right may be said to have accrued only when the enforceable debt is credited in favour of the assessee. It was further held that by virtue of Section 194A of the Act, the person responsible for paying any income by way of interest shall at the time of credit of such income to the account of the payee, or at the time of payment thereof, whichever is earlier; deduct tax. In this case, the Bank had neither credited nor paid the interest and accordingly, no tax was deducted and the question of accrual does not arise. Therefore, the income, which had been received and not acknowledged or which had not been acknowledged as payable to the assessee, could not be taxed.
Under the circumstances, the ITAT observed that the CIT-A was not justified in confirming the action of the AO taxing the interest income. Accordingly, the order was reversed and the appeal was allowed.
Now, the order of the ITAT, stood in challenge before the Hon’ble High Court.
Contention made on behalf of the Petitioner Revenue:
It was submitted that the tax audit report in Form No.3CD certified that the system of accounting followed by the assessee was mercantile. In such circumstances, the entire interest accrued should have been offered to tax for the assessment year in which it accrued.
It was submitted that since the assessee was following the mercantile system of accounting, there was no reason to exclude the interest income on the ground of its non receipt. Nor could it be argued that it was the responsibility of the bank under Section 194 A of the Act to deduct tax at source.
Contentions made on behalf of the Respondent Assessees:
It was contended that the interest due on the deposits was not credited to their bank account till the end of the relevant assessment year, and therefore, the interest did not become accrued and due and hence liable to income tax for that assessment year.
Observations made by the High Court:
The Hon’ble High Court observed that as per the judgment of Hon’ble Supreme Court the settled position is that interest accrued is taxable income and attracts tax as soon as it accrues.
It was further observed that the Supreme Court in a case while describing the difference between the mercantile system of accounting with cash system of book keeping has held that under mercantile system, receipt are not the sole test of chargeability and profits and gains that accrues or arises or are deemed to have accrued or arisen also liable to be charged for income-tax. The assessbility of profits credited in the books of account arises not because they are received but because they have accrued or arisen. The Hon’ble High Court, in view of the above, held that the argument of the assessee for non taxability of interest for it not being credited to their bank account was not acceptable.
It was observed that the depositor is entitled to get interest as and when it becomes due, which may be monthly, quarterly, half yearly, yearly or at the end of the term of deposit, which is at the option of the depositor. It is also trite that on the option being exercised, to so deffer the receipt, the Bank pays cumulative interest.
The Hon’ble High Court noted that the assessee did not produce any evidence to substantiate the claim that the interest was not payable in the assessment year, but merely asserted that the interest accrued was not entirely received.
The Hon’ble High Court opined that even if the maturity period or the expiry date did not fall in the relevant assessment year, it could not be said that the interest was not due. The interest that accrued in the relevant year was for the amounts that already remained in deposit with the Bank and on the depositors asking, it was payable. The period of deposit being the option of the depositor the reciept stood deferred at the behest of the assessee. As a corollary there cannot be a claim made of hypothetical income or there being no corresponding liability to pay. If the assessee chose to close the deposit prematurely on any date, then the Bank was liable to pay whatever interest that is accrued till that date. Interest for the period, in which the amounts stood in deposit, accrues on the close of the previous year and if it so accrues, it becomes the income of that particular assessment year, liable to be taxed in that year.
Regarding the view of the ITAT with respect non deduction of tax by bank, the Hon’ble High Court observed that in view of the fact that the assessee had exercised the option to let the interest accumulate to the deposit and thereby earned compound interest by the end of the deposit term, it would not mulct any liability on the bank to pay tax on periodical accrual of interest to the income tax authorities. The Bank’s liability to deduct tax at source arises only when it pays the interest. The amount that is to be received as interest, is known to the assessee and was accounted, as income accrued by way of interest in the account books of the assessee following the mercantile system. The interest income that accrued cannot, by any stretch of imagination, be termed as hypothetical income.
Decision/ Conclusion/Held:
The Hon’ble High Court dismissed the findings of the ITAT that the interest income on Bank deposits was hypothetical income and that the assessee was entitled to get the interest excluded from assessment. The question raised answered in favour of the Revenue and against the assessee. The appeal was allowed and the order of the ITAT was set aside.
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