ASSISTANT COMMISSIONER OF INCOME TAX,CIRCLE-2(2)(1), BANGALORE vs. EMBASSY RR PROJECTS PRIVATE LIMITED, BANGALORE

Originally M/s Embassy Property Development Pvt Ltd (M/s EPDPL) entered into loan agreements dated 6th June 2020 with M/s RR Plantina Infra (the borrower) which subsequently renamed to M/s Sai Shrusti Infrastructure Innovation Projects and later on converted into M/s Sai Shrusti Infrastructure Innovation Projects Pvt Ltd. As per the impugned agreement, M/s EPDPL agreed to extend loan of Rs. 150 crores in tranches for the purpose of development of a Software Technology Park on a land allotted by Karnataka Industrial Areas Development Board to the borrower and subsequently an amount of Rs. 70 crore was disbursed. Later, M/s EPDPL transferred the original loan agreement to the assessee company through a novation agreement .

The AO during the assessment proceedings enquired the assessee to furnish certain details with respect to the impugned loans which were duly provided. Further, the AO to verify the genuineness of loan transactions issued notices under section 133(6) of the Act to M/s RR Platina Infra (borrower). Despite multiple notices, no response was received from the third-party namely M/s RR Platina Infra under section 133(6) of the Act. The AO alleged that the PAN provided by the assessee for RR Platina Infra was mismatched and that no reliable evidence or confirmation was furnished. The AO thus proposed to treat the sum of ₹69 crores as an unexplained investment under section 69 of the Act through show cause notice dated 6th March 2024.

In response, the assessee clarified that the PAN provided did, in fact, belong to RR Platina Infra, which had subsequently changed its name to M/s. Sai Shrusti Infrastructure Innovation Projects on 25.08.2022. The assessee submitted documentary evidence including a copy of the PAN card, Form II for name change, the original loan agreement (ICD), and a novation agreement showing the transfer of the ICD from Embassy Property Development Pvt. Ltd. to the assessee. Additionally, the assessee submitted a communication from RR Platina Infra confirming its response to the notice issued under section 133(6)

The AO upon examining the loan and novation agreements, observed that loan was extended to the sister concern to get equity shares for the value equal to the loan amount plus interest at 18% on such loan. The AO observed that as per the agreement the assessee agreed to advance an amount of Rs. 150 crores in return the assessee was to get equity of Rs. 175 crores and the excess value of Rs. 25 crore was nothing but the interest @ 18% on such loan. The AO noted that the conversion clause and valuation metrics indicated the creation of capital assets worth ₹175 crores for a total investment of ₹150 crores, clearly implying capitalization of interest income of ₹25 crores. The AO accordingly held that such income had accrued during the year and should be taxed as business income. Therefore, the AO added an amount ₹25.02 crores to the assessee's income.

The aggrieved assessee preferred an appeal before the learned CIT(A).

Before the learned CIT(A), the assessee submitted that the addition made by the AO on account of interest income was incorrect and unjustified. It was explained that as per the terms of the loan agreement, specifically clause 4.8 of agreement, interest was not payable on a yearly basis, but only upon the occurrence of a "Conversion Event". This Conversion Event referred to the formal conversion of the partnership firm into a private limited company through the filing of Form URC-1 with the Registrar of Companies. Since no such Conversion .

The assessee further pointed out that even the borrower, M/s RR Platina, had not made any provision for interest payment in its books of accounts, which clearly shows that there was no mutual understanding or expectation of interest payment in that year. The assessee also argued that the addition was made without issuing a written show cause notice and based only on oral discussions, which goes against the principles of natural justice and principles laid down in several judicial precedents.

It was also contended that the attempt by the AO to tax notional income was contrary to law, as income tax can only be levied on real basis and not hypothetical income unless specifically provided under the Act. The assessee emphasized that no interest was ever recorded or charged in the subsequent years either which shows consistency and clarity in the accounting treatment. Furthermore, since the assessee was not in the business of money lending, any interest, if received, could not be classified as business income.

In view of these facts, the assessee requested the learned CIT(A) to delete the addition of interest income as it was not supported by the terms of the agreement or the provisions of the Act.

The learned CIT(A) after considering the facts in totality concurred with the argument advanced by the assessee and deleted the addition made by the AO by observing as under: The detailed discussion made above revealed a fact that, the AO computed the notional interest income without accrual of any such interest to the appellant in the relevant assessment year. The appellant referred the terms and conditions of the loan and relied upon the same terms that 18% of interest per annum compounded annually payable only in the event that the conversion of outstanding amount into equity or partnership interest in the case borrower is not completed under clause 4.2 or clause 4.8 of the said agreement. In the present case, the ICD given by the appellant to M/s RR Platina had not been converted in any such manner and the ICD did not result in any such accrual of interest to the appellant. There is no provision in the Act to charge the interest on notional basis. The appellant relied upon the decision of Hon’ble Supreme Court in the case of Poona Electric Supply Company Ltd. vs. CIT (1965) 3 SCR 818, decision of Hon’ble High Court of Delhi in the case of CIT vs. Shoorji Vallabhdas & Co. [1962] 46 ITR 144, CIT vs. VXL India Ltd vs. CIT [1993] 199 ITR 702, Island Hotels Ltd. [2010] 323 ITR 490 and CIT vs. Vijay Singh [2010] 323 ITR 466 of Hon’ble High Court of Guwahati in the case of Highways Construction Company Pvt Ltd vs. CIT [1993] 199 ITR 702. In all these decisions, Hon’ble High Courts held that notional interest cannot be charged on the interest free loan given by the assessee. In the present case, the condition for the conversion of the outstanding amount into equity or partnership interest was not met out in the relevant assessment year or subsequently. Hence there is no scope for charging notional interest on the ICD. 12. Further, as rightly contended by the appellant that such interest income cannot be computed under the head “Business Income”. The appellant in-spite of clarifying the terms and conditions during the course of VC, the AO proceeded to compute the notional interest of Rs. 25,02,00,000/- on the advances made. Such notional interest added as income from business is not maintainable. The judicial decisions relied upon by the appellant in their written submission is squarely applicable to the facts and circumstances of the present appeal. Hence the AO is directed to delete the addition of notional interest as income from business.

Being aggrieved by the order of the learned CIT(A), the Revenue is in appeal before us.

The learned DR before us submitted that loan was diverted for tax evasion and diverting profits. The ld. DR vehemently supported the order of the authorities below.

On the other hand, the learned AR for the assessee before us submitted that the loan in question was advanced purely for commercial purposes. It was given with the intent of forming a joint venture for a real estate development project, for which land had already been allotted by KIADB to the borrower. The ld. AR clarified that the lender (the assessee) and the borrower were two separate and independent legal entities, and that the entire transaction was routed through normal banking channels with proper agreements and documentation in place.

The learned AR strongly denied the Revenue’s allegation that the loan was meant for tax evasion or for building and diverting profits. It was pointed out that neither the Assessing Officer nor the ld. CIT-A had raised any such allegation during the assessment or appellate proceedings. Hence, this new claim introduced by the Revenue at this stage was merely an afterthought and not backed by any evidence or factual records.

The learned AR also highlighted that under the terms of the Loan Agreement, interest at 18% was payable only if the investment was not converted into equity or partnership interest. Since, the borrower was expecting to convert its legal status into a private limited company, and optionally convertible debentures were already issued, the interest clause was not triggered. Thus, no interest income accrued or became receivable during the relevant year, and the addition made by the AO on notional basis was completely unjustified.

We have heard the rival contentions of both the parties and perused the materials available on record. The core issue in the present appeal pertains to the addition of ₹25.02 crores on account of alleged interest income, which the AO treated as business income accrued to the assessee during the relevant assessment year.

In the result, the appeal filed by the Revenue is dismissed.