No Double Taxation on Liability Write-Back: Delhi ITAT Deletes Section 41(1) Addition and Notional Interest Demand

Continental Engines Pvt. Ltd. Vs DCIT (ITAT Delhi)

No Double Taxation on Liability Write-Back: Delhi ITAT Deletes Section 41(1) Addition and Notional Interest Demand

The Delhi ITAT dismissed the Revenue’s appeal and granted substantial relief to Continental Engines Pvt. Ltd., holding that liabilities already offered to tax in subsequent years cannot again be taxed under Section 41(1) and that notional interest cannot be added merely because interest-free loans were given to subsidiaries.

The Assessing Officer had treated outstanding liabilities aggregating to ₹1.81 crore as ceased liabilities under Section 41(1). However, the assessee demonstrated that these liabilities were subsequently written back and duly offered to tax in later assessment years. After examining the evidence and remand report, the CIT(A) found that taxing the same amount again in AY 2017-18 would result in double taxation. The Tribunal agreed and upheld the deletion of the entire addition.

The Revenue had also challenged the deletion of ₹1.37 crore added as notional interest on interest-free loans advanced to subsidiary companies. The Tribunal noted that the Assessing Officer had failed to establish any nexus between borrowed funds and the advances made to subsidiaries. Further, the assessee had sufficient interest-free funds available. Relying on the Supreme Court decision in CIT v. Reliance Industries Ltd. (410 ITR 466), the Tribunal held that where adequate interest-free funds exist, it is presumed that advances are made out of such funds and no disallowance or notional addition can be made.

On the assessee’s appeal, the Tribunal found merit in the contention that the Assessing Officer had made an ad-hoc capitalization of 5% of fixed asset additions towards installation expenses without identifying any actual expenditure incurred. Since the assessee claimed that installation and related charges were already embedded in vendor invoices, the matter was restored to the Assessing Officer for limited verification.

Accordingly, the Revenue’s appeal was dismissed, while the assessee’s appeal was allowed for statistical purposes

FULL TEXT OF THE ORDER OF ITAT DELHI

These cross appeals filed by the Revenue (ITA No.- 8875/Del/2025) and the assessee (ITA No.- 7990/Del/2025) are directed against the order dated 10.09.2025 of the ld. Commissioner of Income Tax (Appeals)- 29, New Delhi-110055, [hereinafter referred to as the ‘Ld. CIT(A)] arising out of the assessment order dated 30.12.2019 passed under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the ‘the Act’) by the ACIT, Circle 6(2), New Delhi (hereinafter referred to as the ‘AO’) pertaining to Assessment Year (A.Y.) 207-18. These cross appeals were heard together and are being disposed of by way of this common order for the sake of convenience and brevity.

2. Grounds in both the appeals for Assessee and Revenue are reproduced as under:

2.1 ITA No.- 7990/Del/2025

“1. That the learned Commissioner of Income Tax (Appeals) (“Ld. CIT(A)”) has erred both in law and on facts in upholding the ad-hoc addition of Rs. 83,47,048/- made by the Assessing Officer (“AO”) under section 43(1) of the Income-tax Act, 1961, towards installation and related expenses computed at 5% of the cost of new fixed assets after allowing standard depreciation, notwithstanding the fact that no such expenditure was incurred by the appellant.

2. That the Ld. CIT(A) has failed to appreciate that the AO has made an ad-hoc capitalization of 5% of the cost of new fixed assets without identifying any specific instance of installation expenditure, without any inquiry or verification, and without bringing any material on record to show that the appellant had incurred but not capitalized any such expenditure.

3. The Ld. CIT(A) has erred in not recognizing that Section 43(1) specifically defines ‘actual cost’ and does not require any arbitrary or estimated increase in cost without proper evidence of the expenditure being incurred by the appellant, or any substantiated claim of cost understatement.

4. That the Ld. CIT(A) has failed to appreciate that a substantial portion of the additions amounting to ₹3,44,36,569/- related to assets such as computers, furniture & fixtures, intangibles, office equipment, buildings, and vehicles, which do not require installation or labour activities; hence applying a blanket 5% capitalization to the entire asset additions is arbitrary and factually incorrect.

5. That the Ld. CIT(A) has erred in ignoring the undisputed fact that the remaining Plant & Machinery additions already included embedded freight, handling and incidental charges in the vendor invoice value, and no separate costs were charged by suppliers, as evidenced by invoices submitted during assessment proceedings.

6. That the Ld. CIT(A) has erred in not considering the detailed factual submissions, explanations, and documentary evidences including invoices furnished by the appellant during the appellate proceedings demonstrating that no expenses have been incurred by the appellant in respect to the addition of Plant and Machinery.

7. That the appellant craves leave to add, alter, amend or vary any of the ground either at or before the hearing of the appeal.”

2.2. ITA No.- 8875/Del/2025

“1. That on the facts and in the circumstances of the case, the Ld. CIT(A) erred in law and on facts in deleting the addition of Rs. 1,80,68,470/- made by the Assessing Officer u/s 41(1) of the Income-tax Act, 1961, ignoring that the assessee failed to furnish confirmations or evidence establishing the subsistence of these liabilities as on 31.03.2017, and that no business transactions were carried out with the said creditors for more than three years.

2. That on the facts and in law, the Ld. CIT(A) erred in deleting the addition of Rs. 1,36,63,106/-made by the Assessing Officer on account of notional interest on loans advanced to subsidiary companies, without appreciating that the assessee had substantial interest-bearing borrowings and failed to establish nexus of such advances with interest-free funds.

3. That the order of the Ld. CIT(A) is erroneous and contrary to the facts and law and deserves to be set aside to that extent.

4. The appellant craves leave to add, amend, or withdraw any ground of appeal at the time of hearing.”

3. Brief facts of the case are that the assessee filed return declaring income of Rs. 6,93,74,120/- on 31.10.2017 for A.Y. 2017-18. The case was selected for scrutiny and assessment was completed u/s 143(3) at assessed income of Rs. 11,06,62,744/-, after making the following additions: –

3.1 Aggrieved with the said order, the assessee preferred an appeal before the Ld. CIT(A), who allowed part relief to the assessee. Aggrieved by his order, both the assessee and Revenue are in appeal before the Tribunal.

ITA No.- 799/Del/2025

Ground no. 1 to 7- Capitalization of installation expenses – Rs. 83,47,048/-

4. The assessee is aggrieved by the action of the lower authorities in making ad hoc capitalization of 5% of the cost of new fixed assets acquired during the year, without identifying any instance of installation expenditure. It is the claim of the assessee that no such expenditure on installation of fixed assets had been incurred by the assessee.

5. Before us, the Ld. AR has filed a detailed chart of the fixed assets showing the breakup of new fixed assets acquired during the year. Relevant sample bills /invoices have also been filed to demonstrate that in respect of the items added in, the block of Plant and Machinery, the price included freight and installation charges. Thus, no expenditure was incurred by the assessee on installation.

5.1 Ld. Sr. DR, on the other hand, has relied on the orders of the lower authorities. 5.2 We have heard the rival submissions and perused the material available on record. We are of the considered view that there was no justification for making adhoc capitalization of 5% of total cost on account of installation expenses. We are, therefore, inclined to restore the issue to the AO for limited purpose of verification of assessee’s claim regarding installation charges being part of the cost of assets (specifically plant and machinery) acquired during the year and accordingly grant, relief to the assessee, if found correct.

5.3 In the result, assessee’s appeal is allowed for statistical purposes.

ITA No.- 8875/Del/2025

Ground no. 1 : Deletion of addition u/s 41(1) of the Act – Rs. 1,80,68,470/-

6. Brief facts of the case are that the assessee had shown outstanding paybles aggregating Rs. 1,80,68,470/- companies:

(i) Capital Expenditure : Rs. 143,31,470/-

(ii) Revenue Expenditure : Rs. 37,37,000/-

The AO added these to the total income of the assessee u/s 41(1) of the Act. The assessee explained before the Ld. CIT(A) that these were subsequently written back and duly offered to tax in the subsequent assessment years.

6.1 Based on the evidences filed by the assessee, a remand report was sought from the AO. After considering the facts and circumstances and the remand report the Ld. CIT(A) allowed relief to the assessee with the following observations:

“ 9.7 I have considered the submissions including additional evidence filed by appellant, AO’s findings, remand report, and rejoinder. It is evident that the amount of Rs. 1,43,31,470/- was capitalized, and only depreciation was claimed on it and later the amount has been written back. The cessation became final in A.Y. 2020-21, with the amount duly offered to tax that year: Hence, it would result in Double taxation if taxed in A.Y. 2017-18 as well. Therefore, the addition of Rs. 1,43,31,470/- u/s 41(1) of the Act is not sustainable on merits in the case.

9.8 Further, the amount of Rs. 37,37,000/- pertaining to trade creditors, was also offered to tax upon crystallization in subsequent relevant years. Financial records and tax returns demonstrate proper tax treatment. Legal precedent holds that mere passage of time or reflection in the balance sheet does not create cessation unless crystallized. The requirement of a detailed breakup, as flagged in the remand report, for trade creditors, has now been addressed by the appellant through annexures and schedule references matching the tax disclosures in the rejoinder. It is also supported by law that cessation u/s 41(1) arises only when liability is irrevocably written back, and double inclusion should be avoided if already taxed in a subsequent year.

9.9 In the light of above discussion, it is held that both liabilities were crystallized and were offered to tax in later assessment years. Under these circumstances, the subjected addition in A.Y. 2017-18 would result in double taxation and is therefore, unsustainable on merits. Accordingly, the addition of Rs. 1,80,68,470/- is hereby deleted. As such. this ground of appeal is allowed.”

6.2 We have heard the rival submissions and perused the material placed on record. We are of the considered view that, the Ld. CIT(A) has granted relief after due verification and passed a reasoned and speaking order. Hence, no interference is called for in the same. This ground of the Revenue is, therefore, dismissed.

Ground no. 2: Deletion of interest added u/s 36(1)(iii)- Rs. 1,36,63,106/-

7. Brief facts are that the assessee had, during the year, given interest free loans to its subsidiaries for meeting expenses on day to day business operations. The AO held that the assessee had on one hand, paid interest on borrowed funds and on the other hand, given interest free loans to its subsidiaries. He, therefore, added (notional) interest @ 13.5% on these interest free loans to the assessee’s income. Aggrieved, the assessee preferred an appeal before the Ld. CIT(A). It was claimed by the assessee that the AO had failed to establish the nexus between the interest free advances and the borrowings. It was also contended that loans in question were provided from surplus funds available with the assessee.

7.2 The ld. CIT(A) allowed the assessee’s claim and observed as under:

“11.3 I have perused the document available on record. It is a settled position of law that Section 36(1)(iii) merely permits disallowance of actual interest expenditure claimed on capital borrowed not utilized for business purposes; nowhere does it authorize addition of notional interest as fictitious income in the absence of accrual or receipt. The AO has not demonstrated that advances were from borrowed funds on which interest was claimed, nor is there a statutory basis in the Income Tax Act for taxing hypothetical interest not realized by the assessee.

11.4 The reliance is placed on the judgement of Hon’ble Supreme Court of India on this issue in the case of CIT v. Reliance Industries Ltd (reported as 410 ITR 466). The Hon’ble Court has held that when the appellant (company) has sufficient interest-free funds to meet the advances given to its subsidiary companies, it can be presumed that the investments or loans were made out of such interest-free funds. The judgment emphasized the principle of commercial expediency and upheld the decision of the Hon ble High Court and Tribunal allowing the issue in favor of the assessee. 11.5 In view of the above facts and respectfully following the Hon’ble Court’s decision, it is held that the addition of notional interest on loans extended to subsidiaries lacks legal basis. The principle laid down in the referred judgment reinforces the appellant’s plea that the notional interest should not be added to income in the absence of actual interest receipt or accrual on borrowed funds. The appellant had sufficient interest free surplus funds to make these advances to its subsidiary. Therefore, the addition of notional interest on such interest free advances is not justified. Hence, the AO is directed to delete the addition of Rs. 1,36,63,106/- made on this issue and this part of grounds of appeal is allowed.”

7.3 We have heard the rival submissions and perused the material available on record. We are of the view that the action of Ld. CIT(A) in deleting the addition of Rs. 1,36,63,106/- u/s 36(1)(iii) is justified in view of the detailed reasoning given by him and no interference is called for in the same. Accordingly, this ground of appeal of the Revenue is also rejected.

8. In the result, assessee’s appeal is allowed for statistical purposes and the appeal of the Revenue is dismissed.

Order pronounced in the open court on 03.06.2026.