Section 263 Revision Not Justified for Notional Interest: ITAT Rules Income Taxable Only on Maturity
In a recent and significant ruling under Section 263 of the Income-tax Act, 1961, the Income Tax Appellate Tribunal (ITAT), Chandigarh Bench, examined whether the Commissioner’s revision order was justifiable for non-verification of notional interest in the original assessment. In AVON Cycles Ltd. vs PCIT (Assessment Year 2021-22), the Tribunal held that initiating revisionary proceedings merely because the Assessing Officer (AO) did not verify notional interest cannot be justified — especially where such income is not taxable in the year of accrual but only on maturity.
Facts and Issue of the Case
AVON Cycles Ltd. (the assessee) filed its income tax return for the Assessment Year 2021-22, which underwent scrutiny under Section 143(3) read with Section 144B of the Income-tax Act. Following this scrutiny assessment, the Assessing Officer completed the assessment on 26 December 2022, after making necessary inquiries and receiving detailed replies from the assessee on various matters raised during the assessment process.
Subsequently, the Principal Commissioner of Income Tax (PCIT) reviewed the assessment record and issued a show-cause notice under Section 263. Among several grounds cited, the PCIT alleged that the AO had failed to verify the notional interest amounting to approximately ₹1.84 crore, which appeared as income in the assessee’s profit and loss account as per Indian Accounting Standards (IND-AS).
Notional interest, in accounting terms, represents interest that is recognized for accounting purposes but is not actually received in cash — and importantly in this case, is not taxable in the year of accrual but only when actually received or on maturity under the provisions of the Income-tax Act.
The PCIT took the position that since the AO did not verify this notional interest item during the original assessment, the assessment order was “erroneous and prejudicial to the interest of the Revenue”, thereby justifying exercise of revisionary jurisdiction under Section 263.
This triggered an appeal by the assessee before the ITAT, challenging the validity of the revision order, particularly on the notional interest issue.
The central question before the Tribunal was whether the omission to make specific inquiries or verification of notional interest — which is not taxable in the relevant year — could render the assessment order prejudicial to revenue and hence a valid ground for revisional proceedings under Section 263.
Observation by the Tribunal
In its detailed order, the ITAT examined what Section 263 empowers the Commissioner to do and what it prohibits. As per the law, revision under Section 263 can be invoked only if two conditions are satisfied:
- The assessment order passed by the AO is erroneous, and
- It is prejudicial to the interest of the Revenue.
One of the key points emphasized by the Tribunal was that not every omission or failure in verification automatically makes an assessment order prejudicial. For an order to be considered prejudicial, there must be a concrete impact on the tax payable — not a theoretical or accounting discrepancy that has no immediate tax implication.
Importantly, the Tribunal noted that notional interest under IND-AS is recognized for accounting purposes, but as per tax law, such income is not taxable in the year of recognition; it becomes taxable only upon actual receipt or maturity. Thus, even if the AO did not specifically verify the details of notional interest, the mere absence of inquiry cannot be treated as an error that could lead to revenue loss in that year.
The Tribunal also scrutinized the show-cause notice and noticed that the PCIT did not demonstrate how the AO’s omission had resulted in a loss to revenue. Despite the fact that the notional interest was reflected in the books, the PCIT conceded that it was not taxable in the year under consideration. Consequently, there was no evidence that any tax was evaded or revenue compromised due to the AO’s non-verification.
Additionally, the Tribunal highlighted that in other issues raised by the PCIT (such as reconciliation of sales with Form 26AS or stock valuation), the AO had indeed issued relevant queries and the assessee responded with supporting evidence. Even where the AO asked specific questions — such as regarding trade expenses — the Tribunal found that the AO had already examined and accepted the replies.
The Tribunal therefore emphasized that it is not sufficient for the PCIT to simply conclude that the AO did not verify an accounting entry. The key question is whether such omission had any adverse impact on revenue. Without such adverse impact, the order cannot be said to be “erroneous and prejudicial” in the legal sense required under Section 263.
Law Applicable
Section 263 of the Income-tax Act, 1961 confers jurisdiction upon the Commissioner to revise orders passed by an Assessing Officer only when:
- the order is erroneous in law or on facts; and
- such error is prejudicial to the interests of the Revenue.
The statutory provision further empowers the Commissioner to carry out or cause to be carried out such inquiry as deemed necessary before passing a revisional order, after giving the assessee an opportunity of being heard.
Crucially, an order is not regarded as erroneous and prejudicial merely because the Commissioner disagrees with the approach taken by the AO or would have arrived at a different conclusion. This interpretation has been reaffirmed in several judicial decisions, wherein it was held that if the AO has taken one of the plausible interpretations of facts and law, such an order cannot be revisited under Section 263.
Further, recent interpretations of Section 263 make it clear that mere non-verification or inadequate verification does not automatically imply prejudice to revenue — unless it is demonstrated that such omission resulted in tax loss or evasion.
In this context, the ITAT’s ruling stands on settled legal principles that not obligatory verification for every accounting item — especially where it is not taxable in the current year — does not equate to an erroneous order prejudicial to revenue. This aligns with the core principle that revisionary jurisdiction should not be exercised for correcting every factual or accounting detail unless legal error affecting revenue is established.
Conclusion by the Tribunal
After a meticulous examination of the facts, evidence, and legal position, the ITAT held that the revisionary proceeding under Section 263, purely on the ground of non-verification of notional interest, was not sustainable.
The Tribunal observed that:
- Notional interest is not taxable in the year of accrual and therefore its non-verification could not have prejudicially affected revenue.
- The PCIT failed to demonstrate that the AO’s alleged omission in verification led to any actual loss or potential leakage of revenue.
- Without establishing prejudice to revenue, the twin conditions for invoking Section 263 were not satisfied.
Consequently, the Tribunal set aside the PCIT’s revisionary direction with respect to notional interest, effectively restoring the assessment order on this issue. Other parts of the revisionary order (like stock valuation) were separately considered, but as far as non-verification of notional interest was concerned, the Tribunal unequivocally ruled in favour of the assessee.
