2014 (9) TMI 1030 - HC - Income Tax

Disallowance under section 40A(2)(b) - rate of interest - Held that - As the assessee has borrowed funds and used the same for its business purposes. Both, the Commissioner (Appeals) as well as the Tribunal have concurrently found that the borrowed funds have been used for business purposes and have held that interest on such borrowed funds is an allowable expenditure. The only difference in opinion is to the extent of interest allowable on such borrowed funds. The Commissioner (Appeals) has restricted such allowance to the interest paid to transporters and towards goods deposits whereas the Tribunal has held the interest paid at the rate of 18% to be reasonable. Having regard to the findings recorded by the Tribunal for holding the rate of interest at 18% to be reasonable, it is not possible to state that there is any legal infirmity in the conclusion arrived at by the Tribunal so as to give rise to a question of law, much less, a substantial question of law, warranting interference.

Issues Involved:
1. Allowability of interest on borrowed funds under section 36(1)(iii) of the Income Tax Act, 1961.
2. Application of section 40A(2)(b) regarding disallowance of excessive interest paid to related parties.
3. Business expediency and commercial expediency in incurring interest expenditure.

Detailed Analysis:

1. Allowability of Interest on Borrowed Funds:
The primary issue was whether the interest paid by the assessee on borrowed funds at the rate of 18% was allowable as a business expenditure under section 36(1)(iii) of the Income Tax Act, 1961. The Tribunal and the Commissioner (Appeals) both found that the borrowed funds were used for business purposes, specifically for making advance payments for the purchase of bidis. The assessee's turnover and purchase volumes necessitated huge funds, which were borrowed and parked in fixed deposits until needed. The Tribunal concluded that the interest rate of 18% was reasonable and aligned with the fair market value of such services, reversing the Commissioner (Appeals)'s partial disallowance of interest.

2. Application of Section 40A(2)(b):
The Assessing Officer invoked section 40A(2)(b) to disallow the difference between the interest paid to related parties (at rates between 12% to 18%) and the interest earned on fixed deposits (at rates between 5% to 8%). The Commissioner (Appeals) partially upheld this disallowance, determining that the market rate of borrowing was lower than the 18% paid to family members, and thus, disallowed the excess interest of 3% to 4%. However, the Tribunal found the interest rate paid by the assessee to be reasonable and deleted the addition, stating that the interest rate could not have been renegotiated from previous years and that the funds were used for business purposes.

3. Business Expediency and Commercial Expediency:
The Tribunal and the Commissioner (Appeals) both agreed that the funds placed in fixed deposits were part of the business expediency of the assessee. The Commissioner (Appeals) cited the Supreme Court's decision in S.A. Builders, which held that expenditures made for business expediency are allowable. The Tribunal emphasized that the assessee's decision to borrow funds at 18% was driven by commercial expediency, considering the cumbersome procedures and higher interest rates associated with bank loans. The Tribunal held that the assessee's method of conducting business, including the interest payments, was within the prerogative of the assessee and aligned with prudent business practices.

Conclusion:
The High Court upheld the Tribunal's decision, finding no legal infirmity or substantial question of law warranting interference. The appeals were dismissed, affirming that the interest paid at the rate of 18% on borrowed funds was reasonable and allowable as a business expenditure under section 36(1)(iii). The court recognized the commercial expediency and business necessity behind the assessee's borrowing practices and the interest rates agreed upon with related parties.

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