2012 (10) TMI 532 - AT - Income Tax

Disallowance of interest expense u/s 36(1)(iii) - Assessee had paid 18% interest to its related parties on the loans received from relatives - Assessee had received interest only at the rate of 10% -11% from two parties Interest free loan has been given to two parties Held that - As if there was no material to indicate that moneys were advanced out of borrowed funds, the presumption would always be that moneys were advanced out of own funds. As it is to pick out few of the loans given by the assessee and make a comparison of the interest rate, will not be appropriate. There is nothing on record to show that the amounts given by the assessee as loan were coming out of interest bearing funds. - Decided in favor of assessee.

Issues:
- Disallowance of interest expenditure claimed by the assessee
- Commercial expediency for giving loans to unrelated parties
- Application of mercantile system for interest payment

Analysis:
1. Disallowance of interest expenditure claimed by the assessee:
- The Revenue appealed against the deletion of a disallowance of Rs.16,58,713 made by the Assessing Officer (A.O.) against the claim of interest expenditure by the assessee.
- The A.O. noted that the assessee paid higher interest to loan creditors who were relatives, compared to lower interest received from unrelated parties. This led to the disallowance of the differential interest amount.
- The CIT (Appeals) deleted the disallowance, emphasizing that the interest payments to loan creditors were not excessive, considering the long-standing nature of the loans and the commercial expediency of placing surplus funds with private parties for higher returns.
- The A.O. failed to establish that the interest paid was excessive or not in line with fair market value, leading to the deletion of the disallowance.

2. Commercial expediency for giving loans to unrelated parties:
- The assessee argued that the loans to unrelated parties were based on commercial expediency, as placing surplus funds with them yielded higher returns than traditional financial institutions.
- The CIT (Appeals) acknowledged the commercial rationale behind the investments with non-related parties, highlighting the temporary nature of the surplus funds and the higher interest rates offered by private parties compared to banks.
- The CIT (Appeals) observed that the loans were not taken during the year but existed for several years, emphasizing the consistency in interest rates paid over time.

3. Application of mercantile system for interest payment:
- The Revenue contended that the allowance of the interest expenditure under the mercantile system, despite no cash outflow, was not in accordance with the law.
- The A.O. and the Revenue challenged the deletion of the disallowance solely based on the submissions of the assessee, questioning the validity of the commercial expediency claimed.
- The Tribunal upheld the CIT (Appeals) decision, noting that the assessee had substantial own funds and liquid assets available for investments, and there was no evidence to suggest that the loans were funded by interest-bearing funds.

In conclusion, the Tribunal dismissed the Revenue's appeal, affirming the deletion of the disallowance of interest expenditure by the CIT (Appeals). The commercial expediency of the loans to unrelated parties, the absence of excessive interest payments, and the availability of substantial own funds for investments were crucial factors in the decision. The Tribunal found no grounds for interference and upheld the CIT (Appeals) order, resulting in the dismissal of both the appeal and cross-objection.

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