2013 (12) TMI 1416 - HC - Income Tax

Loan taken at higher interest rate than bank rate - Held that - The Tribunal has confirmed the finding of CIT (A) and AO - The appellant borrowed from the outsiders at 18%, the capital borrowed from family members and sister concern was at 24% - Bank rate was not more than 21% - The A.O. tried to enter into the true nature of transaction in which he found it unreasonable for the assessee to borrow from the family members at a higher rate than the borrowings from outsiders - The payment of interest to the family members and sister concern at 24% was diversion of profits - It was found highly unusual for a person to borrow from the family at higher rate than the rate prevailing in the market and the rate of interest to be paid to the bank - Decided against assessee.

Summary

Issues:
- Disallowance of interest claimed by appellant at 24% for family members and sister concerns.
- Justification of disallowance by Income Tax Appellate Tribunal.
- Application of Section 36(1)(c) and determination of diversion of business profits.
- Comparison of interest rates paid to family members, sister concerns, and banks.

Analysis:
The appellant, engaged in wholesale medicine business, borrowed capital from various sources at different interest rates. The Income Tax Department disallowed interest claimed at 24% for family members and sister concerns, citing the rate paid to the bank as 21%. The Commissioner (Appeals) and Income Tax Appellate Tribunal upheld this disallowance. The Tribunal found it unreasonable for the appellant to borrow at 24% from family members when the market rate was lower. The Tribunal viewed the interest payment to family members at 24% as a diversion of profits, given the disparity in rates compared to external borrowings and prevailing market rates.

Under Section 36(1)(c), the appellant argued against disallowance, emphasizing the absence of business profit diversion. Citing precedents like Commissioner of Income Tax v. Motor Sales Ltd., the appellant contended that unless there is evidence of diverted funds for non-commercial purposes, interest should not be disallowed. However, the Tribunal, supported by the AO's findings, concluded that borrowing at 24% from family members and sister concerns, despite lower market rates, indicated profit diversion. The Tribunal's decision aligned with the legal principle that taxing authorities must uncover the true nature of transactions, especially when discrepancies exist between related-party borrowings and market rates.

The Tribunal's findings were deemed legally sound, as they were based on a thorough examination of records and circumstances. The Tribunal's determination that interest payments at 24% to family members and sister concerns constituted profit diversion was upheld. The Court emphasized the importance of assessing transactions from a prudent business perspective and affirmed the Tribunal's decision against the appellant. Consequently, the question of law was resolved in favor of the revenue department, allowing them to take appropriate action based on the judgment.