2014 (3) TMI 145 - HC - Income Tax

Disallowance of excess Interest u/s 40A(2)(a) of the Act - Commercial expediency not proved - Held that - The assessee paid interest in the range of 12% to 18% on unsecured loans - in the business of making beedies finances were needed for steady flow of cash to keep the business going - The interest rates were related to old borrowings - In the earlier years, such interest rate was accepted by the Revenue also, the directors in question were in the highest tax bracket thus, there is no reason to interfere in the findings of the Tribunal thus, there was no question of law arises - Decided against Revenue. Addition made u/s 41(1) - waiver of sales tax liability Mercantile system of accounting followed - Held that - The Revenue submitted that the Karnataka Government had issued a circular during the previous year relevant to the assessment year under consideration waiving sales tax liability to the tune of Rs.22.51 lacs, but it was during the year that the liability thus ceased - The assessee instead accounted for such amount much later during the year when the refund was actually paid - the assessee following mercantile system of accounting must surrender the benefit when the right is accrued and cannot wait for the actual repayment thus, the question is admitted for consideration Decided partly in favour of Revenue.

Summary

Issues:
1. Disallowance of excess interest under section 40A(2)(a) for assessment year 2008-09.
2. Addition under section 41(1) for assessment year 2008-09.

Issue 1: Disallowance of Excess Interest under Section 40A(2)(a):
The Assessing Officer disallowed Rs.9.89 lakhs of interest under section 40A(2)(a) of the Income Tax Act, 1961, as he found the interest paid by the assessee to its directors at 18% to be excessive compared to the interest rates on unsecured loans. The CIT (Appeals) upheld this disallowance, but the Tribunal overturned it, stating that the interest was not on the higher side and had been consistently paid in earlier years. The assessee argued that the directors were in the highest tax bracket, and the interest was paid on old balances. The High Court agreed with the Tribunal, noting that the interest rates were related to old borrowings, accepted by the Revenue in previous years, and the directors were in the highest tax bracket. Consequently, the Court found no reason to disturb the Tribunal's decision, concluding that section 40A(2)(a) did not apply in this case.

Issue 2: Addition under Section 41(1):
The Revenue contended that the assessee, following the mercantile system of accounting, should have accounted for the waiver of sales tax liability by the Karnataka Government during the previous year relevant to the assessment year under consideration. The waiver amounting to Rs.22.51 lakhs ceased during the year in question, but the assessee only accounted for it when the refund was actually received. The Revenue argued that under the mercantile system, the benefit should have been surrendered when the right accrued, rather than waiting for actual repayment. The High Court admitted the Tax Appeal for consideration of this issue alone.

In conclusion, the High Court upheld the Tribunal's decision regarding the disallowance of excess interest under section 40A(2)(a) for the assessment year 2008-09, finding no legal question arising. The Court admitted the Tax Appeal to consider the addition under section 41(1) concerning the treatment of the waived sales tax liability under the mercantile system of accounting.