2014 (4) TMI 106 - AT - Income Tax

Disallowance of interest being prior period - for the earlier year assessee has not debited the interest on unsecured loan in the profit and loss account even though it follows mercantile system of accounting - Held that - The argument that even if the interest would have been debited to the profit and loss account in those years the same would have still been disallowed since the assessee was not in a position to deduct and pay the TDS and the same would have been allowed in the impugned assessment year after payment of the TDS in our opinion is without any force. It is not the case of assessee that he was not aware of rate of interest and amount involved - Since assessee follows mercantile system of accounting and accounts are audited as per Companies Act as well as under provisions of Income Tax Act - Therefore, assessee was duty bound to prepare its accounts properly and not in casual manner like it has maintained by not debiting interest expenditure relating to concerned assessment year - Under these circumstances and in view of detailed order passed by Ld.CIT(A), no infirmity in same and same is upheld Decided against Assessee. Disallowance u/s 40A(2) excessive interest in excess of 12% - Held that - since company had stopped it operation at Chipri no banker would have financed its business for which borrowing from Directors were inevitable and loans have been taken during impugned assessment year - Loans have been obtained without pledging of any title deed or security and without going through any cumbersome process which is otherwise applicable to loans obtained from banks and other financial institutions - Payment of interest @15% p.a. under facts and circumstances of case cannot be considered as excessive or unreasonable Decided against Revenue.

Summary

Issues Involved:
1. Disallowance of interest pertaining to earlier years.
2. Disallowance of interest paid to related parties at a rate higher than the market rate.

Detailed Analysis:

1. Disallowance of Interest Pertaining to Earlier Years:
Facts and Arguments:
- The assessee, a Private Limited company engaged in the manufacturing and sale of Oxalic Acid, filed its original return of income on 26-10-2009, declaring a total income of Rs.4,69,29,950/-.
- During the assessment proceedings, the Assessing Officer (AO) noted that the assessee had debited interest amounting to Rs.95,81,00,212/- on unsecured loans, out of which Rs.52,80,702/- pertained to interest for the Assessment Years (A.Y.) 2006-07, 2007-08, and 2008-09.
- The AO disallowed the interest for earlier years, arguing that the assessee follows a mercantile system of accounting and should have debited these expenses during the relevant accounting periods.

CIT(A) Decision:
- The CIT(A) upheld the AO's decision, stating that under the mercantile system, expenses should be debited in the relevant accounting periods. The CIT(A) noted that the appellant did not charge interest on loans from certain individuals in earlier years, indicating that the interest was not chargeable until the end of the financial year 2008-09.

Tribunal's Analysis:
- The Tribunal noted that the assessee had not debited the interest on unsecured loans for A.Y. 2006-07, 2007-08, and 2008-09, despite following the mercantile system of accounting.
- The Tribunal found that the assessee's argument that the interest would have been disallowed in earlier years due to non-deduction of TDS was without force. The Tribunal upheld the CIT(A)'s decision, stating that the assessee was duty-bound to prepare its accounts properly.

Conclusion:
- The Tribunal dismissed the appeal filed by the assessee, upholding the disallowance of Rs.52,80,702/- for interest pertaining to earlier years.

2. Disallowance of Interest Paid to Related Parties at a Rate Higher Than the Market Rate:
Facts and Arguments:
- The AO noted that the assessee had paid interest at 15% p.a. on unsecured loans from related parties, while the prevailing market rate was 12% p.a. The AO disallowed the excess interest of Rs.10,58,235/-.
- The assessee argued that the loans were unsecured and taken during a financial crisis, justifying the higher interest rate. The assessee also cited the Bombay High Court decision in CIT Vs. Indo Saudi Services (Travel) P. Ltd., which held that no disallowance should be made where there is no attempt to evade tax.

CIT(A) Decision:
- The CIT(A) deleted the addition made by the AO, stating that the rate of interest depends on the urgency and circumstances of borrowing. The CIT(A) noted that unsecured loans typically have higher interest rates and cited various judicial precedents supporting the assessee's position.

Tribunal's Analysis:
- The Tribunal agreed with the CIT(A), noting that the loans were taken from directors and related parties without pledging any security and without going through the formalities required for bank loans.
- The Tribunal found that the payment of interest at 15% p.a. was not excessive or unreasonable under the circumstances.

Conclusion:
- The Tribunal dismissed the appeal filed by the Revenue, upholding the CIT(A)'s decision to allow the interest paid at 15% p.a.

Final Judgment:
- Both the appeals filed by the assessee and the Revenue were dismissed. The Tribunal upheld the CIT(A)'s decisions on both issues, maintaining the disallowance of interest pertaining to earlier years and allowing the interest paid at a higher rate to related parties.