2015 (10) TMI 2767 - AT - Income Tax

Addition u/s 40A(2)(b) towards interest paid on loans - whether the interest paid @ 15% to related parties can be considered as excessive and unreasonable to invoke the provisions of section 40A(2)? - HELD THAT - As per the provisions of section 40A(2) of the Act the Assessing Officer has to establish on record that the payment made by the assessee is unreasonable and excessive compared to the market rate. Nowhere in the assessment order, has the Assessing Officer brought any material to establish the market rate of interest on such types of loan. Commissioner (Appeals) has also ignored this aspect. Therefore, there is no reason why interest payment to related party should be confined to 12.6%. More so, when the loans are not secured against any asset unlike bank loans and the lender always runs a risk of recovery of loan, therefore, charges interest at a bit higher rate. The decision cited by the learned Authorised Representative also supports this view. Moreover, it is a fact on record that the assessee has paid interest @ 15% even to unrelated parties. That being the case, interest paid @ 15% to related parties should be allowed. Ground raised by the assessee is allowed and grounds raised by the Revenue are dismissed.

Summary

Issues:
Common issue in dispute: Decision of Commissioner (Appeals) in partly sustaining addition under section 40A(2)(b) towards interest paid on loans.

Analysis:
The judgment revolves around the dispute concerning the addition made by the Assessing Officer under section 40A(2)(b) of the Income Tax Act, 1961, related to interest paid on loans by a partnership firm engaged in the business of builders and developers for the assessment year 2013-14. The Assessing Officer observed that the interest paid @ 15% to related parties was excessive and unreasonable, leading to disallowance of interest payment amounting to Rs. 2,08,63,210. The firm contended that not all unsecured loans were from related parties and that interest paid to related parties at the same rate as unrelated parties should not be considered unreasonable. The Commissioner (Appeals) directed the disallowance to be restricted to related parties only and applied an average interest rate of 12.6% for related parties. Both the firm and the Revenue appealed to the Tribunal.

The Tribunal considered the submissions and facts on record, noting that the firm had paid interest @ 15% to both related and unrelated parties. It found that the Assessing Officer failed to establish the unreasonableness of the interest rate compared to the market rate, as required by section 40A(2) of the Act. The Tribunal highlighted that the firm's payment to unrelated parties at the same rate was significant and that no material was presented to demonstrate the market rate of interest on such loans. It emphasized the absence of evidence to support the disallowance and the higher risk associated with unsecured loans, justifying a slightly higher interest rate. The Tribunal allowed the firm's appeal and dismissed the Revenue's appeal, concluding that interest paid @ 15% to related parties should be allowed.

In conclusion, the Tribunal's judgment favored the firm, emphasizing the lack of evidence supporting the disallowance of interest payment to related parties under section 40A(2)(b) of the Act. The decision highlighted the importance of establishing the unreasonableness of interest rates compared to market rates and considered the risk factor associated with unsecured loans. The Tribunal's decision favored the firm's position and allowed its appeal while dismissing the Revenue's appeal.