2018 (4) TMI 1870 - AT - Income Tax

Addition u/s 40A(2)(b) - interest paid to directors in excess of interest paid to other parties - AO noticed that the assessee inter alia paid interest to directors of the company at higher rate of 18% p.a. whereas the assessee has also paid interest on borrowed funds at lower rate of 11% - 13% to other parties - as per AO nearly 5% has been paid to the directors in excess of fair market value of lending rate and consequently quantified the disallowance of excess interest with the aid of section 40A(2)(b) - CIT-A confirmed case of the assessee for non-applicability of section 40A(2)(b) - HELD THAT - We find substance at the first instance on the plea paddled on behalf of the assessee that interest rate @ 18% cannot be seen as excessive or unreasonable having regard to the fact that the assessee has incurred interest costs at the similar rate on borrowed funds from uncontrolled parties. This fact itself proves the case of the assessee in affirmative. The revenue has not been able to counter this aspect of justification for making payment of interest alleged at higher rate qua other lenders. Therefore, we do not consider it necessary to look into the other plea of the assessee on requirement of determination of market rate of interest independently. In view of the aforesaid discussion, we do not find any infirmity in the order of the CIT(A) in drawing conclusion in favour of the assessee.

Summary

Issues:
1. Applicability of section 40A(2)(b) of the Income Tax Act to interest paid to directors in excess of interest paid to other parties.

Analysis:
The appeal was filed by the Revenue against the appellate order of the Commissioner of Income Tax(Appeals)-6, Ahmedabad, related to the assessment order passed under section 143(3) of the Income Tax Act, 1961 for the Assessment Year 2011-12. The Revenue contested the deletion of an addition of ?46,51,963 made under section 40A(2)(b) of the Act by the CIT(A). The dispute arose from the payment of interest by the assessee to directors of the company at a higher rate compared to interest paid to other parties for borrowed funds. The Revenue claimed that the excess interest paid to directors was in violation of section 40A(2)(b) of the Act.

The CIT(A) reviewed the case and found merit in the assessee's argument that section 40A(2)(b) was not applicable. The CIT(A) noted that the interest paid to directors was reasonable and not excessive, considering the rates paid to unrelated parties and the absence of charges for guarantees provided by the directors. The CIT(A) referred to precedents where interest rates up to 24% on unsecured loans were considered reasonable, supporting the assessee's position. Consequently, the CIT(A) allowed the appeal, leading to the Revenue's challenge before the Tribunal.

During the Tribunal hearing, the primary issue for consideration was the applicability of section 40A(2)(b) to the interest paid to directors in excess of interest paid to other parties. The assessee argued that the interest rate of 18% to directors was justified as similar rates were paid to other parties for borrowed funds. The Tribunal agreed with the assessee, emphasizing that the comparable rates with other lenders supported the reasonableness of the interest paid to directors. The Tribunal found no need to delve into the determination of the market rate of interest independently. Ultimately, the Tribunal upheld the CIT(A)'s decision in favor of the assessee, dismissing the Revenue's appeal.

In conclusion, the Tribunal affirmed the CIT(A)'s ruling, highlighting the justification provided by the assessee regarding the interest rates paid to directors compared to other lenders. The Tribunal's decision favored the assessee, concluding that the interest paid to directors at 18% was reasonable and not excessive, leading to the dismissal of the Revenue's appeal.