2016 (4) TMI 1428 - AT - Income Tax

Disallowance on account of interest on unsecured loans paid in excess of 18% to the persons specified u/s 40A(2)(b) - assessee company has paid interest at the rate of 21% on unsecured loans to the persons specified u/s 40A(2)(b) - AO has found the same to be excessive and has disallowed interest paid in excess of 18% and made an addition HELD THAT - What needs to be appreciated is that the AO and LD CIT(A) have failed to appreciate the distinction between a secured loan and an unsecured loan. The secured loan comparatively carried a lower risk element as compared to an unsecured loan and basis the risk assessment and other considerations, it typically carried a lower rate of interest. In the instant case, the appellant has taken unsecured loan and an appropriate comparison would have been the rate prevalent in the market vis-a-vis unsecured loan. Apparently, the appellant has stated that the prevailing market rate of interest on unsecured loans was 24%. However, nothing has been brought on record by the AO to suggest what the appellant has stated to be incorrect or there is a better comparison which is available. We have gone through the judgement of Ramesh Chand (HUF) 2013 (2) TMI 151 - PUNJAB HARYANA HIGH COURT wherein addition was made in appellant's case because of higher rate of interest paid by appellant to his mother as against market rate. The High Court confirmed the addition on the ground that since transaction in question was not a genuine and bona fide transaction, Tribunal was justified in confirming addition of interest paid on old loan at higher rate of interest by applying provisions of section 40A(2)(b) and no question of law arises. In the instant case, there is no such allegation or finding of the lower authorities that the subject loan transaction was not a genuine transaction. Hence, this decision is no help to the Revenue. We have also gone through the decision of Aditya Medisales Ltd 2010 (5) TMI 823 - GUJARAT HIGH COURT and finds that the same support the case of the appellant. In that case, the Court has noted that the interest on unsecured borrowings is always higher than the rate of interest paid to the banks or financial institution from where the loans raised are secured loan, and have accordingly accepted interest paid to Sun Pharmaceuticals at the rate of 24% to be reasonable. We are of the view that CIT(A) was not justified in confirming the disallowance on account of interest paid by the appellant to specified persons u/s 40A(2)(b) of the IT Act. Hence, ground of the appellant is allowed.

Summary

Issues: Disallowance of interest on unsecured loans paid in excess of 18% under section 40A(2)(b) of the IT Act.

The judgment revolves around the disallowance of Rs. 2,26,176 on account of interest on unsecured loans paid in excess of 18% to specified persons under section 40A(2)(b) of the IT Act. The Assessing Officer (AO) disallowed the interest paid in excess of 18% by the assessee company, leading to an addition in the appellant's hands. The Commissioner of Income Tax (Appeals) upheld the addition, reasoning that corporate governance norms require transactions with related parties to be at arm's length, justifying a premium of 3-4% over the bank rate of interest. The appellant argued that unsecured loans inherently carry higher interest rates, with the prevailing market rate at 24%, making the paid 21% reasonable. The appellant cited relevant case laws, including the decision of the Hon'ble Gujarat High Court in Aditya Medisales Ltd., to support their position.

The Tribunal analyzed the submissions and found that the AO and CIT(A) failed to appreciate the distinction between secured and unsecured loans. They noted that unsecured loans typically carry higher interest rates due to the increased risk, with the prevailing market rate for such loans being 24%. The Tribunal highlighted that the AO did not provide a basis for deeming 18% as a reasonable rate, and the appellant's assertion regarding market rates was not refuted. Drawing on the decision of the Hon'ble Gujarat High Court in Aditya Medisales Ltd., the Tribunal concluded that the disallowance of interest paid to specified persons under section 40A(2)(b) was unjustified. The Tribunal allowed the appellant's appeal, overturning the disallowance of Rs. 2,26,176 on interest paid on unsecured loans, emphasizing the reasonableness of the 21% interest rate in the context of prevailing market rates for such transactions.

In summary, the judgment delves into the application of section 40A(2)(b) of the IT Act concerning the disallowance of interest on unsecured loans exceeding 18%. It underscores the need to consider market realities and risk differentials in determining the reasonableness of interest rates, ultimately ruling in favor of the appellant based on the prevailing market rate for unsecured loans and relevant legal precedents.