2008 (11) TMI 71 - HC - Income Tax

Interest on capital borrowed - proviso to Section 36(1)(iii) was introduced w.e.f. 1.4.04 - proviso is prospective and it is not applicable to the A.Y. 2001-02 AO was not right in disallowing the claim for deduction - Whether Tribunal was justified to allow interest @ 18% to close relatives covered under S. 40A(2)(b) - Tribunal finding that the interest paid was not higher than rate of interest paid to other creditors, is finding of fact - no question of law arise disallowance not justified

Summary

Issues:
1. Whether interest on capital borrowed for construction during the preoperative period is admissible under Section 43 of the Income Tax Act?
2. Whether interest rate differentiation between close relatives and other creditors under Section 40A(2)(b) is justified?

Analysis:

Issue 1:
The appellant challenged the disallowance of deduction under Section 36(1)(iii) of the Income Tax Act by the Assessing Officer, claiming interest paid on capital borrowed for establishing a new unit. The Assessing Officer contended that interest paid for preoperative expenses was not admissible under explanation 8 to Section 43 of the Act. However, the Commissioner Income-tax(Appeals) and the Tribunal allowed the claim of the assessee. The Tribunal highlighted that the proviso to Section 36(1)(iii) introduced by the Finance Act, 2003, was prospective and not applicable to the assessment year 2001-02. Citing Deputy CIT v. Core Healthcare Ltd., it was emphasized that borrowing on capital or revenue account is not relevant for deduction purposes. The Tribunal agreed with the Commissioner's decision to delete the addition, stating that the Assessing Officer's observations were incorrect. The Tribunal found no fault with the Commissioner's order and dismissed the appeal.

Issue 2:
Regarding the second issue, the Tribunal addressed whether the interest rate differentiation between close relatives and other creditors under Section 40A(2)(b) was justified. The Assessing Officer disallowed interest amount to close relatives under Section 40A(2)(b) on the grounds of excessiveness compared to other creditors. However, the Tribunal noted that the interest rate paid was not higher than that paid to other creditors. Citing a judgment of the Gujarat High Court affirmed by the Supreme Court, the Tribunal concluded that this question did not constitute a substantial question of law. Consequently, the Tribunal dismissed the appeal, upholding the findings related to both issues.

In conclusion, the High Court upheld the decisions of the Commissioner Income-tax(Appeals) and the Tribunal, dismissing the appeal filed by the revenue. The judgment clarified the admissibility of interest on capital borrowed for preoperative expenses and the justification for interest rate differentiation between close relatives and other creditors under the relevant sections of the Income Tax Act.