2016 (3) TMI 825 - AT - Income Tax

Disallowance u/s 40A - CIT(Appeals) restricted the rate of interest to 15% as against 18% claimed by the assessee and 12% allowed by the Assessing Officer - Held that - The loans were taken from the same persons/relatives. It is true that for the purpose of disallowance under sect ion 40A(2) of the Act, the guiding factor is whether the expenditure is excessive or unreasonable, having regard to the fair market value of the case, services or facilities for which the payment has been made. In our opinion, it is a matter of common knowledge that the interest on unsecured loan is normally more than the interest payable on secured loans. In the case of market loans, no security is given and no paper or other formalities are required to be completed. The unsecured loan is also available at the call and convenience of the assessee as and when required. Keeping in view the peculiar facts and circumstances of the present case, we are of the view that the disallowance sustained by the ld. CIT(Appeals) is unwarranted and hence, we delete the same. - Decided in favour of assessee

Summary

Issues:
1. Disallowance of excess interest paid to partners and family members.
2. Interpretation of Section 40A(2)(a) of the Income Tax Act, 1961.
3. Assessment of interest expenditure at a rate of 18%.

Issue 1: Disallowance of Excess Interest Paid to Partners and Family Members:
The Assessing Officer disallowed a sum of Rs. 6,76,279 on account of excess interest paid to partners and family members. The contention was that the interest rate of 18% paid to unsecured loans was reasonable as compared to bank loans secured at 12-13%. However, the Assessing Officer did not accept this argument and added the disallowed amount to the assessee's income. On appeal, the CIT(A) restricted the interest rate to 15% instead of 18%, reducing the disallowance to Rs. 3,38,140. The assessee argued that the interest paid at 18% had been allowed in previous years and cited a previous order where a similar disallowance was deleted. The Tribunal found the disallowance unjustified, considering the nature of unsecured loans and the business expediency involved, ultimately deleting the disallowance amount.

Issue 2: Interpretation of Section 40A(2)(a) of the Income Tax Act, 1961:
The appellant contended that the provisions of Section 40A(2)(a) were misconstrued and misapplied by the authorities in restricting the interest rate to 15% instead of the claimed 18%. The Assessing Officer invoked Section 40A(2)(b) to justify the disallowance, arguing that the interest expenditure was excessive. However, the Tribunal noted that the guiding factor for disallowance under Section 40A(2) is whether the expenditure is excessive or unreasonable in relation to the fair market value of the services or facilities. The Tribunal emphasized that unsecured loans typically attract higher interest rates due to the lack of security and formalities compared to secured loans. Considering these factors, the Tribunal found the disallowance unwarranted and deleted the same.

Issue 3: Assessment of Interest Expenditure at a Rate of 18%:
The primary dispute revolved around the assessment of interest expenditure at a rate of 18%. The Assessing Officer disallowed the excess interest paid, leading to a disagreement on the appropriate interest rate to be considered. The CIT(A) reduced the disallowance by restricting the rate to 15%, which was further challenged by the appellant. The Tribunal analyzed the business expediency, historical treatment of interest rates, and the nature of loans to conclude that the disallowance at the rate of 15% was unjustified. Ultimately, the Tribunal allowed the appeal, emphasizing the common knowledge regarding interest rates on unsecured loans and the discretion of the assessee in managing such loans.

This judgment highlights the meticulous consideration of interest rate disallowances under the Income Tax Act, emphasizing the application of fair market value principles and the nature of loan transactions in determining the reasonableness of interest rates. The Tribunal's decision reflects a balanced approach in interpreting tax provisions and considering the specific circumstances of each case to ensure fair treatment for taxpayers.