2018 (10) TMI 297 - HC - Income Tax

Levy of interest tax on the penal/default interest collected - whether Penal interest collected would fall within the ambit of the Interest Tax Act u/s 2(7) of the Interest Tax Act - Held that - The High Court of Karnataka, in the case of State Bank of Mysore vs. Commissioner of Income-tax reported in (1988 (6) TMI 21 - KARNATAKA HIGH COURT) held that interest is the damages or compensation for delayed payment of money due and therefore, the expression compensation in Section 32 of the Negotiable Instruments Act, will include interest paid by way of damages or compensation for delayed payments. It was further, held that any amount collected by the Bank cannot be anything but interest, whatever may be the nomenclature, and is chargeable interest for the purpose of Interest Tax Act. Loans and advances has been held to be different from discounts and legislature has kept in mind the difference between the two and it is clear that the right to charge for overdue interest by the assessee banks did not arise on account of any delay in repayment of any loan or advance made by the said banks and this right arose on account of default in payment of amounts due under a discounted bill of exchange. It was held that a subject can be brought to tax only by a clear statutory provision in that behalf and interest is chargeable to tax under Interest Tax Act only if it arises directly from a loan or advance. This finding was explained by stating that it is clear from the use of the word on in Section 2(7) of the Interest Tax Act that interest payable on a discounted bill of exchange cannot be equated with interest payable on a loan or advance.

Summary

Issues:
Interpretation of the Interest Tax Act regarding the inclusion of penal interest in chargeable interest.

Analysis:
The appeals were filed by the assessee under Section 260A of the Income-tax Act against the order passed by the Income-tax Appellate Tribunal regarding the levy of interest tax on penal/default interest collected. The substantial questions of law included whether the Tribunal was correct in upholding the levy of interest tax on default interest, and whether the charges collected by the assessee would fall within the definition of interest under the Interest Tax Act.

The assessee, a non-banking financial institution operating chit funds, filed revised returns for the assessment years, returning chargeable interest. The Assessing Officer found that default interest (penal interest) was included in chargeable interest. The assessee argued that default interest is compensation received from borrowers and is not within the purview of chargeable interest. However, the Assessing Officer held that any compensation received by the lender from the borrower, regardless of name, is considered interest on loans or advances.

The CIT(A) deleted the addition made by the Assessing Officer based on a previous decision. The Revenue appealed the decision, and the Tribunal allowed the appeal, leading to the current appeals. The main issue was whether the penal interest collected by the assessee falls within the ambit of the Interest Tax Act, particularly under Section 2(7) of the Act.

Various legal precedents were cited, including decisions by different High Courts and the Supreme Court. The judgments highlighted the distinction between interest on loans and advances and other charges like penal interest. The High Court ultimately held that the charges collected by the assessee did not fall within the definition of interest under the Interest Tax Act. The Tribunal's order was set aside, and the appeals filed by the assessee were allowed.

In conclusion, the High Court's judgment clarified the interpretation of the Interest Tax Act concerning the treatment of penal interest in chargeable interest, relying on legal precedents to support its decision. The order passed by the Tribunal was deemed incorrect, and the substantial questions of law were answered in favor of the assessee, restoring the CIT(A)'s previous order.