2022 (3) TMI 384 - AT - Income Tax

Disallowance u/s 40A2)(b) - Addition of excess interest paid to the related parties - difference between the rate of interest on loan received and paid - HELD THAT - It is settled proposition of law that in order to make a disallowance u/s 40A(2)(b), the AO has to first determine the fair market value/price and then compare the same with the actual expenditure incurred and payment made by the assessee to the specified person. In case, the payment made by the assessee to the specified person is excessive and unreasonable having regard to the fair market value/price, the amount found to be excess or unreasonable is liable to be disallowed u/s 40A(2) of the Income-tax Act. Therefore it is precondition for making the disallowance u/s 40A (2) that the AO has to arrive to the conclusion that the amount paid by the assessee is excessive or unreasonable in comparison to the fair market value/price. In the case in hand, the AO has not carried out such exercise to first determine the fair value of interest rate in question by bringing any comparable instance/case So, naturally and undisputedly it would be for the business purpose only. Therefore, in our considered opinion that lower interest received on loan given to related party for business purpose cannot be subjected to provisions of section 40A(2)(b) of the Act. In the present case, having regard to the facts and circumstances referred to hereinabove, the we have arrived to a conclusion that the Assessing Officer has failed to prove by any comparable case or comparison by market rate that the amount paid by the assessee was excessive or unreasonable. Accordingly, we direct the assessing officer to delete the addition made under section 40A (2) (b) - Decided in favour of assessee.

Summary

Issues:
Disallowance of interest paid to related parties under section 40A (2) (b) of the Income Tax Act, 1961.

Analysis:
The appeal was filed against the order of the Commissioner of Income-tax (Appeals) confirming the disallowance of interest paid by the assessee to related parties. The assessing officer found that the assessee paid interest at a higher rate to related parties compared to the rate at which the assessee received interest. The assessing officer invoked section 40A (2) (b) of the Act and disallowed the excess interest paid, adding it back to the total income of the assessee. The CIT (A) upheld the assessing officer's decision, leading to the appeal before the Tribunal.

The assessee argued that the disallowance under section 40A (2) (b) should not have been made without demonstrating that the expenditure was not wholly and exclusively for the business of the assessee. The assessee also cited precedents to support the argument that the correlation of funds contributed by partners with the interest rate on lent money should not lead to disallowance under section 40A (2) (b).

The Tribunal referred to a previous case where it was held that the assessing officer must objectively demonstrate that the payment made by the assessee is excessive and unreasonable compared to the market rate. In the present case, the assessing officer did not determine the fair market value of the interest rate paid by the assessee to related parties. It was noted that the assessee, being a partner in the firm to which the loan was given, could not charge more than the prescribed rate under section 40(b) (iv) of the Act. The Tribunal concluded that the assessing officer failed to prove that the amount paid by the assessee was excessive or unreasonable, as there was no comparison with fair market value. Consequently, the Tribunal directed the assessing officer to delete the addition made under section 40A (2) (b) of the Act, allowing the appeal filed by the assessee.

In conclusion, the Tribunal ruled in favor of the assessee, emphasizing the importance of objectively determining excessive and unreasonable payments under section 40A (2) of the Income Tax Act and the necessity of comparing payments with fair market value to justify disallowances.