2022 (4) TMI 1119 - AT - Income Tax

Assessment of notional interest on loans - loan has been granted by the assessee to its sister concern - assessee submitted that no interest was charged from HEPL since they were facing financial difficulties - HELD THAT - It has been explained by the assessee that during 2012-13, HEPL expressed inability to pay interest on advances since they were facing financial difficulties. Accordingly, they requested assessee not to charge interest which was agreed upon by both the parties. However, rejecting the same,AO has computed notional interest of 18% on outstanding loans advanced by the assessee. On the basis of these facts, we are of the considered opinion that the addition of notional interest is not sustainable in the eyes of law. It is trite law that only real income is to be assessed to tax unless expressly provided under the act. No statutory provision has been shown to us which mandate addition of notional interest. The assessee had debited interest expenditure during the year. As per the provisions of Sec. 36(1)(iii) AO could have disallowed interest expenditure if the interest was paid in respect of capital borrowed which was not used for the purposes of business or profession. As per the mandate of Sec. 36(1)(iii), the amount of interest paid in respect of capital borrowed for the purposes of business or profession is an allowable deduction. In the instance case AO could have invoked the provisions of s 36(1)(iii) to hold that the borrowed capital was not used for the purposes of business or profession. However, the same has not been done and the provisions of Sec. 36(1)(iii) have not been invoked. Rather Ld. AO has computed notional interest on loans advanced by the assessee which do not find support of any statutory provisions. Therefore, the action of Ld. AO, in adding the notional interest on outstanding loans, in not in accordance with law and hence not sustainable. Another aspect of the matter is that the loan has been granted by the assessee to its sister concern. Naturally the assessee had business interest in that entity. The assessee has charged interest till 31.03.2012 and thereafter no interest has been charged as per mutual understanding since the borrower entity was facing financial difficulties. The assessee did not pay interest to the shareholders till 31.03.2013. Therefore, non-charging of interest was fully justified by the assessee and the same could be said to have been out of commercial expediency. In such a case the ratio of decision of Hon'ble Supreme Court in the case of S.A. Builders Ltd. 2006 (12) TMI 82 - SUPREME COURT would be applicable wherein it was held that once it was established that there was nexus between the expenditure and purposes of business, which need not be the business of the assessee, deduction u/s. 36(1)(iii) was to be allowed. It was further held that the expression 'commercial expediency' is an expression of wide import and includes such expenditure as prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency. Further, the expression 'for the purpose of business' is wider in scope than the expression 'for the purpose of earning profits'. This decision has subsequently been followed by Hon'ble Court in Hero Cycles Pvt. Ltd. 2015 (11) TMI 1314 - SUPREME COURT . We find that the ratio of these decisions is applicable to the facts of the case considering the arguments of the revenue that that the provisions of Sec. 36(1)(iii) have been invoked. Viewed from any angle, the additions as made by Ld. AO is not sustainable - Decided in favour of assessee.

Summary

Issues:
Assessment of notional interest on loans.

Detailed Analysis:

Assessment Proceedings:
The appellant, engaged in the chit fund business, was assessed for AY 2014-15 and faced an addition of notional interest of ?416.71 Lacs. This addition stemmed from the fact that the appellant claimed interest expenses of ?644.65 Lacs and earned interest income of ?111.92 Lacs. The appellant had advanced a loan of ?3100 Lacs to an entity and the outstanding balance at year-end was ?3606.76 Lacs. The appellant explained that the borrower expressed inability to pay interest due to financial difficulties, and hence no interest was charged. However, the AO computed notional interest, which the appellant opposed, citing commercial expediency and past practices.

Appellate Proceedings:
During the appellate proceedings, the appellant argued that there was no provision under the Act to assess notional interest on loans, especially when no interest was charged due to financial difficulties faced by the borrower. The CIT(A) confirmed the addition of notional interest, stating that the appellant paid interest to lenders but did not charge interest on the loan given to the borrower, which was deemed as a part of group tax planning. The CIT(A) dismissed the appellant's grounds, upholding the AO's decision.

Findings and Adjudication:
After careful consideration, it was found that the addition of notional interest was not sustainable under the law. The AO had not invoked the provisions of Sec. 36(1)(iii) to disallow interest expenditure, which could have been applicable if the borrowed capital was not used for business purposes. The non-charging of interest to the borrower was justified by commercial expediency and mutual understanding due to financial difficulties faced by the borrower. The decision of the Hon'ble Supreme Court in S.A. Builders Ltd. and Hero Cycles Pvt. Ltd. supported the appellant's case, emphasizing the wide scope of 'commercial expediency' and 'for the purpose of business.' The Tribunal ordered the deletion of the impugned addition and directed the AO to re-compute the appellant's income accordingly.

In conclusion, the Tribunal allowed the appeal, highlighting the importance of assessing real income and the applicability of commercial expediency in business decisions, ultimately ruling in favor of the appellant and directing the deletion of the notional interest addition.