2023 (10) TMI 1426 - AT - Income Tax

Disallowance of interest expenditure u/s 40A(2)(a) - asessee paid interest to the tune of 9% to 18% on unsecured loans availed by it and assessee also did not bring any material on record to rebut the allegation of the Revenue that SM Edible Pvt. Ltd. is a related party - interest at the rate of 18% paid to SM Edible Pvt. Ltd. on an unsecured loan is excessive and accordingly disallowed interest paid in excess of 12% - HELD THAT - AO considered the rate of interest as allowed under section 40(b)(iv) of the Act, wherein payment of interest to any partner is allowed up to 12%, as the fair market value of the rate of interest. It is pertinent to note that it is not anybody's case that the interest has been paid by the assessee to its partner, rather it is the claim of the assessee that in order to meet the short-term finance, the assessee borrowed money on a short-term basis from SM Edible Pvt. Ltd. and repaid the loan taken during the year with interest @18%. Thus we are of the considered view that without finding the comparative fair market value of the rate of interest for the loan taken by the assessee, AO proceeded to make the part disallowance by drawing an analogy to the section which does not apply to the facts of the present case. As evident from the record that the AO has not disallowed the interest of 18% paid to SM Edible Pvt. Ltd. by comparing the same with the interest paid by the assessee to other parties @9% to 18%. AO while partly disallowing the interest paid by the assessee has not followed the provisions of section 40A(2)(a) which requires comparison with the fair market value of the goods, services or facilities, which in the present case is the loan taken by the assessee. Accordingly, we find no basis in upholding the part disallowance of interest payment made by the assessee, and the same is directed to be deleted - Decided in favour of assessee.

Summary

Issues:
Challenge to impugned order under section 250 of the Income Tax Act, 1961 for assessment year 2014-15; Dispute against part disallowance of interest expenditure under section 40A(2)(a) of the Act.

Analysis:
The appeal was filed by the assessee against the order dated 28/04/2023, challenging the rate of interest disallowed by the Assessing Officer under section 40A(2)(b). The assessee raised grounds related to the justification of interest rate, consideration of prevailing market rate, disallowance of interest paid to related party, and requested to modify grounds during the hearing. The dispute revolved around the disallowance of interest expenditure under section 40A(2)(a) of the Act.

The assessee, a wholesale distributor of mobile phones, declared a total income and was selected for scrutiny. The Assessing Officer observed interest payments to related parties exceeding 12% and disallowed the excess amount under section 40A(2)(a) of the Act. The AO applied section 40(b)(iv) to restrict interest payment to related parties to 12% per annum. The CIT(A) upheld the AO's decision, leading the assessee to appeal.

The Tribunal considered the provisions of section 40A(2)(a) of the Act, emphasizing the requirement to assess fair market value for expenditure made to related parties. It was noted that the AO did not compare interest rates paid to related parties with rates paid to other parties, nor did they determine the fair market value of the interest paid. The Tribunal concluded that the AO's decision lacked basis as it did not follow the Act's provisions, directing the deletion of the part disallowance of interest payment. Consequently, the appeal by the assessee was allowed, setting aside the impugned order.

In conclusion, the Tribunal found in favor of the assessee, highlighting the importance of comparing interest rates with fair market value as per the Act's provisions. The decision emphasized the need for a proper assessment before disallowing expenditure, ensuring compliance with the law.