2013 (11) TMI 357 - AT - Income Tax

Disallowance of interest paid on loans taken from family members u/s.40A(2) of the I.T. Act, 1961 - The assessee has taken the loans amounting to Rs.57.92 lakhs from his wife, sons and from his own HUF and is paying interest at the rate of 18% on the same. The loans were taken in the earlier years and no similar disallowance was made by the department Held that - The decisive factor for the applicability of section 40A(2) of the Act is whether the payment made by the assessee is excessive or unreasonable considering the prevailing market conditions during the relevant period - Interest paid at the rate of 18% per annum on unsecured loans during the relevant period cannot be said to be excessive or unreasonable - Revenue could not cite any instance wherein the assessee on unsecured loan account, other than his relatives account, has paid interest at less than 18% per annum Decided against the Revenue.

Issues Involved:
1. Disallowance of interest paid on loans taken from family members under Section 40A(2) of the Income Tax Act, 1961.
2. Addition on account of low Gross Profit (G.P.) rate.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Paid on Loans Taken from Family Members under Section 40A(2) of the Income Tax Act, 1961:

Facts and AO's Decision:
The assessee, a manufacturer and trader, filed a return declaring an income of Rs.7,07,743/-. The AO observed that the assessee credited interest at 18% on loans from family members, which he considered excessive. The AO restricted the interest rate to 12%, disallowing Rs.3,22,091/- under section 40A(2)(b) of the Act.

CIT(A)'s Decision:
The CIT(A) deleted the disallowance, reasoning that the interest rate of 18% was not excessive compared to market rates. The CIT(A) noted that these were unsecured loans without any securities and that similar rates had been allowed in previous assessments.

Tribunal's Decision:
The Tribunal upheld the CIT(A)'s decision, agreeing that the interest rate was neither excessive nor unreasonable. It emphasized that section 40A(2)(a) requires a finding that the expenditure was excessive or unreasonable, which was not established by the AO.

Dissenting Opinion:
One of the judges dissented, arguing that the interest rate of 18% was excessive and not guided by business considerations. The judge cited a previous Tribunal decision that capped reasonable interest at 12%.

Third Member's Decision:
The Third Member agreed with the CIT(A) and the majority view, concluding that the interest rate of 18% was reasonable for unsecured loans. The decision of the CIT(A) to delete the disallowance of Rs.3,22,091/- was upheld.

2. Addition on Account of Low Gross Profit (G.P.) Rate:

Facts and AO's Decision:
The AO noted a decline in the G.P. rate from 40.23% in the previous year to 20.81% in the assessment year under consideration. The AO attributed this decline to increased direct export expenses and trade commissions but found the explanation insufficient. Consequently, the AO added Rs.12,07,079/- to the income, calculating a 5% addition on total turnover.

CIT(A)'s Decision:
The CIT(A) deleted the addition, noting that the books of accounts were audited and no defects were pointed out by the AO. The CIT(A) found that the assessee satisfactorily explained the reasons for the decline in G.P. and that there was no evidence of sales outside the books or profit suppression.

Tribunal's Decision:
The Tribunal upheld the CIT(A)'s decision, emphasizing that no addition can be made merely on the ground of low G.P. without rejecting the books of accounts. The Tribunal found no evidence of sales outside the books or profit suppression and agreed that the addition was based on surmises and conjecture.

Conclusion:
The appeal of the revenue was dismissed on both grounds. The Tribunal, supported by the Third Member, concluded that the CIT(A) was justified in deleting both the disallowance of interest under Section 40A(2) and the addition on account of low G.P. rate.

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