2022 (4) TMI 579 - AT - Income Tax

Disallowance of interest expenses made u/s. 40A(2)(a) - disallowance of interest from 3% to 2% i.e. accepted 16% interest paid to unsecured loan against 18% paid by appellant since past so many years - assessee had claimed deduction of interest expenses @ 18% on the old unsecured loans that were raised by it from its related parties - HELD THAT - AO, while adopting the bank lending rate had lost sight of the fact that the loans from the bank would have required providing of security, incurring of certain hidden charges, as well as satisfaction of number of other formalities; unlike the raising of unsecured loans by the assessee from its related parties. Backed by our aforesaid observations, we are unable to find favour with the incomparable basis that had been adopted by the Assessing Officer for triggering the provisions of section 40A(2)(a) of the Act. Apart from that, we find, that as brought to our notice by the Ld. AR, the assessee in the immediately preceding year i.e. A.Y. 2013-14 had paid interest on the unsecured loans in question @ 18% and the same had been accepted by the Assessing Officer vide his order passed u/s. 143(3) for the said year. We are of a strong conviction that not only the basis adopted by the Assessing Officer for triggering the provision of section 40A(2)(a) of the Act is fallacious, but the same also militates against the fact that the interest paid by the assessee on the said unsecured loans @ 18% had been accepted by the department while framing the regular assessment in its case for the immediately preceding year i.e. A.Y. 2013-14. We, thus, in terms of our aforesaid deliberations, are unable to persuade ourselves to concur with the view taken by the lower authorities. Accordingly, we set-aside the order of the CIT(Appeals) and vacate the disallowance u/s. 40A(2)(a) of the Act to the extent the same had been sustained by him. Appeal of assessee allowed.

Summary

Issues:
1. Disallowance of interest expenses under Sec. 40A(2)(a) of the Income-tax Act, 1961.
2. Interpretation and application of provisions of Section 40A(2)(a) by the Assessing Officer.
3. Comparison of interest rates on unsecured loans with bank lending rates.
4. Consideration of legitimate needs of business while disallowing expenses.
5. Appeal against the order of CIT(Appeals) regarding the disallowance of interest expenses.

Detailed Analysis:

1. The primary issue in this case revolves around the disallowance of interest expenses under Sec. 40A(2)(a) of the Income-tax Act, 1961. The Assessing Officer disallowed a portion of the interest expenses claimed by the assessee on unsecured loans obtained from related parties, citing it as excessive compared to the fair market value or legitimate needs of the business.

2. The Assessing Officer's interpretation and application of Section 40A(2)(a) were challenged by the assessee in the appeal. The AO disallowed the excess interest rate of 3% and made a consequential disallowance under the said provision, resulting in a specific amount being disallowed from the assessee's claimed expenses.

3. A key aspect of contention was the comparison of interest rates on unsecured loans with bank lending rates. The AO compared the 18% interest paid by the assessee on unsecured loans with the hypothetical 15% rate from a bank. However, the Tribunal found this comparison flawed as it overlooked the differences in requirements and ease of obtaining loans from related parties versus banks.

4. The Tribunal emphasized the importance of considering the legitimate needs of the business while disallowing expenses under Section 40A(2)(a). It noted that the AO's comparison with bank rates failed to account for the practical differences in securing loans from related parties without collateral or additional charges, unlike bank loans.

5. The appeal against the order of the CIT(Appeals) focused on challenging the reduced disallowance upheld by the CIT(A). The Tribunal, after considering all arguments and precedents cited, set aside the order of the CIT(A) and vacated the disallowance under Section 40A(2)(a) to the extent sustained by the CIT(A), thereby allowing the appeal of the assessee.

In conclusion, the Tribunal's detailed analysis and interpretation of the provisions of Section 40A(2)(a) highlight the importance of a nuanced understanding of business needs and practical considerations while determining the reasonableness of expenses, especially in cases involving related party transactions and interest payments on loans.