2019 (2) TMI 2135 - AT - Income Tax

Addition u/s. 40A(2)(b) - disallowance of interest of excess amount of interest paid over and above 12% rate of interest per annum - AO during the assessment proceedings found that the assessee has borrowed money on interest at the rate of 18% per annum from the related parties and as per the AO prevailing market rate of interest on the money borrowed is at the rate of 12% per annum - HELD THAT - AO in the case on hand has assumed the prevailing market rate of interest at the rate of 12% per annum on the borrowed fund without bringing any tangible material on record. Therefore in the absence of any material by which the AO treated the interest paid by the assessee is unreasonable/excessive we are not impressed with the finding of the AO. There is no dispute about the use of fund borrowed by the assessee at the rate of 18% per annum. Thus it is transpired that the assessee has used the borrowed fund for its business. Accordingly we are of the view that it is the assessee who knows its business affairs the best than any other person. Accordingly the assessee can only decide the need for the borrowing from the related parties including the rate of interest. As such the AO is not expected to direct/advice to the assessee to borrow the money for the business at a particular rate of interest. See Oracle India (P.) Ltd 2011 (3) TMI 1613 - DELHI HIGH COURT - Decided against revenue. Addition on account of depreciation - assessee has claimed depreciation in respect of the vehicles which was not registered in its name and are registered in the name of the employees of the company - HELD THAT - We find that the Hon ble ITAT in the own case of the assessee pertaining to the assessment year 2010-11 and 2011-12 2018 (6) TMI 1168 - ITAT AHMEDABAD has deleted the addition made by the AO as held car was used practically for the business purpose of the assessee. It has provided finance for purchasing the car. The only name of the Manager is being reflected in the registration certificate. Otherwise for all other practical purposes car was used by the assessee. CIT(A) has looked into supporting evidence and thereafter allowed incidental expenses as well as depreciation. After going through order of the ld.CIT(A) we do not find any reasons to interfere in it. Car was practically owned and possessed by the assessee. It was used for the purpose of assessee s business. Additional Depreciation claimed on rolling mills Rolls - AO was of the view that the rolling mills rolls being part of machinery cannot be considered as machinery eligible for additional depreciation under the provisions of section 32(1)(iia) - CIT (A) deleted the addition made by the AO and allowed the ground of appeal of the assessee - HELD THAT - There is no dispute about the use of rolling mills rolls in the activity of manufacturing. Accordingly we are of the view that where the machinery is allowed for additional depreciation used in the activity of manufacturing then the parts of the machinery should also be eligible for additional depreciation under section 32(1)(iia) of the Act. Thus we do not find any infirmity in the order of the Ld.CIT (A). Hence we decline to interfere in the same. Thus the ground of appeal of the Revenue is dismissed. Addition u/s 36(1)(iii) - interest expenses in respect of capital work in progress - HELD THAT - On perusal of the balance sheet of the assessee as on 31 March 2012 it was noticed that owned fund of the assessee stands 29, 69, 49, 883/- whereas the capital work in progress stands at Rs. 65, 71, 635/-only. Thus a presumption can be drawn that the assessee has not used any borrowed fund in such capital work-in-progress. In this regard we find support and guidance from the judgment in the case of Reliance Utilities and Power Ltd 2009 (1) TMI 4 - BOMBAY HIGH COURT We hold that no disallowance of interest expense claimed by the assessee can be made on account of fund involved in the capital work-in-progress as discussed above. Hence we do not find any reason to disturb the finding of ld. CIT-A. Accordingly the AO is directed to delete the addition made by him. Disallowance of foreign exchange loss - AO disagreed with the contention of the assessee on the ground that the impugned loss is representing a notional loss. As such the assessee has not suffered any loss - HELD THAT - We note that the fact that such loss is arising to the assessee on account of reinstatement of current liabilities has not been doubted. Thus it is transpired that the assessee has claimed the loss concerning the import of goods and overseas commissions which were not paid till the balance sheet date i.e. 31st March 2012. We note that the fact that such loss is arising to the assessee on account of reinstatement of current liabilities has not been doubted. Thus it is transpired that the assessee has claimed the loss concerning the import of goods and overseas commissions which were not paid till the balance sheet date i.e. 31st March 2012. The assessee is entitled to claim the loss on account of foreign currency transaction. Ground of appeal of the Revenue is dismissed.

Summary

The core legal questions considered in this judgment relate to the validity of various disallowances made by the Assessing Officer (AO) under the Income Tax Act, 1961, specifically concerning:

(1) Whether the excess interest paid to related parties over the presumed market rate is disallowable under section 40A(2)(b) of the Act;

(2) The allowability of depreciation claimed on vehicles not registered in the assessee's name;

(3) The eligibility of additional depreciation claimed on rolling mills rolls under section 32(1)(iia) of the Act;

(4) The disallowance of interest expenses related to capital work in progress under section 36(1)(iii) of the Act;

(5) The allowability of foreign exchange loss arising from the reinstatement of current liabilities under section 37(1) of the Act.

Issue 1: Disallowance of Excess Interest Paid to Related Parties under Section 40A(2)(b)

The AO disallowed Rs. 91,73,496 on the ground that the assessee paid interest at 18% per annum to related parties, which was above the AO's presumed market rate of 12%. The AO held the excess interest as unreasonable and disallowed it under section 40A(2)(b).

The CIT(A) deleted this addition relying on prior ITAT orders in the assessee's own case for AY 2008-09 and 2009-10, which favored the assessee.

The Tribunal noted that the AO failed to produce any tangible material to justify the 12% market rate assumption. The assessee's use of borrowed funds at 18% was undisputed, and the Tribunal emphasized that the assessee, being best acquainted with its business needs, is entitled to decide the borrowing rate. The AO cannot dictate the rate of interest payable.

Judicial precedents were cited, including a Delhi High Court decision in Oracle India (P.) Ltd., which supported the view that interest payments to related parties at a higher rate are not automatically disallowable without evidence of unreasonableness.

The Tribunal further relied on a coordinate bench decision in the assessee's own case and a Gujarat High Court ruling in Sarjan Realities Ltd., which held that merely paying different interest rates to different parties does not establish excessiveness or unreasonableness warranting disallowance under section 40A(2)(b).

The Tribunal concluded that the AO's disallowance lacked justification and directed deletion of the addition.

Issue 2: Depreciation on Vehicles Not Registered in Assessee's Name

The AO disallowed Rs. 65,583 claimed as depreciation on vehicles registered in employees' names, contending the assessee did not own the vehicles.

The assessee contended that the company financed the vehicles and they were used for business purposes; registration in employees' names was to avoid registration charges.

The CIT(A) deleted the addition relying on earlier ITAT orders in the assessee's own case for AYs 2010-11 and 2011-12, which held that practical ownership and use for business sufficed for depreciation claim despite registration details.

The Tribunal concurred with the CIT(A), noting that the vehicles were practically owned and used by the assessee for business, and upheld the deletion of the addition.

Issue 3: Additional Depreciation on Rolling Mills Rolls under Section 32(1)(iia)

The AO disallowed Rs. 11,14,386 of additional depreciation claimed on rolling mills rolls, holding these rolls were parts of machinery, not machinery themselves, and thus ineligible for additional depreciation.

The assessee argued that it had consistently claimed and been allowed additional depreciation on these rolls in earlier years, and that the Income Tax Rules' Appendix I explicitly provided for depreciation on rolling mills rolls.

The CIT(A) allowed the claim, reasoning that since the rolls are integral to the machinery and the machinery is eligible for additional depreciation, the parts should be eligible as well.

The Tribunal noted that in prior assessment years, the same claim was allowed without disallowance, and no proceedings under sections 263 or 147 were initiated to revisit that view. It invoked the principle of consistency as enunciated by the Supreme Court in Radhasoami Satsang, which discourages changing a settled position without material justification.

The Tribunal also observed there was no dispute about the use of the rolls in manufacturing.

Accordingly, the Tribunal upheld the CIT(A)'s order deleting the disallowance.

Issue 4: Disallowance of Interest Expenses on Capital Work in Progress under Section 36(1)(iii)

The AO disallowed Rs. 1,06,568 of interest expenses, reasoning that the assessee did not allocate interest expenses to capital work in progress (CWIP) amounting to Rs. 65,71,635.

The assessee submitted that its owned funds exceeded the CWIP amount, thus no borrowed funds were used for CWIP, negating the basis for disallowance under section 36(1)(iii).

The CIT(A) deleted the addition.

The Tribunal examined the balance sheet, noting owned funds of Rs. 29.69 crores far exceeded the CWIP amount. It relied on precedents from Bombay and Gujarat High Courts which establish a presumption that investments or capital expenditures are made from interest-free funds if such funds suffice. These precedents include Reliance Utilities and Power Ltd., HDFC Bank Ltd., and UTI Bank Ltd.

Applying this principle, the Tribunal held no disallowance under section 36(1)(iii) was warranted and upheld the deletion of the addition.

Issue 5: Disallowance of Foreign Exchange Loss

The AO disallowed Rs. 34,60,766 claimed as foreign exchange loss arising from reinstatement of current liabilities related to imports and overseas commissions, treating it as a notional loss without actual outflow.

The assessee contended the loss was recognized as per Accounting Standard 11 (AS-11) on "Effects of Changes in Foreign Exchange Rates" and was allowable under section 37(1) of the Act. It relied on the Supreme Court decision in CIT vs. Woodward Governor India (P.) Ltd.

The CIT(A) deleted the addition relying on the same Supreme Court judgment.

The Tribunal analyzed the facts and the AS-11 provisions, which mandate monetary items denominated in foreign currency to be translated at the closing rate on the balance sheet date, recognizing exchange differences as income or expense in the relevant period.

The Tribunal quoted extensively from the Supreme Court ruling, which held that exchange differences arising on foreign currency transactions must be recognized in the profit and loss account for the reporting period, even if the loss is notional at the time.

Accordingly, the Tribunal held the foreign exchange loss was allowable and upheld the CIT(A)'s deletion of the addition.

Significant Holdings:

On section 40A(2)(b) disallowance of excess interest, the Tribunal stated:

"The AO in the case on hand has assumed the prevailing market rate of interest at the rate of 12% per annum on the borrowed fund without bringing any tangible material on record. Therefore in the absence of any material by which the AO treated the interest paid by the assessee is unreasonable/excessive, we are not impressed with the finding of the AO."

Further, it emphasized the assessee's autonomy in deciding borrowing terms:

"Accordingly, we are of the view that it is the assessee who knows its business affairs the best than any other person. Accordingly, the assessee can only decide the need for the borrowing from the related parties including the rate of interest. As such the AO is not expected to direct/advice to the assessee to borrow the money for the business at a particular rate of interest."

On additional depreciation under section 32(1)(iia), the Tribunal applied the principle of consistency:

"On these reasonings in the absence of any material change justifying the revenue to take a different view of the matter-and if there was no change it was in support of the assessee-we do not think the question should have been reopened and contrary to what had been decided by the Commissioner in the earlier proceedings, a different and contradictory stand should be taken."

On interest disallowance under section 36(1)(iii), it held:

"If there are funds available both interest-free and overdraft and/or loans taken, then a presumption would arise that investments would be out of the interest-free fund generated or available with the company, if the interest-free funds were sufficient to meet the investments."

On foreign exchange loss under section 37(1), the Tribunal quoted the Supreme Court:

"AS-11 stipulates effect of changes in exchange rate vis-avis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Therefore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P&L account for the reporting period."

The Tribunal dismissed all grounds of appeal raised by the Revenue, thereby affirming the deletions made by the CIT(A) on all issues.