2019 (6) TMI 1739 - AT - Income Tax

Disallowance of interest u/s 40A(2)(b) - discrimination or differences in the rate of interest in respect of unsecured loan parties to whom interest is paid - Company has paid interest @18% p. a. on unsecured loan/deposits obtained from all parties covered u/s 40A(2)(b) - HELD THAT - As in assessee s own case in 2019 (2) TMI 2135 - ITAT AHMEDABAD for Assessment Year 2012-13 except aforesaid there was no basis for the Assessing Officer to come to the conclusion that amount of interest paid at the rate of 12 per cent would relate to the concerned parties was otherwise excessive and/or unreasonable. It is not the case on behalf of the revenue that considering the market rate the aforesaid interest paid at the rate of 12 percent can be said to be excessive and/or unreasonable. Under the circumstances solely because the assesses for whatever reasons/consideration paid the interest at different rates by that itself cannot be a ground to come to the conclusion that paying of interest at higher rate than paid to other party was excessive and/or unreasonable. Under the circumstance both/the commissioner (Appeals) as well as the tribunal have rightly deleted. Decided in favour of assessee.

Summary

The core legal issue considered in this judgment is whether the disallowance of interest paid on unsecured loans at the rate of 18% per annum under section 40A(2)(b) of the Income Tax Act was justified. Specifically, the Tribunal examined whether the interest paid by the assessee to related parties was excessive or unreasonable, warranting disallowance, or whether it was a legitimate business expense deductible under the Act.

The relevant legal framework centers on section 40A(2)(b) of the Income Tax Act, which empowers the Assessing Officer (AO) to disallow expenditure if the payment made to related parties is excessive or unreasonable in relation to the market rate. The AO had disallowed Rs. 1,12,77,760/- on the ground that the interest rate of 18% paid by the assessee exceeded the prevailing market rate of 12%, thus constituting an excessive payment. The assessee contested this, submitting that the interest rate was justified due to the unsecured nature of the loan and absence of collateral, and that all parties receiving interest had declared it as income and paid tax accordingly.

The Tribunal's analysis began by reviewing the facts and the submissions of the parties. The assessee argued that the 18% interest rate was reasonable considering the unsecured, long-term nature of the loans, which entailed higher risk compared to secured bank loans that also attract additional costs such as stamp duty, registration fees, and various processing charges. The assessee further contended that the interest payments were necessary for business expediency, as borrowing at a lower rate was not feasible, and that the company had earned profits despite these interest costs.

In evaluating the AO's position, the Tribunal noted that the AO had assumed a market rate of 12% without producing any tangible material or evidence to substantiate this rate. The absence of concrete evidence undermined the AO's basis for disallowance under section 40A(2)(b). The Tribunal emphasized that the AO cannot arbitrarily fix a market rate without supporting data, and that the assessee, being intimately aware of its business necessities, is best positioned to determine the appropriate borrowing arrangements.

The Tribunal relied heavily on precedents, including a coordinate Bench's earlier decision in the assessee's own case for the preceding assessment year, where similar disallowance was deleted. The Tribunal reproduced the reasoning from that decision, which held that mere differences in interest rates paid to various parties do not automatically render the payments excessive or unreasonable. It also cited a decision of the Hon'ble High Court of Gujarat, which clarified that unless the revenue can demonstrate that the interest rate paid is excessive compared to the market rate, disallowance under section 40A(2)(b) is not warranted. Additionally, the Tribunal referred to the judgment of the Hon'ble Delhi High Court in Oracle India (P.) Ltd., which supported the principle that the AO is not entitled to dictate the rate of interest at which a company should borrow funds.

The Tribunal further noted that the parties receiving interest had filed their returns and paid taxes on the interest income, negating any claim of revenue loss. The Tribunal also observed that the assessee had used the borrowed funds for business purposes and had earned profits, which militated against the contention that the interest payments were unreasonable or detrimental to the business.

In addressing competing arguments, the Tribunal rejected the AO's assumption of a 12% market rate due to lack of evidence and dismissed the contention that paying different interest rates to different parties automatically implies excessiveness. The Tribunal underscored that the commercial judgment of the assessee in determining the rate of interest is to be respected unless the revenue can prove otherwise.

Accordingly, the Tribunal concluded that the disallowance of Rs. 1,12,77,760/- under section 40A(2)(b) was not justified. It set aside the AO's order and upheld the decision of the CIT(A) deleting the disallowance. The appeal filed by the revenue was dismissed, and the cross-objection filed by the assessee was also dismissed as infructuous.

Significant holdings of the Tribunal include the following verbatim observations:

"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."

"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."

"Solely because assessee had paid interest at different rates to different parties, that itself could not be a ground to come to the conclusion that payment of interest to related parties at rate other than that paid to other party was excessive and unreasonable."

"Payment of interest @ 18% per annum to the relatives, on unsecured loans cannot be said to be excessive or unreasonable."

The core principles established are that the AO must produce concrete evidence to demonstrate that an interest rate paid is excessive compared to the market rate before invoking section 40A(2)(b) disallowance; the commercial judgment of the assessee regarding borrowing terms is to be respected; and mere variation in interest rates paid to different parties does not ipso facto render the payments excessive or unreasonable.

In final determinations, the Tribunal dismissed the revenue's appeal against the deletion of disallowance under section 40A(2)(b) and upheld the CIT(A)'s order in favor of the assessee, confirming that the interest payments at 18% on unsecured loans were reasonable and allowable business expenses.