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2025 (5) TMI 277 - AT - Income TaxDisallowance of interest on unsecured loans - loans were either unexplained or not genuine - AO treated certain unsecured loans as unexplained u/s 68 and disallowed proportionate interest thereon - CIT(A) deleted the addition of principal amounts u/s 68 for the reason that the loans did not pertain to the year under consideration the interest claimed on such loans was disallowed on the ground that the assessee failed to substantiate the genuineness and creditworthiness of the loan transactions. HELD THAT - It is settled law that the deletion of an addition u/s 68 on technical grounds-namely that the credit pertains to an earlier year and is carried forward as opening balance-does not automatically confer legitimacy upon the transaction. CIT(A) has specifically recorded that the loan amounts reflected in the opening balances pertain to earlier years which were not subject to scrutiny assessment and therefore the principle of res judicata is inapplicable. The non-examination of those credits in the past does not ipso facto prove their genuineness in the present year. Allowability of interest u/s 36(1)(iii) is a fresh claim each year and is contingent upon the existence of a genuine and subsisting liability. In the present case the assessee has not brought on record any credible documentary evidence to substantiate the identity and creditworthiness of the parties or the genuineness of the loan transactions. As during the course of the hearing before us the Bench specifically asked AR whether any material has been placed on record to show that the loans in question on which interest has been claimed have been repaid in subsequent years or that interest thereon has actually been paid AND AR fairly admitted that such details had not been brought on record and further submitted that he does not consider such evidence relevant to his contention that interest should be allowed solely because no addition u/s 68 has been made in the year under consideration. In our considered view this argument is misconceived and contrary to the settled legal position. Deduction of interest expenditure is governed by section 36(1)(iii) of the Act which allows deduction only where the capital has been genuinely borrowed and used for the purposes of business. If the assessee fails to establish the genuineness of the underlying loan the interest payable or paid thereon cannot be allowed. Mere routing of interest through banking channels or deducting TDS is not conclusive proof of allowability. Assessee s failure to bring on record evidence of repayment of the loans even years after their receipt reinforces the Revenue s contention that the alleged loans lack commercial substance. A genuine business liability is typically reflected in either repayment schedules confirmations or servicing of debt - none of which have been demonstrated in the present case. Assessee has relied on various decisions to argue that non-compliance with notices u/s 133(6) or 131 of the Act by third parties should not automatically lead to adverse inferences particularly when other documentary evidence exists on record. We have perused the said decisions and find them to be factually distinguishable from the case at hand. In those cases there existed tangible and corroborative evidence in the form of confirmations repayment details PANs TDS deduction business necessity and historical assessments which are conspicuously absent in the present case. Here the assessee not only failed to discharge the initial onus but also failed to bring on record any evidence of repayment or genuine subsistence of the loan liability thereby justifying the disallowance of interest by the lower authorities. Thus the reasoning adopted by the Ld. CIT(A) in both years namely that the assessee failed to discharge its burden to prove the genuineness and creditworthiness of the lenders and that interest cannot be allowed on an unverified or fictitious liability is sound and supported by settled judicial principles. We find no justification to interfere with the findings so recorded. Decided against asseessee.
The principal legal questions considered in these appeals pertain to the allowability of interest expenditure claimed by the assessee on unsecured loans during the assessment years 2017-18 and 2018-19. Specifically, the issues involve:
Issue-wise Detailed Analysis: 1. Allowability of Interest on Unsecured Loans when Principal is Treated as Unexplained under Section 68 The legal framework governing this issue is section 68 of the Income Tax Act, which deals with unexplained cash credits, and section 36(1)(iii), which allows deduction of interest on borrowed capital genuinely used for business purposes. Judicial precedents consistently hold that unless the principal amount is accepted as genuine, interest paid thereon cannot be allowed as a deduction. The Court examined the Assessing Officer's disallowance of interest on the basis that the principal unsecured loans were either unexplained or not genuine. For AY 2017-18, the AO treated certain unsecured loans as unexplained cash credits under section 68 and disallowed proportionate interest. For AY 2018-19, although no fresh loans were received, interest on opening balances of such loans was disallowed citing lack of genuineness and creditworthiness. The CIT(A) upheld the disallowance, emphasizing that the genuineness of the loans had not been established despite deletion of additions under section 68 for principal amounts. The Court noted that deletion of additions under section 68 on technical grounds (such as loans being opening balances from earlier years not under scrutiny) does not confer automatic legitimacy to those loans or to interest claimed thereon. The Court referred to the principle that the allowability of interest under section 36(1)(iii) is a fresh claim each year, contingent upon the existence of a genuine and subsisting liability. Mere absence of addition under section 68 in the relevant year does not entitle the assessee to claim interest deduction without proving genuineness. The assessee's contention that interest cannot be disallowed without a fresh addition under section 68 was rejected as misconceived. The Court held that the burden to establish genuineness and creditworthiness lies on the assessee each year to claim interest deduction. 2. Evidentiary Burden and Proof of Genuineness and Creditworthiness The Court scrutinized the evidence presented by the assessee, including the deduction of TDS on interest payments and credit to lenders' accounts. However, it was observed that the assessee failed to produce credible documentary evidence such as confirmations from lenders, repayment schedules, or any indication that the loans were serviced or repaid in subsequent years. The Court specifically queried the assessee's representative about evidence of repayment or actual payment of interest, to which the latter admitted no such evidence was placed on record and argued such evidence was irrelevant. This stance was found contrary to settled legal principles that require demonstration of genuine subsistence of liability for interest deduction. The Court also considered the assessee's reliance on judicial decisions which held that non-compliance by third parties with notices under sections 133(6) or 131 should not lead to adverse inference if other corroborative evidence exists. However, the Court distinguished those precedents on facts, noting that in the present case, no tangible evidence such as confirmations, PAN details, or repayment records were furnished. The absence of such evidence justified the AO's and CIT(A)'s findings of non-genuineness. 3. Effect of Deletion of Section 68 Addition on Interest Deduction The Court analyzed the legal effect of deletion of additions under section 68 on the principal loan amounts. It observed that the CIT(A) deleted the additions on the ground that the loans pertained to earlier years not under scrutiny and hence the principle of res judicata does not apply. The Court emphasized that non-examination of earlier years' credits does not ipso facto prove their genuineness in the current year. Accordingly, the deletion of principal additions under section 68 on technical or procedural grounds does not automatically entitle the assessee to claim interest deduction without independently establishing the genuineness and creditworthiness of the loans in the relevant year. 4. Application of Law to Facts and Treatment of Competing Arguments The Court applied the legal principles to the facts of the case, noting that the assessee failed to discharge its onus under section 68 to prove the identity, creditworthiness, and genuineness of the lenders. The absence of confirmations, repayment evidence, or any commercial substance to the loans led to the conclusion that the interest claimed was not allowable under section 36(1)(iii). The assessee's argument that interest should be allowed merely because no fresh addition under section 68 was made was rejected as contrary to settled law. The Court found the reasoning of the CIT(A) sound and supported by judicial precedents, and upheld the disallowance of interest in both assessment years. Significant Holdings: "It is settled law that the deletion of an addition under section 68 of the Act on technical grounds-namely, that the credit pertains to an earlier year and is carried forward as opening balance-does not automatically confer legitimacy upon the transaction." "The allowability of interest under section 36(1)(iii) of the Act is a fresh claim each year and is contingent upon the existence of a genuine and subsisting liability." "If the assessee fails to establish the genuineness of the underlying loan, the interest payable or paid thereon cannot be allowed. Mere routing of interest through banking channels or deducting TDS is not conclusive proof of allowability." "The assessee's failure to bring on record evidence of repayment of the loans, even years after their receipt, reinforces the Revenue's contention that the alleged loans lack commercial substance." "The reasoning adopted by the Ld. CIT(A) in both years-namely, that the assessee failed to discharge its burden to prove the genuineness and creditworthiness of the lenders, and that interest cannot be allowed on an unverified or fictitious liability-is sound and supported by settled judicial principles." In conclusion, the Court dismissed the appeals and upheld the disallowance of interest amounting to Rs. 36,69,000 for AY 2017-18 and Rs. 38,94,295 for AY 2018-19, affirming that interest deduction under section 36(1)(iii) is not permissible in the absence of proof of genuineness and creditworthiness of the underlying unsecured loans.
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