2025 (5) TMI 2116 - AT - Income Tax

Interest on unsecured loan u/s 36(1)(iii) - CIT(A) erred in confirming the addition to the extent on the ground that debtors were evidenced through unsecured loan when the fact remains that the entire unsecured loans were utilized for business work-in progress only out of commercial expediency HELD THAT - We come to the conclusion that entire unsecured loan has been utilized for the purpose of business. No fund used for any capital investment. We do not find that any of the loan fund utilized by the assessee for any personal purposes. We find substance in the argument of Counsel that the AO could not specifically pin point any personal/capital usage of fund received towards unsecured loans and the reason for decrease in trade payables is due to the buying capacity of the assessee with better terms which led to better gross profit / margin as compared to preceding year. It is further pertinent to mention herein that the disallowance of interest on which due TDS duly deducted disallowance thus on guesswork. We come to the conclusion that the addition u/s 36(1)(iii) of the Act is directed to be deleted. Accordingly we allow the appeal of the assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

- Whether the addition of Rs. 35,88,850/- made under section 36(1)(iii) of the Income Tax Act on account of interest on unsecured loans is justified, given that the assessee utilized the unsecured loans entirely for business purposes and no part was used for capital or personal purposesRs.

- Whether the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] erred in sustaining the addition of interest on unsecured loans without specifically establishing any capital or personal use of the fundsRs.

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Legitimacy of addition under section 36(1)(iii) on interest paid on unsecured loans

Relevant legal framework and precedents: The relevant provision is section 36(1)(iii) of the Income Tax Act, which disallows interest expenditure if the loan is not taken for business purposes. The Hon'ble Supreme Court decision in India Cement Ltd. vs. CIT ([1966] 60 ITR 52 (SC)) was relied upon, which established that loans are liabilities and cannot be treated as assets or debtors. The Court held that interest on loans not used for business purposes is not allowable as a deduction.

Court's interpretation and reasoning: The Tribunal examined the facts and financial data submitted by the assessee, including the balance sheet and comparative charts of sundry debtors and unsecured loans. It was noted that the assessee, a wholesale trader of electrical goods, had an outstanding unsecured loan of approximately Rs. 49.58 crores as on 31.03.2018 and had taken fresh unsecured loans of Rs. 24.39 crores during the year. The funds were applied to reduce sundry creditors by Rs. 14.01 crores and to create new sundry debtors of Rs. 4.80 crores.

The Tribunal observed that sales increased by about 21%, while sundry debtors increased by only 16%, indicating business growth consistent with the use of funds for business operations. The Tribunal found no evidence of capital investment or personal use of the unsecured loan funds. The AO and CIT(A) had not specifically identified any personal or capital utilization of the loan funds.

Key evidence and findings: The assessee submitted detailed charts showing the correlation between unsecured loans, interest paid, and sundry debtors. The balance sheet corroborated the existence of large unsecured loans utilized in the business cycle. No contradictory evidence was presented by the Revenue to prove diversion of funds for non-business purposes.

Application of law to facts: Applying the principle from India Cement Ltd., the Tribunal recognized that while loans are liabilities, the interest paid is deductible if the loan is used for business purposes. Since the assessee demonstrated that the unsecured loans were used entirely for business working capital and not for capital assets or personal use, the interest should not be disallowed under section 36(1)(iii).

Treatment of competing arguments: The Revenue relied on the AO and CIT(A) findings to sustain the addition, arguing that the unsecured loan interest was not allowable. However, the Tribunal found that the Revenue failed to specifically pinpoint any misuse of funds. The assessee's argument that the disallowance was based on guesswork and that TDS was duly deducted on the interest was accepted. The Tribunal gave weight to the detailed financial data and the absence of any contrary evidence from the Revenue.

Conclusions: The Tribunal concluded that the addition of Rs. 35,88,850/- on account of interest on unsecured loans under section 36(1)(iii) was not justified and directed deletion of the addition.

3. SIGNIFICANT HOLDINGS

- "The loan obtained cannot be treated as an asset or debtor for enduring the benefit of business of the assessee. The loan is a liability and has to be repaid." (India Cement Ltd. vs. CIT)

- "We do not find that any of the loan fund utilized by the assessee for any personal purposes. We find substance in the argument of the ld. Counsel that the AO could not specifically pin point any personal/capital usage of fund received towards unsecured loans."

- "The disallowance of interest on which due TDS duly deducted, disallowance thus on guesswork."

- Final determination: The addition of Rs. 35,88,850/- under section 36(1)(iii) of the Act is deleted, and the appeal of the assessee is allowed.