2025 (7) TMI 425 - AT - Income Tax

Disallowance u/s 57(iii) of interest expenditure - deduction on account of payment of loan interest and management fees which resulted in a loss - AO was of the opinion that the assessee has lent money to family concerns at lower rate of interest which resulted into loss and restricted the amount of interest paid to the amount of interest received and made the addition - HELD THAT - Assessee has lent money to its sister concerns from whom he has charged interest at the rate of 8.50%. The assessee has also lent money to 3 unrelated parties from whom the assessee has charged interest at the rate of 12%. The assessee could not give any satisfactory explanation for such discrimination. Even before us the ld. Counsel for the assessee kept on harping on the argument that reasonableness cannot be questioned. Neither the AO nor the Bench was questioning the reasonableness of the expenditure. The only explanation sought was in respect of disparity of rate of interest charged from related parties and the unrelated parties because in our considered opinion in similar transactions with the related parties and unrelated parties all that has to be seen is whether it is at arm s length or not. We are of the considered view that the assessee has grossly failed in justifying the lower rate of interest charged from the related parties vis- -vis the rate of interest charged with the unrelated parties. Therefore we do not find any reason to interfere with the findings of the lower authorities.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

• Whether the addition of Rs. 28,05,940/- made by the Assessing Officer (AO) by disallowance of interest expenditure under section 57(iii) of the Income Tax Act is justified.
• Whether the AO and the Commissioner of Income Tax (Appeals) [CIT(A)] were correct in restricting the interest expenditure to the quantum of interest income earned by the assessee.
• Whether the reasonableness of the interest rate paid by the assessee can be questioned by the revenue authorities when the interest expenditure is claimed under section 57(iii).
• Whether disparity in the interest rates charged on loans advanced to related parties vis-`a-vis unrelated parties affects the allowability of the interest expenditure.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Justification of Addition under Section 57(iii) for Interest Expenditure

Relevant legal framework and precedents: Section 57(iii) of the Income Tax Act permits deduction of interest expenditure incurred for the purpose of earning income chargeable under the head "Income from Other Sources." The Supreme Court decision in CIT vs. Rajendra Prasad Moody [1979] 1 SCC 250 and the coordinate bench decision in Akash Goyal vs. ACIT [2020] 113 taxmann.com 10 (Agra-Trib.) were relied upon by the assessee to contend that the reasonableness of the interest paid cannot be questioned when claimed under this section.

Court's interpretation and reasoning: The Tribunal observed that the precedents cited by the assessee dealt primarily with the question of whether the expenditure was incurred for the purpose of business or profession. However, the present issue was distinct and related to the disparity in interest rates charged on loans advanced to related parties versus unrelated parties. The Tribunal emphasized that the AO and the CIT(A) were not disputing the genuineness of the expenditure per se but were concerned with the arm's length nature of the transactions, especially the reasonableness of the interest rates charged.

Key evidence and findings: The assessee had declared interest income of Rs. 1,04,82,353/- but claimed interest expenditure of Rs. 1,32,88,293/- (comprising Rs. 1,32,14,955/- as loan interest and Rs. 73,338/- as management fees), resulting in a loss of Rs. 28,05,940/-. The AO found that the assessee had lent money to family concerns at a lower interest rate (8.5%) compared to unrelated parties (12%). The detailed chart of loans and advances showed significant disparity in interest rates charged to related and unrelated parties.

Application of law to facts: The Tribunal held that the question was whether the interest rates charged to related parties were at arm's length and reasonable compared to those charged to unrelated parties. The failure of the assessee to satisfactorily explain the lower interest rates charged to related parties justified the disallowance of the excess interest expenditure claimed.

Treatment of competing arguments: The assessee's argument that reasonableness of interest paid cannot be questioned under section 57(iii) was rejected by the Tribunal on the ground that the issue here was not the genuineness of expenditure but the disparity in interest rates indicating non-arm's length transactions.

Conclusion: The addition made by the AO and confirmed by the CIT(A) was upheld as justified. The Tribunal found no error in restricting the interest expenditure to the interest income earned due to failure to justify the lower rate charged to related parties.

3. SIGNIFICANT HOLDINGS

The Tribunal's key legal reasoning and principles established include:

"Neither the AO nor the Bench was questioning the reasonableness of the expenditure. The only explanation sought was in respect of disparity of rate of interest charged from the related parties and the unrelated parties because in our considered opinion, in similar transactions with the related parties and unrelated parties all that has to be seen is whether it is at arm's length or not."

"Considering the factual matrix mentioned hereinabove, we are of the considered view that the assessee has grossly failed in justifying the lower rate of interest charged from the related parties vis-`a-vis the rate of interest charged with the unrelated parties. Therefore, we do not find any reason to interfere with the findings of the lower authorities."

The Tribunal clarified that the precedents cited by the assessee were not applicable because they dealt with the purpose of expenditure rather than the arm's length nature of interest rates charged in related party transactions.

Ultimately, the Tribunal dismissed the appeal, affirming the addition of Rs. 28,05,940/- disallowed under section 57(iii) on account of interest expenditure claimed in excess of the interest income, due to the failure to justify the disparity in interest rates charged on loans advanced to related parties compared to unrelated parties.