2025 (7) TMI 1171 - AT - Income Tax

Allowable expense u/s 36(1)(iii) - AO disallowed the penal interest paid by the assessee to Janata Sahakari Bank charged for overdrawn cash credit facility - definition of interest provided u/s 2(28A) - assessee has taken the cash credit facility from the said bank for the purpose of its business - AO disallowed the claim of the assessee holding the expense to be penal in nature HELD THAT - As per Meaning of Interest - The definition of interest provided u/s 2(28A) of the Act means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised . No disallowance can be made u/s 36(1)(iii) of the Act as the assessee has fulfilled all the requisite conditions stipulated therein viz. - (a) the money must have been borrowed by the assessee (b) It must have been borrowed for the purpose of business and (c) the assessee must have paid interest on the borrowed amount i.e. the assessee has shown the same as an item of expenditure. From the definition of the term interest provided u/s 2(28A) of the Act interest means interest payable in any manner in respect of moneys borrowed or debt incurred. Going by the plain reading of this definition in our view the term interest would therefore include even the penal interest in respect of moneys borrowed by the assessee. Further we also find force in the alternate argument advanced by the AR that the assessee s claim of expense cannot be disallowed under the provisions of section 37(1) read with Explanation 1 thereto as well. It is only when in any expenditure incurred by the assessee for any purpose which is an offence or which is prohibited by law shall be deemed to be not incurred for the purpose of business calling for disallowance u/s 37(1) of the Act. It is undisputed fact that the penal interest has been paid on capital/money borrowed for the business of the assessee. The assessee paid the penal interest for overdrawing the credit facility which in our considered view is not an offence or which is prohibited by law. The said expense in our view is compensatory in nature and has been paid towards breach of contractual obligation with the bank. The Memorandum to Finance Bill 1998 also clarifies that the disallowance u/s 37(1) covers the cases of payments on account of protection money extortion hafta bribes etc. as business expenditure which is certainly not the case of the assessee under dispute. Therefore the payment of penal interest cannot be regarded as payment for infraction of law and disallowed being the penal in nature. The reliance placed by the Ld. DR in the case of S.A. Builders 2006 (12) TMI 82 - SUPREME COURT is misplaced as the present case in hand is distinguishable on facts. The order of the Ld. Addl./JCIT(A) is set aside and the Ld. AO is directed to modify the assessment allowing the claim of expense of penal interest to the assessee. Appeal of assessee allowed.

Summary

ISSUES:

Whether penal interest charged on overdrawn cash credit facility is allowable as a deduction under section 36(1)(iii) of the Income Tax Act, 1961.Whether penal interest can be disallowed under section 37(1) read with Explanation 1, on the ground that it is expenditure incurred for a purpose which is an offence or prohibited by law.Admissibility of additional evidence filed before the Tribunal relating to penal interest charged by the bank.

RULINGS / HOLDINGS:

Penal interest paid on overdrawn cash credit facility qualifies as "interest" under section 2(28A) and is therefore deductible under section 36(1)(iii) since the money was borrowed for business purposes and interest was paid thereon.Disallowance under section 37(1) read with Explanation 1 is not applicable as the penal interest was not incurred for any purpose which is an offence or prohibited by law; overdrawing the cash credit facility is a breach of contractual terms but not an offence or illegal act.Additional evidence, including bank certificate and interest statements, was admitted by the Tribunal as it goes to the root of the matter and was not previously produced before the lower authorities, consistent with Supreme Court precedent.

RATIONALE:

The Tribunal applied the statutory framework of sections 36(1)(iii), 2(28A), and 37(1) read with Explanation 1 of the Income Tax Act, 1961.Section 36(1)(iii) allows deduction of interest paid on capital borrowed for business purposes; the definition of "interest" under section 2(28A) includes any charge in respect of money borrowed, encompassing penal interest.Explanation 1 to section 37(1) excludes from deduction any expenditure incurred for purposes that are offences or prohibited by law; since overdrawing the cash credit facility is a contractual breach and not an offence, penal interest paid is not disallowed under this provision.The Tribunal distinguished precedents relied upon by the revenue as relating either to normal interest or penalties for offences, which are factually and legally different from the present case.The admission of additional evidence was supported by the Supreme Court decision permitting such evidence when it is material and was not previously available to the assessing authorities.