2025 (7) TMI 1291 - AT - Income Tax

Disallowance towards interest paid u/s 50(3) of the GST Act u/s 37(1) - assessee had claimed as deduction being interest paid u/s 50(3) of the GST Act due to input tax credit mismatch which arose because the supplier failed to deposit the GST amount - AO and CIT(A) disallowed the same treating it as penal in nature - HELD THAT - We find that Section 50(3) of the GST Act provides for interest on wrongful availment and utilisation of credit but nowhere does it indicate that such interest is penal. We have also gone through the decision of Lachmandas Mathuradas 1997 (12) TMI 16 - SUPREME COURT wherein as held that interest paid on arrears of sales tax is compensatory in nature and not penal. The rationale applies equally to interest under GST laws given the same compensatory nature. We are of the considered view that the interest paid u/s 50(3) of the GST Act is compensatory in nature incurred in the normal course of business and not for any infraction of law. Therefore the same is allowable as a deduction u/s 37(1). Accordingly the disallowance made by the Ld. AO and sustained by the Ld. CIT(A) is directed to be deleted. Disallowance u/s. 36(1)(iii) - disallowance of interest made u/s 36(1)(iii) in respect of advances given to certain entities - HELD THAT - We have gone through the judgment of Reliance Industries Ltd. 2019 (1) TMI 757 - SUPREME COURT wherein the Court held that if interest-free funds are available with the assessee sufficient to cover the advances a presumption arises that such advances have been made out of interest-free funds. In the present case no nexus has been established by the AO between the borrowed funds and the interest-free advances. The mere reliance on the statement of Mr. MSN Reddy without a factual tracing of funds cannot override the presumption established by the financial statements. Accordingly we hold that the disallowance under Section 36(1)(iii) of the Act is unsustainable in law and the same is directed to be deleted.

Summary

ISSUES:

Whether interest paid under Section 50(3) of the GST Act on delayed payment of GST is penal or compensatory in nature and whether it is allowable as a deduction under Section 37(1) of the Income Tax Act.Whether disallowance of interest expenditure under Section 36(1)(iii) of the Income Tax Act is justified on advances given to certain entities when such advances are claimed to be made out of interest-free funds rather than borrowed funds.

RULINGS / HOLDINGS:

The interest paid under Section 50(3) of the GST Act is "compensatory in nature" and not penal, as the provision "nowhere does it indicate that such interest is penal." Therefore, such interest is "allowable as a deduction under Section 37(1) of the Act," and the disallowance of Rs. 1,03,44,404/- is directed to be deleted.Where interest-free funds are available with the assessee sufficient to cover advances, a presumption arises that such advances have been made out of interest-free funds. The disallowance of Rs. 73,02,428/- under Section 36(1)(iii) of the Act is unsustainable in law in the absence of factual nexus or fund flow analysis establishing that advances were made from borrowed funds. Hence, the disallowance is directed to be deleted.

RATIONALE:

The Court applied the language of Section 50(3) of the GST Act, which mandates interest on "undue or excess claim of input tax credit" but does not characterize such interest as penal. The Court relied on the Supreme Court precedent in Lachmandas Mathuradas Vs. CIT, which held that interest on arrears of sales tax is compensatory and not penal, extending this rationale to GST interest.In respect of Section 36(1)(iii) disallowance, the Court applied the principle established by the Supreme Court in CIT v. Reliance Industries Ltd., which creates a presumption that advances are made from interest-free funds if such funds are sufficient. The Court emphasized the need for the Revenue to establish a direct nexus between borrowed funds and advances through factual evidence or fund flow analysis, which was absent. The Court rejected reliance solely on a statement without corroborative evidence.