LAXMICHAND MEGHJI DEDHIA,MUMBAI vs. WARD 27(2)(3), MUMBAI, NAVI MUMBAI

The Ld. AR submitted that the assessee has filed a paper book comprising pages 1 to 94, which is placed on record. The Ld. AR submitted that the assessee had borrowed funds from various parties and the said funds were advanced to the firm in which the assessee was a partner. According to him, there was a direct nexus between the borrowed funds and the interest-bearing advances made to the firm. The assessee had two distinct streams of interest income from the firm, namely, interest on capital and interest on loans advanced to the firm. The assessee had offered the interest earned on such loans under the head “Income from Other Sources” and claimed the corresponding interest expenditure u/s 57(iii) of the Act. The Ld. AO himself had accepted the character of the income and allowed a substantial part of the interest expenditure, but restricted the rate of interest to 12% and made an ad hoc disallowance of Rs.2,79,952/-, representing the alleged differential rate of 3%. The assessment record shows that the assessee had declared interest income under the head “Income from Other Sources” and the Ld. AO proceeded to restrict the interest expenditure on the reasoning that interest was received at 12% whereas interest had been paid at a higher rate.

The Ld. AR further contended that the Revenue authorities had erroneously applied a test of commercial prudence to determine the allowability of expenditure u/s 57(iii). It was submitted that the assessee had earned substantial interest on the loans advanced to the firm and, therefore, the nexus between the borrowed funds and the corresponding interest income stood established. The assessee specifically distinguished between interest on capital of Rs.4,09,410/- and interest of Rs.22,19,218/- earned on loans advanced to the firm. It was further submitted that the actual interest paid was Rs.13,66,762/-, whereas the disallowance had been computed by taking interest at Rs.13,99,762/-, resulting in an excess disallowance of Rs.6,600/-.

In respect of brokerage of Rs.96,893/-, the Ld. AR submitted that the brokerage was paid to finance brokers for arranging the borrowed funds and was, therefore, directly connected with the earning of interest income. It was contended that such brokerage constituted cost incidental to borrowing and was covered by the definition of “interest” u/s 2(28A) of the Act. Accordingly, the expenditure was claimed as deductible u/s 57(iii). Without prejudice, it was submitted that if the corresponding income was regarded as business income, the expenditure would be allowable while computing such business income. The Ld. AO had disallowed the brokerage essentially on the ground that the borrowed funds had not resulted in any additional income because the loans were advanced at a lower rate.

Regarding the disallowance of Rs.1,55,758/-, the Ld. AR submitted that the expenditure comprised, inter alia, car insurance of Rs.18,965/-, interest on car loan of Rs.21,375/-, mobile expenses of Rs.8,101/-, profession tax of 6 Rs.1,387/-, besides depreciation. It was argued that the Ld. CIT(A), while restoring the matter for verification of depreciation, did not adjudicate the remaining components of expenditure. Therefore, the issue had not been adjudicated in its entirety and the assessee sought appropriate direction in respect of the entire expenditure of Rs.1,55,758/-.

In respect of the disallowance of Rs.60,348/- u/s 14A r.w. Rule 8D, the Ld. AR submitted that no expenditure was incurred for earning exempt income and the statutory satisfaction required for invoking Rule 8D had not been properly recorded. It was further contended that the assessee had sufficient own interest-free funds of Rs.2,01,42,559/- as against investments of Rs.9,99,626/-. The Ld. AR also submitted that the assessee had positive net interest income and that interest/brokerage expenditure, part of which had already been subjected to disallowance under other provisions, had again been considered while computing the disallowance under Rule 8D, thereby resulting in duplication of disallowance. The assessee's concise submissions specifically challenge the disallowance on the ground that no expenditure had been incurred for earning exempt income.

Per contra, the Ld. DR strongly relied upon the orders of the revenue authorities. The Ld. DR submitted that the assessee had admittedly borrowed funds at a rate higher than the rate at which corresponding advances were made and, therefore, the Ld. AO was justified in restricting the deduction of interest expenditure. The Ld. DR further submitted that the assessee was required to establish that the expenditure claimed u/s 57(iii) was laid out wholly and exclusively for the purpose of earning the corresponding income. The assessment order records the Revenue's finding that the assessee was paying interest at 15% while receiving interest at 12%, on which basis the differential interest was disallowed.

Regarding brokerage, the Ld. DR relied upon the finding of the Ld. AO that the expenditure was incurred for arranging loans which, according to the Revenue, were advanced at a lower rate and, therefore, the claim was not allowable. With respect to the expenditure of Rs.1,55,758/-, the Ld. DR relied upon the direction already issued by the Ld. CIT(A). On the issue u/s 14A, the Ld. DR supported the application of Rule 8D and submitted that the assessee had interest-bearing borrowed funds. Accordingly, the Ld. DR prayed for sustaining the findings of the Revenue authorities.

We have heard the rival submissions and perused the material available on record, including the paper book comprising pages 1 to 94 filed by the assessee. We find that the principal controversy relating to the disallowance of interest of Rs.2,79,952/- requires examination with reference to the actual utilisation of the borrowed funds and the corresponding interest income earned by the assessee. The assessee has specifically contended that there were two distinct components of interest received from the firm, namely interest on capital and interest on loans advanced to the firm, whereas the Ld. CIT(A) proceeded on the premise that the interest received from the firm was essentially referable to the assessee's status as a partner. The assessee has further raised a specific factual grievance that the disallowance was calculated with reference to interest of Rs.13,99,762/- instead of the actual interest expenditure of Rs.13,66,762/-. These factual aspects have a direct bearing upon the claim u/s 57(iii) and require proper verification. The original grounds themselves show that the assessee had challenged both the restriction of interest and the computation thereof.

The issue of brokerage of Rs.96,893/- is consequentially connected with the borrowing of funds and the assessee's claim regarding nexus between such borrowing and the interest-bearing advances. Similarly, in respect of the expenditure of Rs.1,55,758/-, we find that the grievance of the assessee is that the Ld. CIT(A) directed verification only in respect of depreciation without adjudicating the other components of expenditure forming part of the same disallowance. Considering these facts, the issues relating to the disallowance of interest of Rs.2,79,952/-, brokerage of Rs.96,893/- and expenditure of Rs.1,55,758/- are restored to the file of the Ld. AO for fresh adjudication after verification of the nexus, actual interest paid, interest income earned on the loans advanced to the firm, brokerage expenditure and the individual components of the expenditure of Rs.1,55,758/-. The assessee shall be afforded reasonable opportunity to furnish the supporting evidence, and the Ld. AO shall decide these issues in accordance with law.

In respect of the disallowance of Rs.60,348/- u/s 14A r.w. Rule 8D, the assessee has specifically pleaded availability of substantial own interest-free funds, absence of nexus between borrowed funds and investments yielding exempt income, positive net interest income and duplication arising from inclusion of interest/brokerage expenditure already subjected to disallowance. The original appellate grounds also raised the availability of own interest-free funds and positive net interest income. In these circumstances, this issue is also restored to the file of the Ld. AO for fresh adjudication, who shall examine the assessee's claim on the basis of the relevant accounts and record the requisite satisfaction in accordance with section 14A read with Rule 8D, after granting reasonable opportunity to the assessee.

Accordingly, the grounds referred to above are allowed for statistical purposes, in terms indicated hereinabove. Ground No.1, being general in nature, requires no separate adjudication. The general ground seeking liberty to add, amend or alter the grounds also requires no separate adjudication.

In the result, the appeal of the assessee bearing ITA No.3505/Mum/2026 is allowed for statistical purposes.