Loading judgment…
Facts
The assessee, engaged in wholesale business, paid interest at 15% to relatives on an unsecured loan. The Assessing Officer (AO) disallowed the excess interest by comparing it with the bank's secured loan interest rate of 10.2%. The assessee argued that unsecured loans from relatives cannot be compared with secured bank loans.
Held
The Tribunal held that the AO erred in comparing interest paid on an unsecured loan from relatives with the interest rate on a secured bank loan. The interest rate for unsecured loans is naturally higher. The AO should have compared with the market rate for similar unsecured loans.
Key Issues
Whether disallowance of interest paid to relatives on unsecured loan is justified by comparing it with interest paid on secured bank loan, without considering market rates for unsecured loans.
Sections Cited
143(3), 143(2), 40A(2)
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, “SMC” BENCH : BANGALORE
Before: SHRI PRASHANT MAHARISHI
This appeal is filed by H V Textile (the assessee/appellant) for the assessment year 2017-18 against the appellate order passed by the Joint Commissioner of Income tax (Appeals) [ld. CIT(A)] dated 24.6.2025 wherein the appeal filed by the assessee against the assessment order passed u/s. 143(3) of the Income-tax Act, 1961 [the Act] dated 06-12-2019 by the Income Tax Officer ward 1 (3) , Hubballi [ld. AO] was dismissed.
In substance the only ground of appeal
is the disallowance of interest expenditure of ₹ 14,20,580/– made by the learned assessing officer by invoking the provisions of section 40. A (2) (B) of the act by comparing the interest of bank loan of ₹ 10.2 percent per annum against the interest paid at the rate of 15% per annum and thereby disallowing the excess interest paid.
3. Fact shows that the assessee is carrying on the business into wholesale basis. It filed its return of income on 13/10/2017 declaring a total income of ₹ 65,570/–. The return of income was picked up for scrutiny and notice under section 143 (2) of the act was issued on 17th/8/2018. During the course of assessment proceedings, the learned assessing officer noted that assessee has paid interest to its relatives of ₹ 4,438,688/– and the interest is paid to the relatives at the rate of 15% per annum. The assessee has also availed a loan from Corporation Bank of ₹ 144 lakhs on which the assessee has paid interest at the rate of 10.2% per annum. Therefore, the learned assessing officer issued a show cause notice to the assessee that why the interest paid by the assessee to the relative at the rate of 15% per annum should not be restricted at the rate of 10.2% per annum and the balance access sum paid by the assessee as interest would be disallowed. The assessee submitted that identical issue arose in the case of the assessee for assessment year 2008 – 09 when the interest was claimed at the rate of 15% and the learned assessing officer has made the disallowance, the learned CIT – A has allowed the appeal in favour of the assessee and therefore the issue squarely covered in favour of the assessee. The assessee also stated that bank loan interest cannot be compared with the unsecured loan received from the family members. The loan from the family members is without any hypothecation of stock et cetera where the bank loan is fully secured. The learned assessing officer did not accept the explanation of the assessee and issued a show cause notice to the assessee that excess interest at the rate of 4.8% per annum would be brought to tax. The assessee reiterated the similar reply. The learned assessing officer rejecting the same stating that it is paid higher than the bank interest, disallowed a sum of ₹ 14,20,380/–. Some other disallowances were also made but same are not in dispute before us. The assessment order was passed under section 143 (3) of the act on 6/12/2019.
4. The assessee preferred an appeal before the learned CIT – A who passed an order on 24 June 2025 the assessee reiterated the submissions made before the learned assessing officer. The learned CIT – A has held that the interest of family members needs to be regulated as per the provisions of section 40 A (2) of the act and therefore the contention raised by the assessee has no force. It was further stated that assessee has paid excess interest by 47% compared to the bank rate. Even if assuming that the bankers charging interest monthly processing fee and other charges, it will be very much less than the 15%. The earlier order of the learned CIT – A was also not considered as acceptable by the learned CIT – A holding that that was in assessment year 2008 – 09 and thereafter no scrutiny has taken place the assessee also relied upon the several judicial precedents which were also not accepted by the learned CIT – A. Therefore, he held that the assessing Ofc has rightly disallowed a sum of ₹ 1,420,380/– under section 40 A (2) on account of excessive interest paid to the related parties. The disallowance is based on a reasoned comparison with prevailing interest rates and is supported by adequate justification. Accordingly, the disallowance was confirmed.
5. Assessee aggrieved with the same is in appeal before us. The learned authorized representative has submitted a paper book containing 132 pages and also cited the judicial precedents in case of compilation. The assessee also referred to circular number six – P dated 6/7/1968. The argument of the learned authorized representative is the same which is made before the learned assessing officer and the appellate authority.
The learned departmental representative imminently supported the orders of the learned lower authorities and submitted that assessee has paid excess of interest by 47% compared to the bank interest rate of 10.20% and therefore the interest payment at the rate of 15% is definitely excessive and unreasonable and correctly disallowed.
We have carefully considered the rival contention and perused the orders of the learned lower authorities. The only issue involved in that assessee has paid interest at the rate of 15% to its relatives on unsecured loan and the learned assessing officer has compared the interest on secured loan paid to the bankers. In fact, the bank rates are 10.20% undisputedly but same is a secured loan for which the assessee has put the hypothecation of stock. Further the loan received from the related parties are completely unsecured. Therefore, comparison of the interest paid to a secured lender cannot be compared with the interest paid to an unsecured lender. Naturally, the interest rate paid to the unsecured lender would be much higher than the interest rate that would have been payable to the secured lender. The learned assessing officer and the learned first appellate authority has compared both of them wrongly. The learned assessing officer is duty-bound to compare the payment made to the related parties with the market rate having similar circumstances, then to find out the excess payment to the related party and then to disallow such excess. In the present case the learned assessing officer has not looked into the comparable market rate of unsecured loan. In view of this, we do not find any reason to uphold the addition made by the learned assessing officer under section 40 A (2) of the act. Accordingly, we direct the learned assessing officer to delete the disallowance of ₹ 1,420,380/–. In the result second ground of appeal is allowed.
8. All other grounds are either consequential or general in nature and therefore those are dismissed.
In the result, the appeal by the assessee is partly allowed.
Pronounced in the open court on this 30th day of September 2025.