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Facts
The assessee, MSN Pharmachem Pvt. Ltd., a pharmaceutical manufacturer, faced two disallowances after a search and seizure operation for AY 2021-22. These were Rs.1,03,44,404/- for interest paid on delayed GST (treated as penal by lower authorities) and Rs.73,02,428/- for interest on advances given to group entities (allegedly from borrowed funds). The Ld. CIT(A) upheld both disallowances, leading the assessee to appeal before the tribunal.
Held
The tribunal held that interest on delayed GST payments under Section 50(3) of the GST Act is compensatory and hence an allowable business deduction under Section 37(1) of the Income Tax Act. For the second issue, it was found that the assessee possessed sufficient interest-free funds to cover the advances, establishing a presumption that advances were from these funds, and the AO failed to prove a nexus with borrowed funds. Both disallowances were directed to be deleted.
Key Issues
1. Whether interest paid on delayed GST under Section 50(3) of the GST Act is compensatory or penal and thus allowable as a deduction under Section 37(1) of the Income Tax Act. 2. Whether disallowance under Section 36(1)(iii) for interest on advances to group entities is justified when the assessee has sufficient interest-free funds.
Sections Cited
132, 153A, 143(2), 143(3), 37(1), 36(1)(iii), 50(3) (GST Act), 50(1) (GST Act), 42 (GST Act), 43 (GST Act)
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, Hyderabad ‘A’ Bench, Hyderabad
Before: SHRI RAVISH SOOD & SHRI MADHUSUDAN SAWDIA
आदेश/ORDER PER MADHUSUDAN SAWDIA, A.M.: These appeals are filed by the above captioned assessees, feeling aggrieved by the separate orders passed by the Learned Commissioner of Income Tax (Appeals)-12, Hyderabad (“Ld. CIT(A)”), all dated 28.01.2025 for the A.Y. 2021-22 respectively. Since common issues are involved in these appeals and are related to the same assessee group, they are heard together and one consolidated order is being passed for the sake of convenience and brevity. 2. We take up as lead appeal. The assessee has raised the following grounds of appeal :
Brief facts of the case are that MSN Pharmachem Private Limited (“the assessee”) is a company engaged in the business of manufacturing of drugs and pharmaceuticals. A search and seizure operation under Section 132 of the Act was carried out in the MSN Group of cases on 24.02.2021. The assessee was also covered under the said search and seizure operation. Accordingly, notice under Section 153A of the Income Tax Act, 1961 (“the Act”) was issued to the assessee on 15.02.2022. In response, the assessee filed its return of income on 15.03.2022, declaring total income of Rs.317,35,77,150/-. The case of the assessee was taken up for scrutiny and notice under Section 143(2) of the Act dated 16.03.2022 was issued to the assessee. After considering the submissions of the assessee, the Learned Assessing Officer (“Ld. AO”) completed the assessment under Section 143(3) of the Act on 31.03.2023 by determining the total income at Rs.320,10,22,226/-.
Aggrieved by the order of the Ld. AO, the assessee preferred appeal before the Ld. CIT(A), who partly allowed the appeal. Still aggrieved, the assessee is in further appeal before us.
At the threshold of hearing, the Learned Authorised Representative (“Ld. AR”) submitted that, only following two issues arose in the present appeal:
(i) Disallowance of Rs.1,03,44,404/- towards interest paid under Section 50(3) of the GST Act; and (ii) Disallowance of Rs.73,02,428/- u/s. 36(1)(iii) of the Act.
As far as the first issue is concerned, the Ld. AR submitted that the assessee had claimed input tax credit on raw material purchases, but the supplier failed to deposit the corresponding GST to the Government account. Consequently, the GST Department raised a demand on the assessee and levied interest of Rs.1,03,44,404/- under Section 50(3) of the GST Act, which the assessee duly paid. The Ld. AO treated the said interest as penal in nature and disallowed the same. The Ld. CIT(A) without considering the submission of the assessee, upheld the action of the Ld. AO. The Ld. AR argued that the interest under Section 50(3) of the GST Act is compensatory in nature and arises on account of mismatch or excess availment of input tax credit, not due to any deliberate evasion or default. It was pointed out that Section 50(3) of the GST Act nowhere states the levy to be penal in nature. The Ld. AR placed reliance on judicial precedents in the case of Lachmandas Mathuradas Vs. CIT (2002) 254 ITR 799 (SC); wherein, the Hon’ble Supreme Court has held that interest paid on arrears of sales tax is compensatory in nature and not penal. Accordingly, the Ld. AR submitted that interest on GST paid by the assessee is compensatory and allowable as deduction.
6.1 The Ld. AR further invited attention to page no. 102 of the appellate order, where the Ld. CIT(A) reproduced Section 50(1) and 50(3) of the GST Act, and erroneously concluded that Section 50(3) interest is penal in nature. Finally the Ld. AR prayed before the bench to delete the addition made by the Ld. AO.
6.2 Per contra, the Learned Departmental Representative (“Ld. DR”) submitted that the interest paid under Section 50(3) of the GST Act is distinct from Section 50(1) of the GST Act and is levied on account of ineligible credit claimed by the assessee. It was argued by the Ld. DR that, the disallowance is justified as the interest is akin to penal consequences for incorrect credit availment.
6.3 We have heard the rival submissions and also gone through the record in the light of the submissions made on either side. The assessee had claimed Rs.1,03,44,404/- as deduction being interest paid under Section 50(3) of the GST Act due to input tax credit mismatch, which arose because the supplier failed to deposit the GST amount. The Ld. AO and Ld. CIT(A) disallowed the same treating it as penal in nature. We have gone through Section 50(3) of the GST Act which reads as follows:
“50(3): A taxable person who makes an undue or excess claim of input tax credit under sub-section (10) of section 42 or undue or excess reduction in output tax liability under sub-section (10) of section 43, shall pay interest on such undue or excess claim or on such undue or excess reduction, as the case may be, at such rate not exceeding twenty-four per cent, as may be notified by the Government on the recommendations of the Council.” 6.4 On perusal of the above provision, 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 Hon’ble Supreme Court in the case of Lachmandas Mathuradas Vs. CIT (2002) 254 ITR 799 (SC); wherein, the Hon’ble Supreme Court has 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.
6.5 In light of this decision, we are of the considered view that the interest paid under Section 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 under Section 37(1) of the Act. Accordingly, the disallowance of Rs.1,03,44,404/- made by the Ld. AO and sustained by the Ld. CIT(A) is directed to be deleted.
As far as the second issue is concerned, the Ld. AR submitted that the disallowance of Rs.73,02,428/- made by the Ld. AO under Section 36(1)(iii) of the Act is wholly unjustified. He submitted that, the advances in question were made out of the assessee’s own surplus interest-free funds, and not from borrowed capital. The Ld. AR invited our attention to the audited balance sheet of the assessee as on 31.03.2021, placed at page no. 5 of the paper book, which clearly shows that the assessee had equity and reserves of Rs.1,05,624.23 lakhs, whereas the total interest-free advances made by the assessee along with its group companies stood at Rs.6,082 lakhs. It was thus argued by the Ld. AR that, the interest-free funds were significantly more than the advances, and accordingly, no disallowance could be made under Section 36(1)(iii) of the Act. The Ld. AR relied upon the judgment of the Hon’ble Supreme Court in the case of CIT v. Reliance Industries Ltd. (2019) 102 taxmann.com 52 (SC), where 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. The Ld. AR submitted that, the Ld. AO has simply relied on a statement of one Mr. MSN Reddy, who allegedly stated that advances were made from borrowed funds. However, no factual finding or fund flow analysis has been made to establish any direct nexus between borrowed funds and interest-free advances.
7.1 Per contra, Ld. DR placed reliance on para 6.4 of the assessment order, where the Ld. AO has stated that advances were made from borrowed funds, based on the statement of Mr. MSN Reddy. The Ld. DR argued that both the Ld. AO and Ld. CIT(A) have rightly disallowed the interest expenditure under Section 36(1)(iii) of the Act.
7.2 We have considered the rival submissions and perused the record, including the audited financials and judicial precedents placed before us. It is not in dispute that the total equity and surplus available with the assessee as on 31.03.2021 was Rs.1,05,624.23 lakhs, while the interest-free advances given by the assessee along with its related concerns stood at Rs.6,082 lakhs. Thus, it is evident that the assessee had sufficient interest-free funds to cover the said advances.
7.3 We have gone through the judgment of the Hon’ble Supreme Court in the case of Reliance Industries Ltd. (supra), 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.
7.4 In the present case, no nexus has been established by the Ld. 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 of Rs.73,02,428/- under Section 36(1)(iii) of the Act is unsustainable in law, and the same is directed to be deleted.
In the result, the appeal of the assessee is allowed.
The issues involved in these appeals are identical to the issues involved in the appeals in , wherein we have allowed the appeal of the assessee. Therefore, our discussion and findings in are mutatis mutandis applicable to these appeals also. As the appeals of the assessees in has been allowed, these appeals of the assessees are also allowed.