MUKESH CHHOTELAL GUPTA,AHMEDABAD vs. THE DY.CIT, CIRCLE-1(1)(1), AHMEDABAD

2.4 In the course of enquiry, the AO required the assessee to establish the source of interest income, the persons from whom borrowings were made, the flow of interest payments, deduction of tax at source, and, in particular, the nexus between the expenditure in the nature of interest and the income offered under the head “other sources.” The assessee, inter alia, filed bank statements, ledgers, copy of his interest ledger, confirmation/ledger of Shri Alpesh B. Patel, copy of the return and computation of Shri Alpesh B. Patel evidencing offer of interest income from the assessee, and contended that both interest income and interest expense were consistently recognised on the mercantile basis in accordance with section 145(1) read with Tax Accounting Standard-1 (matching concept). It was further asserted that substantial loans and advances were old and that in an earlier scrutiny for A.Y. 2016-17 a similar claim under section 57 had been examined and accepted. The assessee also sought a video-conference hearing, which, as recorded in the assessment order, was held on 21.09.2021.

2.5 The AO, however, was not satisfied. He recorded that there was no material to show how interest to the tune of Rs.66,59,593/- claimed in the name of Shri Alpesh B. Patel was paid and from which account such payments had flown; that no tax had been deducted at source on such huge interest; that though confirmations/ITR of Shri Alpesh B. Patel were produced, there was no data as to when Shri Alpesh B. Patel had lent such amounts to the assessee and to whom the assessee had, in turn, advanced monies on interest. On perusal of the assessee’s ICICI Bank account, the AO tabulated entries relating to Shri Alpesh B. Patel showing only a deposit of Rs. 20,00,000/- on 25.04.2017 and a withdrawal of Rs.20,00,000/- on 02.05.2017. The AO concluded that, as per bank trail, only about Rs.17 lakhs stood actually paid to Shri Alpesh B. Patel during F.Y. 2017-18, whereas a journal entry of Rs.66,59,593/- was passed on 31.03.2018; that no TDS had been effected; and that no proximate connection between the interest receipts and the interest payments had been demonstrated.

2.6 Proceeding on the above and noting that none of the interest payments were made during the year and were stated to have been made in subsequent years, the AO held that the assessee failed to satisfy the statutory requirement of section 57(iii) that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning such income. He, therefore, disallowed Rs.34,17,989/- and added the same to the returned income, initiated penalty proceedings under section 270A for under-reporting/misreporting, and completed the assessment under section 143(3) r.w.s. 144B.

2.7 Aggrieved, the assessee carried the matter in appeal. The CIT(A), after reproducing the assessee’s submissions, recorded, inter alia, the assertions that the assessee follows mercantile accounting in terms of section 145(1) and Tax Accounting Standard-1; that interest income of Rs.51,17,989/- comprised FD interest and interest from parties, of which interest receivable on mercantile basis from identified parties—Anuj Gupta (Rs.17,75,000/-), Priyanka Gupta (Rs.13,52,448/-) and Meenaben Vedprakash Chhabria (Rs. 1,56,389/-) which aggregated Rs.32,83,837/-; that confirmations/ITR of Shri Alpesh B. Patel, showing offer of interest from the assessee, had been filed; that the claim under section 57 was restricted to the interest income recognised; and that similar claim had been accepted in scrutiny for A.Y. 2016-17.

2.8 The CIT(A) thereafter examined the assessment record and observed that, as per the AO, only Rs.17 lakhs stood actually paid to Shri Alpesh B. Patel during F.Y. 2017-18 as against the journal entry of Rs.66,59,593/-; that no tax had been deducted at source; and that the assessee had not established a direct nexus between the borrowed funds and the interest- bearing advances or deposits. Referring to the requirement of establishing the relationship in substance between interest income and interest expenditure, and adverting to the principle that the taxing authority is entitled to unravel the true character of the transaction, the CIT(A) held that the assessee failed to prove that the funds borrowed from Shri Alpesh B. Patel were for the purpose of earning the interest income returned. On this reasoning, the CIT(A) affirmed the disallowance of Rs.34,17,989/- and dismissed the appeal.

3. Being further aggrieved, the assessee has preferred the present appeal before us, raising following grounds:

1. Disallowance of Interest Expense u/s 57 is Unjustified: The AO and CIT(A) erred in disallowing Rs.34,17,989 in interest expenses, despite the appellant maintaining proper records and complying with the mercantile accounting system.

2. Failure to Consider Documentary Evidence: Both the AO and CIT(A) failed to consider supporting documents such as IRs of lenders, confirmations, bank statements, and ledger accounts, which clearly justified the appellant's claim.

5. Applicability of Mercantile Accounting and Matching Principle: - The appellant followed mercantile accounting, as per Tax Accounting Standard-1, offering interest income on an accrual basis. - The AO failed to apply the matching principle, which allows expenses to be deducted in the year the corresponding income is recognized. - 6. Non-Consideration of Past Assessments: - The AO and CIT(A) ignored previous scrutiny assessments for AY 2016-17 which had accepted similar interest claims. - Such arbitrary deviation from past assessments is against principles laid down by the Supreme Court in Radhasoami Satsang v. CIT [1992] 193 ITR 321 (SC).

7. Breach of Natural Justice: - The AO failed to properly examine the evidence submitted and disregarded legitimate business transactions. - The AO's action is based on assumptions rather than verified facts, which violates the principles of natural justice. PRAYER: In light of the above grounds, it is respectfully prayed that the Hon'ble Tribunal may:

1. 1. Delete the disallowance of Rs. 34,17,989 made under section 57. 2. Grant relief to the appellant by allowing the appeal in full. 3. Pass any other order deemed fit in the interest of justice.

4. The learned Authorised Representative (AR) for the assessee submitted that the authorities below have grossly erred in disallowing the claim of interest expenditure of Rs.34,17,989/- under section 57 of the Act, despite the assessee maintaining regular books of account, adopting the mercantile system of accounting, and offering corresponding interest income to tax on accrual basis. The learned AR emphasised that the assessee had earned interest income aggregating to Rs.55,08,187/- under the head “Income from Other Sources,” which included Rs.51,17,989/- being interest receivable from various parties, including fixed deposit interest. Against this, the assessee had claimed deduction of interest expenditure incurred on borrowed funds to the extent of the interest income accrued, and voluntarily disallowed the balance interest expenditure, thereby ensuring strict matching. The learned AR also relied upon the principle of consistency and submitted that in A.Y. 2016–17, the assessee’s case was selected for scrutiny and the interest claim under section 57 was examined and accepted by the Department. In absence of any change in facts or legal position, the Revenue was not justified in deviating from the accepted position, especially when the assessee had followed the same accounting treatment and offered interest income on accrual basis.

6.1 We also find from the record that several of the parties to whom loans were stated to have been advanced are closely associated or related to the assessee. Despite this, the learned AR could not justify why the alleged lender, Shri Alpesh B. Patel, did not directly advance monies to those persons, particularly when the assessee did not appear to carry on any regular money lending business nor demonstrated any arm’s length rationale for such intermediation. The explanation merely rested on accounting entries, without establishing the underlying commercial purpose or genuineness of the transaction. The principle of nexus, as envisaged under section 57(iii), is not confined to a mere quantitative correlation or mechanical matching between income and expenditure, but requires that the expenditure must be incurred wholly and exclusively for the purpose of earning such income.

6.2 The learned Authorised Representative placed reliance on the assessment order passed under section 143(3) of the Act for A.Y. 2016–17, a copy of which was filed in the paper book, to contend that in the earlier year the Assessing Officer had accepted the claim of interest expenditure under section 57 without making any disallowance, despite similar facts and accounting treatment. However, upon perusal of the assessment order for A.Y. 2016–17 placed before us, we find that the said order is a cryptic two-page order, passed under limited scrutiny through CASS, and does not contain any discussion or finding with respect to the assessee’s claim of deduction under section 57 of the Act. The entire income declared by the assessee was accepted as such, without any specific reference to the allowability of interest expenditure or verification of the nexus between borrowed and advanced funds. Thus, in our considered view, the mere fact that the return was accepted without variation in the earlier year cannot be regarded as a conscious or informed adjudication of the issue by the Assessing Officer, nor can it constitute a binding precedent so as to attract the principle of consistency.

6.3 We have also carefully perused the ledger accounts placed in the paper book. It is observed that all the ledger accounts pertaining to the alleged loans and advances contain substantial opening balances, indicating that the transactions were continuing in nature and not limited to the relevant previous year. However, the assessee has not furnished any explanation with regard to the purpose of such borrowings or rationale for lending the funds to the identified parties. No agreements, correspondence, or supporting documentation was placed to establish the commercial expediency of the transactions or to demonstrate that the borrowings were incurred wholly and exclusively for the purpose of earning interest income assessable under the head "Income from Other Sources."

Moreover, though the assessee has filed a copy of the Profit and Loss account, the Balance Sheet, which would have disclosed the deployment of funds, composition of liabilities, and the nature of advances made, was not filed as part of the paper book. In the absence of such critical information, we are unable to draw any inference with respect to the application of borrowed funds or to examine whether there existed any real-time nexus between the interest-bearing borrowings and the income-yielding advances.

6.4 On an overall consideration of the facts on record, we are inclined to dismiss the appeal on merits in view of the assessee’s failure to establish the requisite nexus between the borrowed funds and the amounts advanced. However, having regard to the assessee’s reliance on past assessments and the plea of judicial consistency, as well as in order to verify the correctness of the claim based on complete facts and evidences, we deem it fit and proper, in the interest of justice, to restore the matter to the file of the Assessing Officer. The Assessing Officer shall afford the assessee a reasonable opportunity to furnish cogent reasons, supporting documentation, and explanations to prove the real nexus of the funds borrowed and advanced, and thereafter decide the issue afresh by passing a speaking order in accordance with law.

6.5 We, therefore, set aside the impugned order of the learned CIT(A) as well as the assessment order on this limited issue and restore the matter to the file of the Assessing Officer with a direction to afford the assessee a reasonable opportunity to furnish cogent reasons, documentary evidences, and explanations to prove the actual utilisation of borrowed funds and to establish the real nexus between such borrowings and the advances made. The Assessing Officer shall examine the claim afresh in accordance with law and pass a speaking order.

Order pronounced in the Court on 12th August, 2025 at Ahmedabad.