SURENDRA K SHETH (HUF),MUMBAI vs. ITO 17(3)(4), MUMBAI

The dispute in the present appeal is confined to part disallowance of interest expenditure by applying provisions of section 40A(2)(b) of the Act.

Briefly the facts are, the assessee is a Hindu Undivided Family (HUF). For the assessment year under dispute, the assessee filed its return of income on 26- 12-2014 declaring total income of Rs.7,38,880/-.In course of assessment proceedings, the Assessing Officer on verifying the materials on record found that the assessee had availed unsecured loans both from related and unrelated parties. Further, he found that while the assesse is paying interest @ 11% to 12% per anum (p.a.) to unrelated parties, it is paying interest @15% p.a. to related parties. Noticing this, the Assessing Officer called upon the assessee to explain the reason for paying higher rate of interest to related parties and also to explain why excess interest paid should not be disallowed. Though, the assessee justified the payment of interest at higher rate to the related parties; however, the Assessing Officer held that interest paid @15% p.a. to family members and related parties is unreasonable and excessive in comparison to interest paid to non related parties at 11% to 12% p.a. Therefore, he proceeded to disallow the excess 3% interest paid by the assessee which worked out to Rs.7,05,410/-. The assessee contested the aforesaid disallowance before the first appellate authority. Taking note of the fact that market rate of interest varies between 12.05% to 15.41% as pr the Reserve Bank of India (RBI) report, learned Commissioner (Appeals) held that interest paid over and above the average rate of interest of 13.73% is unreasonable and excessive in terms of section 40A(2)(b) of the Act. Accordingly, he directed the assessing officer to disallow the excess interest paid of 1.27%.

The learned Counsel for the assessee submitted, the assessee has paid 15% interest on the unsecured loan availed from related parties because they are long term loans compared to short term loans availed from unrelated parties. Drawing attention to RBI report as well as schedule lending rate of commercial banks, the learned Authorised Representative submitted, various banks charged interest of more than 15% on term loans. Thus, he submitted, compared to commercial rate per annum, the interest paid by the assessee to the related parties at 15% cannot be construed to be high and unreasonable. Further, he submitted, in case assessee would have availed loan from banks and financial institutions, apart from paying higher rate of interest, the assessee, not only would have paid additional cost by way of processing charges, but would have been required to secure the loan by mortgaging its assets. Thus, he submitted, the interest paid @15% being reasonable, should be allowed. In support of his contention, learned Counsel for the assessee relied upon the following decisions:-

Motilal Laxmichand Sanghavi vs ACIT (2019) 178 ITD 710 (Mum) 2. PCIT vs Cama Hotels Ltd (2016) 240 Taxman 770 (Guj) 3. CIT vs Sarjan Realities Ltd (2014) 227 Taxman 225 (Guj) 4. CIT vs Shiv Kumar (2013) 217 Taxman 73 (Del) 5. R.N. Gupta & Co. Ltd vs ACIT (2016) 69 taxmann.com 291(Chd) 6. DCIT vs Shiv Kumar (ITA No.3247/Del/2010) 5. Strongly relying upon the observations of the Assessing Officer and learned Commissioner (Appeals), the learned Departmental Representative submitted, when the assessee has paid interest at a rate more than what is paid to unrelated parties, provisions of section 40A(2)(b) are clearly attracted. Thus, she submitted, the disallowance sustained by learned Commissioner (Appeals) has to be upheld.

However, the issue before me is whether the interest paid by the assessee to the related parties can be considered to be excessive or unreasonable having regard to the fair market value of interest in terms of section 40A(2)(b) of the Act. From the RBI report reproduced in learned Commissioner (Appeals) order and a copy of which has also been furnished in the paper book, it is very much clear that the rate of interest normally charged by commercial banks on loan varies between 12% to 20%. Further, it cannot be denied that if the assessee would have availed loan from banks and financial institutions, apart from paying higher rate of interest it would have paid additional cost by way of processing charges and would also have been required to furnish collaterals to secure the loan. Whereas, while availing loan from the related parties, which are stated to be long term loans, the assessee neither has to pay any additional cost nor has to furnish any collaterals. Thus, the assessee is rather in an advantageous position as the related parties always run the risk of not being able to recover the loan in case of default. Considering the aforesaid factors, interest paid by the assessee @15% to the related parties cannot be said to be excessive or unreasonable having regard to the fair market value of the goods, services or facility for which the payment is made, in terms of section 40A(2)(b). In any case of the matter, the difference between the interest paid by assessee at 15% and the reasonable rate of interest ultimately allowed by learned Commissioner (Appeals) at 13.73% works out to a negligible amount of 1.27%. That being the case, in my considered opinion, the provisions of section 40A(2)(b) would not be applicable in the present case. Therefore, I am inclined to delete the disallowance sustained by learned Commissioner (Appeals). Grounds are allowed.

In the result, appeal is allowed.