INDIABUILD REALITY PRIVATE LIMITED ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-3(1)(1), BANGALORE

This appeal was originally heard and an order dated 22.12.2017 was passed by the Tribunal. Later on, the assessee filed MP No.65/Bang/2018 pointing out that the Tribunal omitted to adjudicate ground No.2 raised by the assessee in its appeal. By an order dated 10.05.2018, the Tribunal recalled its order dated 22.12.2017 for the limited purpose of adjudicating ground No.2 raised by the assessee in its appeal. Accordingly, this appeal was listed for hearing to adjudicate ground No.2.

Ground No.2 raised by the assessee before the Tribunal reads as follows:-

The issue raised in ground No.2 is with regard to disallowance of interest expenses on the ground that interest paid on borrowings by the company to related party is excessive and unreasonable and by invoking the provisions of section 40A(2)(b) of the Income-Tax Act, 1961 [“the Act”].

There is no dispute that interest was paid on loans borrowed from a related party and that the justification of quantum of such interest payment u/s. 40A(2)(b) of the Act had to be examined by the AO. The assessee paid interest on loans taken from related party at 15.5%. According to the AO, reasonable market rate of interest is only of 12% and therefore to the extent of interest payment beyond 12%, the same should be disallowed and added to the total income of assessee. Accordingly, the expenses allowed by the AO on account of interest was Rs.4,66,780 as against the claim of assessee for deduction of a sum of Rs.6,19,720. The order of the AO was confirmed by the CIT(A). Hence Gr.No.2 by the Assessee before the Tribunal.

I have heard the rival submissions. It is seen that the assessee submitted before the AO that the bank prime lending rate of SBI was 14.75% and since the loan in question was unsecured loan, 15.5% should be considered as reasonable rate of interest paid by the assessee. The ld. Counsel for the assessee brought to my notice that the person to whom assessee paid interest was also assessed to tax at maximum marginal rate of interest on the interest paid by the assessee and therefore there is no loss to the revenue in terms of tax evasion. My attention was drawn to Circular No.6-P dated 06.07.1968 wherein the purpose behind the introduction of provisions of section 40A(2)(b) of the Act was explained by the CBDT as follows:-

Reliance was also placed on the decision of the Hon’ble Gujarat High Court in the case of CIT v. Smt. L. Parameswari [2017] 79 taxman.com 119 (Guj) wherein the Hon’ble Gujarat High Court took the view that the provisions of section 40A(2) are not automatic and can be called into play only if the AO establishes that the expenditure incurred is in excess of the fair market value. The conclusion of the AO that the expenditure was excessive or unreasonable has to be based on tangible material and not on assumptions and surmises.

The ld. DR relied on the order of CIT(A).

I have considered the rival submissions and I am of the view that the plea taken by the assessee in the facts and circumstances of the case ought to have been accepted by the revenue authorities. There is no finding given by the revenue authorities as to how the interest payment in question was excessive or unreasonable. There has been no tax evasion by reason of the payment of interest to the related party, as in the hands of the recipient the payment has suffered taxes. Though this may not be the only relevant criterion, but on the other facts and circumstances prevailing in the present case, I am satisfied that the disallowance u/s. 40A(2)(b) of the Act cannot be sustained and the same is directed to be deleted.

In the result, ground No.2 raised by the assessee is allowed.