SATISH PRAKASH AGARWAL,AGRA vs. THE ACIT, CIRCLE 1(2)(1), AGRA, AGRA

This appeal in ITA No. 113/Agr/2021 for the assessment year

2016-17 has arisen from the appellate order dated 15.09.2021 [DIN &

Order No. ITBA/NFAC/S/250/2021-22/1035585472(1)], passed by

learned Commissioner of Income-tax (Appeals), NFAC, Delhi, which

appeal before learned CIT(A) in turn has arisen from the assessment

order dated 23.12.2018 passed by Assessing Officer u/s. 143(3) of the

Income-tax Act, 1961(Order No. ITBA/AST/S/143(3)/2018-

19/1014523221(1)).

ITA No.113/Agr/2021

ITAT, Agra Bench, Agra, reads as under :

ITA No.113/Agr/2021

when there remained no loss under the head 'Income from Business and Profession' after the Ld. Assessing Officer made addition of Rs. 34,38,533/- to the total income of appellant on account of disallowance of interest expense. 6. The appellant craves leave to add, alter, modify any grounds of appeal taken by him on or before the date of final hearing.” 2.2 The assessee has raised additional ground of appeal “ Because the Assessment Order is bad in law in so far as the ld. AO has exceeded the mandate for which the process of scrutiny was initiated.”

assesseefiled return of income on 06.03.2017 ,declaring income of

Rs.5,17,690/-. Case was selected by Revenue for framing limited

scrutiny under CASS to identify whether loss from partnership is

admissible. Statutory notices u/s. 143(2) and 142(1) were issued by the

Assessing Officer to the assessee, during the course of assessment

proceedings. The assesseehas declared income from house property,

income from other sources and loss from business or profession, in the

return of income filed with the Revenue. The assessee has shown loss of

Rs.10,06,265/- from business or profession, which was sought to be set

off/adjustedby the assesseewith the income from house property and

income from other sources. Assessing Officer observed that the

assessee has taken interest bearing loans and the same were invested

in the partnership firmnamely Freedom ShoesLLP ,from where the

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assessee is earning income by way of remuneration, interest and share

in profits. The assessee participated in the assessment proceedings at

the fag-end when the assessment was getting time barred, and

submitted the details, which were found by the Assessing Officer to be

not complete. The assessee submitted before the AO during assessment

proceedings that the assessee has taken loans and has invested funds

in the partnership firm from where the assessee earns the income in the

form of remuneration , interest and share in profits. That the assessee

paid interest of Rs. 50,83,665/- on loan taken from ICICI Bank and other

private persons. The assessee claimed to have enclosed confirmation of

unsecured loans. The details of interest paid were also enclosed. The

assessee also submitted that the assessee is not carrying any such

business where the books of accounts are required to be maintained.

Thus, the assessee submitted that there is no balance sheet or Profit &

Loss Account. The assessee also enclosed unsecured loan list as well

copy of bank statement. The AO observed from the many of the

confirmation letters submitted that the assessee has given incomplete

information in relation to Address & PAN no.. The AO observed that in

some of the cases the assessee has not submitted confirmation letter nor

the Address and PAN of the lenders. The AO deputed inspector to

conduct enquiry in 6 cases where complete addresses were provided by 4 | P a g e

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the assessee. The inspector submitted that the parties have confirmed

advancing loan to the assessee and subsequent receipt of interest.

However, they could not provide supporting documents such as ITR,

computation of income and bank statement. In one case, the lender Mrs.

Neelima Jain was not available as she was out of country. The AO

observed that creditworthiness and genuineness of the unsecured loan

was not fully established in the absence of documentary evidences.There

were in all 33 lenders from whom the assessee borrowed the money as

per list provided by the assessee before the AO during assessment

proceedings. The assessee has in as many as 14 cases did not gave

PAN, addresses nor confirmation letters from the lenders from whom the

assessee has borrowed the funds. The AO issued notices u/s 133(6) to

11 lenders out of which only 5 lenders responded to the enquiries made

by the AO. The AO based on the analysis of the enquiry observed that

the creditworthiness of the lender and genuineness of the interest could

not be proved. The observations of the AO are recorded in the

assessment order. The assessee even did not furnish the copy of

partnership deed. The AO observed that the interest expenses incurred

by the assessee can be deducted against income earned from the

partnership firm .The AO further observed that interest paid cannot be

permitted to be deducted against remuneration earned by the assessee 5 | P a g e

ITA No.113/Agr/2021

from the partnership firm. Thus, the Assessing Officer was not satisfied

with the explanation given by the assessee, which led to the

disallowance of Rs.34,38,533/-towards interest on loans, which was

claimed by the assessee as deduction in relation to unsecured loans

raised by the assessee, which was sought to be set off against income

from remuneration from partnership firm, in which the assessee was

partner, namely Freedom Shoes LLP, and further for rest of the interest

expenses which is claimed as deduction against incomeincome earned

by the assessee cannot be allowed as per AO because of the fact that

the genuineness of the interest expenses claimed are not established.

3.2 The Assessing Officer further disallowed loss of Rs.10,06,265/-

claimed by the assessee under the head “ Profits and Gains of Business

and profession”, which the assessee sought to adjust/set off against

income from house property and income from other sources. Thus, as

against the returned income of Rs.5,17,690/-, the Assessing Officer

assessed the income of the assessee to the tune of Rs.49,62,488/-.

and the ld. CIT(Appeals) partly allowed the appeal of the assessee. The

ld. CIT(A) observed that the assessee has 25% share in partnership firm

M/s Freedom Shoes LLP. The assessee has earned interest income of

Rs. 30,37,400/- on capital employed in the said firm , and against that the 6 | P a g e

ITA No.113/Agr/2021

assessee has claimed interest expenses of Rs. 50,83,665/-.The ld.

CIT(A) observed that the assessee has borrowed funds from the private

parties at the rate of 15% , while the assessee borrowed funds from ICICI

Bank at the interest rate of 12%. The ld. CIT(A) observed that the

assessee has paid interest on higher rate compared to rate of interest on

which interest is received from partnership firm on the loans given . As

per ld. CIT(A), this is avoidance of tax. The onus is on the assessee to

prove that money borrowed is not used for non-business purposes and

the lending has been done keeping in view commercial expediency.

Learned CIT(Appeals) observed that the excessive interest expenditure

being the interest at the higher rate vis-a-vis interest income received by

the assessee from partnership firm @ 12% needs to be disallowed,

which led to disallowance of Rs.20,46,265/- being affirmed by ld. CIT(A),

being the difference between the interest paid of Rs.50,83,665/- and

interest received of Rs.30,37,400/-. The contention of the assessee that

once the interest expenditure is disallowed then there cannot be

separate disallowance of the loss of Rs.10,06,625/-, as there will be

positive income under the head income from business or profession

(after considering disallowance of interest expenditure) ,but this

contention was not accepted by the ld. CIT(Appeals) and the same was

dismissed. 7 | P a g e

ITA No.113/Agr/2021

and ld. Counsel for the assessee drew my attention to the written

synopsis and the paper book filed by the assessee. It was submitted that

the case of the assessee was selected for framing limited scrutiny under

CASS for the reason whether loss from partnership firm is admissible. It

was submitted that the Assessing Officer has made double additions,

firstly disallowance of interest expenditure to the tune of Rs.34,38,533/-

and secondly disallowance of business loss of Rs.10,06,265/- . The AO

did not allow the set off of said losses against income from house

property and income from other sources. It was submitted that once the

expenditure of interest of Rs.34,38,533/- was disallowed by the

Assessing Officer, there remains positive business income in the hands

of the assessee and hence, there was no business loss remaining, which

could have been set off against income earned under the other heads.

Thus, total disallowance made by the Assessing Officer is not

sustainable in the eyes of law. Learned CIT(Appeals) also erred in

sustaining the addition by holding the interest expenditure paid by the

assessee on the borrowed funds to be excessive vis a vis interest

received by the assessee. It was submitted that as per provisions of the

Income Tax Act, only interest @ 12% on capital invested by partners can

be paid/allowed as deduction in the hands of the firm ,and rest is to be 8 | P a g e

ITA No.113/Agr/2021

disallowed as per provisions of the Act. Thus, there was no error on the

part of the assessee charging 12% interest on the capital invested in the

partnership firm, Freedom Shoes LLP. It was submitted that disallowance

of Rs.10,06,265/- was double addition and the same ought to have been

deleted.

CIT(Appeals).

record. I have observed that the assessee filed return of income on

06.03.2017, declaringtotal income of Rs.5,17,690/-. Assessee is drawing

income from house property, income from other sources, and also

income by way of remuneration, share of profits from the partnership firm

namely Freedom Shoes LLP as well as income from interest from the

said partnership firm on the capital contributed by the assessee. Case of

the assessee was selected by Revenue for framing limited scrutiny

under CASS for the reasons whether loss from partnership firm is

admissible. The assessee has shown loss of Rs.10,06,265/- from

business or profession in his return of income, which the assessee has

sought to be set off against the income from house property and income

from other sources. The assessee is a partner in the partnership firm,

Freedom Shoes LLP. The assessee is having 25% share in the said 9 | P a g e

ITA No.113/Agr/2021

partnership firm. It is also observed from the computation of income filed

by the assessee that the assesseebeing partner of the Partnership Firm

M/s Freedom Shoes LLP has claimed to have earned share of profit from

the partnership firm, M/s. Freedom Shoes LLP, to the tune of

Rs.5,94,609/-, which was claimed to be exempt from income-tax keeping

in view provisions of Section 10(2A).It is seen that the case of the

assessee was selected by Revenue for framing limited scrutiny by

CASS to identify whether loss from partnership firm is admissible.

The share of profit from partnership is exempt from tax in the hands of

the partner(Section 10(2A)). Thus,theassessee does not have any share

of loss arising from the partnership firm Freedom Shoes, LLP. The case

of the assessee was selected for framing limited scrutiny by CASS to

identify whether loss from partnership firm is admissible. Thereis no

share of loss arising from the partnership firm in the hands of the

assessee. This is a case of limited scrutiny .Thus, the AO cannot

proceed further with assessment beyond stipulated under limited scrutiny

unless approvals are taken from higher authorities as prescribed by

CBDT in its guidelines. There are no mention about the same in the order

of the authorities below. Limited scrutiny cannot be converted into

complete scrutiny unless with the approval of higher authorities as

stipulated. Proceeding further,the assessing has earned remuneration of 10 | P a g e

ITA No.113/Agr/2021

Rs.10,40,000/- from the said partnership firm, M/s Freedom Shoes, LLP

wherein the assessee is having 25% share in the said firm. The

assessee also derived interest income of Rs.30,37,400/- from the said

partnership firm Freedom Shoes, LLP on capital invested in the said firm.

It is well settled that the remuneration earned from the partnership firm by

the partners as well as interest income earned from the capital invested

in the partnership firm are chargeable to tax under the head ‘ income

from Profits and Gains from Business or Profession’. It is also stipulated

in the Act that the partnership firm shall be allowed interest paid on

capital of the partners @ 12% and any excess is to be disallowed in the

hands of the partnership firm(Section 40(b)(iv)). The assessee has

charged interest @ 12% from the said partnership firm. It is also

observed that the assessee has incurred interest expenditure of

Rs.50,83,665/-, which is sought to be adjusted under and head profits

and gains from business or profession. Said expenses of Rs.50,83,665/-

constitute interest on loan to the tune of Rs.49,90,463.25, brokerage

expenses of Rs.31,500/- and processing fee on ICICI loan of

Rs.61,701.50, paid by the assessee. The net income, which is declared

under the head “profits and gain from business or profession” is a loss to

the tune of Rs.10,06,265/-. Proceeding further, it is observed that the

Assessing Officer made enquiries with respect to the interest paid on 11 | P a g e

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various loans raised by the assessee. The Assessing Officer made

enquiries and delved into finding out creditworthiness of the lenders and

genuineness of the loans. The Assessing Officer after making enquiries

has disallowed the interest to the tune of Rs.34,38,533/- and made

additions of the said amount. Further, the Assessing Officer has

disallowed business loss of Rs.10,06,265/-, which was claimed by the

assessee to be set off against the income from other sources and house

property. Ld. CIT(Appeals), on the other hand has disallowed the interest

expenditure to the tune of Rs.20,46,265/- by observing that the assessee

has made investment in capital in partnership firm of Rs.2,75,000/-(sic.

Rs. 2,75,00,000/-) and the assessee has received interest of

Rs.30,37,400/- on capital deployed in the partnership firm, whereas the

assessee has paid interest of Rs.50,83,665/-, which establishes that the

rate of interest paid is more than the rate of interest received in the

partnership firm. ICICI Bank has given loans to the assesseeat the

interest rate of 12% while the assessee has raised unsecured loans

bearing interest @ 15% from private parties. Learned CIT(Appeals)

observed that there is tax avoidance and there is no commercial

expediency for borrowing funds at the higher rate and thus, excessive

interest of Rs.20,46,265/- was disallowed by the ld. CIT(Appeals).

Similarly, contentions of the assessee that business loss of 12 | P a g e

ITA No.113/Agr/2021

Rs.10,06,265/- was disallowed by the Assessing Officer to be set off

against income from house property and income from other sources, is

the double addition as the interest expenditure stood already disallowed

by the Assessing Officer, was rejected by the ld. CIT(Appeals) and the

assessment order was affirmed. It is observed that the Assessing Officer

disallowed interest expenditure of Rs.34,38,533/- by verifying the

creditworthiness and genuineness of the transactions, but the ld.

CIT(Appeals) has looked into the excessiveness of the interest charged

from the partnership firm @ 12% as against borrowed funds on

unsecured loans @ 15%. CIT(Appeals) also compared the loans raised

from ICICI Bank, which was bearing interest @ 12% while other

unsecured loans raised by the assessee from private parties were

bearing interest @ 15%. Thus, it is observed that this change in stands

by the ld. CIT(Appeals) in bringing to tax income of the assessee by way

of disallowance of interest expenditure to the tune of Rs. 20,46,265/-

being excessive and lacking commercial expediency as against the

disallowance by the AO of the interest to the tune of Rs. 34,38,533/- on

the ground that creditworthiness of the lender as also genuineness of the

interest expenses could not be proved, is not challenged by the Revenue

either by filing appeal against the order of ld. CIT(Appeals) nor any cross

objection has been filed by the Revenue and hence, the order of 13 | P a g e

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assessmentwhich stood merged with CIT(Appeals)’s appellate order has

attained finality so far as Revenue is concerned. In my considered view,

the assessee has invested Rs.2,75,00,000/- in the capital of partnership

firm Freedom Shoes LLP and said investment in capital of the

partnership firm carries the interest @ 12% as claimed by the assessee.

Income-tax Act itself stipulates that the partnership firm shall be allowed

interest paid at the capital @ 12% and any excessive interest shall be

disallowed in the hands of the firm and will not be allowed as deduction

while computing income from business or profession. Reference is drawn

to provisions of Section 28(v), 40(b) and Section 184 .Thus, I do not hold

any infirmity so far as charging of interest @ 12% by the assessee from

the partnership firm, as it carries the force and mandate of law(Section

40(b)) so far as allowability in the hands of the partnership firm is

concerned. The assessee has borrowed from ICICI Bank loans @ 12%,

which is a Bank/Financial Institution governed by RBI regulations and

other monetary controls. The assessee has also borrowed unsecured

loans from private parties which carry higher interest @ 15%. These are

private contracts, and the rate of interest @15%cannot be said to be

unusually high, excessive or unconscionably exorbitant, which could be

considered to be at alter of the conscious warranting disallowance. The

assessee has also claimed to have earned interest income of 14 | P a g e

ITA No.113/Agr/2021

Rs.13,96,689/- from other parties, which were offered to tax under the

head income from other sources. It was submitted that it was not the

interest of only Rs.30,37,400/- earned by the assessee as interest on

capital from partnership firm, but there was further interest earned of

Rs.13,96,689/- from other parties. Thus, total interest earned was of

Rs.44,34,089/-. The assessee is partner in the partnership firm Freedom

Shoes LLP holding 25% shares, the assessee had made investment in

the capital of the firm to the tune of Rs. 2,75,00,000/- claiming the same

to be business requirements and the said amount carried interest@12%.

There is no adverse material on record to prove that there was no

commercial expediency in investing by the assessee in the partnership

firm Freedom Shoes, LLP in which the assessee is partner to the tune of

25% share in profits. The said investment in the capital of the partnership

firm bore interest @ 12% as stipulated under the Act albeit the assessee

has paid higher interest on borrowed funds but merely because the

excess interest is paid, the same cannot be disallowed unless it is

brought on record that there is no commercial expediency or the rate of

interest is unconscionably high or ex-orbitant, which is not the case in the

instant appeal. Reference is drawn to the judgment of Hon’ble Supreme

Court in the case of SA Builders Limited v. CIT, reported in AIR 2007 SC

482, 2007 Keeping in view the abovesaid discussions, I order deletion of 15 | P a g e

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the addition as was made by the AO and sustained by ld. CIT(A). I order

accordingly.

7.2. So far as the disallowance of loss of Rs.10,06,265/- is concerned,

which the assessee has sought to set off against income from house

property and income from other sources. The said loss has not arisen

from the share of loss from partnership firm. There is share of positive

profit from the partnership firm Freedom Shoes, LLP to the tune of Rs.

5,94,609/- which the assessee earned and claimed exemption u/s

10(2A). The aforesaid loss of Rs. 10,06,265/- has arisen from set off of

interest paid on loans raised by the assessee from ICICI Bank and

private parties to be set off against the income from remuneration from

the partnership firm Freedom Shoes LLP and interest income from

capital invested in partnership firm Freedom Shoes, LLP. The income

from interest earned on capital invested in the partnership firm by the

partner as well remuneration of partner from partnership firm is

chargeable to tax under the head Profits and Gains of Business or

Profession. The assessee has paid interest on loans borrowed from ICICI

Bank and from private parties. The assessee has negative income after

such set off under the head Profits and Gains of Business or Profession ,

which is sought to be set off against income from house property and

16 | P a g e

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income from other sources. I do not find any restriction in such set off

keeping in view the provisions of section 71, which reads as under :

Set off of loss from one head against income from another. 71. (1) Where in respect of any assessment year the net result of the computation under any head of income, other than "Capital gains", is a loss and the assessee has no income under the head "Capital gains", he shall, subject to the provisions of this Chapter, be entitled to have the amount of such loss set off against his income, if any, assessable for that assessment year under any other head. (2) Where in respect of any assessment year, the net result of the computation under any head of income, other than "Capital gains", is a loss and the assessee has income assessable under the head "Capital gains", such loss may, subject to the provisions of this Chapter, be set off against his income, if any, assessable for that assessment year under any head of income including the head "Capital gains" (whether relating to short-term capital assets or any other capital assets). (2A) Notwithstanding anything contained in sub-section (1) or sub- section (2), where in respect of any assessment year, the net result of the computation under the head "Profits and gains of business or profession" is a loss and the assessee has income assessable under the head "Salaries", the assessee shall not be entitled to have such loss set off against such income. (3) Where in respect of any assessment year, the net result of the computation under the head "Capital gains" is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled to have such loss set off against income under the other head. (3A) Notwithstanding anything contained in sub-section (1) or sub- section (2), where in respect of any assessment year, the net result of the computation under the head "Income from house property" is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled to set off such loss, to the extent the amount of the loss exceeds two lakh rupees, against income under the other head. (4) Where the net result of the computation under the head "Income from house property" is a loss, in respect of the assessment years commencing on the 1st day of April, 1995 and the 1st day of April, 1996, such loss shall be first set off under sub-sections (1) and (2) and thereafter the loss referred to in section 71A shall be set off in the relevant assessment year in accordance with the provisions of that section.

17 | P a g e

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7.3 Thus, in my considered view, the aforesaid loss of Rs.10,06,265/-

is allowed to be set off against income from other sources as well as

income from house property. It would be relevant to point out that the

assessee has earned total interest income of Rs.44,34,089/-, out of

which Rs.30,37,400/- was interest income from partnership firm while the

remaining interest income of Rs.13,96,689/- is from other parties which is

offered to tax under the head ‘income from other sources’. The assessee

has paid total interest expenditure of Rs.49,90,463.25 during the year

under consideration. Further, the assessee has incurred expenditure of

Rs.31,500/- under the head brokerage and Rs.61,701.50 for processing

fee on loans from ICICI Bank. I find no bar in such set off. There is no

such finding of the authorities below that these expenses were not on

business account. Hence, I reverse the orders of the authorities below

.The assessee succeeds in its appeal. I order accordingly.

Order pronounced in the open court on 07.02.2025

Sd/- (RAMIT KOCHAR) ACCOUNTANT MEMBER Dated: 07.02.2025 *aks/- 18 | P a g e

ITA No.113/Agr/2021