SABARI DISTRIBUTION PRIVATE LTD,UDYOGAMANDAL vs. THE ACIT, KOCHI

The assessee is a sole distributor for product of Proctor & Gamble Hygiene and Healthcare Ltd. Gillette India Ltd. in Kerala. The assessee also is a distributor of American Tourist Brand Luggage items. The assessee filed the return of income for AY 2012-13 on 26.9.2012 declaring an income of 74,84,090. The return was selected for scrutiny under CASS and statutory notices were duly served on the assessee.

The AO called for various details including the books of accounts, bills and vouchers which were duly submitted by the assessee. During the course of verification, the AO noticed that the assessee has taken unsecured loan of Rs.1 crore from the director, Shri Shashi Kumar for which it was paying interest @ 15%. The total interest paid during the year was Rs.15 lakhs. The AO also noticed that the assessee was paying interest @ 13.5% for cash credit facility taken from Dhanalakshmi Bank. The AO therefore issued a notice to show cause why the excess interest paid to the Director be not disallowed u/s. 40A(2)(b) of the Act. The assessee submitted that the loan taken from Dhanalakshmi Bank is a secured loan secured by stock debtors and immovable properties of the assessee whereas the loan taken from the director is an unsecured loan. The assessee submitted that the difference in the interest rate is due to this fact and that the rate of interest for secured loan and unsecured loan cannot be equated. The assessee further submitted that even the bank like HDFC, Kotak Mahindra offer unsecured loan @ 17 to 18% p.a. and therefore the interest rate by the assessee to the director cannot be stated to be unreasonable to invoke the provisions of section 40A(2)(b). The AO did not accept the contentions of the assessee and disallowed a sum of Rs.1,50,000 as being excess interest paid u/s. 40A(2)(b). The assessee preferred an appeal before the CIT(A) to confirm the disallowance by relying on the decision of Punjab & Haryana High Court in the case of Anil Goyal v. CIT, [2008] 306 ITR 2012 (P&H). Aggrieved, the assessee is in appeal before the Tribunal.

The ld AR reiterated the submissions made before the lower authorities. The ld AR also submitted that in the earlier years assessment, the CIT(A) has allowed the interest paid to the directors. The ld. AR also submitted that for the purpose of disallowance u/s. 40A(2)(b), the interest on unsecured loans should be compared with interest on unsecured loans from other institutions and not with secured loans and therefore the impugned amount does not fall within the purview of section 40A(2)(b). The ld. DR relied on the order of the lower authorities.

We heard the rival submissions and perused the material on record. The assessee during the year has paid a sum of Rs.15 lakhs as interest on unsecured loan of Rs.1 crore taken from its director. It is the contention of the lower authorities that interest rate of 15% is in excess of what the assessee is paying towards the loan taken from financial institution @ 13.5%. We see merit in the argument that the interest paid to the financial institutions is for secured loan whereas the interest paid to the directors is an unsecured loan, thereby the interest is on the higher side. The Finance Act, 1968 introduced the new section 40A(2)(b) talks about the expenditure incurred in a business or profession for which payment has been or is to be made to the taxpayer’s relative, associate concern, is liable to be disallowed in computing the profits of the business or profession to the extent the expenditure is to be excessive or unreasonable. In our view, while examining the reasonableness of the expenditure, it is to be judged having regard to the fair market value of the books and services towards which the payment is made, the legitimate needs of the business or profession and the benefits derived by or accruing from the expenditure. Though it is the discretion of the AO to disallow the excessive or unreasonable amount, the AO is required to exercise this power based on the above mentioned criterion. In assessee’s case, the difference in the rate of interest is not excessive and being unsecured, the rate of interest is more than the interest paid by the assessee on a secured loan. The submissions that the market rate for the unsecured loan by similar financial institutions is in the rage of 17 to 18%, also has merits. In view of these discussions, in our considered view, the excess interest paid by the assessee to the director is not unreasonable and therefore we delete the disallowance made by the AO u/s. 40A(2)(b).

In the result, he appeal is allowed in favour of the assessee.

CIT(A)

DR, ITAT, Bangalore. By order