ITAT Greenlights Capitalization of Penal Interest

Court Name : ITAT Delhi

Parties : ITO Vs Logix Buildcon Pvt Ltd 

Decision Date : 11 July 2023

Judgement ref : ITA No. 1372/Del/2019

Picture this: You're a company that has taken a lease from the New Okhla Industrial Development Authority (NOIDA). You've paid penal interest to NOIDA due to a delay in the payment of lease installments. Now, you're wondering, "Can I capitalize this penal interest for tax purposes?"

This was the question at the heart of a case that went before the Income Tax Appellate Tribunal (ITAT). The ITAT ruled in favor of the company, allowing the capitalization of the penal interest paid to NOIDA.

The ITAT noted that the penal interest was paid for the acquisition of a capital asset, i.e., the leasehold rights over the land. Therefore, it was capital in nature and could be capitalized. The ITAT also observed that the penal interest was not a penalty for infraction of any law, and hence, it was not disallowable under the Income Tax Act.

This ruling is a significant one for companies in similar situations. It provides clarity on the tax treatment of penal interest paid to authorities like NOIDA. So, the next time you're faced with a similar situation, you'll know exactly where you stand. Remember, the key is that the penal interest must be connected to the acquisition of a capital asset to be capitalized.

O R D E R

PER C. M. GARG, J. M.:

1. This is an appeal filed by the revenue against the order of the ld

CIT(A)-5, New Delhi dated 27.11.2018 for AY 2015-16.

2. The assessee has raised the following grounds of appeal:-

“On the facts and in the circumstances of the case, the Ld. CIT(A)

has erred in law in deleting the disallowance of Rs. 8,35,81,377/-

on account of Penal Interest to New Okhla Industrial Development

Authority and in directing the AO not to reduce the said amount

and allow it to be capitalized under project expenses.”

3. Ld. Sr. DR supported the assessment order and submitted that

the ld CIT(A) has erred in law in deleting the disallowances of Rs.

8,35,81,377/- on account of Penal Interest to new Okhla Industrial

Development Authority and in directing the AO not to reduce the said

amount and allow it to be capitalized under project expenses.

4. Drew our attention towards relevant parts of the assessment

order the ld Sr DR submitted that the AO rightly made disallowance in

of penal interest out of project expenses (work in progress) by holding

that the interest being penal in nature is clearly not allowable under the

provisions of the Act. The ld Sr. DR submitted that the assessee has

been granted relief by the ld CIT(A) without any basis, therefore, the

impugned first appellate order may kindly be set aside and restore to

the file of AO.

5. Replying to the above, the assessee’s representative supported

the first appellate order and drew our attention towards relevant para

7.3 to 7.8 of the first appellate order and submitted that the impugned

interest claimed by the assessee is neither related to any offence or

arising out of any prohibition in law or any infraction of law but relates

to the delay in payment for the lease amount to the Noida Authority and

payable as per the agreement @3% of the default amount due to delay

for the payment of lease amount.

6. The ld AR contended that therefore, the additional interest

payment was as per agreement and the same was not in penal in

nature therefore, the assessee rightly capitalized the same as work in

progress. Further, drawing our attention to towards 4th para of last page

of assessment order the ld AR submitted that the AO himself noted that

the assessee has not claimed but has only capitalized the same under

the head project expenses (work in progress), thus, the same will not

have any bearing the on the taxable income for the year under

consideration, but will have bearing only on further profits/ income.

Therefore, the findings of the AO himself supports the case of the

assessee therefore, the order of the ld CIT(A) may kindly be upheld.

7. On careful consideration of the above submissions, from

assessment order we note that the AO denied capitalization of interest

paid to Noida authority by holding and alleging that the same is penal in

nature, thus, not allowable under the provisions of the Act. On the other

hand from the relevant part of the first appellate order, we note that the

ld CIT(A) recorded following findings for grant of relief to the assessee

and allowing the assessee to capitalized impugned amount of interest

paid, which reads as follows:

“7.1 I have carefully considered the assessment order,

submissions by the appellant and the case laws relied upon.

7.2 It is observed from the profit & loss account for the year

ended 31.03.2015 that no revenue from operations has been

shown and no such interest expenses have been claimed / shown

or routed through the profit & loss account. The liability towards

such interest as per the lease deed including the penal interest @

3% has been taken into the work in progress (project expenses)

by the appellant in the balance sheet. This amount remained

unpaid, which is also confirmed by the Noida Authority and

accepted by the AO.

7.3 The AO considered this amount as penal in nature, based on

the lease deed and as per the confirmation from the Nolda

Authority.

7.4 The appellant contended as reproduced above that this is the

default amount as additional interest, being compensatory in

nature and actually remained unpaid. There is no violation of law

therefore, it cannot be said that it is a penal interest in nature and

not an allowable expenses.

7.5 It is seen that the expenses in the nature of penalty are not

allowable u/s 37(1) r.w. Explanation 1 of the Act which is as

follows:

"37. (1) Any expenditure (not being expenditure of the

nature described in sections 30 to 36 and not being in the

nature of capital expenditure or personal expenses of the

assessee), laid out or expended wholly and exclusively for

the purposes of the business or profession shall be allowed

in computing the income chargeable under the head "Profits

and gains of business or profession".

[[Explanation 1]-For the removal of doubts, it is hereby

declared that any expenditure incurred by an assessee for

any purpose which is an offence or which is prohibited by

law shall not be deemed to have been incurred for the

purpose of business or profession and no deduction or

allowance shall be made in respect of such expenditure]"

7.6 In this regard, first of all the interest has not been claimed as

expenditure with the meaning of section 37 of the Act or any

other section as stated (30 to 36). Further, this is treated by the

appellant as work in progress and for the year under

consideration, shown as work in progress, which is capital in

nature. Therefore, it cannot be treated as not allowable.

7.7 Now coming to the contention of the appellant that simple

interest, paid on delayed payment is not penal in nature. Further,

the ratio laid down in case laws relied upon by the appellant are

applicable to the issue of the appellant also. This interest claim

(yet to be paid) is neither relates to any offence or arising out of

any prohibition in law or any infraction of law but relates to the

delay in payment for the lease amount to the Noida Authority and

payable as per the agreement @ 3% of the default amount due to

delay in such payment. Thus it is an additional interest payment

as per the agreement. This has been capitalized as work in progress.

7.8 In view of the above discussion and considering the facts and

circumstances in this case and in law, it is held that this amount

of Rs. 8,35,81,377/- is towards the project expenses and not

liable for reduction from the project expenses, being part and

parcel of the project cost as additional interest payment.

However, looking to the fact that the payment has not been

actually made, therefore, the actual payment is to be considered

as cost of project in future while considering the income of the

appellant.

7.9 The AO is directed not to reduce the said amount and allow

the same to be capitalized under the project expenses.

7.10 These grounds of appeal are allowed accordingly.”

8. Further, we note that there is no findings by the AO nor any

submission by the ld Sr. DR to show that the interest paid by the

assessee was penal in nature. Per contra, from the findings and

observations of ld CIT(A), as has been reproduced hereinabove, it is

clear that the after evaluation of documentary evidence including

agreement with the Noida Authority, the ld CIT(A) noted that the

interest claimed by the assessee neither relates to any offence or

arising out of any prohibition in law or any infraction of law but relates

to the delay in payment for the lease amount to the Noida Authority and

thus parable as per the agreement @3% of the default amount for the

period of delay in such payment. With these observations, the ld CIT(A)

allowed the assessee to capitalize the interest paid by the assessee to

Noida Authority. The ld CIT(A) also observed that the said interest

amount have been incurred towards project expenses and not liable to

be reduced from the project expenses, being part and parcel of the

project cost as additional interest payment due to delay in payment of

lease charges. In view of the foregoing, we are inclined to agree with

the conclusion of the ld CIT(A), where he directed the AO not to reduce

the amount of interest from the work in progress and allow the same to

be capitalized under the project expenses. Therefore, no interference is

called for the in the first appellate order.

9. Accordingly, ground of revenue is dismissed being devoid of

merits.

10. In the result, appeal of the revenue is dismissed.

Order pronounced in the open court on 11/07/2023.

Sd/- -Sd/-

(M. BALAGANESH) (C. M. GARG)

ACCOUNTANT MEMBER JUDICIAL MEMBER

Dated: 11/07/2023

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INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH “E”: NEW DELHI

BEFORE Shri C.M. Garg, Judicial Member

AND

Shri M. Balaganesh, Accountant Member

ITA No. 1372/Del/2019

(Assessment Year: 2015-16)

ITO,

Ward-15(3),

New Delhi

Vs. Logix Buildcon Pvt. Ltd,

85, Ground Floor, World

Trade Centre, Barakhamba

Road, New Delhi

(Appellant) (Respondent)

PAN: AABCL833L

Assessee by : Ms. Shweta Bansal, CA

Revenue by: Ms. Raja Rajeshwari R, Sr. DR

Date of Hearing 25/05/2023

Date of pronouncement 11/07/2023