Tax Tribunal Upholds Interest Deduction, Revenue’s Appeal Dismissed

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Case Name:

Commissioner of Income Tax vs. Shreekant Phumbhra (High Court of Calcutta)

ITA No.63 of 2009

Date: 25th July 2016

Key Takeaways:

1. The court upheld the Tribunal’s decision to allow interest deduction under Section 43B of the Income Tax Act.
2. The judgment clarifies the interpretation of interest payments in overdraft accounts.
3. The court partially allowed deductions related to investments, applying Section 14A proportionately.

Issue:

The main questions were:

1. Did the Tribunal err in rejecting the Revenue’s contention for disallowance of interest under Section 43B(e) read with Explanation 3D of the Income Tax Act?
2. Was the Tribunal wrong in rejecting the Revenue’s argument for disallowance of interest on loans used for non-business purposes?

Facts:

• The case is about the assessment year 2004-05.
• The Assessing Officer initially disallowed interest payments of Rs. 22,39,581.82 and Rs.14,292/-.
• Another disallowance of Rs.49,31,602/- was made for interest on loans used for non-business purposes.
• The Commissioner of Income Tax (Appeals) reversed these decisions.
• The Income Tax Appellate Tribunal upheld the CIT(A)'s order.
• The Revenue then appealed to the High Court.

Arguments:

Revenue’s side:

• Argued that the interest payments should be disallowed under Section 43B(e) of the Income Tax Act.
• Claimed that loans were used for non-business purposes, particularly for investments in shares.

Assessee’s side:

• Contended that interest was paid regularly, and deposits exceeded the interest charged.
• Argued that there was no specific repayment schedule for the overdraft account.
• Stated that all transactions related to investments and trading passed through a common account.

Key Legal Precedents:

The judgment mentions the case of Subhas Projects Marketing Limited (ITA 076/Cal/2004), which the Tribunal relied on for its decision. However, the details of this precedent aren’t elaborated in the given text.

Judgement:

The High Court dismissed the Revenue’s appeal. Here’s the breakdown:

1. On the first issue of interest disallowance under Section 43B, the court agreed with the CIT(A) and Tribunal. They found no reason to interfere with the lower authorities’ decision.
2. On the second issue of interest on loans for non-business purposes, the court upheld the CIT(A)'s partial allowance of the deduction. The CIT(A) had allowed a proportionate deduction based on the ratio of dividend income to total income.

FAQs:

Q: What is Section 43B of the Income Tax Act about?

A: Section 43B deals with certain deductions to be allowed only on actual payment. In this case, it was specifically about interest payments to scheduled banks.

Q: Why was the interest payment initially disallowed?

A: The Assessing Officer thought the interest wasn’t actually paid and might have been converted into a loan.

Q: How did the CIT(A) calculate the allowable interest for non-business purposes?

A: They used the ratio of dividend income to total income to determine the proportion of interest that should be disallowed under Section 14A.

Q: What’s the significance of this judgment for taxpayers?

A: It clarifies how interest payments in overdraft accounts should be treated and how to calculate deductions for expenses related to exempt income.

Q: Did the High Court make any new legal interpretations?

A: Not really. The High Court mostly agreed with the lower authorities’ interpretations and didn’t see any reason to interfere with their decisions.

This appeal is directed against the judgement and order dated 28th March, 2008 by which the learned Income Tax Appellate Tribunal, “D” Bench, Kolkata allowed an appeal being ITA No.1818/Kol/2007 preferred by the Assessee and dismissed an appeal being ITA No.2105/Kol/2007 preferred by the Revenue both pertaining to the assessment year 2004-05.

The aggrieved revenue has come up in appeal. The following questions were formulated on 29th July, 2009 when the appeal was admitted:

“1. Whether the Tribunal below substantially erred in law in rejecting the contention of the revenue asking disallowance of Rs.22,30,581/- and Rs.14,294/- made by the assessing officer under section 43B(e) read with explanation 3D of the Income Tax Act ?

2. Whether in the facts and circumstances of the case the Income Tax Appellate Tribunal substantially erred in law in rejecting the contention of the revenue asking for disallowance of Rs.40,24,262/- made by the assessing officer, being the income as interest on loan utilised for non-business purposes by the assessee ?

The assessing officer disallowed payment of interest amounting to a sum of Rs.22,39,581.82 and Rs.14,292/- ,due to the following reasonings:

“There is no schedule of repayment drawn by the bank for the purposes of realizing the outstanding principal amount. A review of the bank’s statement and books of account will show that total amount deposited with the bank during the year far exceeds the total interest of Rs.22,53,874.43 (Rs.22,39,581.82 in M/s.Shreekant Phumbhra & Rs.14,292.61 in M/s. Shreekant Phumbhra & Co.) charged by the bank. The nature of accounts as discussed above has also to be considered for the purpose of applicability of the provisions of section 43B of the Income Tax Act, 1961. In this view of the matter, it is submitted that no question arises of making any disallowance under section 43B. Therefore, it will be seen that there is no violation of the provisions contained in Section 43B.

12(2)(b) The provisions of section 43B runs as under :

“43B. Notwithstanding anything contained in any othe rp[rovision of this Act,a deduction otherwise allowable under this act in respect of (a)..(b)...(c)...(d)...(e) any sum payable by an assessee as interest on any loan or advances from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan or advances, Or......(f) shall be allowed irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him”. Explanation 3D- For the removal of doubts, it is hereby declared that a deduction of any sum, being interest payable under clause (c) of this section shall be allowed if such interest has been actually paid and any interest referred to in that clause which has been converted into a loan or advance shall not be deemed to have been actually paid., The above explanation has been inserted by the Finance Act with retrospective effect from 01.04.1989 and as such is applicable for the previous year 2004-05.

The assessee submits that there is no schedule for payment that the total amount deposited exceeds the total interest of Rs.22,53,874 (Rs.22,39,581.82 in M/s.Shreekant Phumbhra and Rs.14,292.61 in M/s.Shreekant Phumbhra and Co.) charged by the bank and that the loan is secured against pledge of shares.

The provision is very much clear. Even there had been any agreement for converting the interest into a loan with the obvious effect of enhanced debit balance the same is covered in this provision as the above Explanation 3D. The above interest of Rs.22,53,874.43 and Rs.14,292 are allowed and disallowed and added back to the respective Net profit of the above two concerns.”

The learned CIT(A) reversed that order on the basis of the following reasonings :

“As discussed above, in an overdraft account, as and when interest is debited, the debit balance increases signifying increase in the amount of loan. But this is an automatic process and it does not require any authorization or volition from the constituent. Even if there is no consent in writing, interest will continue to be debited in an overdraft account. It is correct that the appellant paid more than the interest charged. As such the question is not merely whether the interest of an overdraft account remained outstanding as on 31.03.2004 or not but whether such interest was converted into loan or advance. Still, more important issue for consideration is to examine whether the entire deposits or part thereof made into the overdraft account was towards the payment of interest and repayment of principal or not or whether such deposits were towards day to day investments and trading activities only ? It was submitted and was also accepted by the AO that there was no payment schedule. In a payment schedule, normally a institution works out the number of equated monthly installments (EMI) which includes some interest and a portion of principal. As such, EMI is comprised of interest and principal, while interest is recovered on monthly basis the principal loan is also repaid on such basis. Thus, in such cases interest and the principal recovered are quantifiable.

However, where there is no schedule of payment, the exact amount of interest not being known, it creates problem in finding out as to what amount of interest and what amount of principal are comprised in a deposit made into the overdraft account. Since, there is no material which proves that there was outstanding interest as on 31.03.2004 in the overdraft account under consideration,I am of the view that the interest accrued on month to month basis had been paid on month to month basis as the deposit of each month was much more than the corresponding interest debited in respective month and as such no part of such interest remained which could be said to have been converted into any loan or advance as on the close of the previous year so as to be deemed not actually paid.

Under the facts and the circumstances, the disallowance of interest of Rs.22,39,581/- is deleted. This ground is allowed.”

The learned Tribunal did not interfere. Since the observation of learned CIT(A) while deleting the above addition remains uncontroverted before us, we do not see any reason to interfere with the order of learned CIT(A) and reject the contention. The first question raised by the Revenue is answered in the negative and against the revenue. The assessing officer disallowed interest amounting to Rs.49,31,602/- due to the following reasons :

“(20) Thus on the facts and in the circumstances of the case it is quite apparent that no capital fund was available for making invest in Long Term and Short Term assets. Therefore, it has to be inferred that the entire Investment in Long Term Investment and in Short Term Investment has essentially come from his loan fund. Therefore, interest attributable to the fund engaged in Long Term Investment and Short Term Investment has to be considered as not allowable. (21) M/s. Shreekant Phumbhra (NSE):

(a) While Interest on Bank Loan has already been disallowed u/s. 43B, on the facts and in the circumstances of the case as discussed above, Interest of Rs.1,49,33,053/- as claimed is also disallowed as per the computation below being the concerned loan amounts utilized directly or indirectly other than for business purpose:

Investment in shares / Total unsecured loan x Interest on unsecured loan Rs.1,49,33053 multiplied by (1,80,47,449/- divided by 5,46,48,273)- Rs.49,31,602/-

In other words Interest of Rs.49,31,602 is disallowed.”

The CIT(A) deleted disallowance to the extent of Rs.40,24,172/- on the basis of the following reasonings :

“Thus the total dividend received out of the investment is Rs.9,07,340, (Rs.61,140, Rs.41,350). Since, the provision of section 14A is applicable in the case of the appellant, considering the dividends from investments as shown above against the respective recipients are correct, the expenses including the interest is being proportionately disallowed as it is admitted that certain portion of the expenses and investments have flown from common account in view of the above provision. In the case of the expenses, ratio of dividend to gross income will be worked out and on that basis expenses shall be disallowed. Considering the facts that neither the appellant nor the AO is in a position to exactly quantify the total amount of funds used in acquisition of shares and scrips during the previous year either from the borrowed fund or from the circulating capital of the business, while the assessee continues to assert that all transactions relating to investments and trading (all credits and debits) passed through a common lodger account and from a “mixed fund” i.e. common HDFC (settlement) bank account and hence must not be bifurcated for the purpose of 14A cannot be accepted in view of his argument which he added as an alternative argument in case other expenses while considering the cases relied which are found to have been rendered on different factual contexts. Accordingly, since the total dividend of M/s. Shreekant Phumbra was Rs.8,05,756/- while the income from operation was Rs.1,88,52,202/- the percentage of dividend from investment to the income from operation will be @ 4.27. In the case of M/s. Shreekant Phumbra & Company the total dividend including appellant’s dividend from personal investments was taken clubbed together at Rs.1,02,490/- and the income of the firm from share dealings was Rs.66,09,100/- and the percentage of dividend to income will be @1.55%. Accordingly, the disallowance to the extent of Rs.8,04,989/- in respect of M/s. Shreekant Phumbra and Rs.1,02,441/- in case of M/s. Shreekant Phumbra & Company aggregating to Rs.9,07,340/- is sustained as against total disallowance of Rs.49,31,602/-. The addition of Rs.40,24,172/- (Rs.49,31,602/- - Rs.8,04,989 – Rs.1,02,441/-) is deleted. This ground is partly allowed.

The learned Tribunal upheld the order of the CIT (A) relying on an earlier judgement of the Tribunal in the case of Subhas Projects Marketing Limited (ITA 076/Cal/2004). It is against this order of the learned Tribunal, the revenue has come up in appeal.

Mr.Dhudhoria, learned Advocate appearing for the revenue was unable to point out any mistake or infirmity in the reasoning advanced by the CIT(A) and affirmed by the learned Tribunal. The second question, in that view of the matter, is also answered in the negative.

The questions formulated at the time of admission of the appeal are, thus, answered in the negative and against the revenue.

The appeal is dismissed.

Parties shall, however, bear their own costs.

(GIRISH CHANDRA GUPTA, J.)

(ARINDAM SINHA, J.)