Tejmohan Singh, Advocate for the Assessee. Rishi Kumar, JCIT for the Revenue.

The above appeal has been preferred by the assessee against the order of the Commissioner of Income Tax (Appeals), Patiala [(in short referred to as ‘CIT(A)’] dated 28.10.2019, relating to assessment year 2016-17, passed u/s 250(6) (of Income Tax Act, 1961) (hereinafter referred to as ‘Act’).

2. The solitary issue in the present appeal pertains to disallowance of interest paid on unsecured loans taken from specified persons holding the same to be in excess of the fair market rate ,as per section 40A(2)(b) (of Income Tax Act, 1961), restricting the same to 12% as against 18% claimed by the assessee.

3. The grounds raised by the assessee read as under:

1. That the Ld. Commissioner of Income Tax (Appeals) has erred in law as well as on facts in upholding the addition of Rs. 21,86,197/- applying the provisions of Section 40A(2) (of Income Tax Act, 1961) for alleged excess interest paid on unsecured loans which is arbitrary and unjustified.

2. That the Ld. Commissioner of Income Tax (Appeals) has failed to consider the explanations rendered and the past history in the correct perspective and as such the addition upheld is arbitrary and unjustified.

3. That the appellant craves leave to add or amend the grounds of appeal before the appeal is finally heard or disposed off.

4. That the order of the Ld. Commissioner of Income Tax (Appeals) is erroneous, arbitrary,opposed to law and facts of the case and is, thus, untenable.

4. Before us, the Ld. Counsel for the assessee contended that it had repeatedly demonstrated both to the Assessing Officer (AO) and the Ld. CIT(A) that the interest rate paid by it to the specified persons @18% on unsecured loans was as per the market rate prevailing and there was therefore no cause for making any disallowance under section 40A(2)(b) (of Income Tax Act, 1961). The Ld. Counsel for the assessee contended that it had been pleaded that there was no level playing field between unsecured loans taken from private persons and between bank/NBFC borrowings since banks charged interest on monthly basis resulting in compounding of interest thus increasing the effective rate of interest and moreover bank loans involve guarantees and securities and annual renewal charges, insurance charges and loan processing charges ,all of which are not involved in case of unsecured loans. The Ld. Counsel for the assessee contended that it had been pointed out that generally unsecured loans and guaranteed loans involved rate of interest BPLR+2 to 4% and the BPLR of SBI during the impugned year was 14.60%, therefore the rate of interest charged by the assessee @18% was the market rate charged on unsecured loans. It was further pointed out that the assessee had been availing unsecured loans / trade advance facility from Hinduja Leyland finance ltd. (NBFC of Hinduja Group) bearing 14.5% rate of interest. Our attention was drawn to the submissions made by the assessee in this regard before the Ld. CIT at para 2.4 and 2.5 of the order as under:

2.4 The loan taken by the assessee is unsecured and there is no level playing field between bank/NBFC borrowings and unsecured loans from private parties. The bank charges interest on monthly basis resulting in compounding of interest which ultimately increases the effective rate of interest. On the other hand, in case of loans from any private person, no such formalities of guaranties / securities are needed and moreover the annual renewal charges, insurance charges and loan case processing charges are not borne by the borrower. The interest is payable on annual basis and not monthly basis. The appellant assessee can avail the facility of loan from a private person without undergoing any procedural formalities and can obtain the loan and repay the same as per its own convenience and necessities.

The Company received subject unsecured loans in the preceding years and payment of interest @18% in the subject year is consistent with the preceding years. Kindly appreciate that business expediency factor is to be decided from the businessmen's point of view and not by the AO. The income-tax authorities must not put themselves in the shoes of the assessee and see at what rate a prudent business man should borrow money from the depositors for his business necessity.

2.5 We may be permitted to further submit that in case of unsecured and unguaranteed loans the rate of interest is usually BPLR + 2 to 4% and. Such loans are granted by banks for very small amount as personal loans against security of post dated cheques and repayable in EMI. In the F.Y.2015-16 the average Benchmark Prime Lending Rate (BPLR) of State Bank of India in April,2015 was 14.60%. Thus, rate of interest for unsecured and unguaranteed loans from bank was in range of 17-19% payable monthly in EMI. A chart of BPLR is placed at page no.19-19 of the paper book .

Your kind attention is invited to the fact that the Company was availing unsecured loan -Trade Advance facility from Hinduja Leyland Finance Ltd. (NBFC of Hinduja group) bearing 14.5% rate of interest with each trade advance with general repayment period of 30 days from the date of advance with interest. Copy of trade advance account received from lender company is placed at page no. 16-18 of the paper book. At the cost of repetition, it is stated that the monthly charging of interest results in compounding of interest which ultimately increases the effective rate of interest. Moreover funds are available for short period.

4.1 The Ld. Counsel for the assessee further contended in the preceding year also it had paid interest on unsecured loans to specified persons @18% and the said issue had been examined during the assessment proceeding and accepted by the AO. The Ld. Counsel for the assessee contended that this fact had also brought to the notice of the authorities below placing before them the show cause notice issued during assessment proceeding for the preceding year proposing to restrict the rate of interest on unsecured loans from specified persons to 12% as against 18% paid by the assessee company. The reply filed by the assessee to the same had also been filed before the lower authorities along with the copy of the assessment order showing no addition being made on account of the same. Our attention was drawn to the submissions made by the assessee in this regard before the Ld CIT(A) reproduced at 4 of his order is as under:

4. In response to show cause notice dt. 14.12.2018, appellant company through its A.R. filed reply vide letter dt. 15.12.2018 stating that interest on unsecured loans of specified persons was allowed @18% by his predecessor in office after deliberation while completing assessment for the preceding A.Y.2015-16.Ld. A.O. was requested to follow the principle of consistency in the year under consideration also. Ld. A.O. was also requested to verify the facts from the assessment record for the A.Y.2015-16 before taking any decision. Copy reply dt. 15.12.2018 is placed at page no. 13-15 of the paper book.

The sequence of events on the issue of interest to specified persons allowed in the assessment proceedings for the preceding A.Y.2015-16 is as under:

a) The predecessor in office of the Id. A.O. had also proposed to restrict rate of interest on unsecured loans at 12% against 18% paid by assessee company to specified persons vide her show cause notice dt. 17.08.2017(Para 4.2.5.2). The relevant extracts of para 4.2.5.2 are reproduced for your ready reference.”

"As per details available, out of the total finance cost of Rs.2,66,54,790/-, the interest expense on unsecured loans amounting to Rs.65,39,032/- has been debited to the P&L.

Account. Admittedly, the interest on unsecured loans has been paid @18%, which is higher to that of prevalent market rate of 12%. The interest has apparently been paid either to the family member or to the known persons, who have advanced the amount of loan out of their surplus funds available, which otherwise would have fetch much lower interest in case the same have been deposited with the banks. Though the interest rate allowable by the banks, even on FDR's, was much lower to that of 12% but in the interest of natural justice, it would be appropriate to allow the prevalent market rate of 12% as is normally admissible.

The case laws relied upon by the assessee company are not relevant to the facts and circumstances of the instant case, under reference. It is, therefore, proposed to allow the amount of interest expenses at the prevalent market rate of 12% as against the rate of interest of 18%, as claimed. The interest a12% payable on unsecured loans comes to Rs.43,59,355/-. Therefore, the amount of excess interest of Rs. 21,76,677/- debited to P&L account is proposed to be disallowed. However, before making such disallowances, the assessee company is given an opportunity to furnish its explanation with jurisdiction thereof, supported with documentary evidence." Copy of show cause dt. 17.08.2017 is placed at page no.42-57 of the paper book . Para 4.2.5.2 appears on page 52.

b) In response, the assessee company through its counsel filed its arguments backed by relevant judicial decisions claiming that there is no case for disallowance of interest by reducing rate of interest to 12% p.a. The assessee's contention was accepted and assessment was completed without making any disallowance of interest. Copy of reply filed and assessment order for the A.Y.2015-16 placed at page no.58-66b of the paper book.

4.2 The Ld. Counsel for the assessee contended that principle of consistency demanded therefore that no disallowance be made in the impugned year also.

4.3 The Ld. Counsel for the assessee further contended that in any case the entire exercise was revenue neutral since the major depositors to whom interest had been paid by the assessee company fell in the highest tax bracket of 30% for the impugned year, therefore it could not be said that the assessee had benefited by making interest payment at rate higher than the market rate to the aforesaid persons.

4.4 The Ld. Counsel for the assessee thereafter contended that the Ld. CIT(A) had upheld the disallowance by merely reiterating the findings of the AO without considering the contentions raised by the assessee as above. He drew our attention to the findings of the Ld. CIT(A) at page 14 and 15 of the order as under:

The facts of the case, basis of disallowance/addition made by the AO and arguments of the AR during the course of appellate proceedings have been considered. The AR has argued that in the present case, the assessee has availed loan from the persons covered u/s 40A(2)(b) (of Income Tax Act, 1961) and paid interest at the rate of 18%. As per the AR, loan taken by the assessee is unsecured loan and there is no level playing field between banks/NBFC borrowings and unsecured loans from private parties. As per the AR, the provision of Section 40A(2) (of Income Tax Act, 1961) were invoked on conjectures & surmises without establishing that the rate of interest paid was excessive or unreasonable. The AR has mentioned that the AO has not brought anything on record to suggest that there were willing money lender who could land capital @12% to the appellant. The AR relied upon certain case laws in support of his contentions. Another argument of the AR was that revenue neutrality was not considered by the AO. It is also stated that the issue was examined by the predecessor in the Assessment Year 2015-16 and after considering the reply of the assessee no adverse view was taken. As per the AR, the principle of consistency has thus not been followed by the AO. It is seen that all these grounds were taken before the AO during the assessment proceedings also and the AO has duly dealt with various contentions raised by the appellant during the assessment proceedings including the case laws relied upon by the assessee. The argument about the claim that the issue was covered in the assessment order for the assessment year 2015-16 has been duly discussed by the AO in the assessment order and the conclusions of the AO are not rebutted by the AR during the appellate proceedings: The AO has also discussed the doctrine of res-judicata which is not applicable to the assessment proceedings under the Income Tax Act, as held by the Hon'ble Supreme Court. It is seen that the AO has duly discussed the legal & factual position regarding the disallowance of interest and applicability of Section 40A(2) (of Income Tax Act, 1961) to the facts of the case in hand. The conclusions drawn by the AO are found as per law and hence liable to be upheld. The AO has given the basis for adopting the fair market value of the interest (5)12% on unsecured loans based upon the prevailing market conditions during the period relevant to assessment year 2016-17. This is a fact that the interest rates have come down over a period of time and the interest rate of 12% adopted by the AO is quite reasonable for the year under consideration. There was a time when the interest rate were higher than this amount but that was long time ago and the assessee was required to follow the market trend. Even the assessee has not been able to show that it was paying a higher rate of interest to the other parties who are not specified persons as referred in Section 40A(2)(b) (of Income Tax Act, 1961). The argument about the slab rate of 30% applicable to the depositor has also been duly discussed by the AO and it has rightly been observed that the income accruing needs to be taxed in the hands of that person only.

Therefore, the assessee cannot be allowed to shift the profit which is taxable in its hand and pass on the same in the hands of the Directors and other related persons. The tax on income accruing to the assessee has to be paid by the assessee itself. If this argument of the AR is accepted then it will render the provision of section 40A(2)(a) (of Income Tax Act, 1961) as infructuous. Therefore, this contention of the AR is liable to. be rejected being against the spirit of provision of Section 40A(2) (of Income Tax Act, 1961). The principle of consistency will not be applicable in this case because the interest rate which were prevailing earlier some time ago cannot be said to be the fair market value as referred in Section 40A(2)(a) (of Income Tax Act, 1961) and the assessee was required to make changes even if a higher rate of interest was charged in the past when the fair market value was higher. With the decline in the interest rate in the market, the assessee was also required to reduce the rate of interest being paid on unsecured loans. In view of the detailed discussion by the AO in the assessment order and under the facts & circumstances of the case, the disallowance of Rs. 21,86,197/- made by the AO by invoking the provision of section 40A(2) (of Income Tax Act, 1961) is found sustainable as per law and hence confirmed.

Accordingly, these grounds of appeal are dismissed.

4.5 Referring to the same he pointed out that the Ld. CIT(A), on the issue of the impugned disallowance having been considered and accepted in the preceding year, had merely accepted the finding of the AO stating that the AO had discussed the legal and factual position regarding the impugned disallowance and that his conclusions were as per law and hence liable to be upheld. At this juncture the Ld. Counsel for the assessee pointed out from the assessment order that the AO had rejected this contention of the assessee by stating that in the preceding year the issue of disallowance of interest under section 40A(2)(b) (of Income Tax Act, 1961) had not been examined and only the issue of identity and credit worthiness of the unsecured loans had been examined. He drew our attention to para 5 of the assessment order as under:

“Moreover, the contention of assessee that the issue was covered by the assessment order for assessment year 2015-16 is erroneous because in assessment year 2015-16 the issue of unsecured loans was considered but only to enquire into the identity and creditworthiness of lenders of unsecured loans and genuineness of such loan transactions. Such enquiry was conducted to examine the applicability or otherwise of section 68 (of Income Tax Act, 1961). At no point of time during the assessment proceedings for assessment year 2015-16 was section 40A(2) (of Income Tax Act, 1961) invoked.”

4.6 The Ld. Counsel for the assessee contended that it had been clearly demonstrated ,through the records of the assessment proceedings for the preceding year, that the AO had raised the issue of the disallowance of interest under section 40A(2)(b) (of Income Tax Act, 1961) in his show cause notice to the assessee to which due reply had been filed by the assessee after considering which no disallowance had been made. He therefore contended that this finding of the Ld. CIT(A) that the principle of consistency did not apply was not based on proper appreciation of facts before him and on due application of mind. He thereafter pointed out that the ld. CIT(A) had even accepted the findings of the AO that the 12% rate of interest was the fair market value of interest without controverting the submissions made by the assessee as reproduced above before him. He therefore contended that the Ld. CIT(A)’s finding on the issue needed to be dismissed since he had merely upheld the findings of the AO without due application of mind and without properly considering the submissions (factual) before him. He therefore pleaded that the rate of interest paid on unsecured loans taken from specified person @18% be accepted as fair market rate and the disallowance made by restricting the said rate to 12% amounting to Rs. 21,86,197/- be deleted.

5. Ld. DR on the other hand heavily relied on the order of the Ld. CIT(A)

6. We have heard the rival contentions and carefully gone through the orders of the authorities below.

7. We find merit in the contention of the Ld. Counsel of the assessee that its claim of 18% rate of interest, paid on unsecured loans taken from specified persons, as the market rate of interest was justified and hence allowable as per section 40A(2)(b) (of Income Tax Act, 1961). None of the factual contentions of the assessee to justify its claim ,we find, have been rebutted by the Revenue. The assessee ,we find, had justified its claim contending that unsecured loans stood on a totally different footing as compared to secured loan taken from banks, by way of the banks charging interest periodically resulting in compounding of interest and hence higher effective rate of interest ,of banks taking guarantee for the loans given, and charging insurance and processing charges for the same, all of which are not found in the case of unsecured loans taken from private parties, thus justifying a higher rate of interest as compared to banks/NBFC; that generally the rate of interest on unsecured loans is BPLR +2 to 4% and that in the impugned year the SBI BPLR was 14.5% and further that the assessee itself had paid interest @ 14.5% on a loan taken from an NBFC. It was also duly demonstrated that in the preceding year the AO had accepted 18% as the market rate of interest on unsecured loans after duly examining the issue during assessment proceedings.None of the aforesaid facts have been controverted either by the Ld.CIT(A) or by the Ld.DR before us.

Therefore considering the aforestated uncontroverted facts, the rate of interest mof 18% paid on unsecured loan by the assessee, we hold, stands justified as the market rate of interest.

The Ld.CIT(A),we find, has upheld the disallowance without applying his mind to the factual contentions of the assessee and simply reiterating the findings of the AO.

The LD.CIT(A) dismissed assessees contention regarding the applicability of the principle of consistency on the issue as in the preceding year the AO had found the interest rate of 18% justified ,reiterating the AO’s finding that the issue dealt in the preceding year was different ,when the fact is that the assessee had placed before him all evidence by way of show cause notice issued by the AO asking why 12% interest rate be not applied against 18% paid by the assessee,the reply filed by the assessee to it and the order of the AO making no addition /disallowance on the issue. Further ,despite the assessee justifying the interest rate of 18% by demonstrating the fact that unsecured loans and loans taken from banks could not be compared and that unsecured loans generally attracted rate of interest BPLR + 2 to 4 % and the assessee was paying 14.5% interest on loan taken from NBFC,the Ld.CIT(A) has held the said rate unjustified without dealing with the factual contentions as aforestated and merely making general observations that too without any basis, that interest rates have come down and 12% rate is reasonable and that the AO has given reasonable basis for adopting 12% rate as fair rate of interest. We therefore dismiss all the arguments of the Revenue.

The disallowance of interest therefore made by restricting the rate of interest to 12% under section 40A(2)(b) (of Income Tax Act, 1961), amounting to Rs. 21,86,197/- is therefore directed to be deleted.

8. In the result, appeal of the Assessee is allowed.

Order pronounced on 22/10/2020.

Sd/- Sd/- (DIVA SINGH) (ANNAPURNA GUPTA)

Judicial Member Accountant Member

Dated: 22/10/2020