Interest on VAT is Compensatory, Not Penal – ITAT Allows Deduction

Kankariya Automobiles Pvt. Ltd. Vs ITO (ITAT Pune)

Interest on VAT is Compensatory, Not Penal – ITAT Allows Deduction

The Pune ITAT in Kankariya Automobiles Pvt. Ltd. vs ITO allowed deduction of interest on delayed payment of VAT, holding that such interest is compensatory in nature and hence allowable as business expenditure.

The assessee, a vehicle dealer, had debited ₹4.92 lakh towards VAT interest. The AO disallowed the same in a reassessment completed u/s 144, primarily due to non-compliance and the view that VAT was excluded from sales, making related interest non-deductible. The CIT(A) upheld the disallowance by treating the interest as penal in nature, relying on selective readings of judicial precedents.

Before the Tribunal, the assessee relied on the Supreme Court ruling in Lachmandas Mathuradas vs CIT, arguing that interest on arrears of tax is compensatory and allowable. The ITAT observed that the CIT(A) had misinterpreted the Supreme Court decision-in fact, the Apex Court had clearly held such interest to be compensatory and allowable.

Rejecting the Revenue’s stand and distinguishing cases relating to TDS interest u/s 201(1A), the Tribunal held that interest on VAT stands on a different footing and qualifies as a business expenditure. Accordingly, the addition was deleted and the appeal was allowed.

Not all tax-related interest is penal-VAT interest, being compensatory, survives the disallowance axe.

FULL TEXT OF THE ORDER OF ITAT PUNE

This appeal filed by the assessee is directed against the order dated 09.04.2025 of the Ld. CIT(A) / NFAC, Delhi relating to assessment year 2014-15.

2. There is a delay of 44 days in filing of the appeal before the Tribunal for which the assessee has filed a condonation application along with an affidavit explaining the reasons for such delay. After considering the contents of the condonation application filed along with the affidavit and after hearing the Ld. DR, the delay in filing of the appeal is condoned and the appeal is admitted for adjudication.

3. Facts of the case, in brief, are that the assessee is a private limited company engaged in the business of dealership of Maruti Suzuki India Limited and deals in purchase and sale of vehicles. It filed its return of income on 28.11.2014 declaring total income of Rs.40,18,540/-. The original assessment was completed u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) on 21.12.2016 by making disallowance of Rs.1,67,335/- u/s 36(1)(va) r.w.s. 2(24)(x) of the Act and disallowance of interest of Rs.2,554/- u/s 201(1A) of the Act. Subsequently the Assessing Officer noticed that the assessee has debited an amount of Rs.4,92,606/-being VAT tax interest. According to the Assessing Officer, the same is not an allowable expenditure and therefore, he reopened the assessment after recording reasons as per provisions of section 147 of the Act. Thereafter, he issued notice u/s 148 of the Act on 31.03.2021. However, the assessee did not file any return in response to the same. The subsequent notice issued u/s 142(1) of the Act remained un-complied with. He, therefore, proceeded to complete the assessment u/s 144 of the Act. On verification of the Profit and Loss Account he noted that the assessee has debited interest on VAT expenses to the tune of Rs.4,92,606/-. From the notes forming part of financial accounts he noted that the sales exclude VAT tax. Since the assessee, according to the Assessing Officer, has shown the sales turnover excluding VAT in Profit and Loss Account, he was of the opinion that the expenses incurred by the assessee towards interest on VAT is not an allowable expenditure. In absence of any reply from the side of the assessee for substantiating the claim of expenditure made towards interest on VAT expenses, the Assessing Officer disallowed an amount of Rs.4,92,606/- and added the same to the total income of the assessee.

4. In appeal, the Ld. CIT(A) / NFAC upheld the action of the Assessing Officer by observing as under:

6.4 I have also gone through the Apex Court observations in this regard in the case of Lachmandas Mathura Vs. CIT reported in 254 ITR 799, wherein the Hon’ble court has held that the interest on arrears of sales tax is penal in nature and has rejected the contention of the assessee that it is compensatory in nature. In taking the said view the High Court has placed reliance on its Full Bench’s decision in Saraya Sugar Mills (P.) Ltd. v. CIT [1979] 116 ITR 387 (All.)

6.5 The payment of interest takes colour from the nature of levy with reference to which such interest is paid and the tax required to be paid but is not paid in time, which rendered the assessee liable for payment of interest was in the nature of a direct tax and similar to the income tax payable under the Income-tax Act. The interest paid under Section 201(1A) of the Act, therefore. would not assume the character of business expenditure and cannot be regarded as a compensatory payment.

6.6 The Income Tax Appellate Tribunal (ITAT), Delhi Bench in the case of M/s. New Modern Bazaar Departmental Store Pvt. Ltd. is a Pvt. Ltd. held that the interest on Late Payment of TDS does not constitute Business Expenditure. In this case the assessee argued before the Id. CIT(A) that interest on late deposit of TDS is compensatory and not penal in nature. The Id. CIT(A) held that interest paid under the provisions of the Act is not a deductible expenditure, not compensatory in nature. Thus, he confirmed the action of the Assessing Officer. The assessee submitted that the interest is compensatory in nature and a part of business operations of the assessee. If the same amount was taken as loan from a bank, the interest paid on the same anyway would have been allowed as deduction u/s 36. The Revenue submitted that interest on late deposit of TDS is neither an expenditure wholly and exclusively incurred for the purpose of business and further it is a payment, which is in the form of penalty, so it is not an allowable expenditure. The ITAT dismissed the appeal of the assessee.

6.7 The Hon’ble Madras High Court in CIT Vs. Chennai Properties & Investment Ltd. (1999) 239 ITR 435 (Mad.) has held that interest under section 201(1A) paid by the assessee does not assume the character of business expenditure and also cannot be regarded as compensatory payment. This decision of Hon’ble Madras High Court has also been followed by various benches of ITAT, specifically in Velankani Information Systems Limited Vs. DCIT [2018] corn 599 (Bangalore- Trib.) as under:

“As far as delay in remittance of TDS u/s 201(1A) of the Act is concerned, we find that the Hon’ble Madras High Court has taken a view that interest u/s 201(1A) is also in the nature of tax and notwithstanding the fact that is not the tax liability of the assessee, the same cannot be allowed as deduction. The following were the relevant observations of the Hon’ble Madras High Court: —

1. As already noticed the payment of interest takes colour from the nature of the levy with reference to which such interest is paid and the tax required to be but not paid in time, which rendered the assessee liable for payment of interest was in the nature of a direct tax and similar to the income-tax payable under the Income Tax Act. The interest paid u/s 201(1A) of the Act, therefore, would not assume the character of business expenditure and cannot be regarded as a compensatory payment.

2. Counsel for the assessee in support of his submission that the interest paid by the assessee was merely compensatory in character besides relying on the case of Makalakshmi Sugar Mills Co. also relied on the decision of the apex court in the cases of Prakash Cotton Mills Pvt. Ltd. V. CIT [1993] 201 ITR 684:

Malwa Vansapati and Chemical Co. v. CIT [1997] 225 ITR 383 and CIT vs. Ahmedabad Cotton Manufacturing Co. Ltd. [1994] 205 1TR 163. In all these cases, the court was concerned with an indirect tax payable by the assessee in the course of its business and admissible as business expenditure.

3. The ratio of those cases is not applicable here. Income-tax is not allowable as business expenditure. The amount of tax deducted is not an item of expenditure.

4. We therefore, follow the decision of Hon’ble Madras High Court and uphold the order of CIT(A) in so far as it relates to disallowance of interest on delayed payment of TDS u/s 201(1A) of the Act.”

6.8 Further, the Co-ordinate Bench of ITAT Bangalore in the case of Jindal Aluminimum Limited ITA No. 31/Bang/2019 having similar facts where interest on TDS is held as ineligible business expenditure.

6.9 Hence, in view of the aforesaid discussion, I hold that interest payment on late payment of VAT is not eligible business expenditure for deduction and it is not compensatory in nature. Payment of interest on late payment VAT is not an expenditure wholly and exclusively incurred for the purpose of the business and therefore the same is not allowable as deduction u/s 37(1) of the Act. Therefore, the disallowance made by the AO is hereby confirmed. The ground of appeal is dismissed

5. Aggrieved with such order of the Ld. CIT(A) / NFAC, the assessee is in appeal before the Tribunal by raising the following grounds:

1. On the facts and in circumstances of the case and in law, the Ld. CIT(A)-NFAC erred in confirming the addition made by the Ld. Assessing Officer without considering the fact that the assessment order is unsinged thereby making it null and void. Hence, the addition of Rs.4,92,606/- on account of interest on VAT may please be deleted.

2. Without prejudice to the other ground and on the facts and in circumstances of the case and in law, the Ld. CIT(A)-NFAC erred in confirming the addition made by the Ld. Assessing Officer without considering the fact that interest on VAT paid is allowable expense. Hence, the addition of Rs.4,92,606/- on account of interest on VAT may please be deleted.

3. The Appellant craves the permission to add, amend, modify, alter, revise, substitute, delete any or all grounds of the appeal, if deemed necessary at the time of hearing of the appeal.

6. The Ld. Counsel for the assessee at the outset filed a copy of the decision of Hon’ble Supreme Court in the case of Lachmandas Mathuradas vs. CIT reported in (2002) 254 ITR 799 (SC) and submitted that Hon’ble Supreme Court in the said decision has reversed the decision of Hon’ble Allahabad High Court and decided the issue in favour of the assessee by holding that interest on arrears of tax is compensatory in nature and therefore is an allowable expenditure. Referring to para 6.4 of the order of the Ld. CIT(A) / NFAC he submitted that the Ld. CIT(A) / NFAC has only quoted one sentence of the said order without considering the decision of Hon’ble Supreme Court in its entirety. So far as various other decisions relied on by the Ld. CIT(A) / NFAC are concerned, he submitted that those were all relating to interest on delayed payment of TDS u/s 201(1A) of the Act and not on account of interest on VAT expenses. He submitted that since the issue stands decided in favour of the assessee by the decision of Hon’ble Supreme Court, the order of the Ld. CIT(A) / NFAC is liable to be set aside.

7. The Ld. DR on the other hand heavily relied on the orders of the Assessing Officer and the Ld. CIT(A) / NFAC. He submitted that the assessee has debited interest on VAT expenses, however, in the audited financial accounts it has been mentioned that the sales exclude VAT tax. Since the assessee has shown the sales turnover excluding VAT in Profit and Loss Account, therefore, the expenses incurred by the assessee towards interest on VAT is not an allowable expenditure. He accordingly submitted that the order of the Ld. CIT(A) / NFAC be upheld and the grounds raised by the assessee be dismissed.

8. We have heard the rival arguments made by both the sides, perused the orders of the Assessing Officer and the Ld. CIT(A) / NFAC and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. We find the Assessing Officer in the instant case disallowed interest on VAT expenses of Rs.4,92,606/- paid by the assessee on the ground that the same is not an allowable expenditure. We find the Ld. CIT(A) / NFAC, following the decision of Hon’ble Supreme Court in the case of Lachmandas Mathuradas vs. CIT (supra) held that Hon’ble Supreme Court following the decision of Full Bench of Hon’ble Allahabad High Court in the case of Saraya Sugar Mills (P.) Ltd. vs. CIT reported in (1979) 116 ITR 387 (All), has decided the issue against the assessee. However, a perusal of the order of Hon’ble Supreme Court shows that the Hon’ble Supreme Court in fact has decided the issue in favour of the assessee by observing as under:

“1. This appeal arises out of the Income-tax Reference No. 54 of 1978 , wherein the Income-tax Appellate Tribunal, Delhi Bench, had referred the following questions to the Allahabad High Court for opinion (page 413) :

“1. Whether, the Tribunal was in law justified in allowing the assessee’s claim in respect of interest on the arrears of sales tax in computing the asses-see’s income for the year under consideration ?

2. Whether, the interest on the outstanding balance of sales tax was an allowable deduction under the Income-tax Act ?

3. Whether there was material on record justifying the Tribunal’s finding that the liability of Rs.69,383 for damages had crystallised in the accounting period relevant to the assessment year under consideration ?

4. Whether the claim of the assessee for damages could be held to be an allowable deduction computing the assessee’s income liable to assessment for the year under consideration ?”

2. The Allahabad High Court by its impugned judgment dated January 28, 1980, has answered the said questions against the assessee and in favour of the Revenue. Hence, this appeal.

3. While granting special leave to appeal the appeal has been confined to questions Nos. 1 and 2 only. The High Court has proceeded on the basis that the interest on arrears of sales tax is penal in nature and has rejected the contention of the assessee that it is compensatory in nature. In taking the said view, the High Court has placed reliance on its Full Bench decision in Saraya Sugar Mills P. Ltd. v. CIT [1979] 116 ITR 387 (All). Learned counsel appearing for the appellant-assessee states that the said judgment of the Full Bench has been reversed by the larger Bench of the High Court in Triveni Engineering Works Ltd. v. CIT , wherein it has been held that interest on arrears of tax is compensatory in nature and not penal. This question has also been considered by this court in Civil Appeal No. 830 of 1979 titled Saraya Sugar Mills Pvt. Ltd. v. CIT, decided on February 29, 1996. In that view of the matter, the appeal is allowed and questions Nos. 1 and 2 are answered in favour of the assessee and against the Revenue.”

9. Since the issue stands decided in favour of the assessee by the decision of Hon’ble Supreme Court in the case of Lachmandas Mathuradas vs. CIT (supra), therefore, we set aside the order of the Ld. CIT(A) / NFAC and direct the Assessing Officer to allow the amount of Rs.4,92,606/- debited to the Profit and Loss Account being interest on VAT expenses. The grounds raised by the assessee are accordingly allowed.

10. In the result, the appeal filed by the assessee is allowed.

Order pronounced in the open Court on 13t^h February, 2026.