When a payment is compensatory in nature and not related to any deposit/debt/loan, then such a payment is out of ambits of provisions of section 194A

ORDER

Mukul Kr. Shrawat, Judicial Member –

The revenue is in appeal and the respondent­assessee has filed a cross-objection, both have emanated from the order of Learned CIT (Appeals)-VII, Ahmedabad, dated 26-3 -2008 passed for assessment year 2005-06.

(A) Revenue’s appeal; ITA No. 2075/A hd./2008 – Assessment year 2005-06

2. The only ground of the revenue is as follows :—

“1. The CIT(A) erred in deleting the addition made on account of interest payment of Rs. 7,83,666 out of the total payment of Rs. 12,47,746 under section 40(a)(ia) of the Income-tax Act by holding that such interest payment was additional purchase price.”

2.1 Facts in brief and the issue involved as emerged from the corresponding assessment order passed under section 143(3) of the Income-tax Act dated 28-9-2007 were that the assessee in his individual capacity is a proprietor of a concern dealing in trading of ball-bearings. It was noticed by the Assessing Officer that the assessee has claimed interest expenses of Rs. 12,47,746 as per Profit & Loss Account. Bifurcation of the interest account was submitted according to which out of the total interest claimed an amount of Rs. 7,83,666 was towards interest to FAG Bearing (India) Ltd. Admittedly, on the said amount of interest no tax was deducted at source. Explanation of the assessee was that since the assessee was having dealership of FAG Bearing (India) Ltd. and reselling the ball-bearings, therefore as per the terms of payment he was allowed 2.5 per cent cash discount on payments made within 15 days and 1.5 per cent cash discount in case of payment made within 30 days. It was also explained that as per the terms, the assessee was allowed interest-free credit period for 60 days. It was further informed that in case of overdue payment the cost of purchase is paddled with a liability to pay a compensatory sum which was termed as interest. Whenever there was default in making payment beyond the normal credit period, then the same was agreed to be compensated accordingly. It was, therefore, explained that the said amount was nothing but in the nature of additional sale price paid. As per the assessee since it was not in the nature of interest in strict terms, hence there was no liability to deduct the tax at source. However, the Assessing Officer was not convinced and according to him as per section 2(28A) of the Income-tax Act interest means, interest payable in any manner in respect of any money borrowed or debited. In his opinion, for such payment the provisions of section 1 94A of the Income-tax Act were applicable. Finally, it was concluded that in terms of the provisions of section 40(a)(ia) of the Income-tax Act, the expenditure of the said interest payment was to be disallowed. The matter was carried before the first appellate authority.

5. We have heard both the sides at some length. Admitted factual position is that the assessee is having a dealership of FAG Bearing (India) Ltd. and, therefore, in the business of sales of ball-bearings. This fact has also not been denied that there were certain terms and conditions agreed upon between the two parties in case of delay in payments. Whenever there was delay in  payment or the payments got overdue, there was a condition to compensate the delay. Likewise, in case of prompt payment, the terms of payments have prescribed a facility of cash discount. Therefore, the fundamental and primarily argument from the side of the respondent­assessee was that the amount paid to compensate the delay in making the payment was nothing but the added sales price of the said commodity. Inter alia, it has also been argued that the impugned nature of payment was not within the definition of interest as prescribed under section 2(28A) of the Income-tax Act. With this factual back ground, the case laws relied upon is Nirma Industries Ltd. (supra), which now stood upheld and SLP of revenue was dismissed as per the citation CIT v. Nirma Industries Ltd. [2008] 166 Taxman 95 (SLP No. 28). In addition to this precedent, Learned Authorised Representative has also placed reliance on following decisions :—

“33. However, the parties having made elaborate submissions, the matter may be examined from a slightly different angle. When the assessee enters into a contract for sale of its products it could either stipulate (a) that interest at the specified rate would be charged on the unpaid sale price and added to the outstanding till the point of time of realisation, or (b) that in case of delay the payment for sale of products worth Rs. 100 to carry the sale price of Rs. 102 for first month’s delay, Rs. 104 for second month’s delay, Rs. 106 for third month’s delay and so on. If the contention of revenue is accepted, merely because the assessee has described the additional sale proceeds as interest in case of contract as per illustration (a) above, such payment would not be profits derived from industrial undertaking, but in case of illustration (b) above, if the payment is described as sale price it would be profits derived from the industrial undertaking. This can never be, because in sum and substance these are only two modes of realising sale consideration, the object being to realise sale proceeds at the earliest and without delay. Purchaser pays higher sale price if it delays payment of sale proceeds. In other words, this is a converse situation to offering of cash discount. Thus, in principle, in reality, the transaction remains the same and there is no distinction as to the source. It is incorrect to state that the source for interest is the outstanding sale proceeds. It is not the assessee’s business to lend funds and earn interest. The distinction drawn by Revenue is artificial in nature and is neither in consonance with law nor commercial practice.”

7. In the light of the above precedent, we deem it proper to discuss the relevant provisions of Income-tax Act.7.1 Section 2(28A) of the Income-tax Act has defined the term “interest” as follows:

“Section 2(28A) : “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.”

7.2 The true character of the term interest has been defined, but the definition appears to be wide, inter alia, covers interest payable in any manner in respect of loans, debts, deposits, claims and other similar rights or obligation. This definition further includes service charges but those charges should be in respect of the money borrowed. By this definition, therefore, it is evident that if the charges are in respect of a debt or in respect of any credit facility then such charges are inclusive in the definition of “interest”. Therefore, the interest is a payment of money in lieu of use of borrowings. It is payable by a debtor to the creditor. But it is also worth to note that the said definition is not wide enough to include other payments. There ought to be distinction between the payments not connected with any debt, with a payment having connection with the borrowings. A payment having no nexus with a deposit, loan or borrowings is out of the ambits of the definition of interest as per section 2(28A) of the Income-tax Act. While pondering upon the issue, we have come across a decision of Respected National Consumer Disputes Redressal Commission, wherein in the case of Ghaziabad Development Authority v. Dr. N.K. Gupta [2002] 258 ITR 337 (NCDRC), it was held as under

“Held, affirming the order of the State Commission, that section 194A of the Income-tax Act, 1961, did not apply to the payment made by the petitioner Authority. The Authority was asked to pay interest on the amount refunded to the complainant because of its failure to construct the promised flat and to provide the necessary facilities. The amounts deposited by the respondent with the petitioner Authority were not paid by way of deposit, nor had the petitioner Authority borrowed those amounts. Interest payment in this case was by way of damages. Merely because the damages were described as by way of interest that did not convert them into interest under the Act. The word used in the order of the State Commission was not “interest” as defined in section 2(28A). Interest, in the order of the Commission, meant compensation or damages for delay in construction or handing over possession of the same causing consequential loss to the complainant by way of escalation in the price of the property and also on account of distress and disappointment faced by him. Interest, in the order, had been used merely as a convenient method to calculate the amount of compensation in order to standardize it. Otherwise, each case of an allottee would have to be dealt with differently. Nomenclature did not decide the issue. In view of the definition of “interest” in section 2(28A), the provisions of section 194A were not applicable and the petitioner Authority was wrong in deducting tax at source from the interest payable to the respondent (complainant).”

7.3 This decision is very helpful to decide this appeal because it was held that if the nature of payment is to compensate an allottee, then the provisions of section 194A not to be applied as far as the question of deduction of TDS on interest is concerned. Though the said compensation was mentioned as “interest” but the Hon’ble Members have held that the word used “interest” did not fall within the definition as defined under section 2(28A) of the Income-tax Act.

8. The provisions of section 194A reads as follows :—

“194A. Interest other than “Interest on securities”.—(1) Any persons. Not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of interest other than income [by way of interest on securities], shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force.”

8.1 If a person is responsible for paying any income by way of interest shall at the time of credit or at the time of payment is required to deduct income-tax. Vide an Explanation annexed to this section, it is clarified that where any income by way of interest is credited either under the “suspense account” or “interest payable account” or “by any other name”, then also such person is liable to deduct tax. On plain reading of this section, it is apparent that the term “interest” used in this section relates to and in connection of a debt or a loan or a deposit. The circumstances under which the assessee is required to deduct the tax has also been narrated. Therefore, a conclusion can be drawn that if a payment is compensatory in nature and not related to any deposit/debt/loan, then such a payment is out of the ambits of the provisions of section 194A of the Income-tax Act. To buttress this legal proposition, we hereby placed reliance on the decision of Hon’ble Gujarat High Court in the case of Nirma Industries Ltd. (supra), wherein the question was the admissibility of deduction under sections 80HH and 80-I of the Income-tax Act in respect of interest received from trade debtors. The observation was that when an assessee enters into a contract for sale of its product, it could either stipulate that interest at the specified rate would be charged on the unpaid sale price or it can be agreed upon that in case of delay the sale price shall escalate. As per the Hon’ble Court, the sum and substance of the discussion was that only two modes are plausible for realization of sale consideration. However, for a businessman the object is to realize the sale proceeds at the

(B) Assessee ’s Cross Objection No. 120/A hd./2008 – A. Y. 2005-06 (Arising out of 2075/A hd./2008 – A. Y. 2005-06)

13. The following grounds have been raised by the assessee in the cross objection :—

“1. Assuming for the sake of argument that payment of Rs. 7,83,666 was interest payment, the amended provisions of section 40(a)(ia) of the Act would not be applicable and as such no disallowance is called for under section 40(a)(ia) of the Act.

2. It is prayed that even assuming the payment of Rs. 7,83,666 as interest instead of additional purchase price, it is prayed that the disallowance may please be deleted.”

13.1 Cross Objection was not pressed by the Learned Authorised Representative, hence, the same is dismissed as such.

14. In the result, the appeal of the revenue as well as cross objection filed by the assessee both are dismissed.