Payment can be considered as interest only when it is in respect of pre-existing debt obligation

 Brief of the case:

The Hon’ble Kerala HC in the case of Beacon Projects Private Limited held that a sum paid can be termed as interest only when the same is paid in respect of a pre-existing debt obligation and there existed a debtor-creditor relationship.

Facts of the case:

• The assessee company is a builder which had entered into construction agreements with various customers. The agreement provides for construction of a flat by the assessee for and on behalf of the purchaser.
• Payments are to be made by the purchaser in instalments as specified in the agreement. After entering into the agreement and making certain payments, some purchasers requested the assessee for cancellation of the agreement as they are unable to fulfill their further obligations.
• On receipt of such request, assessee identified new purchasers and entered into fresh agreements with them for prices which are higher than what was agreed upon with the purchasers who opted out.
• The purchasers were refunded their instalments along with the extra amount received from new purchasers. Such extra refund to purchasers was claimed as expenses.
• AO treated such additional refund as interest and thus , concluded that by not deducting tax on the same u/s 194A , assessee is in default u/s 201.

Contention of the Assessee:

• The additional amount refunded is not an interest because it is not paid for a loan taken by the assessee company from the purchasers.
• The same is only a compensation for cancellation of contract and such amount cannot considered as interest paid within the meaning of Sec 2(28A) because the same requires that an amount can be interest only when it has been paid in respect of pre-existing debt obligation and debtor-creditor relationship exist  whereas in the present case the instalments paid by purchasers were for the purchase of flats and were not in nature of loan advanced.

 Contention of the Revenue:

• The amount was refunded in excess of the original amount paid for on cancellation of contract , thus , it is simply an accretion to the original deposit which is interest in nature as the amount paid originally was an advance for the purchase of flats.
• Thus, the tribunal was right in holding that the amount was in nature of interest and liable to tax deduction u/s 194A.

Held by Hon’ble High Court:

• The point of dispute is that whether the amount debited to P&L A/c under indirect expenses being excess payments refunded, to be treated as interest paid by assessee within the meaning of Sec 2(28A).
• ‘Interest’ has been defined u/s 2(28A) of the Act and it means interest payable in respect of monies borrowed or debt incurred. Thus, a payment can be termed as interest only when the same is made towards any pre-existing debt obligations and there exists debtor-creditor relationship between the parties.
• In the present case assessee refunded the amounts paid by purchaser in addition to the extra amount received from new purchasers. Such extra amount so refunded cannot be treated as interest because the original sums paid by purchasers were not in the nature of any debt and as such no debtor – creditor relationship existed between the purchaser and assessee.
• As such the tests of Sec 2(28A) not satisfied and as a result of which the extra amount refunded cannot be termed as interest thereby no obligation to deduct tax at source u/s 194A.