Cash System u/s 145(1) Accepted, Interest Nexus u/s 57(iii) Must Be Proved

Ravi Kumar Gollapudi Vs DCIT (ITAT, Hyderabad Bench)

Interest Paid Today, Interest Received Tomorrow: Cash System u/s 145(1) Cannot Defeat Deduction u/s 57(iii), but Nexus Must Pass the Test—Hyderabad ITAT Remands ₹13.66 Lakh Disallowance

The controversy

The Hyderabad Bench of the ITAT examined whether interest expenditure incurred on borrowed funds could be disallowed merely because the interest actually received during the year was lower than the interest paid. The assessee contended that he regularly followed the cash system of accounting & had received the balance interest in subsequent years.

The Tribunal held that recognition of interest income on actual receipt basis is permissible u/s 145(1). Therefore, a mismatch between interest paid & interest received in a particular year cannot, by itself, justify complete disallowance. However, deduction u/s 57(iii) would be available only after establishing a direct nexus between the borrowed funds, the interest-bearing advance & the corresponding income offered to tax.

Interest expenditure against income from other sources

The assessee, Shri Ravi Kumar Gollapudi, filed his return for AY 2018-19 declaring a total income of ₹30,33,940. His case was selected for limited scrutiny & notice u/s 143(2) was issued.

During assessment proceedings, the AO noticed that the assessee had claimed interest expenditure of ₹65,47,089 against interest income of ₹58,81,505 offered under the head “Income from other sources.” In the preceding year, the assessee had reported interest income of ₹65,26,481, while the interest expenditure was ₹65,66,814.

The AO further found that the assessee had obtained a fresh loan of ₹3,25,32,284 from M/s IIFL, on which interest of ₹13,65,835 was paid. This interest formed part of the aggregate expenditure claimed by the assessee.

According to the AO, the assessee failed to demonstrate that the loan from M/s IIFL had been utilised for earning interest income. The AO therefore disallowed ₹13,65,835. He also made a further addition of ₹7,07,021 because the interest income had declined compared with the preceding year. The assessment was completed at ₹51,06,796.

The CIT(A) deleted the addition of ₹7,07,021 relating to the reduction in interest income but sustained the disallowance of ₹13,65,835, resulting in the appeal before the Tribunal.

Borrowed money allegedly advanced to Saket Engineering

The assessee argued that the finding regarding absence of utilisation was factually incorrect. The funds borrowed from M/s IIFL had allegedly been advanced to M/s Saket Engineering Pvt. Ltd. on interest.

To support the claim, the assessee relied upon a certificate issued by Saket Engineering showing interest paid for AYs 2018-19 to 2020-21. An Excel statement containing details of loans obtained, amounts advanced, interest paid & interest received for these years was also produced.

During AY 2018-19, the assessee had received interest of ₹9,25,652 from Saket Engineering & offered it to tax. The amount was lower than the interest of ₹13,65,835 paid to M/s IIFL because the assessee followed the cash system. According to him, the balance interest was received & offered in AYs 2019-20 & 2020-21. In those subsequent years, the interest received from Saket Engineering was stated to be higher than the corresponding interest paid to M/s IIFL.

Conditions for deduction u/s 57(iii)

The Tribunal observed that u/s 57(iii), expenditure other than capital expenditure is deductible where it is laid out or expended wholly & exclusively for making or earning income chargeable under the head “Income from other sources.”

Consequently, when interest expenditure is claimed against interest income, the assessee must establish that the borrowed funds were utilised wholly & exclusively for earning that income. The expenditure of ₹13,65,835 would therefore be deductible only if the loan from M/s IIFL was actually deployed in the interest-bearing advance to Saket Engineering.

The Revenue was thus justified in requiring proof of a direct nexus between the IIFL borrowing, the advance to Saket Engineering & the interest income received.

Cash system recognised u/s 145(1)

The Tribunal noted that section 145(1) permits income under the heads “Profits & gains of business or profession” & “Income from other sources” to be computed under either the cash or mercantile system regularly employed by the assessee.

If the assessee had consistently followed the cash method, there was no inherent defect in recognising interest income only when actually received. Therefore, the fact that interest received from Saket Engineering during AY 2018-19 was lower than interest paid to M/s IIFL could not automatically result in disallowance of the entire expenditure.

The timing difference may simply reflect the adopted accounting method. However, the cash system cannot excuse the assessee from proving the source, flow & utilisation of funds or from showing that the corresponding income was ultimately offered to tax.

Detailed verification directed

The Tribunal found that the certificate & Excel statement required verification against the underlying records for AYs 2018-19 to 2020-21. It accordingly restored the matter to the AO.

The AO was directed to verify the flow of funds from M/s IIFL, their advancement to Saket Engineering, the interest received during all three years & its reconciliation with the interest paid. He must also verify whether the interest allegedly received in later years was actually offered to tax under the cash system regularly followed by the assessee.

If the assessee establishes the requisite nexus & proves that the corresponding interest was duly offered in the respective years, the AO must allow the deduction u/s 57(iii). The assessee was directed to furnish all necessary documentary evidence & was to be granted a reasonable opportunity of hearing.

FULL TEXT OF THE JUDGMENT/ORDER OF ITAT, HYDERABAD BENCH

This appeal is filed by Shri Ravi Kumar Gollapudi (“the assessee”), feeling aggrieved by the order passed by the Learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC) (“Ld. CIT(A)”) dated 26.11.2025 for the A.Y. 2018-19.

2. The assessee has raised the following grounds of appeal:

“1. Learned CIT Appeals erred under facts and law to confirm disallowance of interest of Rs. 13,65,835/- contrary to the Computation of income offered under cash method of accounting.

2. In disallowing the interest expense Rs. 13,65,835/-, revenue failed to rebut the genuineness of payment entries, deduction allowable under Section 57(iii) on satisfying borrowing, utilization, and payment tests for allowing deduction under cash method of accounting which was followed consistently.

3. Revenue erred in failing to recognize method of accounting consistently followed and accepted in the assessment of the previous years.

4. The appellant begs to pray to modify, amend, alter, or delete one of more grounds of appeal with the permission of the Honourable Tribunal.

5. Any other ground that may be urged at the time of hearing of the appeal.”

3. The brief facts of the case are that the assessee is an individual who filed his return of income for the assessment year 2018-19 on 30.07.2018, declaring total income of ₹30,33,940/-. The case of the assessee was selected for limited scrutiny and, accordingly, notice under section 143(2) of the Income-tax Act, 1961 (“the Act”) dated 22.09.2019 was issued by the Assessing Officer to the assessee. During the course of assessment proceedings, the Assessing Officer observed that, during the year under consideration, the assessee had claimed deduction of interest expenditure of ₹65,47,089/- against interest income of ₹58,81,505/- offered under the head “Income from other sources”. The Assessing Officer further observed that the interest income of the assessee was ₹65,26,481/- in the immediately preceding assessment year, i.e., assessment year 2017-18, which got reduced during the year under consideration, whereas the interest expenditure had remained more or less at the same level, being ₹65,66,814/- during assessment year 2017-18. On verification, the Assessing Officer further found that, during the year under consideration, the assessee had taken a fresh loan of ₹3,25,32,284/- from M/s IIFL, on which the assessee had paid interest of ₹13,65,835/-. The assessee had claimed the said interest payment as part of the aggregate interest expenditure of ₹65,47,089/- during the year under consideration. According to the Assessing Officer, the assessee could not establish that the loan obtained from M/s IIFL had been utilized for the purpose of earning interest income. Accordingly, the Assessing Officer disallowed the interest expenditure of ₹13,65,835/- paid to M/s IIFL and added the same to the income of the assessee. The Assessing Officer also made a further addition of ₹7,07,021/- on account of reduction in interest income during the year under consideration as compared to assessment year 2017-18. Accordingly, the Assessing Officer completed the assessment under section 143(3) read with sections 143(3A) and 143(3B) of the Act vide order dated 13.04.2021, assessing the total income of the assessee at ₹51,06,796/-.

4. Aggrieved by the assessment order, the assessee preferred an appeal before the Ld. CIT(A). The Ld. CIT(A) deleted the addition of ₹7,07,021/- made by the Assessing Officer on account of reduction in interest income during the year under consideration as compared to assessment year 2017-18. However, the Ld. CIT(A) sustained the addition of ₹13,65,835/- made by the Assessing Officer on account of interest paid by the assessee to M/s IIFL on the fresh loan taken during the year under consideration. Accordingly, the Ld. CIT(A) partly allowed the appeal of the assessee.

5. Aggrieved by the order of the Ld. CIT(A), the assessee is in appeal before us. At the outset, the Learned Authorized Representative (“Ld. AR”) submitted that the only issue arising out of the grounds raised by the assessee is with regard to the addition of ₹13,65,835/- on account of interest paid to M/s IIFL. In this regard, the Ld. AR submitted that the lower authorities had made/sustained the addition on the ground that the assessee had failed to substantiate that the loan obtained from M/s IIFL had been utilized for the purpose of earning interest income. He submitted that the fresh loan obtained by the assessee from M/s IIFL was, in fact, advanced by the assessee to M/s Saket Engineering Pvt. Ltd. on interest and, therefore, the finding of the lower authorities that the loan obtained from M/s IIFL had not been utilized for earning interest income is factually incorrect. In support of his contention, the Ld. AR invited our attention to the certificate issued by M/s Saket Engineering Pvt. Ltd. regarding interest paid by it to the assessee for assessment years 2018-19 to 2020-21 placed at page no.43 of the paper book. The assessee has also filed a copy of the Excel sheet containing the details of loans taken, amounts advanced to M/s Saket Engineering Pvt. Ltd., interest received therefrom and other relevant particulars for assessment years 2018-19 to 2020-21 and submitted that, during the year under consideration, the assessee had received interest of ₹9,25,652/- from M/s Saket Engineering Pvt. Ltd. and had offered the same to tax. He submitted that the assessee is following the cash system of accounting and, therefore, during the year under consideration, the interest actually received from M/s Saket Engineering Pvt. Ltd. amounting to ₹9,25,652/- was less than the interest of ₹13,65,835/- paid by the assessee to M/s IIFL. He further submitted that in the subsequent assessment years, i.e., assessment years 2019-20 and 2020-21, the assessee had offered higher amounts of interest received from M/s Saket Engineering Pvt. Ltd. as compared to the corresponding interest paid to M/s IIFL. According to him, although the interest offered during the year under consideration appears to be less than the interest paid to M/s IIFL, the difference is only on account of the assessee following the cash system of accounting and the balance interest pertaining to the advance made to M/s Saket Engineering Pvt. Ltd. was received and offered to tax in the subsequent assessment years. Accordingly, the Ld. AR prayed for deletion of the addition.

6. Per contra, the Learned Departmental Representative (“Ld. DR”) relied upon the orders of the lower authorities and submitted that the assessee had failed to substantiate before both the lower authorities that any interest income had been earned against the interest expenditure incurred on the fresh loan obtained from M/s IIFL. He submitted that the interest expenditure of ₹13,65,835/- paid to M/s IIFL would be allowable under section 57(iii) of the Act only if the assessee establishes that the borrowed funds were utilized wholly and exclusively for the purpose of making or earning the interest income. He, therefore, submitted that the assessee is required to establish a direct nexus between the loan obtained from M/s IIFL, the amount advanced to M/s Saket Engineering Pvt. Ltd. and the interest income received therefrom. Accordingly, the Ld. DR supported the disallowance made by the Assessing Officer and sustained by the Ld. CIT(A).

7. We have heard the rival submissions and perused the material available on record. The limited issue before us is whether the interest expenditure of ₹13,65,835/- incurred by the assessee on the loan obtained from M/s IIFL is allowable as deduction under section 57(iii) of the Act against the interest income offered by the assessee under the head “Income from other sources”. In this regard, we have gone through the provisions of section 57(iii) of the Act, which is to the following effect:

“57. The income chargeable under the head “Income from other sources” shall be computed after making the following deductions, namely :—

(i) ………….

(ii) …………

(iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income;.”

8. On perusal of the above, it is evident that section 57(iii) of the Act provide for deduction of any expenditure, not being in the nature of capital expenditure, laid out or expended wholly and exclusively for the purpose of making or earning income chargeable under the head “Income from other sources”. Thus, where an assessee claims deduction of interest expenditure against interest income chargeable under the head “Income from other sources”, it is incumbent upon the assessee to establish that the expenditure was incurred wholly and exclusively for the purpose of making or earning such income. Therefore, in the present case, the interest of ₹13,65,835/- paid to M/s IIFL would be allowable as deduction under section 57(iii) of the Act if the assessee is able to establish that the borrowed funds on which such interest was paid were utilized wholly and exclusively for the purpose of earning interest income. The contention of the assessee before us is that the fresh loan obtained from M/s IIFL was advanced to M/s Saket Engineering Pvt. Ltd. on interest and that the assessee had received interest of ₹9,25,652/- from M/s Saket Engineering Pvt. Ltd. during the year under consideration. It is further contended that the assessee follows the cash system of accounting and, therefore, the entire interest attributable to the amount advanced to M/s Saket Engineering Pvt. Ltd. was not offered during the year under consideration, as part of such interest was actually received and offered to tax in the subsequent assessment years 2019-20 and 2020-21. In this regard, we have also gone through the provisions of section 145(1) of the Act, which is to the following effect:

“145. (1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.”

9. On perusal of the above, it is evident that provisions contained in section 145(1) of the Act permit income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” to be computed in accordance with either the cash or mercantile system of accounting regularly employed by the assessee. Therefore, if the assessee has regularly followed the cash system of accounting for recognizing the interest income chargeable under the head “Income from other sources”, we do not find any infirmity, per se, in the assessee recognizing such interest income on actual receipt basis, the same being permissible under section 145(1) of the Act. Consequently, merely because the amount of interest actually received from M/s Saket Engineering Pvt. Ltd. during the year under consideration is less than the interest paid to M/s IIFL cannot, by itself, be a ground for disallowing the entire interest expenditure, provided the assessee establishes the requisite nexus between the borrowed funds and the interest-bearing advance. We have also gone through the copy of the Excel sheet furnished by the assessee containing the year-wise details of borrowings, amounts advanced and interest paid/received for assessment years 2018-19 to 2020-21, which is to the following effect:

RAVI KUMAR GOLLAPUDI (PAN – AEP PG9077C)
STATEMENT TO DEMONSTRATE THAT INCOME IS EARNED FROM SAKET ENGINEERS PRIVATE LTD.

10. On perusal thereof, we find that the claim of the assessee regarding the nexus between the interest received from M/s Saket Engineering Pvt. Ltd. and the interest paid to M/s IIFL requires detailed verification of the underlying records for assessment years 2018-19 to 2020-21. Such verification is necessary to ascertain whether the funds borrowed from M/s IIFL were actually advanced to M/s Saket Engineering Pvt. Ltd. with an object to earn interest income. Further, whether the interest income received and offered to tax by the assessee during the year under consideration as well as in the subsequent assessment years pertains to the said advance is also needs verification. Therefore, in our considered view, the issue requires factual verification at the level of the Assessing Officer.

11. In view of the above, we deem it appropriate to set aside the impugned order of the Ld. CIT(A) on this issue and restore the matter to the file of the Assessing Officer for detailed verification of the aforesaid facts. The Assessing Officer shall verify the flow and utilization of the funds borrowed from M/s IIFL and the nexus thereof with the amount advanced to M/s Saket Engineering Pvt. Ltd. The Assessing Officer shall further verify the amount of interest received by the assessee from M/s Saket Engineering Pvt. Ltd. during assessment years 2018-19 to 2020-21 and reconcile the same with the corresponding interest paid by the assessee to M/s IIFL so as to ascertain whether the interest expenditure claimed by the assessee was incurred wholly and exclusively for the purpose of earning the interest income. The Assessing Officer shall also verify whether the interest income stated to have been received from M/s Saket Engineering Pvt. Ltd. during the year under consideration as well as in the subsequent assessment years has actually been offered to tax by the assessee in the respective assessment years. If, upon such verification, the assessee is able to establish the nexus between the funds borrowed from M/s IIFL and the interest-bearing advance made to M/s Saket Engineering Pvt. Ltd. and further establishes that the corresponding interest income has been offered to tax in accordance with the cash system of accounting regularly followed by the assessee, the Assessing Officer shall allow the deduction of interest expenditure in accordance with section 57(iii) of the Act. Needless to say, the assessee shall furnish all the necessary details and documentary evidence before the Assessing Officer and shall be afforded reasonable opportunity of being heard.

12. In the result, the appeal of the assessee is allowed for statistical purposes.

Order pronounced in the Open Court on 4th September, 2026.