Finance charges could not be treated as interest within the meaning of Interest Tax Act, 1974

Issue before Court:

Whether ITAT was right in not treating the processing or finance charges as interest income under the definition provided under section 2 of Interest Tax Act.

Brief facts:

• Assessee was carrying on financial business which included accepting deposits as a mutual benefit fund company. It also used to lend money and, for that purpose, charged from its borrowers certain amounts under different heads which included “financing charges”.
• The AO was of the opinion that for AY 1996-97 the amount claimed as processing charges was in fact interest, and liable to be treated as such for the purposes of the Interest Tax Act, 1974.
• AO relied upon the inclusive nature of definition of interest under Section 2 of the said Act. Consequently, the sum of Rs.3,17,52,377/- was added back and brought tax under the Interest Tax Act.
• CIT (A) granted part relief and deleted half of the addition. The further appeal to the ITAT however succeeded.

Contention of the revenue:

The amounts claimed as finance charge was in fact are interests as per definition of section 2(7) of Interest Act, 1974 which reads as follows:

“Interest” means interest on loans and advances made in India and includes :”

Contention of the assessee:

Assessee contended that these amount are actually processing fee charges from borrowers to process finance.

Held by the Court:

 ♣ The ITAT while allowing appeal of the assessee relied upon the decision of the Madhya Pradesh High Court in Commissioner of Income Tax V. State Bank of Indore (1988) 172 ITR 24 and held that the financing charges could not be treated as interest as per the following finding of the court:

“It is apparent from the definition of interest that it is only the interest on loans and advances made in India that would be considered as interest within the meaning of the I. T. Act 974 (sic). Section 5 of the Interest Tax Act, contemplates interest accruing or arising to the assessee in the previous year.”

 ♣ In order to support his conclusions, the AO ought to have made further enquiries such as what was the ordinary rate which the assessee charged from non-members for similar services and what did other similar placed companies or entities charge from their members or borrowers.

♣ Financial charges were one time charges and were not recurring.

Conclusion:  Hon’ble High Court of Madhya Pradesh in the matter of CIT vs. State Bank of Indore (Supra) elaborated that interest accruing or arises to the assessee can be taxed in the hands of the assessee. In this particular case assessee charges a certain amount as finance charge from its borrowers to process the finance further and liability to pay interest accrued later on after the completion of finance.