Netting of income u/s 57 allowed as there is direct nexus between interest received and paid

Mukesh Kanyailal Shah Vs Office of the Principal Commissioner of Income Tax PCIT (ITAT Mumbai)

ITAT Mumbai held that there is a direct nexus between interest received on loan given to firm and interest payment on loan taken from the bank and hence netting of the net interest income allowable under section 57 of the Income Tax Act.

Facts- The ld. PCIT in his revisionary jurisdiction called for the assessment records and noted that assessee has claimed interest expenses of Rs.37,16,200/- on SBI term loan as against interest income received from the partnership firm of Rs. 46,23,832/-. The assessee has declared net interest income after claiming interest expenses u/s.57, i.e., interest paid on SBI term loan of Rs.37,16,200/- was claimed as expenditure allowable u/s.57 of the Act. He observed that AO has not verified the said claim properly and therefore, the order of the AO is erroneous in so far as prejudicial to the interest of the Revenue.

Conclusion- The loan taken by the firm from the assessee, in turn was taken by the assessee from the SBI. Thus, the assessee received interest on loan given to the firm and on the same loan taken from the bank, the assessee has paid interest. Thus, there was direct nexus between earning of the interest income and interest paid. Accordingly, the netting of the net interest income after deducting the interest paid to the bank had direct nexus which is allowable under Section 57. This aspect of the matter was also examined by the AO and assessee has filed all the replies which were called upon by the AO. Thus, we do not find any infirmity in allowing the interest paid by the AO and therefore, order of ld. PCIT cannot be sustained, because on merits the assessment order is neither erroneous nor prejudicial to the interest of the Revenue and therefore, on merits, the appeal of the assessee is allowed.

FULL TEXT OF THE ORDER OF ITAT CHENNAI

The aforesaid appeal has been filed by the assessee against order dated 30/03/2022, passed by Ld. Pr. CIT, Mumbai-19, in his revisionary jurisdiction u/s.263 of the Act for the A.Y.2017-18.

2. In the grounds of appeal, the assessee has raised the following grounds:-

1. On the facts and in the circumstances of the case and in law, the learned Principal Commissioner of Income Tax (Pr. CIT) erred in invoking the provisions of section 263 of the Act and setting aside the order of the Ld. A.O.

2. On the facts and circumstances of the case & in law, the learned Pr.CIT has erred in Invoking section 263 of the Act on the same issues which specifically formed a part of the CASS limited scrutiny, which were adjudicated by the Ld. AO after due application of his mind, and passed the order u/s 143(3) of the Act. This tantamount to substituting the opinion of the Ld. AO by the Pr. CIT which is bad in law.

3. On the facts and circumstances of the case, the order passed by Pr. CIT under section 263 of the Income Tax Act is unsustainable as power to revise can be invoked in the case of lack of enquiry by the Ld. AO, and not in the case of inadequate enquiry

4. The appellant craves leave to add, alter or delete all or modify any or all the above grounds of appeal.

3. The facts in brief qua the issue raised in the impugned order are that, assessee is an individual and partner in M/s. Ritesh Exports. He has filed the return of income on 30/03/2018 declaring total income of Rs.94,85,830/-. The said return was selected for limited scrutiny under CASS to examine the deduction against the head ‘income from other sources’ claimed in the ITR. The AO during the assessment proceedings called for various details to about the interest income and the claim of interest deduction made by the assessee. After examining the details, the Assessing Officer passed the order u/s.143 (3) vide order dated 06/12/2019 accepting the return of income.

4. Thereafter, the ld. PCIT in his revisionary jurisdiction called for the assessment records and noted that assessee has claimed interest expenses of Rs.37,16,200/- on SBI term loan as against interest income received from the partnership firm of Rs. 46,23,832/-. The assessee has declared net interest income after claiming interest expenses u/s.57, i.e., interest paid on SBI term loan of Rs.37,16,200/- was claimed as expenditure allowable u/s.57 of the Act. He observed that AO has not verified the said claim properly and therefore, the order of the AO is erroneous in so far as prejudicial to the interest of the Revenue.

5. In response to the show-cause notice, the assessee filed detailed submissions and submitted that he has taken term loan of Rs.4 Crores from State Bank of India in F.Y.2013-14 which was disbursed to him on 10/10/2013 and the same fund was transferred to partnership firm, M/s. Ritesh Exports on the next date i.e.11/10/2013. He also submitted that during the course of assessment proceedings, specific question was raised by the AO and in response, the assessee had filed the entire details alongwith requisite documents before the AO alongwith copy of the ledger account of the firm as well as the ledger account of the statement of the term loan in the books of the assessee. The submissions of the assessee have been incorporated in the impugned order. However, the ld. PCIT cancelled the assessment order after observing and holding as under:-

5.4 It has been claimed that sufficient evidences were submitted in support of the claim before the AO who had examined the issue. On perusal of the Assessment records it is seen that the assessee has submitted during the course of assessment proceedings that in the FY 2013-14 he took term loan from SBI amounting to Rs.4 Crores which he deposited in his Partnership firm M/s. Ritesh Exports, it was further claimed that he earned interest amounting to Rs.46,23,832/- from Ritesh Exports and gave interest amounting to Rs 37,16,200/- on SBI Term Loan and the same was claimed u/s 57 of the Act against the interest income earned from M/s. Ritesh Exports. To substantiate his claim the assessee submitted his bank passbook and copy of the latest bank statement of Ritesh Exports On verification of the submissions, it is found that the assessee submitted his bank account passbook containing debit-credit details between November, 2011 to 11th August 2015 and bank statement of Ritesh Exports from 01.09.2019 to 16.09.2019 but did not submit bank statements for the relevant period le. FY 2016-17. Hence, these documents submitted by the assessee during the Assessment proceedings did not substantiate the argument raised by the assessee as there is no supporting documentary evidences on record to directly establish the nexus between the expenses incurred to earn interest income within meaning of Section 57 of the Act and thus as discussed above the provisions of Section 263 are clearly attracted in this case and the contentions of the Assessee in this regard are rejected

6.1 During the course of Revision proceedings the assessee has submitted two interest Certificates from the SBI, Huges Road branch from of two different bank accounts showing that the assessee has paid interest totaling to Rs. 37,12,763/- against the loan borrowed of Rs.4,00,00,000/- along with Ledger account of State Bank of India for the FY 2016-17 and the assessee has also submitted the banks statement of F.Y. 2013­14 showing that he has borrowed loan of Rs.4,00,00,000/- and deposited the same to M/s. Ritesh Exports from which the assessee has claimed to received interest of Rs 46,23,832/-However, the assessee has not submitted any documents like confirmation from M/s. Ritesh Exports or Bank Statement showing that the assessee has received interest of Rs 46,23,832/- from M/s. Ritesh Exports. Further the assessee has also claimed to received interest of Rs 27,067/- from Torrent power Limited which is also net off against the interest expenses claimed of Rs. 37,16,200/- and the assessee has not furnished any explanation in regards to the interest received from M/s. torrent Power Limited. In this regard Section 57(iii) lays down that-

(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;”

The expenditure would therefore be allowable only if it is incurred wholly and exclusively for the purpose of earning such income, thus the nexus between the relevant income and expenses being claimed towards it has to be established. The Assessee is required to substantiate its claim of expense of interest by not only providing evidence of genuineness of the expenses but also the nexus between these expenses with the income from other sources i.e the interest income in this case. As mentioned above although the assessee submitted interest certificate paid against the loan borrowed from the bank (which were also not before the AO), he has not furnished any documentary evidences to confirm that he received interest from M/s. Ritesh Exports. Hence, the nexus between the income earned of Rs. 46,50,899/- and interest expenses of Rs.37,16,200/- being claimed is still not established. Thus, the Assessing Officer is accordingly directed to confirm the payment of interest by Ritesh Exports and verify the nexus with income earned by considering the relevant documentary evidences and reframe the assessment.

6.2 In view of the above, the assessment order dated 06.12.2019 passed u/s. 143(3) of the Act, for AY 2017-18 is accordingly set aside for passing the order afresh considering the above direction, after giving the assessee an opportunity of being heard and producing any evidences in this regard.

6. Before us, ld. Counsel for the assessee apart from making the legal submissions that AO had called upon the entire details of the loan, its utilization and the claim of interest and after examining the same has allowed the claim, then it cannot be held that AO has not done proper verification or enquiry before accepting the claim. Without pointing out any defect on facts and merits of allowability in the order of the AO, ld. PCIT cannot cancel the assessment for deciding the issue afresh.

6.1 On merits, ld. Counsel submitted that the assessee has taken term loan from SBI of Rs.4 Crores which was given to the partnership firm, M/s. Ritesh Exports. The interest on said loan was paid by the assessee, however, the assessee had received the interest from the firm on same loan which was payable to the bank. Accordingly, the assessee has received interest income of Rs.46,23,832/- from the firm M/s. Ritesh Exports and has paid interest of Rs.37,16,200/- on SBI term loan.

6.2 During the course of hearing, the balance sheet of M/s. Ritesh Exports was called upon to examine, whether the assessee has used the loan for making any capital contribution or has given to the firm for the business purpose. The ld. Counsel has produced the balance sheet of M/s. Ritesh Exports and also shown the details of interest payment by the firm. Thus, he submitted that there was nexus between interest received from the firm and the interest paid to the bank on the term loan and therefore, the same was allowable as deduction u/s.57 and once this aspect has been duly verified and examined by the AO, the ld. PCIT could not have set aside the order to re-examine this issue once again.

7. On the other hand, the ld. CIT DR strongly relied upon the order of the ld. PCIT and submitted that the assessee could not establish the linkage between the loan taken from the SBI and utilization of loan carrying interest income and whether out of such interest income, assessee has paid the interest to the SBI. He further submitted that the term loan was for entirely different purpose and therefore, the ld. PCIT has rightly directed the AO to examine this issue.

8. We have heard the rival submissions and perused relevant finding given in the impugned order as well material referred to before us. The undisputed fact with respect to the issue involved are that, assessee is a partner in the firm M/s. Ritesh Exports and he has taken a term loan from SBI of Rs.4 Crores which was deposited in his partnership firm but not towards the capital account of the partner. From the perusal of the profit and loss account of the assessee, we find that assessee has received interest on capital from M/s. Ritesh Exports of Rs.17,60,000/-and there is a separate income of interest on loan received from M/s. Ritesh Exports at Rs.46,23,832/-. This term loan from SBI was taken in the F.Y. 2013-14 and was immediately deposited to the partnership firm from where assessee has been receiving interest from firm and from that interest income; the assessee has been paying interest to the bank. In all the earlier years, the claim of interest is only out of interest income from the firm which has been accepted in scrutiny proceedings u/s. 143(3). In support, the assessment order for the A.Y.2014-15 and 2015-16 has been filed in the paper book. In the computation of income, the assessee had shown interest income and interest expenditure in the following manner:-

MUKESH SHAH
A.Y.2017-18

9. Further from the perusal of the audited balance sheet and profit and loss account of the firm M/s. Ritesh Exports as on 31/03/2017, it is noticed that the assessee has received interest on capital contribution of Rs. 17,60,000/- which has been shown separately. Apart from that, it has paid interest on loan taken from the assessee of Rs.46,23,842/-. The loan taken by the firm from the assessee, in turn was taken by the assessee from the SBI. Thus, the assessee received interest on loan given to the firm and on the same loan taken from the bank, the assessee has paid interest. Thus, there was direct nexus between earning of the interest income and interest paid. Accordingly, the netting of the net interest income after deducting the interest paid to the bank had direct nexus which is allowable under Section 57. This aspect of the matter was also examined by the AO and assessee has filed all the replies which were called upon by the AO. Thus, we do not find any infirmity in allowing the interest paid by the AO and therefore, order of ld. PCIT cannot be sustained, because on merits the assessment order is neither erroneous nor prejudicial to the interest of the Revenue and therefore, on merits, the appeal of the assessee is allowed.

10. In the result, appeal of the assessee is allowed.

Order pronounced on 31st March, 2023