Rate of Interest is Irrelevant for disallowing interest U/s. 57(iii)

Shri Mahendra Singh Meel Vs. ITO (ITAT Jaipur)

The issue under consideration is whether the interest expense can be disallowed u/s 57(iii) on the ground that rate of interest paid was higher that rate of interest received in own case?

ITAT states that Section 57(iii) requires that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of s. 57(iii) and that purpose must be making or earning of income. S. 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of s. 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of s. 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure. Accordingly, when the interest expenditure was laid out by the assessee for earning the interest income, then the rate of interest for payment of interest is not relevant for the purpose of allowing the deduction under section 57(iii) of the Act. The authorities below have committed an error while disallowing the claim of interest on the ground that the payment in case of one party is at a higher rate than the interest earned by the assessee from such expenditure. The orders of the authorities below are accordingly set aside and claim of the assessee is allowed.

FULL TEXT OF THE ITAT JUDGEMENT

This appeal by the assessee is directed against the order dated 17.10.2017 of CIT (Appeals)-2, Jaipur for the assessment year 2014-15. The assessee has raised the following grounds of appeal :-

“ 1. That the learned Authorities below have grossly erred in law and facts in passing the order which is bad in law and facts. Hence liable to be quashed.

2. That the learned Authorities below have grossly erred in law and facts in making/confirming disallowance of claim of interest expenses of Rs. 1,33,335/- on assumption and presumption basis. Hence the addition is liable to be deleted.

3. The appellant has reserved a right to add, amend or alter any ground or grounds of appeal on or before the appeal hearing.”

2. The assessee is an Individual and filed his return of income on 21^st March, 2015 declaring total income of Rs. 6,89,140/- which includes income from house property, business and other sources. During the assessment proceedings, the AO noted that the assessee has shown interest income as well as interest payment. From the details, the AO noted that the assessee has received interest income at the maximum rate of 18% whereas in one of the payments of interest the assessee has paid the interest at 20%. Accordingly, the AO restricted the interest paid against the interest received by applying the rate at 18% instead of 20% paid by the assessee in respect of one party. The assessee challenged the action of the AO before the ld. CIT (A) but could not succeed.

3. Before the Tribunal, the ld. A/R of the assessee has submitted that when the assessee has paid the interest on the borrowed fund which has been used for earning the interest income, then the expenditure incurred by the assessee is wholly and exclusively for earning the interest income. Thus the deduction of interest paid is allowable under section 57(iii) of the Act. There is no provision under section 57 to restrict the claim of expenditure on the ground that the expenditure is more than the income. In support of his contention, he has relied upon the decision of Hon’ble Supreme Court in case of CIT vs. Rajendra Prasad Moody, 115 ITR 519 (SC) as well as the decision of Hon’ble Punjab & Haryana High Court in case of CIT vs. Pankaj Munjal Family Trust, 326 ITR 286 (P&H) and submitted that the Hon’ble Supreme Court has held that it is not necessary that any income should in fact have been earned as a result of the expenditure. The only requirement for allowing the deduction under section 57(iii) is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. Therefore, there is no such condition that the expenditure shall be deducted only if any income is made or earned. Thus the ld. A/R has submitted that the disallowance made by the AO and confirmed by the ld. CIT (A) is unjustified and not sustainable in law.

4. On the other hand, the ld. D/R has relied upon the orders of the authorities below and submitted that the AO has made the disallowance of interest only in respect of one transaction of payment of interest @ 20% whereas the assessee has earned the interest at the maximum rate of 18%. Thus the AO has restricted the payment of interest to 18%.

5. I have considered the rival submissions as well as the relevant material on record. The assessee has received interest income as well as paid interest expenditure, the details of which has been reproduced by the AO in the assessment order as under :-

Further the assessee has also paid following interest to parties :-

Thus the assessee has received total interest income of Rs. 27,08,867/- from 5 parties and paid interest of Rs. 25,17,356/- which has resulted net interest income of Rs. 1,91,511/-. As it is clear from the details of the interest income and interest payment that the assessee has received interest @ 18%, 6%, 15%, 12% and 18% respectively from 5 parties whereas the interest paid by the assessee is 20%, 18%, 12% and 12% respectively to 4 parties. The AO has not doubted the genuineness of the payment and also not given a finding that the payment is either inflated by the assessee. Once the interest is paid to a third party which is not related to the assessee, then it is a commercial decision of the assessee to take the funds at an interest rate which may be higher than the normal prevailing rate due to pressing circumstances or urgent need of funds. When the AO has not disputed the correctness of the payment and genuineness of the transaction, then merely because the payment of interest to one of the parties is higher than the average earning of interest, the same cannot be a reason for disallowing the claim of interest expenditure. The only requirement for allowing the deduction under section 57(iii) is that the expenditure has been incurred wholly and exclusively for the purpose of earning the income. Thus the purpose of expenditure is relevant and not the end result of such expenditure laid out by the assessee. The Hon’ble Supreme Court in case of CIT vs. Rajendra Prasad Moody (supra) has held in para 4 to 6 as under :-

“What s. 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of s. 57(iii) and that purpose must be making or earning of income. S. 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of s. 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of s. 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure. It may be pointed out that an identical view was taken by this court in Eastern Investments Ltd. v. CIT [1951] 20 ITR 1 , 4 (SC), where interpreting the corresponding provision in s. 12(2) of the Indian I.T. Act, 1922, which was ipsissima verba in the same terms as s. 57(iii), Bose J., speaking on behalf of the court, observed:

“It is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned.”

It is indeed difficult to see how, after this observation of the court, there can be any scope for controversy in regard to the interpretation of s. 57(iii).

It is also interesting to note that, according to the revenue, the expenditure would disqualify for deduction only if no income results from such expenditure in a particular assessment year, but if there is some income, howsoever small or meagre, the expenditure would be eligible for deduction. This means that in a case where the expenditure is Rs. 1,000, if there is income of even Re. 1, the expenditure would be deductible and there would be resulting loss of Rs. 999 under the head “Income from other sources”. But if there is no income, then, on the argument of the revenue, the expenditure would have to be ignored as it would not be liable to be deducted. This would indeed be a strange and highly anomalous result and it is difficult to believe that the legislature could have ever intended to produce such illogicality. Moreover, it must be remembered that when a profit and loss account is cast in respect of any source of income, what is allowed by the statute as proper expenditure would be debited as an outgoing and income would be credited as a receipt and the resulting income or loss would be determined. It would make no difference to this process whether the expenditure is X or Y or nil, whatever is the proper expenditure allowed by the statute would be debited. Equally, it would make no difference whether there is any income and if so, what, since whatever it be, X or Y or nil, would be credited. And the ultimate income or loss would be found. We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of s. 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income.

It is true that the language of s. 37(1) is a little wider than that of s. 57(iii), but we do not see how that can make any difference in the true interpretation of s. 57(iii). The language of s. 57(iii) is clear and unambiguous and it has to be construed according to its plain natural meaning and merely because a slightly wider phraseology is employed in another section which may take in something more, it does not mean that s. 57(iii) should be given a narrow and constricted meaning not warranted by the language of the section and, in fact, contrary to such language.”

Similarly, the Hon’ble Punjab & Haryana High Court in case of CIT vs. Pankaj Munjal Family Trust (supra) has held in para 12 as under :-

“12. After hearing the learned counsel for the parties and going through the impugned order, we do not find any force in the contention raised by the learned counsel for the Revenue ; and, in our opinion, no substantial question of law is arising from the impugned order passed by the Tribunal. In the present case, undisputedly, the assessee has borrowed certain amount from the family concerns at 16 per cent. It is also not the case of the Revenue that the assessee has not paid the interest at the said rate to the lender. Merely because the assessee has invested the said borrowed amount for the purchase of 4 per cent, non-cumulative preference shares, it cannot be presumed that the said transaction was colourable because no person with ordinary prudence will borrow money at 16 per cent, and invest the same for the purpose of non-cumulative preference shares. It is the wisdom of the assessee to take a business decision. If a wrong or unwise decision has been taken by the assessee, it cannot be said that the decision is dubious, or the assessee in such transaction has adopted dubious method to evade the payment of tax. In the instant case, there is no evidence of any dubious method or practice adopted by the assessee Tax planning is a legitimate right of the assessee. In the present case, the assessee has not adopted any colourable device or dubious method while borrowing certain amount at a higher rate of interest. The Revenue has also not brought on record any evidence to show that the interest paid by the assessee on the aforesaid borrowed amount was highly exorbitant and no such rate of interest was ever prevalent in the market. Therefore, in our opinion, the Tribunal is right in law in allowing interest as claimed by the assessee.

Accordingly, when the interest expenditure was laid out by the assessee for earning the interest income, then the rate of interest for payment of interest is not relevant for the purpose of allowing the deduction under section 57(iii) of the Act. The authorities below have committed an error while disallowing the claim of interest on the ground that the payment in case of one party is at a higher rate than the interest earned by the assessee from such expenditure. The orders of the authorities below are accordingly set aside and claim of the assessee is allowed.

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