Colourable diversion of income through reduced interest rate was rejected, and the interest difference was sustained as an addition.

A reduction in interest charged to a debtor concern was treated as a colourable device to divert the assessee-firm's income. The analysis accepted that tax authorities cannot dictate the precise commercial rate of interest, but held that contractual freedom in fixing interest cannot be used to defeat revenue by shifting income under an artificial arrangement. On the facts noted, the lower lending rate was linked to the partner's joining the debtor concern, while the assessee itself continued borrowing at a higher rate, and the interest difference was sustained as an addition.

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Issues: Whether the addition made on account of the reduction in interest charged to the debtor concern was justified as a device to divert the assessee-firm's income.

Analysis: The interest rate charged to the debtor concern fell after the relevant partner joined that concern, while the assessee was itself borrowing funds at a higher rate. The reduction in the lending rate was treated as a deliberate device to shift income away from the assessee-firm under the guise of freedom to fix interest. The view that the tax authorities could not dictate the precise commercial rate of interest was accepted, but it was held that such freedom could not be used to defeat the Revenue by a colourable arrangement.

Conclusion: The interest difference was rightly added and the addition was sustained.

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