2025 (4) TMI 647 - AT - Income Tax

Disallowance of interest expenses under section 57(iii) unsustainable when borrowed funds directly invested with proper adjustments

ITAT Mumbai held that disallowance of interest expenses under section 57(iii) was unsustainable. The assessee had borrowed funds exceeding amounts lent ... Disallowance of interest expenses claimed under income from other sources u/s 57(iii) - Out of the total interest, a sum was suo motu disallowed by the assessee in the computation of income, on the ground that the amount of loans received exceeded the amount of loans advanced - HELD THAT:- We find that apart from interest income from property and business the assessee also earned interest income from loans. It is observed that the assessee had borrowed funds exceeding the amount lent. Accordingly, the assessee computed a proportionate interest expense which was voluntarily disallowed suo motu in the computation of income. In the present case, the assessee had availed of unsecured loans and paid interest thereon. The borrowed funds were directly invested in the company, and the interest payment was duly adjusted against the corresponding loan. Accordingly, following the findings of the Co-ordinate Bench in the assessee’s own case for Assessment Year 2020–21, we hold that the addition made by the AO is unsustainable. Decided in favour of assessee. ISSUES PRESENTED and CONSIDEREDThe core legal issues considered in the judgment are as follows:1. Whether the disallowance of interest expenses claimed under Section 57(iii) of the Income-tax Act by the Assessing Officer (AO) and upheld by the Commissioner of Income Tax (Appeals) [CIT(A)] was justified.2. Whether the assessee was entitled to claim a deduction of interest expenses incurred on borrowed funds, which were used to earn interest income from loans extended to related companies.3. Whether the CIT(A) erred in concluding that the deduction claimed under Section 57(iii) was a colorable device without sufficient evidence.4. The relevance of previous judicial precedents, including the Supreme Court decision in CIT vs. V.P. Gopinathan, in determining the allowability of the interest deduction.ISSUE-WISE DETAILED ANALYSIS1. Disallowance of Interest Expenses under Section 57(iii)Relevant Legal Framework and Precedents: Section 57(iii) of the Income-tax Act allows for the 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 from other sources. The Supreme Court's decision in CIT vs. V.P. Gopinathan was cited by the Revenue to argue against the deduction, asserting that the interest income earned from temporary deployment of surplus funds should be assessed under 'Income from Other Sources.'Court's Interpretation and Reasoning: The Tribunal emphasized that the facts of the present case were distinguishable from those in the Gopinathan case. The borrowed funds were directly invested in a company where the assessee served as a director, and the interest expense was claimed against the interest income from these loans.Key Evidence and Findings: The assessee had borrowed unsecured loans and extended these funds to related companies, earning interest income. The assessee also voluntarily disallowed a portion of the interest expense in the computation of income, acknowledging that the borrowed funds exceeded the amount lent.Application of Law to Facts: The Tribunal relied on the decision of the Co-ordinate Bench in the assessee's own case for a previous assessment year, where similar issues were adjudicated in favor of the assessee. The Tribunal found that the borrowed funds were used for advancing loans to related companies, and the interest expense incurred was for the purpose of earning interest income, thus qualifying for deduction under Section 57(iii).Treatment of Competing Arguments: The Revenue argued that the interest expense lacked commercial purpose and was part of a tax avoidance scheme. However, the Tribunal found no evidence to support this claim and noted that the Revenue's reliance on the Gopinathan decision was misplaced.Conclusions: The Tribunal concluded that the disallowance of interest expenses by the AO and CIT(A) was unsustainable. The addition of Rs. 1,20,39,731/- was deleted, allowing the deduction under Section 57(iii).2. Allegation of Colorable DeviceRelevant Legal Framework and Precedents: A colorable device refers to a transaction that appears legitimate but is intended to deceive or evade tax obligations. The CIT(A) had concluded that the deduction claimed was a colorable device without substantial evidence.Court's Interpretation and Reasoning: The Tribunal found no material evidence to support the CIT(A)'s conclusion that the deduction was a colorable device. The Tribunal noted that the transactions were genuine, and the interest expenses were incurred for earning interest income.Key Evidence and Findings: The assessee had provided a detailed computation of interest income and expenses, demonstrating the purpose of the borrowed funds. The Tribunal found that the transactions were consistent with commercial expediency.Application of Law to Facts: The Tribunal applied the principles of commercial expediency, emphasizing that the test should be judged from the perspective of the businessman and not the Revenue.Treatment of Competing Arguments: The Revenue argued that the transactions were dubious and lacked exclusive purpose. However, the Tribunal found these arguments unsubstantiated and noted that the onus was on the Revenue to prove the existence of a colorable device.Conclusions: The Tribunal rejected the allegation of a colorable device, finding no basis for the CIT(A)'s conclusion.SIGNIFICANT HOLDINGSThe Tribunal's significant holdings include:- The Tribunal held that the assessee was entitled to claim a deduction under Section 57(iii) for interest expenses incurred on borrowed funds used to earn interest income. The Tribunal found that the borrowed funds were used for advancing loans to related companies, and the interest expense was incurred for the purpose of earning interest income.- The Tribunal distinguished the facts of the present case from the Supreme Court's decision in CIT vs. V.P. Gopinathan, noting that the borrowed funds were directly invested in a company, and the interest income was not from temporary deployment of surplus funds.- The Tribunal rejected the allegation of a colorable device, finding no evidence to support the CIT(A)'s conclusion. The Tribunal emphasized the principles of commercial expediency and noted that the transactions were genuine and consistent with business purposes.- The Tribunal set aside the order of the CIT(A) and deleted the addition of Rs. 1,20,39,731/- made by the AO, allowing the assessee's appeal.