2025 (6) TMI 44 - AT - Income Tax

PCIT properly exercised Section 263 jurisdiction when AO failed to disallow interest on loans deemed non-genuine

Narayankrupa Reality Versus The Pr. Commissioner of Income Tax-3, Ahmedabad

Narayankrupa Reality Versus The Pr. Commissioner of Income Tax-3, Ahmedabad - TMI The core legal questions considered in this judgment pertain to the exercise of revisionary jurisdiction under Section 263 of the Income Tax Act, 1961, specifically:1. Whether the Principal Commissioner of Income Tax (PCIT) was justified in invoking revisionary powers under Section 263 to revise the assessment order passed under Section 143(3) of the Act for the Assessment Year 2018-19.2. Whether the assessment order was erroneous and prejudicial to the interests of the Revenue for not disallowing the interest expense on unsecured loans that were disallowed as unexplained credits by the Assessing Officer (AO).3. Whether the interest expenditure debited in the Profit and Loss account on unsecured loans, which were treated as not genuine by the AO, was rightly allowed as a deduction under the provisions of the Act.4. The scope and limits of the PCIT's jurisdiction under Section 263, particularly regarding the need to verify records before assuming revisionary jurisdiction.Issue-wise Detailed Analysis1. Justification for Exercising Revisionary Jurisdiction under Section 263The legal framework under Section 263 empowers the Principal Commissioner or Commissioner to revise any order passed by an Assessing Officer if such order is found to be erroneous in so far as it is prejudicial to the interests of the Revenue. The Court examined whether the PCIT had valid grounds to invoke this power.The PCIT noted that the AO had disallowed unsecured loans amounting to Rs. 6.19 crores on the ground that the identity, creditworthiness, and genuineness of the lenders were not established. However, the AO did not correspondingly disallow the interest expense of Rs. 45.63 lakhs on these loans debited in the Profit & Loss account. The PCIT held that this omission rendered the assessment order erroneous and prejudicial to the Revenue.The assessee contended that the AO had examined the evidence and that the interest expense was legitimately incurred for business purposes and hence allowable under Section 36(1)(iii) of the Act. The assessee further argued that mere addition of unsecured loans to income did not automatically entail disallowance of the interest expense.The PCIT scrutinized the evidence submitted by the assessee, which included names, addresses, and PAN details of lenders, and bank confirmations, but observed that these were insufficient to establish genuineness and creditworthiness. The PCIT emphasized that the assessee failed to produce bank statements of depositors, sources of deposits, or annual accounts of lenders, which were necessary to justify the loans.Consequently, the PCIT concluded that the AO's failure to disallow the interest expense was an error causing prejudice to the Revenue and directed the AO to disallow the interest after proper verification.The Court upheld the PCIT's exercise of jurisdiction, holding that the revisionary power was rightly invoked due to the evident error in the assessment order.2. Whether the Interest on Unsecured Loans Should Have Been DisallowedThe relevant legal provision is Section 36(1)(iii) of the Income Tax Act, which allows deduction of interest on money borrowed for business purposes. The question was whether interest on unsecured loans, which were disallowed as unexplained credits, could be allowed as a deduction.The AO had disallowed the principal unsecured loans, but allowed the interest expense. The PCIT found this inconsistent and held that if the principal amount is treated as unexplained and added back to income, the interest expense on such loans cannot be allowed as a deduction. This is because the loans were not genuine and the interest paid on such loans cannot be considered a legitimate business expense.The assessee argued that the interest expense was incurred for business purposes and was therefore allowable, but failed to produce evidence to substantiate the genuineness of the loans or the linkage of interest to genuine borrowings.The Court noted that the assessee did not contest the PCIT's findings before the Tribunal and did not place any evidence to demonstrate that the interest expense was separate or distinct from the unsecured loans disallowed. The Court held that the PCIT's direction to disallow the interest expense was justified and in accordance with law.3. Scope of PCIT's Jurisdiction under Section 263 and Requirement of Record VerificationThe assessee contended that the PCIT had not perused the records to verify whether the interest expense was already included in the unsecured loans disallowed before assuming jurisdiction under Section 263, and thus the revision was not valid.The Court examined this contention and held that the PCIT's jurisdiction under Section 263 is not fettered by the need to verify every detail prior to assuming jurisdiction. The PCIT had identified a prima facie error in the assessment order-the failure to disallow interest on loans held to be not genuine-and had given the assessee an opportunity to explain.The Court emphasized that Section 263 requires the PCIT to give an opportunity to the assessee to explain the alleged error. In the present case, the assessee failed to demonstrate before the PCIT or the Tribunal that the interest expense was legitimately allowable or that the error noted was incorrect.Thus, the Court held that the PCIT had rightly assumed jurisdiction and the argument that jurisdiction was assumed without record verification was without basis and rejected.4. Treatment of Competing Arguments and Final ConclusionsThe assessee's principal argument was that the AO had duly considered and verified all evidence and that the PCIT's revision was therefore unjustified. The Court found that the AO had indeed disallowed the unsecured loans but failed to disallow the related interest expense, which was inconsistent and erroneous.The Court noted that the assessee did not produce any evidence before the PCIT or the Tribunal to counter the PCIT's findings or to establish the genuineness of the loans and interest expense. The failure to do so was fatal to the assessee's case.The Court further rejected the argument that the revision was barred because the issue was sub judice before the Commissioner of Income Tax (Appeals), holding that the PCIT's jurisdiction under Section 263 is independent and can be exercised notwithstanding parallel appeals.Significant Holdings'The Assessment Order passed by AO is erroneous and prejudicial to the interest of revenue for not having disallowed the interest pertaining to the unsecured loan held to be ingenuine.''Merely because unsecured loans were added back to the income of the assessee, there could not be a case of automatic disallowance of interest expense also relating to the same, but in the present case, the AO failed to disallow interest on unsecured loans which were treated as unexplained credits, and such omission is an error.''The Principal Commissioner of Income Tax had rightly assumed jurisdiction under Section 263 of the Act as there was a clear error in the assessment order causing prejudice to the Revenue.''Section 263 requires that opportunity be given to the assessee to explain the error noted by the Commissioner. The assessee failed to demonstrate before the PCIT or the Tribunal that the error was incorrect.''The PCIT was justified in directing the AO to disallow the interest expense on unsecured loans after proper verification and examination of evidence.'In conclusion, the Court dismissed the appeal filed by the assessee, affirming the PCIT's order under Section 263 holding the assessment order erroneous and prejudicial to the Revenue for not disallowing the interest expense on unsecured loans disallowed as unexplained credits, and upheld the direction for fresh assessment proceedings to disallow such interest expense.