Penal interest paid to bank for overdrawn cash credit facility allowed as business deduction under section 36(1)(iii)

ITAT Pune allowed the assessee's appeal regarding disallowance of penal interest paid to Janata Sahakari Bank for overdrawn cash credit facility. The AO had disallowed the expense considering it penal in nature. The tribunal held that under section 2(28A), "interest" includes any charge in respect of moneys borrowed or credit facility, encompassing penal interest. The assessee satisfied all conditions under section 36(1)(iii): money was borrowed for business purposes and interest was paid. The tribunal distinguished penal interest from prohibited payments, noting it was compensatory for breach of contractual obligation, not an offense under law. The payment was business-related and allowable under section 37(1). The assessment order was modified to allow the penal interest claim.

---

---

ISSUES:

Whether penal interest charged on overdrawn cash credit facility is allowable as a deduction under section 36(1)(iii) of the Income Tax Act, 1961.Whether penal interest can be disallowed under section 37(1) read with Explanation 1, on the ground that it is expenditure incurred for a purpose which is an offence or prohibited by law.Admissibility of additional evidence filed before the Tribunal relating to penal interest charged by the bank.

RULINGS / HOLDINGS:

Penal interest paid on overdrawn cash credit facility qualifies as "interest" under section 2(28A) and is therefore deductible under section 36(1)(iii) since the money was borrowed for business purposes and interest was paid thereon.Disallowance under section 37(1) read with Explanation 1 is not applicable as the penal interest was not incurred for any purpose which is an offence or prohibited by law; overdrawing the cash credit facility is a breach of contractual terms but not an offence or illegal act.Additional evidence, including bank certificate and interest statements, was admitted by the Tribunal as it goes to the root of the matter and was not previously produced before the lower authorities, consistent with Supreme Court precedent.

RATIONALE:

The Tribunal applied the statutory framework of sections 36(1)(iii), 2(28A), and 37(1) read with Explanation 1 of the Income Tax Act, 1961.Section 36(1)(iii) allows deduction of interest paid on capital borrowed for business purposes; the definition of "interest" under section 2(28A) includes any charge in respect of money borrowed, encompassing penal interest.Explanation 1 to section 37(1) excludes from deduction any expenditure incurred for purposes that are offences or prohibited by law; since overdrawing the cash credit facility is a contractual breach and not an offence, penal interest paid is not disallowed under this provision.The Tribunal distinguished precedents relied upon by the revenue as relating either to normal interest or penalties for offences, which are factually and legally different from the present case.The admission of additional evidence was supported by the Supreme Court decision permitting such evidence when it is material and was not previously available to the assessing authorities.

---