No disallowance under section 40A(2) if there is no material on record to demonstrate that payment made was excessive and unreasonable

Short Overview : Even though assessee had made payments to related parties, yet in view of fact that there was no material on record to demonstrate that payment made was excessive and unreasonable having regard to market rate, disallowance made under section 40A(2) by AO was to be deleted.

Assessee-firm was engaged in business of trading in iron and steel, tubes and pipes. AO alleged that assessee had paid interest @15 per cent of loans availed of from HUF of partners who were related parties. AO alleged that reasonable rate of interest which should have been paid on unsecured loans was at 12 per cent and restricted assessee’s claim with regard to interest expenditure on unsecured loans to 12 per cent per annum by invoking provisions of section 40A(2)(b).

It is held that Even though assessee had made payments to related parties, yet in view of fact that there was no material on record to demonstrate that payment made was excessive and unreasonable having regard to market rate, disallowance made under section 40A(2) by AO was to be deleted.

Decision: In assessee’s favour.

IN THE ITAT, MUMBAI ‘D’ BENCH

SAKTIJIT DEY, J.M. & N.K. PRADHAN, A.M.

Motilal Laxmichand Sanghavi v. Asstt. CIT

IT Appeal Nos. 3110 to 3112 (Mum.) of 2018

A.Ys. 2012-13 to 2014-15

26 July, 2019

Appellant by: Jitendra Singh

Respondent by: D.G. Pansari

ORDER 

Saktijit Dey, J.M.

Captioned appeals filed by the same assessee arise out of three separate orders, all dated 12-3-2018, of learned Commissioner (Appeals)-6, Mumbai, for the assessment years 2012-13, 2013-14 and 2014-15.

2. Since all these appeals pertaining to the same assessee and involving common issues, except variation in figures, are arising out of identical set of facts and circumstances, therefore, as a matter of convenience, these appeals were heard together and are being disposed of by way of this consolidated order.
3. Ground no. 1, in all these appeals is general in nature, hence, does not require adjudication.
4. In ground no. 2, the assessee has challenged the disallowance of interest expenditure under section 40A(2)(b) of the Income Tax Act, 1961 (for short “the Act”).
5. Brief facts are, the assessee is a partnership firm engaged in the business of trading in iron and steel, tubes and pipes, etc. For the assessment years under dispute, the assessee had filed its returns of income voluntarily within the due date prescribed under the statute. In the course of the assessment proceedings for the impugned assessment years, the assessing officer noticed that the assessee had claimed expenditure on unsecured loans availed from Hindu Undivided Family (HUF) of the partners who are related parties. Therefore, he called upon the assessee to furnish the details of loan and interest payment to the concerned parties. After perusing the details, he found that the assessee had paid interest @ 15% on the unsecured loans. Since, the unsecured loans were availed from related parties, the assessing officer was of the view that interest paid @ 15% is unreasonable having regard to the market rate of interest. Accordingly, he called upon the assessee to explain why disallowance of interest expenditure should not be made under section 40A(2)(b) of the Act. Though, the assessee objected to the proposed disallowance, however, the assessing officer did not accept the submissions of the assessee. He observed, on the investment made in Fixed deposit by utilizing its own fund the assessee is earning less interest, whereas, on the unsecured loans availed from related parties it is paying interest at higher rates. Thus, he held that interest paid @ 15% per annum is unreasonable having regard to the market rate. Further, the assessing officer held that the reasonable rate of interest which should have been paid on the unsecured loans is @ 12%. Accordingly, the assessing officer restricted assessee’s claim with regard to interest expenditure on unsecured loans to 12% per annum by invoking the provisions of section 40A(2)(b) of the Act. As a result, the following disallowances out of interest expenditure were made in different assessment years under appeal :–

A.Y.	Rs.
2012-13	7,60,187
2013-14	13,51,383
2014-15	17,08,235

6. Being aggrieved with the aforesaid disallowances, though, the assessee preferred appeals before learned Commissioner (Appeals), however, it did not succeed.
7. The learned Authorised Representative submitted, before invoking the provisions of section 40A(2)(b) of the Act, the assessing officer has not recorded any satisfaction that the interest paid on unsecured loan is not in accordance with the market rate. He submitted, no material has been brought on record by the assessing officer to demonstrate that interest paid @ 15% is not as per market rate of interest on such types of loans. He submitted, these loans were continuing from past years and no disallowance of interest expenditure on such unsecured loans has ever been made by the assessing officer in the past assessment years. The learned Authorised Representative submitted, merely because the rate of interest on fixed deposit is less than the interest paid on unsecured loans, it cannot be said that interest paid on unsecured loans is unreasonable. In support of his contention, the learned Authorised Representative relied upon the following decisions :–

(i) Ajanta Handtex (P.) Ltd. v. ITO [IT Appeal No. 4573 (Delhi) of 2015, dt. 26-11-2015]; and

(ii) DCIT v. Park View Developers [IT Appeal No. 7005 & 733 (Mum.) of 2018, dt. 5-10-2018].

8. The learned Departmental Representative submitted, the rate at which the assessee has paid interest on unsecured loans availed from the related parties being higher than the market rate, the assessing officer was justified in making disallowance under section 40A(2)(b) of the Act.
9. We have considered rival submissions and perused the material on record. A reading of the provision of section 40A(2) of the Act as a whole makes it clear that if in the opinion of the assessing officer, the expenditure claimed by the assessee in respect of payment made to any related party/associated concern is excessive or unreasonable having regard to the fair market value, disallowance has to be made under the said provision. Therefore, before making any disallowance under the said provision, two conditions have to be satisfied. Firstly, the payment in respect of which deduction has been claimed must have been made to a related party and secondly, such payment must be excessive and unreasonable having regard to the market rate. Therefore, the assessing officer must form an opinion objectively on the basis of material brought on record to demonstrate that the payment made by the assessee is excessive and unreasonable having regard to the market rate. No doubt, in the facts of the present case, the first condition of section 40A(2) of the Act has been fulfilled as the assessee has made the payment to the related parties. However, as regards the second condition relating to unreasonableness of the payment made, on a perusal of the impugned assessment order it is noticed that the assessing officer has not brought any material on record to demonstrate that the payment made is excessive and unreasonable having regard to the market rate. Simply stating that the rate of interest paid on unsecured loan is higher than the fixed deposit interest rate, the assessing officer has restricted the rate of interest on unsecured loans to 12% per annum. The assessing officer has not brought any comparable case to demonstrate that the market rate of interest on unsecured loan is 12%. The assessing officer cannot equate the rate of interest on bank fixed deposit with unsecured loan as unsecured loans are without any security, hence, the lender always carries the risk of not being able to recover the money. Therefore, the rate of interest is always little higher compared to the rate of bank interest. The decisions cited by the learned Authorised Representative also support this view. Therefore, in the facts of the present case, in our considered opinion, the payment of interest @ 15% per annum on unsecured loans availed from related parties cannot be considered to be excessive on unreasonable to invoke the provisions of section 40A(2)(b) of the Act. Accordingly, we delete the disallowances made by the assessing officer in all the assessment years under appeal. Grounds are allowed.
10. In ground no.3 in all the appeals, the assessee has challengedad hoc disallowance made out of various expenses debited to the Profit & Loss account.
11. During the assessment proceedings, the assessing officer noticed that the assessee had debited expenditure to the Profit & Loss account under various heads such as telephone expenses, motor car expenses, sales promotion expenses, travel expenses, etc. Therefore, he called upon the assessee to furnish the supporting details to prove its claim. Further, he called upon the assessee to substantiate that no personal element is involved in such expenses. Alleging that the assessee could not furnish the log book to prove the motorcar expenses and holding that the personal element cannot be ruled out, he disallowed 10% out of the total expenses claimed in all the assessment years under appeal. Though, the assessee challenged the aforesaid disallowances before the learned Commissioner (Appeals), however, the disallowances were sustained.
12. The learned Departmental Representative relied upon the order of the assessing officer and learned Commissioner (Appeals).
13. We have considered rival submissions and perused the material on record. As could be seen in course of assessment proceedings the assessee has furnished certain details. However, it could not furnish the log book to show the usage of the motorcar. Similarly, the assessee could not bring sufficient material on record to show that the telephone was not used for personal purpose. In such circumstances, part disallowance out of the motorcar and telephone expenses have to be sustained as personal use of the motor car and telephone cannot be ruled out. However, insofar as the sale promotion and travel expenses are concerned, as per the assessing officer’s own admission, the assessee had submitted the details of such expenses. Therefore, without making necessary enquiry to prove that the expenditure claimed by the assessee under these two heads is not genuine or unverifiable, the assessing officer cannot disallow a part of it purely onad hoc basis. Therefore, in our view, no disallowance out of sales promotion and travelling expenses are called for. In view of the aforesaid, we sustain the disallowance made by the assessing officer out of motor care and telephone expenses. However, we delete the disallowance made under sales promotion and travel expenses. Ground raised is partly allowed.
14. Ground no. 4 in all these appeals being consequential in nature does not require adjudication.
15. In the result, all the appeals are partly allowed.