5 Income Tax Judgments dealing with Interest

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Income tax

5 Income Tax Judgments dealing with Interest

  1. Supreme Court in Shew Kissen Bhatter V/sCommissioner of IncomeTax,WestBengal(1973 ITR (Vol.89) 61), in which the Supreme Court considering the question of payment of interest on interest for which the claim was made under section 9(1)(iv) of the Act held as follows:-

“The question is whether the assessee is entitled to deduct the compound interest payable by him in accordance with the terms of the contract referred to earlier or whether he is only entitled to deduct simple interest at the rate of 6- 3/4% per annum. It must be borne in mind that what the law permits is the deduction of the amount of any interest on such mortgage or charge. The interest payable by the assessee on the capital charge was at the rate of 6 3/4% per annum. But if he fails to pay that in accordance with the terms of the contract, he was liable to pay compound interest. In other words, if he fails to pay interest in accordance with the contract, he was liable to pay interest on interest. Or to put it differently, when the interest payable is not paid, the same became a part of the principal and thereafter, interest has to be paid not only on the original principal but also on that part of the interest which had become a part of the principal. It cannot be said that the interest which became a part of the principal can be considered as the capital charge. What the assessee is entitled to deduct is the interest payable by him on the capital charge and not the additional interest which because of his failure to pay the interest on the due date had been considered as a part of the loan. In fact, the real capital charge is that which was originally due. The other portion is merely an interest on which the assessee has agreed to pay interest. Hence we are unable to accept the contention of the assessee that the interest paid on interest is an interest paid on the capital charge. Mr. Chagla, the learned counsel for the assessee, contended that the law permits his client to deduct any interest paid by him on the capital borrowed or charged and ’any interest’ included compound interest also. This, to our minds, appears to be a fallacious argument. The compound interest is payable not on the capital charge but on that part of the interest on which he has agreed to pay interest. That is not the capital taken note of by section 9(1) (v). If we accept Mr. Chagla contention as correct, then the door will be open for evasion of tax. All that the debtor need do is not to pay interest regularly but utilise that amount for other purpose and make the Revenue pay compound interest payable by him and thus derive advantage out of his own omission. Such an interpretation is impermissible.

2. The Gujarat High Court in Jaswantrai P.MehtaV/s Commissioner of Income-tax((1992) 61 Taxman 71 (Guj.)) with reference to Section 57(iii) of the Act held that the interest paid on account of failure to pay interest for preceding year cannot be considered as expenditure laid out or expended wholly or exclusively for purpose of making or earning income.

3. The Bombay High Court in Commissioner of Income Tax V/s Hindustan Conductors(P)Ltd.((2000) 108 Taxman 258 (Bom.) considered the same question with respect of allowability of the interest on interest under section 36(1)(iii) of the Act and held in paragraphs 8 and 9 as follows:-

“8. We have also given our careful consideration to the submission of Mr. Mehta that the ITO has no power under Section 36(1)(iii) to examine the reasonableness of the rate of interest paid by the assessee on borrowings and to disallow any part of the amount which is paid by the assessee as interest on borrowings. We find it difficult to accept the above contention because, in our opinion, the ITO is undoubtedly entitled, while considering the claim for deduction under Section 36(1)(iii), to examine whether the amount paid as interest is really interest and if he finds that it is not wholly interest but partly interest and partly payment for extra commercial consideration to allow only that part of the so-called interest which in his opinion is interest and disallow the balance which is for extra commercial considerations. It is true that in the normal course the ITO cannot disallow any part of the interest on the ground that the rate of interest is high but that does not mean that he has to allow anything and everything claimed by the assessee as interest on amounts borrowed, even if he finds that in fact all that has been paid is not ‘interest.

9˜Interest’ is the return or compensation for the retention by one person of a sum of money belonging to or owed to another. As the essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had use of the money, or conversely, the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation.

4. (Per Lord Wright in Riches v. Westminister Bank Ltd. [1947Ëœ AC 390 at 396,398 HL)It is only interest in the above sense which is “deductible under Section 36(1) (iii). If in the garb of interest something more is paid over and above ‘interest, that something cannot be allowed as deduction under this section. It will not be correct to say that once a claim is made for deduction of any amount by way of interest on the amount borrowed for the purpose of business, the ITO has no power even to examine whether the amount claimed as ˜interest is really an interest, wholly or in part, and if he finds that it is not wholly interest to ascertain that part of it which is interest and restrict the allowance of deduction under Section 36(1)(iii) only to that part which represents interest and to disallow the balance. In our opinion, under Section 36(1)(iii),the assessee is entitled to deduction only of that part of the amount paid by him for money borrowed which can genuinely be regarded as interest. Any and every payment in the garb of interest in excess of what can really be termed as interest cannot be allowed as a deduction under that section.

5. Commissioner of Income Tax Vs. Shri Ramesh Chandra Bhati ( High Court of Rajasthan) DOJ 14.07.2015

Credit balance represented only cumulative interest on interest for past so many years and therefore, AO held that interest liability claimed is wholly referable to interest, which is not permissible under section 36(1)(iii) of Act . Deduction of interest claimed was thus not attributable directly to business . Section 36(1)(iii) of Act allows deduction of only that part of amount paid as interest, which is interest on money borrowed, which can be genuinely regarded as interest . When principal amount borrowed stood repaid, interest on interest was not genuine amount, even if it was payable to creditor which will qualify for deduction Interest on interest is payable either on default contemplated under agreement or by way of penalty or amount shown in account books to be paid for settlement of account .  In either of case, it is not deductible as Assessee is in default. Interest on interest cannot be said to be benefit extended in carrying on business.  It is an element of default, which attracts interest by way of penalty and which is not permissible deduction

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