Commissioner Of Income Tax-Ii v. Shri Ramesh Chandra Bhati

IN THE HIGH COURT OF JUDICATURE FOR RAJASTHAN AT JODHPUR. D.B.Income Tax Appeal No.133/2006 Commissioner of Income Tax-II V/s Shri Ramesh Chandra Bhati Date of Judgment::-14.7.2015 PRESENT HON’BLE CHIEF JUSTICE MR.SUNIL AMBWANIHON’BLE MR.JUSTICE VIJAY BISHNOI Mr.Sunil Bhandari for the appellant-Department. JUDGMENT (Reportable)BY THE COURT (Per Hon'ble Sunil Ambwani, CJ) 1.We have heard learned counsel appearing for theDepartment. 2.The appeal was admitted on 12.12.2006, after which, itcould not be listed as the service on respondent was not found tobe sufficient. The Department has applied and carried outpublication of notice in the newspaper for service on respondent.The office reported that the notice has been published in theRajasthan Patrika, which has a wide circulation in the State ofRajasthan and thus, service is complete. 3.We are satisfied with the service of summons on theprivate respondent and thus, we proceed to hear and decide thematter. 4.The appeal was admitted on the following substantialquestion of law:- “Whether, on the facts and in the circumstances of the case, the learned ITAT was legally justified in holding thatthe deduction on account of payment of interest on interestwas allowable under section 36(i)(iii) and Section 37(1) ofthe Act of 1961?” 5.The facts of the case are that a return declaring income ofRs.38,590/- was filed on 2.12.1996 alongwith the statement oftotal income, copies of trading and P/L account, balance-sheetand its annexures. The audit report was also filed under section44AB of the Income Tax Act, 1961 (for short, “the Act”). Theassessee did not submit satisfactory explanation on the claim fordeduction of interest of Rs.3,82,187/-. The Assessing Officer(Assistant Commissioner of Income Tax) observed as follows:- “The assessee has claimed total interest of Rs.382187,however, he failed to give break up of interest attributableto interest on interest and the interest attributable tooriginal Principal. From the accounts it is seen that theamounts more than the principal loan stand repaid,therefore, the credit balance represents only cumulativeinterest on interest for the past so many years, therefore,the interest liability claimed is wholly referable to intereston interest. Since interest amounting to Rs.14985/- hadalready been disallowed on ingenuine credits, the balanceamount of Rs.3,67,202/- is disallowed in view of thejudgments cited supra.” 6.The Appellate Authority (Commissioner of Income Tax(Appeals)), partly allowed the appeal of the assessee onthe claim of interest on the ground that the provisions ofSection 36(1)(iii) and Section 37(1) entitle such deduction;the AO was not justified in disallowing the claim and in(Appeals)), partly allowed the appeal of the assessee onthe claim of interest on the ground that the provisions ofSection 36(1)(iii) and Section 37(1) entitle such deduction;the AO was not justified in disallowing the claim and in 7.The Income Tax Appellate Tribunal (ITAT) has dismissedthe appeal with the findings:- 6.The Appellate Authority (Commissioner of Income Tax(Appeals)), partly allowed the appeal of the assessee onthe claim of interest on the ground that the provisions ofSection 36(1)(iii) and Section 37(1) entitle such deduction;the AO was not justified in disallowing the claim and in(Appeals)), partly allowed the appeal of the assessee onthe claim of interest on the ground that the provisions ofSection 36(1)(iii) and Section 37(1) entitle such deduction;the AO was not justified in disallowing the claim and in 7.The Income Tax Appellate Tribunal (ITAT) has dismissedthe appeal with the findings:- “The right to interest on interest was recognized in CIT Vs.Narendra Doshi (2002) reported in 254 ITR 606 in the caseof Hon'ble Supreme Court. Although this interest was to becharged on the refund amount in relation to Sec.214 of theAct, in our opinion the Assessing Officer disallowed thisclaim of the assessee as according to him the assess wasnot entitled to deduction in respect of interest on interest,and that the assessee was not able to compute the elementof interest on interest included in the total claim ofRs.3,82,187. But the Assessing Officer has no where refutedthe claim of the assessee that the assessee had utilized theborrowed fund only for the purpose of business. That beingthe case, when the interest was paid on the interest, thesame becomes allowable u/s 36(1)(iii) and Sec.37(1) of theAct. The facts of the Hon'ble Supreme Court's decision andthe Hon'ble Gujarat High Court decision relied by theAssessing Officer are not relevant because in whose casesonly computation of income from house property andincome from other sources were in question. Therefore, thelast ground of appeal also fails.” 8.Learned counsel appearing for the Department has reliedon the judgment of the Supreme Court inShew Kissen Bhatter V/s Commissioner of Income Tax, West Bengal (1973 ITR(Vol.89) 61), in which the Supreme Court considering thequestion of payment of interest on interest for which the claimwas made under section 9(1)(iv) of the Act held as follows:- “The question is whether the assessee is entitled to deductthe compound interest payable by him in accordance with 8.Learned counsel appearing for the Department has reliedon the judgment of the Supreme Court inShew Kissen Bhatter V/s Commissioner of Income Tax, West Bengal (1973 ITR(Vol.89) 61), in which the Supreme Court considering thequestion of payment of interest on interest for which the claimwas made under section 9(1)(iv) of the Act held as follows:- “The question is whether the assessee is entitled to deductthe compound interest payable by him in accordance with the terms of the contract referred to earlier or whether heis only entitled to deduct simple interest at the rate of 6-3/4% per annum. It must be borne in mind that what thelaw permits is the deduction of the 'amount of any interest.on such mortgage or charge'. The interest payable by theassessee on the capital charge was at the rate of 6 3/4%per annum. But if he fails to pay that in accordance withthe terms of the contract, he was liable to pay compoundinterest. In other words, if he fails to pay interest inaccordance with the contract, he was liable to pay intereston interest. Or to put it differently, when the interestpayable is not paid, the same became a part of the principaland thereafter, interest has to be paid not only on theoriginal principal but also on that part of the interest whichhad become a part of the principal. It cannot be said thatthe interest which became a part of the principal can beconsidered as the capital charge. What the assessee isentitled to deduct is the interest payable by him on thecapital charge and not the additional interest which becauseof his failure to pay the interest on the due date had beenconsidered as a part of the loan. In fact, the real capitalcharge is that which was originally due. The other portion ismerely an interest on which the assessee has agreed to payinterest. Hence we are unable to accept the contention ofthe assessee that the interest paid on interest is an interestpaid on the capital charge. Mr. Chagla, the learned counselfor the assessee, contended that the law permits his clientto deduct any interest paid by him on the capital borrowedor charged and 'any interest' included compound interestalso. This, to our minds, appears to be a fallaciousargument. The compound interest is payable not on thecapital charge but on that part of the interest on which hehas agreed to pay interest. That is not the capital takennote of by section 9(1) (v). If we accept Mr. Chagla'scontention as correct, then the door will be open forevasion of tax. All that the debtor need do is not to payinterest regularly but utilise that amount for other purposeand make the Revenue pay compound interest payable byhim and thus derive advantage out of his own omission.Such an interpretation is impermissible.” 9.The Gujarat High Court in Jaswantrai P.Mehta V/s -Commissioner of Incometax((1992) 61 Taxman 71 (Guj.))with reference to Section 57(iii) of the Act held that the interestpaid on account of failure to pay interest for preceding yearcannot be considered as expenditure laid out or expended wholly or exclusively for purpose of making or earning income. 10.The Bombay High Court in Commissioner of IncomeTax V/s Hindustan Conductors (P) Ltd.((2000) 108 Taxman258 (Bom.) considered the same question with respect ofallowability of the interest on interest under section 36(1)(iii) ofthe Act and held in paragraphs 8 and 9 as follows:- 9.The Gujarat High Court in Jaswantrai P.Mehta V/s -Commissioner of Incometax((1992) 61 Taxman 71 (Guj.))with reference to Section 57(iii) of the Act held that the interestpaid on account of failure to pay interest for preceding yearcannot be considered as expenditure laid out or expended wholly or exclusively for purpose of making or earning income. 10.The Bombay High Court in Commissioner of IncomeTax V/s Hindustan Conductors (P) Ltd.((2000) 108 Taxman258 (Bom.) considered the same question with respect ofallowability of the interest on interest under section 36(1)(iii) ofthe Act and held in paragraphs 8 and 9 as follows:- “8. We have also given our careful consideration to thesubmission of Mr. Mehta that the ITO has no powerunder Section 36(1)(iii) to examine the reasonableness ofthe rate of interest paid by the assessee on borrowings andto disallow any part of the amount which is paid by theassessee as interest on borrowings. We find it difficult toaccept the above contention because, in our opinion, theITO is undoubtedly entitled, while considering the claim fordeduction under Section 36(1)(iii), to examine whether theamount paid as interest is really ‘interest’ and if he findsthat it is not wholly interest but partly interest and partlypayment for extra commercial consideration to allow onlythat part of the so-called interest which in his opinion is‘interest’ and disallow the balance which is for extracommercial considerations. It is true that in the normalcourse the ITO cannot disallow any part of the interest onthe ground that the rate of interest is high but that does notmean that he has to allow anything and everything claimedby the assessee as interest on amounts borrowed, even ifhe finds that in fact all that has been paid is not ‘interest’. 9. ‘Interest’ is the return or compensation for the retentionby one person of a sum of money belonging to or owed toanother. As the essence of interest is that it is a paymentwhich becomes due because the creditor has not had hismoney at the due date. It may be regarded either asrepresenting the profit he might have made if he had useof the money, or conversely, the loss he suffered becausehe had not that use. The general idea is that he is entitledto compensation for the deprivation. (per Lord Wright inRiches v. Westminister Bank Ltd. [1947] 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 ofinterest something more is paid over and above ‘interest’,that something cannot be allowed as deduction under thissection. It will not be correct to say that once a claim ismade for deduction of any amount by way of interest on theamount borrowed for the purpose of business, the ITO hasno power even to examine whether the amount claimed as‘interest’ is really an interest, wholly or in part, and if hefinds that it is not wholly interest to ascertain that part of itwhich is interest and restrict the allowance of deductionunder Section 36(1)(iii) only to that part which representsinterest and to disallow the balance. In our opinion,under Section 36(1)(iii),the assessee is entitled to deductiononly of that part of the amount paid by him for moneyborrowed which can genuinely be regarded as interest. Anyand every payment in the garb of interest in excess of whatcan really be termed as ‘interest’ cannot be allowed as adeduction under that section.” 11.In the present case, the assessee had failed to give breakup of the interest attributable to interest on interest and theinterest attributable to original principal. It was seen from theaccounts that the amounts more than the principal loan stoodrepaid. The credit balance represented only cumulative intereston interest for the past so many years and therefore, the AOheld that the interest liability claimed is wholly referable tointerest, which is not permissible under section 36(1)(iii) of theAct. The deduction of interest claimed was thus not attributabledirectly to business. Section 36(1)(iii) allows deduction of onlythat part of the amount paid as interest, which is the interest onmoney borrowed, which can be genuinely regarded as interest.When the principal amount borrowed stood repaid, the intereston interest was not a genuine amount, even if it was payable tothe creditor which will qualify for deduction. 12.We do not find that the Appellate Authority and the ITAThave given sufficient and cogent reasons in holding that theassessee is entitled to deduction under section 36(1)(iii) of theAct and Section 37(1) of the Act. The ITAT has relied on thejudgment of the Supreme Court in CIT V/s Narendra Doshi(2002) reported in 254 ITR 606, which was related to the issueof interest to be charged on the refund amount and not intereston interest. Section 37(1) is not applicable in view of specificSection 36(1)(iii) under which the assessee could have claimedthe amount of interest and which provides that the amount ofinterest paid in respect of capital borrowed for the purposes ofthe business or profession, can be claimed as permissiblededuction. Interest on interest is payable either on defaultcontemplated under the agreement or by way of penalty or theamount shown in the account books to be paid for the settlementof the account. In either of the case, it is not deductible as theassessee is in default. 13.Further, we are of the view that interest on interest cannotbe said to be a benefit extended in carrying on the business. It isan element of default, which attracts the interest by way ofpenalty and which is not permissible deduction. 14.In the present case, there is an additional feature thatassessee failed to explain the amount which was claimed to bededucted under section 36(1)(iii) of the Act. It was found thatthe entire capital was paid and what was remaining in theaccount was interest on which the interest was shown and whichwas sought to be deducted. The AO was not satisfied with the genuineness of the entry. He observed that since the interestamounting to Rs.1,49,85/- has already been disallowed oningenuine credits, the balance amount was also disallowed. Hehad rightly relied on the judgment of Supreme Court in ShewKissen Bhatter V/s Commissioner of Income Tax, West Bengal(supra) and judgment of Gujarat High Court in JaswantraiP.Mehta V/s Commissioner of Income-tax (supra). 15.In view of the aforesaid discussion, the question isreturned in favour of the Department and against the assessee.The Department will proceed accordingly. (VIJAY BISHNOI),J. (SUNIL AMBWANI),CJ. Parmar