Disallowance of Claim for Interest Expense u/s 36(1)(iii): ITAT Directs AO to Verify Business Nexus and Reassess Deduction [Read Order]

The Ahmedabad Bench of Income Tax Appellate Tribunal ( ITAT )  directed the Assessing Officer ( AO ) to verify the business nexus of the interest expense claimed under Section 36(1)(iii) and reassess the deduction, while also examining the validity of the nexus for the claim under Section 57 of Income Tax Act,1961.

Jitendra Prakashchandra Shah, appellant-assessee, was selected for limited scrutiny regarding interest deduction on "income from other sources." He had received Rs. 52,893/- as interest income from loans given to various concerns and claimed a deduction of Rs. 69,36,456/- under Section 57 of the Act.

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The AO asked the appellant to show the connection between the borrowed funds and the funds on which interest was earned. During the proceedings, the appellant admitted he had mistakenly claimed Rs. 59,25,359/- as interest expenses under Section 57, which should have been claimed under Section 36(1)(iii) as business expenses. He submitted a revised computation, claiming only Rs. 10,11,097/- under Section 57.

However, the AO noted that the assessee's books were audited, but no revised Tax Audit Report or return of income was filed. Additionally, the assessee failed to prove the nexus between the borrowed and lent funds. As a result, the AO added Rs. 69,36,456/- back to the appellant's income under Section 57 of the Act.

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The assessee appealed to the Commissioner of Income Tax(Appeals)[CIT(A)], who agreed with the AO’s decision. The CIT(A) noted that the assessee did not prove the interest expense of Rs. 69,36,456/- was only for earning interest income. Since the assessee did not provide enough proof, the CIT(A) upheld the addition of Rs. 69,36,456/- under Section 57 of the Act.

Aggrieved by the CIT(A) decision the assessee appealed before the tribunal.

The tribunal reviewed the case and noted that the assessee's claim for interest expense deduction of Rs. 69,36,456/- was under scrutiny. The assessee revised its claim, stating that Rs. 59,25,359/- should have been claimed under Section 36(1)(iii) for business expenses, not Section 57. The assessee also provided details of interest paid and parties involved.

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The appellate tribunal observed that the AO and CIT(A) did not address the alternate claim under Section 36(1)(iii) and only rejected the Section 57 claim due to lack of proof of nexus between borrowed funds and earned interest.

Read More: Disallowance of ₹50.05 Lakh u/s 37(1): ITAT directs AO to verify Business Commencement

The two member bench comprising Dr.BRR Kumar(Vice President) and Siddhartha Nautiyal (Judicial Member) ruled that a legitimate deduction claim should not be denied solely for not being included in the return of income. It directed the AO to verify the claim, especially whether the interest expense was for business purposes and if it qualified under Section 36(1)(iii) of the Act.

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The AO was also instructed to check whether the interest funds were used for the construction business and whether the nexus for Section 57 was valid.The AO was directed to verify the claims as mentioned and pass appropriate orders based on the findings.

In short,the appeal was allowed for statistical purposes.

To Read the full text of the Order CLICK HERE

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