Disallowance of Rs.10.28 Lakh Interest on Loan by Charitable Trust as Application of Income: ITAT Sets Aside CIT(A) Order [Read Order]

Zenith Public School,appellant-assessee, was a charitable trust that filed its income tax return for AY 2022-23 on 10.10.2022, which was selected for scrutiny. During the assessment, the AO sought details, which the appellant provided.

The assessee stated that it had total receipts of Rs.98,20,749/- and incurred expenses of Rs.22,41,070/-, applying the remaining Rs.75,79,679/- towards repayment of loans, including Rs.43,74,799/- to the managing trustee, Mr. P. Shanmugam, which included interest of Rs.10,16,097/-. The assessee submitted supporting loan documents and financials showing the interest payments as expenses and receipts.

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The AO issued a show-cause notice proposing to disallow Rs.10,28,208/- as repayment of loan was not allowed under Explanation 4 to section 11. The assessee explained that the amount represented interest and late fees and requested the variation be dropped.

The AO still disallowed the claim. Before the CIT(A), the assessee argued that the borrowings were used for building construction, which was not claimed as application, so Explanation 4 did not apply. The CIT(A) dismissed the appeal, noting the assessee had not clarified if the construction cost had already been claimed and that the loan receipts’ treatment in the P&L account was unclear, and upheld the disallowance.

The two member bench comprising Manu Kumar Giri (Judicial Member) and S.R.Raghunatha (Accountant Member) examined the submissions and records. During FY 2021-22, the assessee claimed loan repayment and interest payments totaling Rs.75,14,899/- as application of income. The assessee had submitted a letter on 18.04.2023 stating that it paid interest on loans taken from Mr. P. Shanmugam along with the principal amount.

In response to the show-cause notice, it clarified that interest and late fees of Rs.10,28,621/- were paid during the year. Despite these clarifications, the AO disallowed Rs.10,28,208/- citing Explanation 4 to section 11.

The tribunal accepted the assessee counsel’s argument that Explanation 4 only applies to repayment of principal and does not restrict claiming interest as application of income. The AO’s disallowance of Rs.10,28,208/- was therefore unjustified. The Departmental counsel claim that it was a typographical error could not be accepted.

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Even if the AO’s intention was to disallow the loan repayment, the assessee had shown that part of the borrowings was used for constructing a building, which was not claimed as application. The CIT(A) had wrongly recorded that the assessee failed to clarify this point. The paper book confirmed that loan repayment of Rs.75,14,899/- was made during the year and was allowable as application of income.

The tribunal concluded that the AO had wrongly disallowed interest payments, and Explanation 4 did not prevent their claim. The order of the CIT(A) was set aside, the addition was directed to be deleted, and the assessee’s appeal was allowed.

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