ITAT Overturns 60.53 Lakh Interest Deduction Disallowance under Section 57

The appellant, a partner in two partnership firms, had filed her return for AY 2020–21, declaring interest income and claiming a deduction of Rs. 1.15 crore under Section 57 of the Income Tax Act. In addition to paying interest at a rate of 9.04% on loans totalling more than Rs. 15.83 crore, she also earned an average interest rate of 5.22% on subsequent loans totalling Rs. 22.43 crore. The Assessing Officer rejected Rs. 60.53 lakh of the claimed interest expense, claiming that there was no business rationale for the funds’ loan to family members or related entities at lower or no interest.

The assessee explained that lower rates were agreed upon due to the borrowers’ limited financial capacity and that interest cannot be notional. However, the AO limited the deduction to the average earning rate of 5.22%, and the CIT(A) upheld the disallowance, terming the lending practice lacking in business prudence or commercial expediency. Thus, aggrieved by the said decision of the CIT(A), the assessee filed an appeal before the ITAT Mumbai Bench.

Issue Raised: Whether restricting interest deduction under Section 57 based on a differential between borrowing and lending rates, absent any finding of non-business purpose, is justified.

ITAT Mumbai’s Decision: The tribunal held that the assessee had borrowed on interest and also earned interest income, and there was no legal requirement to match borrowing and lending rates exactly. Since the assessee had declared interest income and paid interest wholly for earning that income, disallowance of a portion on the ground of rate difference was not tenable. The AO also failed to prove diversion of funds for non-income-generating purposes. The disallowance of Rs. 60.53 lakh was accordingly deleted.

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