CHAPTER – 1

Sections of the Income Tax Act, 1961 relevant to Interest expenditure

Section – 2(28A) - Definition

Interest means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized

Section – 36(1)(iii) – Other Deduction (Relevant Extract)

The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 —

The amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :

Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.

Section – 43B – Certain deductions to be only on actual payment (Relevant Extract)

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

………

(d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution [or a State financial corporation or a State industrial investment corporation], in accordance with the terms and conditions of the agreement governing such loan or borrowing

(e) any sum payable by the assessee as interest on any [loan or advances] from a scheduled bank [or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank] in accordance with the terms and conditions of the agreement governing such loan [or advances]

shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him

[Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return

Section – 37 – General (Relevant Extract)

Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession

Section – 194A – Interest other than Interest on securities

(1) Any person, not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of interest other than income [by way of interest on securities], shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :

[Provided that an individual or a Hindu undivided family, whose total sales, gross receipts or turnover from the business or profession carried on by him exceed the monetary limits specified under clause (a) or clause (b) of section 44AB during the financial year immediately preceding the financial year in which such interest is credited or paid, shall be liable to deduct income-tax under this section.]

[Explanation.—For the purposes of this section, where any income by way of interest as aforesaid is credited to any account, whether called "Interest payable account" or "Suspense account" or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.]

(2) [Omitted by the Finance Act, 1992, w.e.f. 1-6-1992.]

(3) The provisions of sub-section (1) shall not apply—

[(i) where the amount of such income or, as the case may be, the aggregate of the amounts of such income credited or paid or likely to be credited or paid during the financial year by the person referred to in sub-section (1) to the account of, or to, the payee, [does not exceed—

(a) ten thousand rupees, where the payer is a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution, referred to in section 51 of that Act);

(b) ten thousand rupees, where the payer is a co-operative society engaged in carrying on the business of banking;

(c) ten thousand rupees, on any deposit with post office under any scheme framed by the Central Government and notified by it in this behalf; and

(d) five thousand rupees in any other case]:]

(a) time deposits with a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution referred to in section 51 of that Act); or

(b) time deposits with a co-operative society engaged in carrying on the business of banking;

(c) deposits with a public company which is formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes [and which is eligible for deduction under clause (viii) of sub-section (1) of section 36] ;

(ii) [***]

(iii) to such income credited or paid to—

(a) any banking company to which the Banking Regulation Act, 1949 (10 of 1949), applies, or any co-operative society engaged in carrying on the business of banking (including a co-operative land mortgage bank), or

(b) any financial corporation established by or under a Central, State or Provincial Act, or

(c) the Life Insurance Corporation of India established under the Life Insurance Corporation Act, 1956 (31 of 1956), or

(d) the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963), or

(e) any company or co-operative society carrying on the business of insurance, or

(f) such other institution, association or body [or class of institutions, associations or bodies] which the Central Government may, for reasons to be recorded in writing, notify51 in this behalf in the Official Gazette;

[(iv) to such income credited or paid by a firm to a partner of the firm;]

(v) to such income credited or [paid by a co-operative society (other than a co-operative bank) to a member thereof or to such income credited or paid by a co-operative society] to any other co-operative society;]

[(vi) to such income credited or paid in respect of deposits under any scheme framed by the Central Government and notified by it in this behalf in the Official Gazette;

[(vii) to such income credited or paid in respect of deposits (other than time deposits made on or after the 1st day of July, 1995) with a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution referred to in section 51 of that Act);

(viia) to such income credited or paid in respect of,—

(a) deposits with a primary agricultural credit society or a primary credit society or a co-operative land mortgage bank or a co-operative land development bank;

(b) deposits (other than time deposits made on or after the 1st day of July, 1995) with a co-operative society, other than a co-operative society or bank referred to in sub-clause (a), engaged in carrying on the business of banking;]

[(viii) to such income credited or paid by the Central Government under any provision of this Act or the Indian Income-tax Act, 1922 (11 of 1922), or the Estate Duty Act, 1953 (34 of 1953), or the Wealth-tax Act, 1957 (27 of 1957), or the Gift-tax Act, 1958 (18 of 1958), or the Super Profits Tax Act, 1963 (14 of 1963), or the Companies (Profits) Surtax Act, 1964 (7 of 1964), or the Interest-tax Act, 1974 (45 of 1974);]

(ix) to such income credited by way of interest on the compensation amount awarded by the Motor Accidents Claims Tribunal;

(ixa) to such income paid by way of interest on the compensation amount awarded by the Motor Accidents Claims Tribunal where the amount of such income or, as the case may be, the aggregate of the amounts of such income paid during the financial year does not exceed fifty thousand rupees;]

[(x) to such income which is paid or payable by an infrastructure capital company or infrastructure capital fund or a public sector company [or scheduled bank] in relation to a zero coupon bond issued on or after the 1st day of June, 2005 by such company or fund or public sector company [or scheduled bank];]

[(xi) to any income by way of interest referred to in clause (23FC) of section 10.]

[Explanation 1.—For the purposes of clauses (i), (vii) and (viia), "time deposits" means deposits ([including] recurring deposits) repayable on the expiry of fixed periods.

[(4) The person responsible for making the payment referred to in sub-section (1) may, at the time of making any deduction, increase or reduce the amount to be deducted under this section for the purpose of adjusting any excess or deficiency arising out of any previous deduction or failure to deduct during the financial year.]

Section – 40(a)(ia) – Amount not deductible (Relevant Extract)

Notwithstanding anything to the contrary in sections 30 to 41, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",—

(a) in the case of any assessee

……………

(ia) [thirty per cent of any sum payable to a resident], on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, [has not been paid on or before the due date specified in sub-section (1) of section 139

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, [thirty per cent of] such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid

Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso.

Section – 201 – Consequences of failure to deduct or pay (Relevant Extract)

(1) Where any person, including the principal officer of a company,-

(a) who is required to deduct any sum in accordance with the provisions of this Act; or

(b) referred to in sub-section (1A) of section 192, being an employer

does not deduct, or does not pay, or after so deducting fails to pay, the whole or any part of the tax, as required by or under this Act, then, such person, shall, without prejudice to any other consequences which he may incur, be deemed to be an assessee in default in respect of such tax

Provided that any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident—

(i) has furnished his return of income under section 139;

(ii) has taken into account such sum for computing income in such return of income; and

(iii) has paid the tax due on the income declared by him in such return of income

and the person furnishes a certificate to this effect from an accountant in such form as may be prescribed

Provided [further] that no penalty shall be charged under section 221 from such person, unless the Assessing Officer is satisfied that such person, without good and sufficient reasons, has failed to deduct and pay such tax.

(1A) Without prejudice to the provisions of sub-section (1), if any such person, principal officer or company as is referred to in that sub-section does not deduct the whole or any part of the tax or after deducting fails to pay the tax as required by or under this Act, he or it shall be liable to pay simple interest,—

(i) at one per cent for every month or part of a month on the amount of such tax from the date on which such tax was deductible to the date on which such tax is deducted; and

(ii) at one and one-half per cent for every month or part of a month on the amount of such tax from the date on which such tax was deducted to the date on which such tax is actually paid

Section – 14A – Expenditure incurred in relation to income not includible in total income (Relevant Extract)

(1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act

Linking between various sections with the help of flowcharts

If the expenditure satisfies the definition as given in Clause (28B) Section 2 of the Income Tax Act,1961, then such expenditure can be classified as an ‘Interest Expense’ for the purpose of reporting in Statement of Profit & Loss.

Further, such interest is an allowable expenditure for the purpose of computing income under the head of ‘Profit & Gains from Business & Profession’ by invoking the provisions of Section 36(1)(iii) of the Income Tax Act,1961.

Further more, once the interest expenditure passes through the hurdle of Section 36(1)(iii) of the Act, { That interest paid should be in respect to capital borrowed for the purpose of business or profession}, Next thing which is to be checked is compliance with the provisions of Section 43B of the Act as and when applicable i.e. payment of interest expenditure on or before due date of furnishing the return of income.

The very next thing to be kept in mind is applicability of TDS provisions u/s 194A of the Act. If interest is liable for TDS deduction as per Section 194A but TDS has not deducted or after deduction not been deposited to the credit of the Central Government, 30% of interest expenditure which passed the first window of 36(1)(iii) & Second window of 43B would be disallowed u/s 40(a)(ia) of the Act.

Now, if the interest expenditure has passed the first window i.e. 36(1)(iii), second window of 43B & third window of 40(a)(ia) , the next hurdle is to check the applicability of provisions of Section 14A of the Act. If the interest expenditure is in respect to capital borrowed which is resulting into such income which does not form part of the total income, then such interest expenditure is liable to be disallowed in accordance computation as specified under Rule 8D of the Income Tax Rules, 1962.

Analysis of Section

Section 2(28A), Income Tax Act,1961

Section 2(28A) of the Act stipulates that interest payable in respect of money borrowed or debt incurred or credit facility. This section no where discusses :-

1. About the purpose of borrowing – whether personal or business/ profession

2. About the type of borrowing – whether for working capital or capital expenditure.

Section 36(1)(iii), Income Tax Act,1961

Section 36(1)(iii) of the Act, resolves the issues not being considered by Section 2(28A) of the Act . Section 36(1)(iii) laid down the following conditions in order to claim interest as an expenditure while computing income under the head of Profit & Gains from Business or Profession :-

1. The assessee must have borrowed money

2. The money so borrowed must have been used for the purpose of business.

3. Interest is paid or payable on such borrowings.

Section 36(1)(iii) does not make any distinction between interest paid on capital utilized in acquiring capital asset or a revenue asset.

Further, Section 36(1)(iii) provides that in case capital is borrowed for the purpose of acquisition of a capital asset then interest expense for the period beginning from date of borrowing till the date of asset was first put to use shall not be allowed as deduction. To overcome this issue, Explanation 8 of Section 43(1) of the Act provides that ‘it is hereby declared that where any amount is paid or is payable as interest in connection with the acquisition of an asset, so much of such amount as is relatable to any period after such asset is first put to use shall not be included, and shall be deemed never to have been included, in the actual cost of such asset’. It means interest component for period commencing from date of acquisition and end on date of put of use shall be capitalized in the cost of assets and shall be allowed as deduction in the form of depreciation over a period of time.

Section 43B, Income Tax Act,1961

Section 43B of the Income Tax Act, 1961 specifies a list of expenses which are otherwise deductible under the other provision of the Income Tax Act, are deductible on payment basis. However, there is an exception when deduction is available on accrual basis subject to following conditions :-

1. Payment in respect of such expenses is actually made on or before the due date of submission of return.

2. There should be proper evidence with the taxpayer in respect of such payment.

Apart from the other expenses, Section 43B also covers interest expenditure, the relevant extract of the same is mentioned below :-

1. Any sum payable as interest on any loan or borrowing from a public financial institution or state financial corporation or a state industrial investment corporation

2. Interest on any loan or advance taken from a scheduled bank including a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank.

The condition that ‘interest expenditure should have been paid by the taxpayer’ is strongly supported by Section 43B of the Act. Clause (d) & (e) of Section 43B provides that interest on loans/advances/borrowings from the public financial institution or scheduled banks shall be allowed in the previous year in which interest of payment is made or shall be allowed in the same year if the payment of interest expenditure is made on or before due date of furnishing return of income u/s 139 of the Act.

Therefore, only incurring liability to claim interest as an expenditure is not sufficient, taxpayer has to make payment( whenever 43B is attracted) for the same in order to avoid any disallowance & penal actions during the course of assessment proceedings.

Therefore, it can be concluded that Section 36(1)(iii) discuss about the claiming of interest expenditure but Section 43B talks about the allowability/disallowability i.e once interest expenditure satisfies the conditions to claim interest as an expenditure , then Section 43B checks whether it is allowable or not under Income Tax Act, 1961.

Section 194A, Income Tax Act,1961

Any person except individual & HUF not liable to tax audit u/s 44AB of the Income Tax Act,1961 who is responsible for making payment to a resident any income by way of interest other than interest on securities shall deduct TDS @10% if payment amount exceeds the specified threshold amount. However, if recipient does not furnishes PAN to the deductor, tax shall be deducted @ 20%.

Therefore, Section 194A and Section 40(a)(ia) are directly linked with each other. If the payer , nature of payment and amount of payment falls u/s 194A and payer does not comply with provision and makes interest payment without deduction of TDS, then payer shall be considered as committed TDS default and shall attract 30% disallowance of interest expenditure by virtue of Section 40(a)(ia). Further, once Section 40(a)(ia) is attracted , then Section 201 gets attracted automatically as non deduction of TDS makes the payer as ‘Assessee in default’.

However, once payer is not considered as assessee in default u/s 201 by virtue of proviso to Section 201(1), then he shall not be considered as assessee in default for the purpose of Section 40(a)(ia) as well and no disallowance shall be attracted on the payer even though if he fails to discharge the liability to deduct TDS u/s 194A of the Income Tax Act,1961.

Section 40(a)(ia), Income Tax Act,1961

Section 40(a)(ia) of the Income Tax Act,1961 stipulates that payments/credits to a resident on which TDS is deductible under Chapter XVII-B of the Income-tax Act, if the person making payments/credit fails to deduct or after deduction fails to deposit to the credit of Government, then 30 percent of such expenditure shall be disallowed in the hands of payer. There is also an exception to this, in case amount of TDS deducted is deposited to the credit of the Government on or before due date of submission of return of income u/s 139(1) then no such disallowance is attracted.

This 30 percent disallowance on account of TDS defaults is applicable from AY 2015-16. Up to the assessment year 2014-15, 100 percent of such expenditure was not deductible.

Further, with effect from Assessment Year 2013-14, a relief was given subject to following conditions :-

1. Tax is deductible on the exepense but it is not deducted (wholly or partly)

2. The payer is not deemed to be an assessee-in-default under the first proviso to Section 201(1). Under the first proviso to Section 201(1), the payer is not deemed to be an assessee-in-default if –

a) The resident recipient has furnished his return of Section 139

b) The resident recipient has taken into account such income in return of income.

c) The resident recipient has paid the tax due on the income declared in such return of income

d) The payer furnishes electronically a certificate to this effect from a Chartered Accountant in Form No. 26A.

If the above conditions are satisfied, then for the purpose of Section 40(a)(ia), it shall be deemed that the payer has deducted and paid the tax on such amount on the date of the furnishing return of income by the resident recipient and hence expenditure does not get disallowed u/s 40(a)(ia).