Scrutiny issue

This query is : Resolved

Astaf Mansuri (Querist)
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07 January 2014 Scrutiny Issue :

Assessee has paid interest on unsecured loan, and did not charged interest on loans and advances given.

can AO assumed that assessee must have charged interest on loans and advances given ? and can AO make addition sum of interest on loans and advances at the same rate as on unsecured loan ?

Is it necessary to charge interest on loans and advances given when assessee has paid the interest on unsecured loan ??

CS Advocate Abhishek Goyal

CS Advocate Abhishek Goyal (Expert)
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07 January 2014 Normally in most cases the AO makes addition of interest which is not charged on loans and advances given when he has paid interest on unsecured loans. This is because interest paid is claimed as deduction out of taxable income therefore the AO also scrutinizes whether any interest income is shown by the assessee on loans and advances given by him.

C A S.S.Agarwal, M.Com.,LL.B,

C A S.S.Agarwal, M.Com.,LL.B, (Expert)
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07 January 2014 To the extant of your capital the ITO cannot charge interest if you have given free of interest. If the amount exceeds the capital then the interest paid shall be disallowed in proportionate to the capital and loan. There are court judgments on this issue

Astaf Mansuri

Astaf Mansuri (Querist)
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08 January 2014 AGARWAL SIR, WILL YOU PLEASE MENTION THE CITATION OF FEW JUDGMENTs.

Asha Kanta Sharma online

Asha Kanta Sharma online

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23 July 2025 In this situation, where an assessee has paid interest on unsecured loans but has not charged any interest on loans and advances given to others, the Assessing Officer (AO) may scrutinize the matter to ensure that there is no tax avoidance or under-reporting of income.

Here are some key points to consider and some citations for relevant judgments:

### **Key Issues:**

1. **Interest Paid vs. Interest Received**:

* If the assessee is paying interest on unsecured loans but not charging interest on loans and advances provided, the AO may argue that the interest paid should be disallowed in part, or that interest income on the loans and advances should have been declared.

2. **Proportionate Disallowance**:

* The interest paid on unsecured loans may be disallowed proportionately if the assessee has not charged interest on loans given, especially if the amount of loans given exceeds the capital in the business.

3. **AO’s Discretion**:

* The AO may assume that the assessee should have charged interest on the loans given in a manner similar to the interest paid, as this might reflect the commercial reality of the transaction.

4. **Requirement to Charge Interest**:

* It is not necessary to charge interest on loans and advances given if the business arrangement does not require it. However, if the assessee claims a deduction for interest paid, the AO may challenge the lack of corresponding interest income on the loans and advances given.

### **Relevant Case Law Citations**:

1. **CIT v. S.A. Builders Ltd. (2006) 288 ITR 1 (SC)**:

* This landmark judgment established that there is no absolute requirement to charge interest on loans given to subsidiaries or others, even if interest is being paid on loans. The interest paid on the loan should be allowed as a deduction if it is for business purposes.
* **Key observation**: The Supreme Court observed that the business expediency of not charging interest should be considered, and the absence of interest income does not automatically lead to disallowance of interest paid.

2. **CIT v. Rajendra Prasad Moody (1978) 115 ITR 519 (SC)**:

* In this case, the Supreme Court allowed the deduction of interest paid on loans, even when there was no corresponding interest income, provided the loan was used for business purposes. The Court did not require matching of interest income and interest expenditure.

3. **CIT v. T. Veerabhadra Rao (2004) 266 ITR 151 (SC)**:

* The Court held that interest paid on loans could be allowed as a business expense even if the assessee did not charge interest on loans given, provided the loans were used for business purposes.

4. **CIT v. K. N. Upadhya (1996) 219 ITR 384 (SC)**:

* In this case, the Supreme Court discussed the issue of loans taken and loans given. It was clarified that the mere fact that interest was paid on loans taken does not automatically imply that interest should have been charged on loans given, especially if there was no commercial justification for such interest.

5. **CIT v. P. S. S. S. S. (P) Ltd. (1997) 227 ITR 60 (Mad)**:

* In this case, the Madras High Court clarified that charging interest on loans and advances given is not mandatory, and the absence of such interest does not automatically make the interest paid on loans inadmissible, provided the loans given are for business purposes.

### **Conclusion**:

While it is not mandatory for the assessee to charge interest on loans and advances given, the AO might question the interest paid on unsecured loans if there is no corresponding income from loans given. If the loan exceeds the capital, the AO may proportionately disallow the interest paid. The key is the commercial purpose and business expediency behind such transactions.

You may use the **CIT v. S.A. Builders Ltd. (2006)** case to support your argument that there is no legal obligation to charge interest on loans and advances given, provided the loans are for business purposes. However, you should be ready to justify the commercial reasoning behind not charging interest and the use of the loans in the business.

Would you like help drafting a specific response to the AO for this scrutiny issue?

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