Provision for Interest on State Government Loan Held Allowable u/s 37(1); Liability is ‘Ascertained’ Under Mercantile System Even if Repayment Has Not Commenced
ISSUE
Whether interest provided in the books of account regarding a loan from the State Government constitutes an “ascertained liability” allowable under Section 37(1), even if the assessee has not commenced repayment of the principal or interest due to specific conditions in the loan agreement (non-disbursement of full loan amount).
FACTS
Assessment Year: 2014-15.
The Assessee: A cooperative spinning mill following the Mercantile System of accounting.
The Loan: The assessee obtained a loan from the State Government under specific and peculiar conditions.
The Accounting: The assessee provided for interest on the outstanding loan amount in its books and claimed it as an expense in the Profit & Loss account.
The Dispute: The assessee had not drawn the full sanctioned loan amount. Under the agreement, the repayment schedule was likely linked to the full disbursement. Consequently, the assessee had not repaid any principal or interest.
AO’s Stand: The Assessing Officer (AO) disallowed the interest claim, arguing:
No amount was actually paid.
The assessee “purposely” did not obtain the full loan to avoid triggering the repayment clause.
Therefore, the liability was “unascertained” and not allowable.
HELD
Mercantile System: Under the mercantile system of accounting, a liability is deductible when it accrues, not necessarily when it is paid. Interest accrues day-to-day on the outstanding loan balance.
Binding Agreement: The loan was disbursed under a valid agreement. The liability to pay interest arises from the use of the funds, irrespective of when the repayment schedule technically kicks in.
Ascertained Liability: The Tribunal held that the mere fact that repayment had not started (due to the condition of full disbursement not being met) does not make the interest liability “contingent” or “unascertained.” The liability to pay interest on the money already drawn is certain.
Verdict: The interest provision was held to be an allowable expenditure under Section 37(1). [In Favour of Assessee]
KEY TAKEAWAYS
Accrual vs. Payment: This judgment reinforces the fundamental accounting principle that for mercantile system taxpayers, tax deduction follows accrual. Unless a specific section (like Section 43B) mandates actual payment, expenses like interest to State Governments (unless covered by 43B which covers Banks/FIs/Scheduled Banks) are deductible when accrued.
Contractual Triggers: Tax authorities often confuse “Due Date of Payment” with “Accrual of Liability.” Even if a loan agreement says “Interest is payable after 5 years,” the borrower can claim the deduction every year as it accrues, provided they follow the mercantile system.
Unascertained Liability: A liability is “unascertained” only if the obligation to pay itself is in doubt (e.g., a pending lawsuit). Here, the debt was admitted; only the payment timing was deferred.
IN THE ITAT PUNE BENCH ‘A’
Dindayal Magasvargiya Sahakari Soot Girni Ltd.
v.
ACIT*
Vinay Bhamore, Judicial Member
and Manish Borad, Accountant Member
and Manish Borad, Accountant Member
IT Appeal No. 205 (PUN) of 2025
[Assessment year 2014-15]
[Assessment year 2014-15]
DECEMBER 9, 2025
Pramod S. Shingte for the Appellant. Ramnath P. Murkunde for the Respondent.
ORDER
Vinay Bhamore, Judicial Member.- This appeal filed by the assessee is directed against the order dated 05.12.2024 passed by Ld. CIT(A)/NFAC for the assessment year 2014-15.
2. The appellant has raised the following grounds of appeal :-
“1. On the facts and in the circumstances of the case and in law, Ld. AO erred in initiating reassessment proceedings u/s 147 for AY 2014-15, being the year beyond 4 years and for which assessment order u/s 143(3) has already been passed, thereby violating first proviso to section 147, therefore reassessment proceedings are void ab initio and consequential orders needs to be annulled.
| 2. | On the facts and in the circumstances of the case and in law, Ld. AO erred in initiating reassessment proceedings u/s 147 for AY 2014-15, by recording the reason to believe which is based on incorrect presumptions and therefore an action based on such presumed reason to believe is incorrect and order passed in consequence to such action is bad in law. |
| 3. | On the facts and in the circumstances of the case and in law, Ld. AO erred in initiating reassessment proceedings u/s 147 for AY 2014-15 by recording the reason to believe which is based on audit objection. We submit that the reason based on such borrowed satisfaction cannot be the basis of reopening the concluded assessment. Therefore, entire proceedings are void ab initio. |
| 4. | Without prejudice to the above grounds on the facts and in the circumstances of the case and in law, the Ld. AO erred in making addition of Rs. 2,42,00,000 by disallowing interest payable on loan from state government by invoking provisions of section 37 by assuming the same as unascertained liability. The action of Ld. AO is incorrect, illegal and without appreciating the facts of the case and therefore the entire addition deserves to be deleted. |
Your appellant prays for deletion of entire addition. Your appellant craves for to add, alter amend, modify, delete any or all grounds of appeal before or during the course of hearing in the interest of natural justice.”
3. Facts of the case, in brief, are that the assessee is a cooperative spinning mill and has furnished its original return of income on 29.11.2014 by declaring taxable income at Rs.Nil after setting off business losses of the assessment year 2012-13 amounting to Rs.2,65,01,527/-. The case of the assessee was assessed u/s 143(3) of the IT Act on 29.09.2016 by accepting the income returned by the assessee. Subsequently on verification of records of the assessee it is seen that the assessee had provided and debited an amount of Rs.2,42,00,000/- as interest on soft loan of Rs.22 crore received from Government of Maharashtra which was according to the Assessing Officer was an unascertained liability and the case was reopened u/s 147 of the IT Act and notice u/s 148 of the IT Act was issued to the assessee. The assessee furnished return in response to above said notice. Subsequently statutory notices u/s 143(2) and 142(1) were issued to the assessee. The assessee raised objection to the reopening of the case and the Assessing Officer rejected the objection and proceeded to assess the case u/s 143(3) r.w.s. 148 of the IT Act. According to the assessee, detailed note on interest of Rs.2,42,00,000/- is as under :-
“”Total Interest on Loans debited to Profit and Loss a/c is Rs.27798475/-. However you may note the bifurcation of this figure is as under:-
| Interest accrued but not due on Soft Loan | Rs.24200000.00 |
| Interest on Loan against Fixed Deposits with Banks | Rs. 35,98,475.00 |
| Total | Rs.2,77,98,475.00 |
Interest on loan against FDs with banks is charged as per bank statement and is debited to Profit and Loss a/c and is serviced also.
As mentioned in earlier Para No 6interest on soft Loan of Rs.22 Crores has been provided for at Rs. 2.42 Crores as it has been accrued but not due. No actual payment of interest has been made.
This amount is debited to Profit and Loss a/c. However this amount is not disallowed u/s 438 while filing of return of income as it’s a loan from government and the amount was accrued but not became due”.
The assessee further replied as below:-
“Detailed note on Interest of Rs.24200000 is as under
(a) Dindayal Magaswargiya Sahakari Sut Gimi is a Cooperative Spinning Unit formed for Backward Classes under Vishesh Ghatak Yojana under the aegis of 8th Five Year Plan.
(b) As an eligible unit of Backward Class the society has been granted Financial Assistance from “Department of Social WellfareGovernment of Maharashtra” itself. The said financial assistance was devided into financial assistance in the form of Capital Contribution and a Soft Loan.
(c) Thus the interest payable of Rs. 242 lakhs is on the Loan from government itself – this may please be noted.
(d) Further as per GR dtd 02-08-2003 and as per letter dtd 02-07-2004, the amount of interest has not become due till date. As per clause no.2,3 and 4 of the said letter it will become due only after receiving from government at-least 90% of 95% of project cost. (45% in form of Share Capital and 50% in form of Long term Loan). We have not received the said sums till date. You may appreciate from working enclosed herewith that a sum of Rs.5.62 Lacs is not yet received to us and hence as per extant terms of arrangement repayment of interest and principal has not fallen due.
However as per Clause 3 and Clause 6 of Notification dated 02/07/2004 and as per prevalent accounting conventions we have consistently provided for Interest on soft loan on the basis that Interest has been accrued but not fallen due A copy of our working and relevant notification is also enclosed.
(e) On the background of the above facts it would be pertinent to go through CL.(d) of Sec 43B which reads as under
“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 for a State financial corporation or a State industrial investment corporation, in accordance with the terms conditions of the governing such loan or borrowing 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.”
A careful reading of above reveals that-
To become exigible for disallowance, the unpaid interest must (a) belong to the loan from:
(i) any public financial institution [or
(ii) a State financial corporation or
(iii) a State industrial investment corporation]
(b) Have become due as per the terms and conditions of the agreement governing such loan or borrowing.
(f) Now if the above tests are applied to the facts in our case then it can be noted that,
a. The loan granted to our society is from Government (Dept of Social Welfare) itself. Section 43B does not refer to loans from government.
b. The loan/interest itself has not fallen due for repayment, yet as the amount of loan sanctioned in not received completely”.
4.0 The reply of the assessee has been considered and not acceptable. The loan was sanctioned by Govt. of Maharashtra between June 1998 to March 1999 and the assessee was making interest provision from F.Y 1998-99 onwards. The accumulated interest debited and not paid from F.Y 1998-99 to 2013-14 was Rs 37.60 Crore. Thus, by not withdrawing an amount of Rs 5.62 lakh, the company had not paid the government loan. Though, the assessee claimed that neither the principal nor loan was repayable. It was claiming deduction of provisions for interest knowing fully well that it was never payable. As per provisions of section 37 of the Act, provision for unascertained liability is not allowable deduction for purposes of income tax. Further, it has been held by the Supreme Court in McDowell and Co. Ltd v. Commercial Tax Officer (SC) 154 ITR 148 that colorable devices are not part of tax planning Tan View of the above a sum of Rs 2,42,00,000/- for AY. 2014-15 remains unexplained. Hence, an amount of Rs. 2,42,00,000/- debited to profit and loss loss account as interest on loan from the Govt. of Maharashtra as explained above and not paid to the Government is disallowed and added to the income of the assessee for the AY 2014-15.”
4. After considering the replies of the assessee, the Assessing Officer completed the assessment u/s 143(3) r.w.s. 148 of the IT Act by determining total income at Rs.4,32,92,147/-. The above assessed income includes addition on account of disallowance of interest of Rs.2,42,00,000/- payable to Government of Maharashtra being unascertained liability u/s 37 of the IT Act & also includes disallowance on account of carried forward losses.
5. Being unsatisfied with the above assessment order, the assessee preferred an appeal before Ld. CIT(A)/NFAC. After considering the reply of the assessee, Ld. CIT(A)/NFAC dismissed the appeal filed by the assessee, however with regard to allowance of brought forward and carried forward losses gave direction to the Assessing Officer to verify the claim of the assessee by observing as under :-
“6. On merits, it is stated that the AO has made an addition as unascertained liability and that neither section 37 nor any other provision of the Income Tax Act contains the phrase unascertained liability. It is, accordingly pleaded that the view taken up by the AO is grossly national and logical is stated that in balance sheet of AY 201415, Loan from Samaj kalyan Department of Government of Maharashtra reflected as Rs.22 Crores. The appellant, Dindayal Magaswargiya Sahkari Sut Girni is a Cooperative Spinning Unit formed for Backward Classes under Vishesh Ghatak Yojana under the aegis of 8th Five Year Plan. An an eligible that of Backward class the society has been granted Financial Assistance from Department of Social Welfare, Government of Maharashtra” itself. The said financial assistance was divided into financial assistance in the form of Capital Contribution and a Soft Loan :
| Details assistance received from Department of Social Welfare are as under Sr. No. | Nature of Assistance | Amount (In Crores) | Reflection in Balance Sheet |
| 1 | Contribution to Share Capital | 17.27 | “Share Capital” in Balance Sheet |
| 2 | Soft Loan from Social Welfare Department of State of Maharashtra | 22.00 | “Secured Loan ” in Balance Sheet |
Copies of relevant GR were also produced at the time of assessment, it is father submitted that the AO has not doubted on existence of above loan. Admittedly the fact remains established that Loan from State Government Rs.22 Crores exists and that after accepting the fact of Loan of Rs.22 Crores, the AO has questioned the existence of interest payable on that loan. It is further submitted that as per GR dated 02-08-2003 and as per letter dated 02-07-2004, the amount of interest has not become due date. As per clause no.2.3 and 4 of the said letter it would become due only after receiving from government at-least 90% of 95% of project cost. (45% in form of Share Capital and 50% in form of Long term Loan). It is further stated that the appellant has not received the said sums till date that a sum of Rs.5.62 Laos is not yet received and hence as per extant terms of arrangement, the appellant is of the view that repayment of interest and principal has not fallen due. It is pleaded this does not mean that it would never fall due for repayment, it is further stated that as per Clause 3 and Clause 6 of Notification dated 02/07/2004 and as per prevalent accounting conventions, the appellant has consistently provided for interest on son can on the basis that interest has been accrued but not fallen due.
6.6 I have considered the submissions and it is noted that the submission was made before the AO and the AO has considered the same in para 4 of the order. The AO finds that the loan was sanctioned by Maharashtra Government between June, 1998 to March, 1999 and the appellant had been making interest provision from 198-99 onwards and thus the accumulated interest debited and not paid from FY 199899 to 2013-14 was Rs. 37.60 crore. Thus, by not withdrawing an amount of Rs. 5.62 lakhs, the company had not paid the government loan. Thus, the AO noted that despite the admitted claim that neither the principal nor the loan was repayable, it had been claiming deduction. Accordingly, the AO found this device to be colourable and he disallowed the claim u/s 37. 1, accordingly, find no infirmity in the action of the AO and the same is confirmed.
6.7 Ground number 2 relates to the contention that the AO had incorrectly considered the figure of losses brought forward and losses carried forward for relevant assessment year and accordingly had erred in appropriating the disallowance to such brought forward losses which has resulted in incorrect amount of carried forward losses as well as raising of incorrect demand. The appellant has given detailed charts in this regard. The AO is directed to consider this and verify the same from records and give necessary relief if it is found admissible to the appellant.
7. Thus, all the substantive grounds of the appeal stand dismissed, subject to direction in para 6.7 supra. In the result, the appeal stands dismissed.”
6. It is the above order against which the assessee is in appeal before this Tribunal.
7. Ld. AR appearing from the side of the assessee submitted before us that the order passed by Ld. CIT(A)/NFAC to the extent of not allowing deduction of Rs.2,42,00,000/- interest accrued on loan from Government of Maharashtra is not justified. Ld. AR submitted before the bench that the observation of the Assessing Officer that the interest as well as principal sum is not payable is not correct. Ld. AR submitted that according to the conditions agreed by and between both the parties i.e. the assessee cooperative spinning mill and the Government of Maharashtra it was agreed that the repayment will start only after disbursement and receipt of certain percentage of loan amount by the assessee and admittedly the assessee cooperative spinning mill did not received the agreed percentage of loan and due to this fact the repayment could not be started. Ld. AR of the assessee submitted before the bench that the disallowance u/s 37 of the IT Act is not justified by treating the liability of accrued interest as an unascertained liability. Ld. AR further submitted that by following mercantile system of accounting the accounts were being prepared by the assessee since last many years and accordingly the interest accrued on loan was provided in the books of accounts. Ld. AR further submitted that this practice is being followed since long and the Department also not raised any objection, however during the period under consideration the impugned addition has been made. Ld. AR further submitted that it is an admitted fact by the Assessing Officer as well as by Ld. CIT(A)/NFAC that the loan was obtained from Government of Maharashtra and obviously interest on the above loan is also payable however due to the peculiar conditions and for benefit of Cooperative Spinning Mills some relaxation was provided by Government of Maharashtra but it does not mean that the loan or interest is not payable. In support of its contentions that the loan amount as well as interest on such loan is payable to the Government of Maharashtra, Ld. AR submitted that the assessee on its own cannot wave the loan and interest received from the Government of Maharashtra since it was a bilateral consented act on behalf of both the parties. Ld. AR accordingly requested before the bench to allow deduction of interest of Rs.2,42,00,000/- disallowed by the Assessing Officer and confirmed by Ld. CIT(A)/NFAC.
8. Ld. AR in support of its contentions that the deduction on account of provision of interest on loan amount payable to the Government of Maharashtra is an ascertained liability relied on the judgement passed by Hon’ble Supreme Court in the case of Commissioner of Income-tax v. Modern Spinners Ltd. (SC)/[2016] 382 ITR 472 (SC) wherein Hon’ble Supreme Court held that liability under terms and conditions of said loan agreement could not be wiped out since it was not a unilateral act on part of assessee but was a bilateral consented act on behalf of parties which was of binding nature in terms of said agreement and, therefore, it could not be termed as an unascertained liability and assessee would be entitled to deduction of said provision of interest on loan amount.
9. Ld. DR appearing from the side of the Revenue relied on the orders passed by the subordinate authorities and requested to confirm the same.
10. We have heard Ld. counsels from both the sides and perused the material available on record including the paper book furnished by the assessee. In this regard, we find that the assessee cooperative spinning mill obtained loan of Rs.22 crore from Government of Maharashtra under certain specific and peculiar conditions, copy of which are produced by the assessee in the paper book. Since the assessee was following mercantile system of accounting the interest on above loan was provided in the books of accounts and also claimed in the profit and loss account. The Assessing Officer was of the view that since the assessee has not repaid any amount either towards interest or towards loan amount the same is not payable by the assessee, and purposely the assessee cooperative spinning mill has not obtained full amount of loan just to avoid repayment of interest on loan. Accordingly, the Assessing Officer disallowed the provision of interest of Rs.2,42,00,000/- provided in the books of accounts as unascertained liability and disallowed the same u/s 37 of the IT Act and added the same to the income of the assessee cooperative spinning mill.
11. In this regard, we find that it was the contention of Ld. counsel of the assessee that the assessee on its own cannot wave either interest on the loan amount and since the books of accounts were prepared on mercantile system of accounting the interest on the above loan was provided in the books of accounts and shown as payable in the balance sheet since last many years. It was also the contention of Ld. counsel of the assessee that the Assessing Officer has not doubted the disbursement of loan to the assessee cooperative spinning mill by the Government of Maharashtra, however at the same time the provision of interest was doubted by the Assessing Officer and it was presumed that neither interest nor loan amount was payable by the assessee cooperative society. It was also the contention of Ld. counsel of the assessee that since last many years this procedure has been followed and interest payable is provided in the books of accounts on yearly basis and the Department has also accepted the same except in one other year. It was also the contention of Ld. counsel of the assessee that the interest was provided at the rate agreed by the Government of Maharashtra in the agreement entered into by both the parties.
12. Considering the totality of the facts of the case and under the peculiar circumstances of the case, we are of the considered opinion that the loan was disbursed by the Government of Maharashtra to the assessee cooperative society under certain conditions mentioned in the agreement and agreed by both the parties and we also find that there is no quarrel that the loan was not obtained by the assessee cooperative spinning mill. Admittedly, when the state government grant loan to an entity some interest is charged and the loan is also payable under the terms and conditions of the agreement. We also find that since the assessee cooperative spinning mill has not obtained certain percentage of the loan amount out of the sanctioned loan amount the repayment could not be started however as per the mercantile system of accounting the interest is required to be provided in the books of accounts and the same cannot be termed as an unascertained liability which can be disallowed u/s 37 of the IT Act. Under the above facts and in the circumstances of the case we are of the considered opinion that the interest of Rs.2,42,00,000/- provided in the books of account was an ascertained liability and could not be disallowed u/s 37 of the IT Act. In this regard, we also find support from the judgement passed by Hon’ble High Court of Delhi which was confirmed by Hon’ble Supreme Court in the case of Modern Spinners Ltd. (supra) wherein SLP of the department was dismissed, Hon’ble court held as under
“During assessment proceedings, Assessing Officer disallowed deduction on said provision of interest on ground that same would amount to unascertained liability – High Court held that liability under terms and conditions of said compromise could not be wiped out since it was not a unilateral act on part of assessee but was a bilateral consented act on behalf ofparties which was of binding nature in terms of said agreement and, therefore, it could not be termed as an unascertained liability and assessee would be entitled to deduction of said provision of interest – Whether there is no estoppel against Statute and Act enables and entitles assessee to claim entire deduction in manner it was claimed – Held, yes [Para 1] [In favour of assessee]”
13. Respectfully following the above judgement passed by Hon’ble Delhi High Court which was affirmed by Hon’ble Supreme Court (supra), we deem it appropriate to direct the Assessing Officer to allow deduction of interest of Rs.2,42,00,000/- provided in the books of account on loan amount of Rs.22,00,00,000/-obtained from Government of Maharashtra. Accordingly, the Ground no.4 raised by the assessee is allowed.
14. Since we have allowed the appeal of the assessee on Ground no.4, the other grounds becomes academic & need not be adjudicated.
15. In the result, the appeal filed by the assessee is allowed.