Individual Below Turnover Limit Exempt from TDS under 194A

Individual Below Turnover Limit Exempt from TDS under 194A and Interest Expenditure Allowed under Section 57(iii)

Issue

Scope of TDS under Section 194A: Whether an individual assessee whose business turnover in the preceding year did not exceed the prescribed monetary limits under the proviso to Section 194A(1) is required to deduct tax at source (TDS) on interest payments made to resident payees.
Deductions under Section 57(iii): Whether interest expenditure incurred by an individual can be disallowed under Section 57(iii) for lack of nexus when the assessee demonstrates a positive overall fund position, substantial interest income earned, and a fund-flow analysis establishing deployment of borrowed funds for earning interest income.

Facts

Assessment Year: 2018-19.
Return of Income: The assessee, an individual, filed a return declaring income under the head “Income from other sources”, offering interest income earned from various parties and claiming a deduction for interest expenditure paid primarily to three parties.
AO’s Disallowance: The Assessing Officer (AO) disallowed the entire interest expenditure under Section 57(iii) on two grounds:
- Failure to deduct tax at source (TDS) on interest payments made to resident payees.
- Failure to prove that the expenditure was incurred wholly and exclusively for earning taxable interest income.
Rebuttal and Evidence by Assessee:
- The assessee was an individual whose business turnover/gross receipts in the preceding financial year did not exceed the threshold limit requiring TDS deduction under the proviso to Section 194A(1).
- The interest income earned by the assessee was approximately 150% of the interest expenditure claimed.
- The assessee submitted a fund-flow analysis demonstrating the availability and utilization of both interest-free and interest-bearing borrowed funds deployed for earning interest income.

Decision

Exemption from Section 194A TDS:
- Held, since the assessee is an individual whose turnover in the preceding year did not exceed the limit specified in the proviso to Section 194A(1), the assessee was not liable to deduct TDS on interest paid to resident payees. (Para 11)
- Consequently, the disallowance based on non-deduction of TDS was legally unmerited and rejected. (Para 11) (In favour of assessee)
Allowability of Interest Expenditure under Section 57(iii):
- Held, the allowability of expenditure under Section 57(iii) must be evaluated considering the overall fund position and purpose, rather than tracing an isolated movement of funds. (Para 12)
- Held, the record established that the assessee was engaged in giving loans to earn interest, earned substantial income therefrom, and possessed sufficient interest-bearing and interest-free funds to support deployment. (Paras 13 & 14)
- Held, in the absence of evidence showing diversion of borrowed funds for unrelated purposes, a direct nexus exists under Section 57(iii), making the interest expenditure fully allowable. (Para 14) (In favour of assessee)

Key Takeaways

TDS Threshold Safeguard for Individuals: Individual taxpayers whose preceding year’s business turnover falls below statutory audit limits under Section 194A are exempt from deducting TDS on resident interest payments, preventing arbitrary disallowances.
Holistic Nexus Test for Section 57(iii): Allowability of interest expenditure under Section 57(iii) requires a holistic evaluation of overall fund flows and earned interest income rather than an artificial, item-by-item tracing of borrowed money.

IN THE ITAT SURAT BENCH

Ankit Hemantbhai Desai

DCIT

Ms. Suchitra Kamble, Judicial Member
and B.M. Biyani, Accountant Member

IT Appeal No. 719 (SRT) of 2024
[Assessment year 2018-19]

SEPTEMBER 14, 2026

Suresh K. Kabra, CA for the Appellant. Ashish Kumar, Sr. DR for the Respondent.

ORDER

B.M. Biyani, Accountant Member. – Feeling aggrieved by the order of first appeal dated 12.06.2024 passed by learned Commissioner of Income-Tax (Appeals)-NFAC, Delhi [“Ld. CIT(A)”], which in turn arises out of the assessment-order dated 21.04.2021 passed by learned Assessment Unit of Income-tax Department [“Ld. AO”] u/s 143(3) of Income-tax Act, 1961 [“the Act”] for Assessment-Year [“AY”] 2018-19, the assessee has filed this appeal on following ground:

” The Ld. CIT(A) has erred and was not just and proper on the facts of the case and in law in confirming the disallowance of interest to the extent of Rs. 61,75,253/-“

2. The background facts leading to present appeal are as under:

(i)

The assessee is an individual earning income from salary, business and other sources.

(ii)

For AY 2018-19, the assessee filed return of income declaring a total income of Rs. 1,00,98,710/-, which included taxable income of Rs. 38,56,811/- under the head ‘Income from other sources’ computed as under:

Interest income from Bank A/c –	70,887/-
Interest income from parties –	1,06,89,792/-
Interest income from Capital Gain Bonds –	16,233/-
Interest income from I.T. Refund –	1,763/-
Interest expenditure disallowed –	2,49,674/-
Total –	1,10,28,349/-
Less: Interest expenditure claimed –	71,71,538/-
Taxable income from other sources –	38,56,811/-

The detail of major amounts comprising the aforesaid interest expenditure claimed by assessee, are available at Page 96 of PaperBook as under:

M/s Shridhar Constructions Private Limited –	52,27,304/-
M/s Bindal Estate Private Limited –	9,46,949/-
Ms. Shweta Desai –	9,95,098/-
Total –	71,69,351/-

(iii)

The case of assessee was selected for scrutiny assessment and the Ld.AO issued notices u/s 143(2)/142(1) which the assessee complied with. Ultimately, the Ld. AO completed assessment u/s 143(3) r.w.s. 144B after disallowing interest expenditure of Rs. 71,71,538/- claimed by assessee u/s 57(iii) in computing taxable income from other sources. The Ld. AO made aforesaid disallowance, inter alia, for these reasons:

(a)

Interest of Rs. 52,27,304/- was paid to ‘M/s Shridhar Constructions Private Limited’ but the said party had not declared interest income in its books, therefore the deduction claimed by assessee to that extent was false.

(b)

Remaining interest of Rs. 9,46,949/- was paid to ‘M/s Bindal Estate Private Limited’ and Rs. 9,95,098/- to ‘Ms. Shweta Desai’. The assessee deducted TDS out of interest paid to Ms.Swetha Desai but, however, did not deduct TDS out of interest paid to ‘M/s Bindal Estate Private Limited’. Therefore, disallowance is attracted for TDS default also.

(c)

Further, the interest expenditure was not incurred wholly and exclusively for the purpose of earning income.

(iv)

Aggrieved, the assessee carried matter in first appeal whereupon the Ld. CIT(A) partly reversed the AO’s action. He allowed deduction of interest of Rs. 9,95,098/- paid to Ms. Shweta Desai while upholding the rest of disallowance.

(v)

Still aggrieved, the assessee has come in present appeal before us.

3. Before us, the Ld. AR for assessee filed following Written-Submission:

4. Further, during the course of hearing, the Ld. AR made oral submissions, which were broadly in the nature of re-iteration of the written-submission reproduced above, as under:

(i)

He referred Pages 95-96 of Paper-Book (re-produced in preceding para) wherein the complete details of the interest of Rs. 1,06,89,792/-earned by assessee from different parties on loans/advances given and the interest of Rs. 71,69,351/- paid to different parties on loans borrowed, are given. Referring to the details of interest paid, Ld. AR submitted that ‘Ms. Shweta Desai’ was a non-resident during the year, hence the assessee deducted TDS u/s 195 as required by law. However, all other payees were residents in India and therefore there was no obligation upon assessee to deduct TDS u/s 194A as alleged by lower authorities. Ld. AR explained that the assessee was not required to deduct TDS u/s 194A because the assessee is individual and the turnover/gross receipts of assessee from business/profession during the year were only Rs. 2,10,000/- [Page 20 of Paper-Book -Computation of Total Income] which did not exceed the monetary limit prescribed in section 44ADA [Proviso to section 194A(1)].

(ii)

He referred Page 22 of Paper-Book where a chart showing availability of funds from different sources vis-a-vis the application of funds for different purposes, with comparative figures of current year as well as preceding year, is placed. Analysing the data given in chart, Ld. AR attempted to demonstrate a broad picture of assessee’s financials. He presented analysis of interest-free funds and interest-bearing funds available with assessee vis-a-vis the segmental details of utilization of those funds for different purposes like fixed assets, investments, giving loans, etc. By his analysis, he sought to demonstrate two-fold aspects, namely:

(a)

The assessee mainly utilized the borrowed funds for giving interest-bearing loans. At the same time, the assessee also utilized his own/interest-free funds for giving loans so as to earn interest income. That is why, the interest income earned by assessee was as high as Rs. 1,06,89,792/- whereas the interest expenditure claimed as deduction was much lesser at Rs. 71,71,538/-.

(b)

Majority of the borrowed loans were old as taken in earlier years. During current year, the borrowals were made mainly to repay the old loans which were taken in earlier years for giving interest bearing loans.

With this analysis, Ld. AR contended that the assessee had utilized borrowed loans for the purpose of giving interest-bearing loans. Therefore, the interest expenditure was necessarily incurred for the purpose of earning interest income and allowable as deduction.

5. With above submissions, Ld. AR contended that the Ld. AO was wrong in disallowing entire interest of Rs. 71,71,538/- and thereafter the Ld. CIT(A) was also wrong in upholding disallowance partly. He requested that on facts, the assessee’s entire claim must have been allowed and no disallowance was warranted.

6. Per contra, Ld. DR for revenue made following submissions:

(i)

In so far as the requirement of deducting TDS u/s 194A is concerned, the Proviso to section 194A(1) does not refer to the turnover/gross receipts of business/profession of “current year”, rather it refers to the turnover/gross receipts of “preceding year” for deciding the applicability of TDS. However, the assessee’s turnover/gross receipts of the “preceding year” are not clear from the available documents. Therefore, the Ld. AR’s contention in this regard cannot be accepted.

(ii)

He emphasized the observations made by Ld. AO in Paras 4.2 & 4.3 of assessment-order regarding movement of funds. The Ld. AO has particularly observed that the assessee took a loan of Rs. 2.2 crore from M/s Shridhar Construction Private Limited which was partly invested to the extent of Rs. 1 crore in tax-exempt mutual funds and partly utilized for repayment of an interest-free loan taken from ‘Hemant Desai’. Hence, according to Ld. AR, the assessee had not utilized the interest-bearing borrowed funds for giving interest-bearing loans.

(iii)

He submitted that before AO, the assessee claimed ‘fund replacement theory’ i.e. the new borrowals had been used for repayment of old loans but the Ld. AO has rejected assessee’s submission.

(iv)

He submitted that, in Para 5.2 of assessment-order, the Ld. AO has made a very crucial observation that ‘M/s Shridhar Construction Private Limited’ had not declared corresponding interest income and therefore the interest of Rs. 52,27,304/- claimed by assessee as payable to the said party, was false. He referred to the Page 2 of Paper-Book where the Ledger A/c of ‘M/s Shridhar Construction Pvt. Ltd.’ extracted from assessee’s own books of account, is placed. He demonstrated that the assessee has himself not accounted for interest in the Ledger A/c of party.

7. In rejoinder, Ld. AR for assessee made following submissions:

(i)

He drew our attention to the Balance-Sheet of assessee available at Page No. 16 of Paper-Book. He showed that the assessee had shown “Interest Payable – Shridhar – Rs. 52,27,304/-” as a separate line item under the heading “Current Liabilities” and that is why the interest payable to M/s Shridhar Construction Pvt. Ltd. was not passed through Ledger A/c of said party.

(ii)

He submitted that M/s Shridhar Construction Pvt. Ltd. had declared interest income earned from assessee to Income-tax Department.

8. Thereafter, the Bench directed the Ld. AR to file following documents:

(i)

The documents of preceding AY 2017-18 to show the turnover/gross receipt of business/profession for deciding the applicability of TDS under Proviso to section 194A(1).

(ii)

The documents to show the status of interest income declared by ‘M/s Shridhar Construction Pvt. Ltd.’ to Income-tax Department.

9. Subsequently, after conclusion of hearing, the Ld. AR filed following documents:

10. We have considered rival contentions of both sides and perused the orders of lower-authorities as well as the material held on record to which our attention has been drawn. The assessee in present case is aggrieved by the disallowance of interest expenditure claimed in return made by Ld. AO and partly upheld by Ld. CIT(A). The Revenue authorities have made disallowance on two-fold basis, namely (i) the alleged default in deduction of tax at source u/s 194A out of interest payment and (ii) the interest expenditure claimed by assessee is not incurred for the purpose of earning income.

11. As regards the first basis of disallowance i.e. the non-deduction of TDS u/s 194A, we find merit in the submission of the Ld. AR. The assessee is an individual and as per the material filed by assessee pursuant to the direction given by Bench (re-produced in earlier para), the turnover/gross receipts from business/profession in the preceding AY 2017-18 were Rs. 8,40,000/- which did not exceed the monetary limit prescribed for the purpose of the Proviso to section 194A(1). Accordingly, the assessee was not liable to deduct tax at source u/s 194A in respect of the interest payments made to resident payees. Consequently, this basis adopted by lower authorities does not have merit and rejected.

12. As regards the second basis of disallowance i.e. the interest expenditure was not incurred wholly and exclusively for the purpose of earning income, at first we find that the assessee had earned interest income of Rs. 1,06,89,792/- from parties against which the interest expenditure of Rs. 71,71,538/- was claimed. Thus, the interest income earned by assessee is about 150% of interest expenditure. Then, the assessee has also placed on record a fund-flow analysis demonstrating the availability and utilisation of interest-free as well as interest-bearing borrowed funds. The Ld. AO has primarily relied upon certain specific movements of funds, particularly the utilisation of loan received from M/s Shridhar Construction Private Limited, to conclude that the borrowed funds were diverted towards tax-exempt investments and repayment of an interest-free borrowing. In our considered view, however, the allowability of expenditure u/s 57(iii) is required to be examined having regard to the overall facts and the purpose for which the expenditure was incurred and cannot be decided merely by tracing an isolated movement of funds without considering the overall fund position. The material placed on record demonstrates that the assessee was engaged in giving loans for earning interest income and had, in fact, earned substantial interest income therefrom. The fund-flow analysis placed on record also demonstrates that the assessee had both interest-free and interest-bearing funds available with him and had deployed funds for various purposes including giving interestbearing loans. In such circumstances, the mere fact that a particular borrowing was utilised for a particular payment cannot, by itself, establish that the borrowing was diverted for a non-income-earning purpose, particularly when the overall fund position and subsequent deployment of funds are considered. The Revenue has not brought any cogent material on record to establish that the interest-bearing borrowings, to the extent of the interest expenditure claimed, were utilised for purposes wholly unconnected with the earning of such income. In this regard, although we agree with the Revenue’s observation that the assessee had utilised part of the interestbearing funds borrowed from ‘M/s Shridhar Construction Private Limited’ for repayment of the interest-free loan earlier taken from ‘Hemant Desai’, however such utilisation, by itself, cannot be regarded as sufficient to conclude that the interest-bearing borrowing was utilised for a purpose wholly unconnected with the earning of taxable interest income. The manner in which the assessee manages or restructures his overall fund position including replacement of one borrowing by another, is a matter of his financial decision and in the absence of any material demonstrating that the relevant borrowing was diverted for a purpose having no nexus with the activity of earning taxable interest income, the deduction of interest expenditure cannot be denied merely on the basis of such fund movement. In present case, the Revenue has not brought any cogent material to establish such diversion.

13. We further find that the specific factual basis adopted by the Ld. AO for treating the interest of Rs. 52,27,304/- payable to ‘M/s Shridhar Construction Private Limited’ as false, is demolished by assessee. The Ld. AR for assessee has at first shown that though the assessee had not recorded the corresponding interest entry in the Ledger A/c of said party, the assessee had separately accounted for same and disclosed the amount as “Interest Payable – Shridhar” under the head “Current Liabilities” in Balance-Sheet. Furthermore, pursuant to the specific direction of Bench, the Ld. AR/assessee has furnished records of the said party (re-produced in earlier para) to establish that the corresponding interest income had been declared by said party to Income-tax Department.

14. Thus, on an overall consideration of the facts including the substantial interest income earned by the assessee, the fund-flow position and the absence of any cogent material demonstrating diversion of the relevant borrowings for purposes wholly unrelated to earning taxable interest income, we are satisfied that the interest expenditure claimed by the assessee bears sufficient nexus with the activity of earning such income and satisfies the conditions prescribed u/s 57(iii) of the Act. The disallowance sustained by Ld. CIT(A) is, therefore, not justified and the same is deleted. The ground raised by the assessee is allowed.

15. In result, this appeal is allowed.