Interest on unproven loan genuineness is disallowed, even for opening balances.

By | May 29, 2025
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Interest on unproven loan genuineness is disallowed, even for opening balances.

Issue:

Whether interest expenditure claimed on unsecured loans can be disallowed under Section 36(1)(iii) of the Income-tax Act, 1961, if the assessee fails to establish the genuineness, creditworthiness of the creditor, and repayment of the underlying loans, even if no new loans were received in the assessment year in question but interest was paid on opening balances of prior years’ loans.

Facts:

  • The assessee, a partnership firm involved in construction and development, claimed interest expenditure on unsecured loans for Assessment Years 2017-18 and 2018-19.
  • Assessment Year 2017-18: The Assessing Officer (AO) disallowed a portion of the interest expense, treating the underlying loans as unexplained credits under Section 68 of the Income-tax Act, 1961.
  • Assessment Year 2018-19: Although no new loans were received in this year, the AO disallowed interest on the opening balances of the earlier loans, citing a lack of genuineness and creditworthiness of the creditors.
  • Commissioner (Appeals): The Commissioner (Appeals) (CIT(A)) deleted the Section 68 addition for Assessment Year 2018-19, acknowledging that the loans pertained to earlier years. However, the CIT(A) upheld the disallowance of interest expenditure in both assessment years, reasoning that the assessee failed to prove the genuineness of the underlying loans.
  • The assessee argued that merely routing interest through banking channels or deducting TDS was sufficient proof.

Decision:

The court held in favor of the revenue. It confirmed that the deduction of interest expenditure is governed by Section 36(1)(iii), which mandates that capital must be genuinely borrowed and used for business purposes. The court affirmed that if the assessee fails to establish the genuineness of the underlying loan, the interest payable or paid thereon cannot be allowed. It further clarified that routing interest through banking channels or deducting TDS is not conclusive proof of allowability. Since the assessee failed to discharge its initial onus and did not provide evidence of repayment or genuine subsistence of the loan liability, the disallowance of interest by the lower authorities was justified.

Key Takeaways:

  • Conditions for Interest Deduction (Section 36(1)(iii)): For interest on borrowed capital to be deductible, two primary conditions must be met:
    1. The capital must have been genuinely borrowed.
    2. The borrowed capital must have been used for the purposes of the business or profession.
  • Onus on Assessee for Loan Genuineness: The initial burden to prove the genuineness of a loan, the identity of the creditor, and their creditworthiness lies squarely with the assessee. This onus is not discharged merely by showing that the loan was received through banking channels or that TDS was deducted on interest payments.
  • Sustained Disallowance of Interest: If the genuineness of the principal loan itself is not established, the interest paid on that loan cannot be allowed as a deduction, regardless of whether the loan was incurred in the current year or was an opening balance from a previous year. The “taint” of non-genuineness extends to the interest payment.
  • Importance of Repayment/Subsistence Proof: The court emphasized the assessee’s failure to provide evidence of actual repayment or the genuine subsistence of the loan liability. This further undermined the claim of genuineness.
  • Section 68 vs. Section 36(1)(iii) – Distinct Grounds: While Section 68 deals with unexplained cash credits (additions to income), Section 36(1)(iii) deals with the allowability of interest expenditure. Even if a Section 68 addition is deleted (e.g., because the loan pertains to an earlier year), the disallowance of interest under Section 36(1)(iii) can still stand if the genuineness of the loan for the purpose of claiming interest deduction is not proven. The focus shifts from the credit itself to the allowability of the expenditure linked to it.
IN THE ITAT AHMEDABAD BENCH ‘D’
Shyam Realities
v.
Dy.CIT, Circle-2(2)(1) Ahmedabad
T.R. Senthil Kumar, Judicial member
and MAKARAND V. MAHADEOKAR, Accountant member
IT Appeal Nos.1387, 1388 (Ahd) 2024
[Assessment Year 2017-18, 2018-19]
APRIL  28, 2025
Bandish Soparkar, AR for the Assessee. Atul Pandey, Sr.DR for the Revenue.
ORDER
Makarand V. Mahadeokar, Accountant Member. – These two appeals filed by the assessee for Assessment Years (AYs) 2017-18 and 2018-19 are directed against the respective appellate orders passed by the Ld. Commissioner of Income-tax (Appeals), National Faceless Appeal Centre (NFAC), New Delhi [hereinafter referred to as “CIT(A)”], dated 27.06.2024. In the impugned orders, the Ld. CIT(A) confirmed the disallowance of interest on unsecured loans to the extent of Rs.36,69,000/- for A.Y. 2017-18 and Rs.38,94,295/- for A.Y. 2018-19, as originally disallowed by the Assessing Officer. Since the issues involved in both appeals are common and interlinked, arising from the same factual and legal matrix, both appeals were heard together and are being disposed of by way of this consolidated order.
Facts of the case:
2. The assessee is a partnership-firm engaged in the business of construction and development. During the respective assessment years, the Assessing Officer disallowed interest expenditure on unsecured loans on the ground that the loans were either unexplained or not genuine. For A.Y. 201718, the AO treated certain unsecured loans as unexplained under section 68 of the Act and disallowed proportionate interest thereon. For A.Y. 2018-19, although no fresh loans were received, interest on opening balances of such unsecured loans—treated as bogus in the earlier year—was again disallowed by the AO, citing lack of genuineness and creditworthiness. The CIT(A) upheld the disallowance in both years, primarily on the basis that the genuineness of the loans had not been established, and therefore, the interest paid on such loans could not be allowed.
3. Following is the tabulated summary of assessments in case of both the years:
ParticularsA.Y. 2017-18A.Y. 2018-19
Return filing date30.10.201731.10.2018
Returned IncomeRs. 33,06,110/-Rs. 97,90,060/-
Assessment completed under section143(3)143(3) r.w.s. 144B
Date of AO’s order21.12.201909.09.2021
Date of CIT(A)’s order27.06.202427.06.2024 (common order)
Additions made by AO1. Rs. 83,34,774/ – u/s 68 (unsecured loans)1. Rs. 14,69,04,326/-(additional revenue based on 60% WIP)
2. Rs. 36,69,000/- interest disallowance on above loans2. Rs. 38,94,295/-interest disallowance on earlier year loans
3. Rs. 4,70,832/- (loan balance discrepancy)3. Rs. 33,90,51,606/-(alleged violation of section 269SS)
4. Rs. 47,16,513/ – (bogus purchases)
Assessed IncomeRs. 204,97,229/-Rs. 51,04,16,994/-
CIT(A)’s decision1. Addition u/s 68 deleted1. WIP addition of Rs. 14.69 Cr deleted
2. Interest disallowance Rs. 36,69,000/ – sustained2. Section 269SS addition of Rs. 33.90 Cr deleted
3. Bogus purchase addition deleted3. Interest disallowance of Rs. 38,94,295/-sustained
Key reasons for AO’s disallowanceFailure to prove genuineness / creditworthiness of loan creditors; no confirmation from 12 partiesContinued failure to prove genuineness of loans from prior year; interest disallowed based on earlier findings
Key findings of CIT(A)Genuineness of principal loans not established despite deletion of u/s 68 addition; interest disallowance upheldPrincipal not added u/s 68 in current year, but interest disallowed for lack of evidence proving loan genuineness

 

4. Aggrieved by the orders of the CIT(A), the assessee is in appeal(s) before us raising following grounds:
ITA No. 1387/Ahd/2024 for AY 2017-18
1.On the facts and in the circumstances of the case as well in law, the NFAC (Appeals), New Delhi has erred in upholding the disallowance of interest on Unsecured Loans to the tune of Rs. 36.69 Lacs.
2.The appellant further reserves its right to add, alter, amend or modify any of the aforesaid grounds before or at the time of hearing of an appeal.

ITA No. 1388/Ahd/2024 for AY 2018-19

1.On the facts and in the circumstances of the case as well in law, the NFAC (Appeals), New Delhi has erred in upholding the disallowance of interest on Unsecured Loans to the tune of Rs. 38,94,295/-.
2.The appellant further reserves its right to add, alter, amend or modify any of the aforesaid grounds before or at the time of hearing of an appeal.
5. During the course of hearing before us, the Ld.Authorized Representative (AR) submitted that the interest paid on the loans cannot be disallowed unless the principal is held to be non-genuine in the relevant year. It was further submitted that in the absence of any fresh addition u/s 68 of the Act in A.Y. 2018-19, interest disallowance lacks legal foundation. The assessee had deducted TDS on the interest paid and the same was credited to the accounts of lenders. It was argued that unless the principal amount is treated as non-genuine, interest cannot be disallowed separately.
5.1. The Ld. AR also placed reliance on the following judicial precedents:
■Vidya Education Investments (P.) Ltd.(Delhi – Trib.).
■United Foods (P.) Ltd.(Delhi – Trib.).
■Ojas Tarmake (P.) Ltd(Gujarat).
■Hareshbhai Sakariya (Surat-Trib.).
These decisions were cited to support the proposition that interest cannot be disallowed in the absence of a sustainable addition of principal under section 68, and that the AO had not brought on record any contrary evidence except non-compliance with notices issued under section 133(6) of the Act.
5.2. The Ld. Departmental Representative (DR) supported the findings recorded by the Assessing Officer as well as the Ld. CIT(A) in their respective orders. It was submitted that the assessee had repeatedly failed to discharge its onus under section 68 of the Act with respect to establishing the identity, creditworthiness, and genuineness of the persons from whom unsecured loans were allegedly obtained. It was also contended that interest under section 36(1)(iii) of the Act, especially when the principal transaction itself is not proved to be genuine, cannot be allowed as expenditure. Reliance was placed on the findings of the Ld. CIT(A) who, after admitting additional evidence and calling for a remand report, recorded a categorical conclusion that the assessee failed to establish the creditworthiness of the lenders and the genuineness of the transactions, and accordingly upheld the interest disallowance in both years.
6. We have carefully considered the rival submissions, perused the assessment orders, the orders of the Ld. CIT(A), the materials placed before us, and the relevant judicial precedents cited. The core issue arising in both appeals pertains to the allowability of interest expenditure claimed by the assessee on certain unsecured loans which were either treated as unexplained cash credits by the Assessing Officer or, though not added under section 68 due to their nature as opening balances, were nevertheless disallowed for interest deductibility under section 36(1)(iii) of the Act. While the Ld. CIT(A) deleted the addition of principal amounts under section 68 for the reason that the loans did not pertain to the year under consideration, the interest claimed on such loans was disallowed and the disallowance was confirmed in both assessment years on the ground that the assessee failed to substantiate the genuineness and creditworthiness of the loan transactions.
6.1. It is settled law that the deletion of an addition under section 68 of the Act on technical grounds—namely, that the credit pertains to an earlier year and is carried forward as opening balance—does not automatically confer legitimacy upon the transaction. It is important to note that the Ld. CIT(A) has specifically recorded that the loan amounts reflected in the opening balances pertain to earlier years which were not subject to scrutiny assessment, and therefore the principle of res judicata is inapplicable. The non-examination of those credits in the past does not ipso facto prove their genuineness in the present year.
6.2. The allowability of interest under section 36(1)(iii) of the Act is a fresh claim each year and is contingent upon the existence of a genuine and subsisting liability. In the present case, the assessee has not brought on record any credible documentary evidence to substantiate the identity and creditworthiness of the parties or the genuineness of the loan transactions. In fact, during the course of the hearing before us, the Bench specifically asked the Ld. Authorized Representative whether any material has been placed on record to show that the loans in question, on which interest has been claimed, have been repaid in subsequent years, or that interest thereon has actually been paid. In response, the Ld. AR fairly admitted that such details had not been brought on record and further submitted that he does not consider such evidence relevant to his contention that interest should be allowed solely because no addition under section 68 of the Act has been made in the year under consideration. In our considered view, this argument is misconceived and contrary to the settled legal position.
6.3. The deduction of interest expenditure is governed by section 36(1)(iii) of the Act, which allows deduction only where the capital has been genuinely borrowed and used for the purposes of business. If the assessee fails to establish the genuineness of the underlying loan, the interest payable or paid thereon cannot be allowed. Mere routing of interest through banking channels or deducting TDS is not conclusive proof of allowability.
6.4. Further, the assessee’s failure to bring on record evidence of repayment of the loans, even years after their receipt, reinforces the Revenue’s contention that the alleged loans lack commercial substance. A genuine business liability is typically reflected in either repayment schedules, confirmations, or servicing of debt—none of which have been demonstrated in the present case. The assessee has relied on various decisions to argue that non-compliance with notices under section 133(6) or 131 of the Act by third parties should not automatically lead to adverse inferences, particularly when other documentary evidence exists on record. We have perused the said decisions and find them to be factually distinguishable from the case at hand. In those cases, there existed tangible and corroborative evidence in the form of confirmations, repayment details, PANs, TDS deduction, business necessity, and historical assessments, which are conspicuously absent in the present case. Here, the assessee not only failed to discharge the initial onus but also failed to bring on record any evidence of repayment or genuine subsistence of the loan liability, thereby justifying the disallowance of interest by the lower authorities.
6.5. Thus, the reasoning adopted by the Ld. CIT(A) in both years—namely, that the assessee failed to discharge its burden to prove the genuineness and creditworthiness of the lenders, and that interest cannot be allowed on an unverified or fictitious liability—is sound and supported by settled judicial principles. We find no justification to interfere with the findings so recorded. In view of the foregoing discussion and on a comprehensive consideration of the facts and applicable law, we are of the view that the disallowance of interest amounting to Rs.36,69,000/- in A.Y. 2017-18 and Rs.38,94,295/- in A.Y. 2018-19 is legally sustainable. Accordingly, grounds of appeals of the assessee are dismissed.
7. In the result, both the appeals of the assessee are dismissed.