Is TDS to be deducted u/s 194A w.r.t interest payments in the nature of trade liability

Introduction

Section 194A states that any person not being an individual or a HUF, who is responsible for paying to a resident any income by way of interest other than interest income 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.

Following are the rates of TDS:

1. 10% when the PAN is furnished (7.5% from 14 May 2020)
2. 20% if the PAN is not provided

So it is apparent from a plain reading of Section 194 A that a person who is paying interest has to deduct tax at source (10% or 20% as the case may be).

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Is such tax required to be deducted when the interest paid is in the nature of a trade liability?

A similar situation was resolved in the case of Parag Mahasukhlal Shah vs Department Of Income Tax on 17 June, 2011.

Let us look into what interest means under the Income Tax Act before we proceed with the details of this case.

Section 2(28A) of The Income Tax Act, 1995 states that interest means interest payable in any manner in respect of any moneys borrowed or debt incurred (including 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 utilised.

Facts of the Case

1. Assessee in his individual capacity is a proprietor of a concern dealing in trading of ball-bearings.
2. It was noticed by the Assessing Officer (AO) that the assessee has claimed interest expenses which include interest to their dealer (supplier).
3. On the said interest amount no tax was deducted at source.
4. Assessee was having dealership of ball-bearings from him supplier.  As per the terms of payment he was allowed 2.5% cash discount on payments made within 15 days, 1.5% cash discount in case of payment made within 30 days and an interest-free credit period for 60 days.
5. It was further informed that in case of overdue payment the cost of purchase is added with a liability to pay a compensatory sum which was termed as interest.
6. Therefore, the said interest amount was nothing but in the nature of additional sale price paid.
7. As per the assessee since it was not in the nature of interest in strict terms, hence there was no liability to deduct the tax at source.
8. However, the AO was not convinced and according to him as per section 2(28A) of the Income Tax Act interest means, interest payable in any manner in respect of any money borrowed or debited. In his opinion, for such payment the provisions of section 194A of the Income Tax Act were applicable.
9. It was concluded that in terms of the provisions of section 40(a)(ia), the expenditure of the said interest payment was to be disallowed. The matter was carried before the Commissioner of Income Tax (Appeals) [CIT(A)].

Proceedings at CIT(A)

1. CIT(Appeals) has followed an order of the Jurisdictional High Court, namely, Nirma Industries Ltd. vs. Dy. CIT (2006) where it was held that the interest received from the trade debtors for late payment of sales consideration is the amount derived from the sale proceeds. According to the judgment, purchaser pays higher sale price due to delay in payment. As per the argument the said payment is therefore out of the ambits of the TDS provisions.
2. Accepting the defense, the AO was directed to delete the addition.
3. AO being aggrieved with the order of CIT(A) appealed for the same to the Income Tax Appellate Tribunal (ITAT).

Proceedings of ITAT

1. It was admitted that there were certain terms and conditions agreed upon between the two parties in case of delay in payments.
2. Whenever there was delay in payment, there was a condition to compensate the delay.
3. Likewise, in case of prompt payment, the terms of payments have prescribed a facility of cash discount.
4. Therefore, the fundamental and primarily argument from the side of the assessee was that the amount paid to compensate the delay in making the payment was nothing but the added sales price of the said commodity.
5. It was also argued that the nature of payment was not within the definition of interest as prescribed u/s 2(28A).
6. The term interest has been defined in Section 2(28A), but the definition appears to be wide. It covers interest payable in any manner in respect of loans, debts, deposits, claims and other similar rights or obligation. This definition includes service charges but those charges should be in respect of the money borrowed.
7. It is evident that if the charges are in respect of a debt or in respect of any credit facility, then such charges are inclusive in the definition of “interest”. Therefore, the interest is a payment of money in lieu of use of borrowings. It is payable by a debtor to the creditor.

8. However, the said definition is not wide enough to include other payments.

9. There ought to be distinction between the payments not connected with any debt, with a payment having connection with the borrowings. A payment having no nexus with a deposit, loan or borrowings is out of the ambits of the definition of interest as per section 2(28A).

10. This decision of the Ghaziabad Development Authority vs. Dr. N.K.Gupta case was helpful to decide this appeal because it was held that if the nature of payment is to compensate an allottee, then the provisions of section 194A not to be applied as far as the question of deduction of TDS on interest is concerned.

11. On plain reading of Section 194A, it is apparent that the term “interest” used in this section relates to and in connection of a debt or a loan or a deposit.

12. Therefore, if a payment is compensatory in nature and not related to any deposit/debt/loan, then such a payment is out of the ambits of the provisions of section 194A.

Hence, the ITAT was of the view that the impugned payment had a direct nexus with the Trade liability being connected with the delayed purchase payment, hence, did not fall within the category of “Interest” as defined in Sec 2(28A) for the purpose of deduction of Tax at Source as prescribed u/s 194A. Resultantly, assessee was not held as a defaulter of non-deduction of tax at source u/s 194A.

Similar Cases pertaining to this issue:-

Phatela Cotgin Industries P.Ltd. vs. CIT – Interest received on delayed payment on account of sale to customers has to be termed as income derived from the Industrial Undertaking and such income was held as distinct from interest income which is received from Fixed Deposit.

 CIT vs Indo Matsushita Carbon Co Ltd – If the purchaser did not make the payment in time and agreed to pay the interest on the belated payments, the said interest would have direct nexus with the business activity.

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