Mumbai Tribunal deletes Tax Addition made by Assessing Officer by creating 'notional interest' on loan advanced by Company to Director

 Advancing of interest-free funds by company to director does not warrant computation of notional interest income in the hands of Company.

The assessee, a company, had advanced an interest-free loan to its director. During the course of assessment proceedings, the Assessing Officer observed that the amount so advanced was equivalent to the company’s total subscribed capital along with a portion of its reserves. The Assessing Officer further noted that the company had claimed interest expenditure in its profit and loss account. On this basis, the Assessing Officer computed notional interest income at the rate of 18 percent on the outstanding loan amount and made an addition to the income of the assessee. Aggrieved by the said addition, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals), who decided the issue in favour of the assessee on the ground that only real income is liable to tax.

The matter was thereafter carried in appeal before the Tribunal. Before the Tribunal, the assessee contended that notional income cannot be brought to tax, particularly where, in the exercise of commercial discretion, the assessee had advanced an interest-free loan to its director. It was further argued that the Assessing Officer cannot substitute his judgment for that of the businessman. The assessee also submitted that the Assessing Officer had himself acknowledged that the loan was advanced out of interest-free funds and, therefore, no addition was warranted. The Tribunal accepted the submissions of the assessee, upheld the order of the Commissioner of Income-tax (Appeals), and ruled in favour of the assessee.

Advancing loans out of interest-free funds is a matter of commercial prerogative of the assessee, and the revenue cannot substitute its judgment by imputing notional interest on such advances.