Merely because interest liability was recognised by journal entries at the close of the year, it does not make expenditure fictitious or non-genuine.
In a recent judgment, ITAT has held that merely because the interest liability has been recognised through journal entries at the close of the accounting year cannot lead to the conclusion that the expenditure is fictitious or non-genuine.
ABCAUS Case Law Citation:
5197 (2026) (08) abacus.in ITAT
The appellant assessee was a partnership firm engaged in the business of real estate and financial consultancy. The assessee had not originally filed its return of income for the year under consideration. On the basis of information available with the Department that the assessee had received interest income on which tax had been deducted at source under section 194A, the Assessing Officer initiated proceedings under section 147 by issuing notice under section 148.
The Assessing Officer, while completing the reassessment, examined the claim of payment of interest to partner companies of the assessee-firm. The AO was of the opinion that interest payment was not allowable as according to him the partners’ capital accounts reflected debit balances at the beginning and at the close of the year.
The AO further observed that the interest entries had been passed through journal vouchers on the last day of the accounting year without actual payment through the banking channel and, therefore, concluded that the expenditure represented diversion of income by way of fictitious entries. The Assessing Officer accordingly disallowed interest payment.
The CIT(A) affirmed the additions.
Before the Tribunal, the assessee contended that interest was paid to the partners of the assessee-firm and the partnership deed specifically authorized payment of interest on the partners’ capital accounts. The Assessing Officer had merely compared the opening balance and the closing balance and ignored the actual movement in the running capital accounts throughout the year.
It was submitted that the opening balances stood modified by reversal entries passed on 1st April of the Financial Year , after which the accounts carried substantial credit balances for most of the previous year. Interest had been computed on the basis of the daily running credit balances and not on the opening or closing balances. The debit balances appearing at the end of the year had arisen only because of substantial withdrawals made towards the close of the financial year and could not retrospectively obliterate the credit balances existing during the year. The detailed day-wise interest calculations, running ledger accounts and reversal entries placed in the paper book clearly demonstrated that interest had been calculated transaction-wise, after considering the balance outstanding after each receipt and withdrawal together with the number of days for which such balance remained outstanding.
The assessee submitted that Form No.16A issued in favour of both the partner companies also evidenced deduction and deposit of tax at source on the interest credited by the assessee. Therefore, the allegation that the interest expenditure was fictitious or represented diversion of income was wholly contrary to the record.
The Tribunal observed that the entire edifice of the disallowance rested upon the premise that since the opening and closing balances reflected debit balances, no interest could have been payable during the year. Such an approach is fundamentally misconceived. None of the provisions of the Income-tax Act and the partnership deed obliges an assessee to compute interest merely with reference to the opening and closing balances of the account.
The Tribunal opined that the manner of maintaining running accounts and the methodology for computing interest are essentially commercial decisions of the assessee. It is well settled that the Assessing Officer cannot substitute his own method of accounting or commercial expediency for that adopted by the assessee unless the method followed is shown to be contrary to law or demonstrably incorrect
The Tribunal further observed that undue emphasis had been laid by the authorities below on the fact that the interest was credited through journal entries on last day i.e. 31st March of the financial year. Such reasoning overlooked the settled principles governing mercantile accounting. Under the mercantile system, an accrued liability is recognised by crediting the payee’s account. In fact, section 194A itself recognises deduction of tax at the time of credit or payment, whichever is earlier.
Accordingly, the ITAT held that the authorities below were not justified in disallowing the interest expenditure and the addition was directed to be deleted.
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