The Income Tax Appellate Tribunal, Mumbai, has clarified that disallowance of interest expenditure under Section 57(iii) of the Income-tax Act cannot be sustained merely because the assessment was framed ex parte, provided the assessee establishes a clear nexus between the interest paid and the interest income earned through credible documentary evidence.
Background & Facts
The Dispute
The appellant, Ankur Chandulal Shah, claimed a deduction of ₹1,06,32,156 as interest paid on borrowings used to fund loans advanced to M/s Ariha Diamonds Jewellery Pvt. Ltd., from which he earned interest income of ₹1,76,81,852. He reported the net interest income of ₹70,51,426 under the head "Income from Other Sources". The Assessing Officer disallowed the entire interest deduction under Section 57(iii) because the appellant failed to respond to statutory notices, resulting in an ex parte assessment under Section 144.
Procedural History
- 2017: Assessee filed return declaring total income of ₹1,13,74,120, including claimed interest deduction.
- 2017-18: Assessment proceedings initiated; no response to notices led to ex parte assessment under Section 144.
- 2025: Commissioner of Income-tax (Appeals) upheld disallowance, citing lack of documentary proof of fund usage.
- 2026: Appeal filed before ITAT Mumbai; additional evidence submitted under Rule 46A.
Relief Sought
The appellant sought deletion of the disallowed interest expenditure of ₹1,06,32,156, arguing that the nexus between interest paid and interest earned was established through confirmations, ledger accounts, and computation of net income.
The Legal Issue
The central question was whether Section 57(iii) permits deduction of interest expenditure when the assessee demonstrates a direct nexus between the borrowed funds and the interest income earned, even if the original assessment was ex parte and the evidence was submitted only at the appellate stage.
Arguments Presented
For the Appellant
The appellant relied on CIT v. Rajendra Prasad Moody to argue that the phrase "for the purpose of making or earning such income" under Section 57(iii) focuses on intention and nexus, not actual receipt in the same year. He submitted that confirmations from the borrower company, loan agreements, bank statements, and detailed computation of net income collectively established the required nexus. He emphasized that Rule 46A permits submission of additional evidence before the appellate authority, and once admitted, the burden shifts to the Revenue to disprove genuineness.
For the Respondent
The Revenue contended that the ex parte nature of the assessment rendered the claim invalid, as the assessee failed to comply with statutory notices. It argued that without loan agreements or fund flow statements, the connection between borrowed funds and the interest-earning loan remained speculative. It relied on CIT v. Dalmia Jain & Co. Ltd. to assert that mere intention is insufficient without concrete proof of usage.
The Court's Analysis
The Tribunal rejected the Revenue’s reliance on the ex parte assessment as a ground for denial. It held that once additional evidence was admitted under Rule 46A and a remand report was sought, the appellate authority was obligated to evaluate the merits of the claim on the basis of the record before it.
"The essence of Section 57(iii) lies in whether the expenditure has been laid out wholly and exclusively for the purpose of making or earning income under the head 'Income from Other Sources'."
The Tribunal found that the appellant’s submission - comprising confirmation letters from Ariha Diamonds, ledger entries, and a clear computation showing net interest income - established a proximate and live nexus. The fact that the interest income was disclosed, accepted, and taxed by the Assessing Officer further undermined the claim of lack of nexus.
The Court distinguished CIT v. Dalmia Jain & Co. Ltd., noting that the case concerned speculative lending without any documented source of funds. Here, the source of funds and their deployment were documented. The Tribunal also clarified that CIT v. Rajendra Prasad Moody does not require actual receipt of income in the year, only that the expenditure be incurred with the intent to earn such income - and in this case, the income was not only intended but actually earned and taxed.
The appellate authority’s rejection on grounds of "lack of proof" was found to be contrary to the material on record and legally unsustainable.
The Verdict
The appellant won. The ITAT held that Section 57(iii) allows deduction of interest expenditure when a direct nexus between the borrowed funds and the interest income is established through credible documentary evidence, even if the original assessment was ex parte. The disallowance of ₹1,06,32,156 was deleted.
What This Means For Similar Cases
Documentary Nexus Trumps Procedural Default
- Practitioners must ensure all relevant documents are filed under Rule 46A at the appellate stage, even if the assessment was ex parte.
- The mere fact of non-response to notices does not invalidate claims if substantive evidence is later produced and admitted.
- Revenue authorities cannot rely on procedural lapses to deny substantiated claims.
Net Income Approach Is Legally Recognized
- Taxpayers may compute and declare net interest income under "Income from Other Sources" without needing to match each loan to each borrowing.
- The cumulative nexus between aggregate interest paid and aggregate interest earned suffices under Section 57(iii).
- This approach aligns with the principle of taxing net gains, not gross receipts.
Judicial Precedents Clarify Intent vs. Proof
- CIT v. Rajendra Prasad Moody confirms that intention alone is sufficient - but only if supported by evidence of the activity.
- This judgment reinforces that intention must be evidenced, not assumed.
- Practitioners should cite Moody to argue for deduction where income is earned, even if not in the same year, provided documentation supports the link.
