1. This is an appeal filed by Andhra Pradesh State Film Development Corporation Ltd., Hyderabad, against the order of the Commissioner (Appeals)-II, Hyderabad, for the assessment year 1978-79.
2. The assessee is a State undertaking which had obtained loans from the State Government. The terms of the loans are available in G.O. Ms.
No. 830 General Administration (IPR&T) Department, dated 1-12-1976. The assessee was to pay 11 per cent interest on the loan. On failure on the part of the assessee to adhere to the deadlines for payment of instalments, the assessee was liable to pay 16 1/2 per cent interest.
The assessee could not keep up its instalments. However, it had provided only for 11 per cent interest in the accounts for the accounting year 1976-77. When the accounts for the accounting year 1977-78 became the subject-matter of Audit, it was pointed out by the Audit that the assessee should have made provision at the higher rate.
So, the assessee provided for interest at the higher rate for this year and also made good the omission for interest difference for the immediately preceding year. Interest for this year at 161/2 per cent (18 per cent in respect of later loans) came to Rs. 89,666.35. The amount that was sought to be made good as relating to the immediately preceding year was Rs. 25,797.36. The total interest claimed for the year is, therefore, Rs. 1,15,463.71. The ITO disallowed the entire claim on the ground that the assessee had paid the interest as penal interest and that, therefore, it was not allowable as a deduction. The first appellate authority confirmed the disallowance after citing some authorities. In second appeal, the assessee claimed that the citations related to payments consequent on infringement of law. Those decisions, it was claimed, would not apply to the assessee's case. During the hearing, it was pointed out that the recent decision of the Supreme Court in the case of Mahalakshmi Sugar Mills Co. v. CIT  123 ITR 429 would support the assessee's case. It was pointed out that the Supreme Court found that even interest payable on arrears of cess under the Cess Act was in reality part and parcel of the liability to pay cess. It was compensation for delay in payment of cess and not a penalty. In the assessee's case, it was contended, the lower rate of interest was more an incentive to ensure prompt payment, while the correct rate of interest was only 16 1/2 per cent and later 18 per cent. According to the representative, the assessee had merely forgone the concessional rate of interest by being unable to adhere to the instalment dates. It was claimed that the entire amount of interest was disallowed without any justification. There was obviously no reason for disallowance of interest even at the lower rate even in the view held by the authorities. The learned departmental representative relied upon the orders of the authorities below. He further pointed out that the assessee had asked the Government for rescheduling the repayments. If that were done, the assessee may not be liable to pay any penal interest. He further pointed out that the interest includes the difference between the lower and the higher rate of interest chargeable for the accounting year 1976-77.
3. We have carefully considered the records as well as the arguments.
The transaction between the assessee and the State Government is as between any borrower and lender. In substance, the assessee was liable to pay interest at 16 per cent (and 18 per cent) unless of course the payment of interest and return of loan by instalments is made strictly in accordance with the terms in which case the interest will be only 11 per cent. We do not find any infringement of law by the assessee in respect of these transactions. The payment was a contractual one.
Hence, we are of the view that even without the assistance of the decision of the Supreme Court relied upon by the learned representative for the assessee, the payment of interest at the higher rate as stipulated in the Government order setting out the terms of the loan should have been allowed as a deduction. Such amount no doubt is not the entire amount as claimed by the assessee, but only Rs. 89,666.35, which is the interest at the rate of 16 1/2 per cent (and 18 per cent) in respect of the outstanding loans due to the State Government.
4. The Supreme Court, in the case of Mahalakshmi (supra), was dealing with interest payable on arrears of cess under the U.P. Sugarcane Cess Act, 1956. It was found by the Supreme Court that even in respect of such statutory liability, interest paid for delayed payment was, in essence, in the nature of a compensation for the use of moneys not belonging to the assessee and not in the nature of a penalty for an infringement of law. The assessee is in a much better position as the higher rate of interest was due to the default on the assessee's part to adhere to the dates of instalments. The very fact that the Government order envisages delayed payment and provides for it would make it appear that there is not even a breach of contract and much less an infringement of law. Such an arrange ment is common in all business transactions and such differential rates are provided to encourage prompt payment of dues. It will be too much to hold that the mere additional interest due to delayed payment loses its character as interest and becomes a penalty merely because the lender is State Government. We do not find any justification for the rigid view taken by the authorities. We do not, therefore, discuss the citations given by both the sides as they are far off the mark and deal with situations which are not analogous to the facts of the assessee's case.
5. The learned departmental representative pointed out that the assessee requested the State Government to reschedule the payments. If the payments are rescheduled, the assessee may not be liable to pay the full amount. He, therefore, tried to salvage a part of the disallowance by claiming alternatively that the allowance could only be to the extent of interest at the rate of 11 per cent. The Government had not agreed with the assessee's request. It was for this reason that the Audit had re quired provision at higher rate of interest. Interest had alrerdy accrued on these loans at the higher rate as per terms agreed between the parties. If there is a remission of interest at a later stage, there are adequate provisions to bring such remission to tax.
There is no reason for disallowing any part of the amount of Rs. 89,666.35. This will be allowed as a deduction.
6. As for the balance of Rs. 25,797.36, it is interest relating to accounting year 1976-77 pertaining to the preceding assessment year. It should have been claimed in the relevant year. Since the assessee anticipated rescheduling of the dates, the assessee did not provide for the same. If the rescheduling is not done and the amount becomes payable and is actually paid, it may well be treated as liability either of the year of Government order or the year of payment. At any rate, it cannot be treated as a liability for this year. We have, therefore, to confirm the disallowance to limited extent of Rs. 25,797.36, though for reasons which are different from those set out by the authorities below.
7. In the result, the appeal is partly allowed. Relief due Rs. 89,666.35.