2009 (2) TMI 504 - AT - Income Tax

Disallowance of interest expenditure u/s 36(1)(iii) - interest free loan to sister concern - interest bearing borrowed funds and own capital has lost its separate identity as both are mixed - contention of the assessee is that advances were given for the purpose of business in accordance with commercial expediency. HELD THAT - The payment of interest on the amount not used in the business cannot be regarded as a business expenditure as the business does not derive any benefit by the outgoing by way of interest on an amount which is no longer in the business, but had been diverted from the business. This provision, therefore, cannot be construed as enabling an assessee to burden the business with interest even while taking the amount initially borrowed for the business, but subsequently taken out of the business by diverting it as interest-free loans to sister concerns and relatives or for personal use. From the judgment of High Court in the case of CIT v. Gopikrishna Murlidhar 1961 (11) TMI 68 - ANDHRA PRADESH HIGH COURT , We find that the assessee has right to replace his own capital with borrowed funds which were already used for the purpose of business in acquiring assets and other. With the help of this ratio of the judgment such problem can be resolved by examination and analyses of financial statements prepared on the basis of books of account maintained by the assessee. It is well accepted proposition that for the purpose of ascertaining profit and gains, the normal principles of commercial accounting should be applied, so long as they do not conflict with any express statutory provisions as held by the Hon ble Supreme Court in CIT v. UP State Industrial Development Corpn. 1997 (4) TMI 2 - SUPREME COURT . Thus such problem can be resolved by analyzing statement of accounts and in particular balance-sheet. The onus is on the assessee to furnish the relevant material regarding replacement of borrowed funds by own capital and interest-free funds available with the assessee. The presumption of availability of interest-free funds in the form of capital in case of company can be drawn on material furnished by the assessee-company. Considering the corporate sections, it is important and relevant to state that in case of company governed by Companies Act, such interest-free, if the same is not found in conformity with the provisions of the Companies Act and regulatory bodies to that extent, it cannot be presumed that the assessee has given interest-free funds out of interest funds available with the assessee in the form of capital and reserve. The owner of capital and reserve of a company is shareholders and their consent for giving interest-free funds only can be presumed that the interest-free loans are given in conformity with above discussion. The commercial expediency is also required to be established by the assessee by furnishing relevant material based on which it can be said that interest-free funds given to sister concern are in conformity with provisions of Companies Act and provisions of regulatory bodies. Before disallowing such interest AO is duty bound to examine those material as enough power in this regard provided in IT Act. Needless to mention that AO should record all such facts clearly by passing a speaking order. Since in the case under consideration, such complete details are not found on record we, therefore, remit both the grounds of appeal to the file of AO to decide the issue afresh in accordance with law keeping in above discussion and guidelines. AO is further directed that though the CIT(A) has also directed that netting claim also be examined, whether the same is allowable in accordance with law or not has to be found out by AO. The appeal of the assessee is treated as allowed for statistical purposes.

Summary

Issues Involved:
1. Disallowance of interest expenditures.
2. Disallowance under section 14A in connection with exempt income.
3. Deduction under section 80HHC.
4. Charging of interest under section 234D.

Detailed Analysis:

1. Disallowance of Interest Expenditures:
The primary issue concerns the disallowance of interest expenditures by the Assessing Officer (AO). The AO observed that the assessee had obtained a loan of Rs. 23.15 crore from M/s. Paks Veterinary Drug Manufacturing Co. Ltd. and paid interest of Rs. 108.69 lakh. However, the assessee had advanced Rs. 8,16,41,865 to M/s. Paks without charging any interest. The AO disallowed Rs. 38,31,920 and Rs. 17,11,417 of the interest claim, reasoning that the assessee provided interest-free funds to its sister concern. The CIT(A) confirmed these disallowances.

The assessee contended that the advances were for business purposes and relied on the Supreme Court judgment in S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1. The assessee also claimed that the advances were made from interest-free funds available with it and sought a netting benefit.

The Tribunal examined the allowability of interest expenditure under section 36(1)(iii) of the Income-tax Act. It emphasized that the borrowed capital should be used for business purposes and that interest on such borrowings is deductible only if the borrowed amount remains in the business. The Tribunal noted that if the borrowed funds are diverted for non-business purposes, the interest on such borrowings is not deductible.

The Tribunal also discussed the scenario of mixed funds (borrowed and own funds) being used for non-business purposes. It referred to the Andhra Pradesh High Court decision in CIT v. Gopikrishna Murlidhar [1963] 47 ITR 469, which allowed the assessee to replace its own capital with borrowed funds used for business purposes. The Tribunal concluded that if the assessee has sufficient interest-free funds to cover the interest-free advances, no disallowance is warranted. If not, a proportionate disallowance is justified.

The Tribunal remitted the issue back to the AO to decide afresh, considering the above guidelines and providing the assessee an opportunity for a hearing.

2. Disallowance under Section 14A:
The second issue pertains to the disallowance under section 14A concerning exempt income of Rs. 2,76,251. The Tribunal referred to the ITAT Mumbai Special Bench decision in ITO v. Daga Capital Management (P.) Ltd. [2008] 26 SOT 603, which requires the AO to determine the expenditure incurred in relation to exempt income after being satisfied that the assessee's claim is incorrect.

The Tribunal remitted the matter back to the AO to verify the assessee's claim and decide in light of the Special Bench decision, ensuring the disallowance does not exceed the originally disallowed amount.

3. Deduction under Section 80HHC:
The third issue involves the deduction under section 80HHC. The AO calculated the deduction at NIL due to negative profit and did not allow 90% of the provision for doubtful debts written back (Rs. 9,32,000) and miscellaneous income (Rs. 70,000) while computing the profit of the business.

The Tribunal referred to the Supreme Court judgment in IPCA Laboratory Ltd. v. Dy. CIT [2004] 266 ITR 521, which held that deduction under section 80HHC(3)(c) is allowed only if there is positive profit. It also cited the Bombay High Court judgment in CIT v. Kantilal Chhotalal [2000] 246 ITR 439 regarding the 90% claim from doubtful debts and miscellaneous income.

The Tribunal remitted the matter back to the AO to decide in accordance with these judgments, providing the assessee an opportunity for a hearing.

4. Charging of Interest under Section 234D:
The final issue concerns the charging of interest under section 234D. The Tribunal noted that this section was inserted by the Taxation Laws (Amendment) Act, 2003, effective from 1-6-2003 and applicable from the assessment year 2004-05. The Tribunal referred to the ITAT decision in ITO v. Ekta Promoters (P.) Ltd. [2008] 113 ITD 719 (Delhi) (SB), which supported the assessee's position.

Conclusion:
In conclusion, the appeal of the assessee is allowed for statistical purposes, with directions to the AO to re-examine the issues afresh, considering the detailed guidelines and legal precedents discussed.