2013 (4) TMI 767 - AT - Income Tax

Disallowance of interest u/s 36(l)(iii) in respect of interest free loan/ advance to sister concern - HELD THAT - The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure, if it was incurred on grounds of commercial expediency . Undoubtedly, this aspect of the matter is important for the reason that in case the fact of commercial expediency of advancing interest free advances to the subsidiary companies is established, even if one is to come to the conclusion that interest free advances to the subsidiary companies are out of the borrowed funds, interest on borrowed funds is to be allowed in full nevertheless. However, having held that the assessee did have sufficient interest bearing funds to advance interest free advances to sister concerns, this aspect of the matter is somewhat academic. In a case in which an assessee has sufficient interest free funds, to cover the interest free advances, the principles laid down by Hon ble Supreme Court in SA Builders case 2006 (12) TMI 82 - SUPREME COURT dealing with governing commercial expediency in advancing interest free advances will not really be relevant. Ld Commissioner (Appeals) s stand was thus devoid of legally sustainable merits on this aspect as well. Thus, we uphold the grievance of the assessee and direct the Assessing Officer to delete the impugned disallowance out of interest expenses. The assessee gets the relief accordingly. In the result, the appeal is allowed.

Summary

Issues Involved:
1. Justification of sustaining the disallowance of Rs. 6,32,980/- in respect of interest expenses incurred by the assessee.

Issue-wise Detailed Analysis:

1. Justification of Sustaining the Disallowance of Rs. 6,32,980/- in Respect of Interest Expenses Incurred by the Assessee:
The primary issue in this appeal is whether the Commissioner of Income Tax (Appeals) [CIT(A)] was justified in sustaining the disallowance of Rs. 6,32,980/- in respect of interest expenses incurred by the assessee. The assessee, engaged in the business of trading in steel and iron bars, had unsecured borrowings amounting to Rs. 66,55,643/- with an interest rate of 12%. The Assessing Officer (AO) noted that the assessee had extended interest-free advances despite having a capital balance of only Rs. 11,44,483/-. The AO concluded that the interest-bearing loans were utilized for purposes other than business and disallowed the interest paid on these borrowings.

Upon appeal, the CIT(A) upheld the AO's decision, referencing the Supreme Court's judgment in SA Builders Vs CIT, which states that "commercial expediency or business purpose should be established to avoid disallowance." The CIT(A) also cited the Kerala High Court's judgment in CIT Vs V N Baby & Ors, which posited that borrowing funds on interest for business purposes while giving interest-free advances is not justifiable. The CIT(A) found no commercial expediency in the assessee's interest-free advances and confirmed the disallowance.

The Tribunal, however, found that the CIT(A) and AO's reliance on the Kerala High Court's judgment and similar precedents was misplaced. The Tribunal referred to the Supreme Court's judgment in Munjal Sales Corp Vs CIT, which clarified that if an assessee has both interest-bearing and interest-free funds, and it can be shown that interest-free loans were not given out of interest-bearing funds, the interest paid on borrowed funds cannot be disallowed. The Tribunal also cited the Bombay High Court's judgment in CIT Vs Reliance Utilities & Power Ltd, which established that if interest-free funds available to an assessee are sufficient to meet its investments, it should be presumed that the investments were made from interest-free funds.

The Tribunal further noted that the jurisdictional High Court in CIT Vs Raguvir Synthetics Ltd supported this view, indicating that if an assessee has sufficient interest-free funds to cover interest-free advances, the interest on borrowed funds should not be disallowed. The Tribunal concluded that the CIT(A) erred in disallowing the interest expenses, as the assessee had sufficient interest-free funds to cover the interest-free advances.

In light of these findings, the Tribunal directed the AO to delete the disallowance of Rs. 6,32,980/- out of interest expenses, allowing the assessee's appeal. The judgment emphasized that the mere existence of both interest-bearing and interest-free funds does not automatically justify disallowance of interest expenses unless it is shown that interest-free advances were made out of interest-bearing funds. The Tribunal's decision was pronounced in the open court immediately upon conclusion of the hearing.