2012 (5) TMI 639 - AT - Income Tax

Disallowance of interest to the advances given to HGPL - Held that - CIT(A) while deciding this issue has deleted the additions of ₹ 46,64,53,318/-. However, at the same time on the proposed addition of ₹ 27,54,66,028/-, the Ld. CIT(A) has given part relief to the assessee and confirmed the disallowance of proposed interest relateable to advances made within the year on proportionate basis based on the ratio of borrowed funds to total funds. The assessee before us has suo motto calculated such disallowance at ₹ 9,01,98,977/-. To this extent, we find that both the orders of lower authorities are lacking in details regarding break up of interest attributable to the various categories referred to above. So far as the advance to HGPL is concerned, we find that the said advance has direct bearing with the commercial needs of the assessee. Once it has been established that the advances have been made for commercial reasons, no part of interest can be disallowed. Therefore, modifying the order of Ld. CIT(A), the AO is directed to allow the claim of interest

Summary

Issues Involved:
1. Disallowance of interest on advances given to M/s. Hy-Grade Pellets Ltd (HGPL).
2. Calculation and addition of interest not charged on advances in the income assessment.

Detailed Analysis:

1. Disallowance of Interest on Advances Given to M/s. Hy-Grade Pellets Ltd (HGPL):
The assessee's main grievance was the disallowance of interest amounting to Rs. 9,01,98,977/- on advances given to HGPL. The assessee argued that HGPL, a significant investment and key supplier of raw materials, was in financial distress and charging interest would further burden HGPL, potentially disrupting the supply chain critical for the assessee's operations. The assessee maintained that the advances were made out of business necessity and prudence, and the interest expenditure was incurred for business purposes, thus allowable under Section 36(1)(iii) of the Income Tax Act, 1961. The Assessing Officer (AO) disagreed, asserting that the assessee should have credited the interest accrued as per the mercantile system of accounting and that the funds were diverted for non-business purposes, leading to disallowance.

2. Calculation and Addition of Interest Not Charged on Advances in the Income Assessment:
The AO calculated the disallowance based on a proportionate formula, resulting in a proposed addition of Rs. 27,54,66,028/-. However, while computing the total income, the AO erroneously added Rs. 46,64,53,318/-. The assessee contested this addition before the Commissioner of Income Tax (Appeals) [CIT(A)], who ruled that income cannot be taxed on a notional basis unless it is earned or accrued. The CIT(A) found no evidence that the assessee was entitled to interest from HGPL and thus deleted the addition of Rs. 46,64,53,318/-. However, the CIT(A) partially upheld the AO's alternative proposition, disallowing interest on advances made during the year for operational expenses of HGPL, calculated proportionately.

Upon appeal, the Tribunal noted the discrepancy in the AO's calculations and acknowledged the commercial necessity of the advances to HGPL. It was established that the advances were made to ensure uninterrupted supply of raw materials, crucial for the assessee's manufacturing processes. The Tribunal concluded that since the advances were made for commercial reasons, no part of the interest could be disallowed. Consequently, the Tribunal directed the AO to allow the interest claim, thereby allowing the assessee's appeal.

Conclusion:
The Tribunal allowed the appeal, directing the AO to allow the interest claim, emphasizing that the advances to HGPL were made out of commercial necessity and thus no part of the interest could be disallowed. The Tribunal also rectified the discrepancy in the AO's addition figures, ensuring accurate and fair assessment.