2012 (3) TMI 44 - AT - Income Tax

Interest free advances - Additions made by AO applying 12% rate of interest - Held That - the assessee was having sufficient interest free fund in the form of capital and reserves Rs. 5.48 crores against interest-free advances of Rs. 1.30 crores. Since the assessee has having sufficient interest-free funds to interest free advances, we therefore, delete the addition of Rs. 15,66,180/- Reliance placed on Torrent Financiers v. Asstt. CIT (2001 - TMI - 55358 - ITAT AHMEDABAD-A).

Summary

Issues Involved:
1. Validity of the assessment order.
2. Disallowance of Rs. 15,66,180/- out of interest expenses.
3. Disallowance of Rs. 30,46,389/- as prior period expenses.
4. Addition of Rs. 7,88,215/- on account of alleged inflated labour & transportation expenses.

Detailed Analysis:

1. Validity of the Assessment Order:
The assessee raised a general ground challenging the validity of the assessment order, claiming it to be "bad in law." However, this ground was not pressed during the hearing and was subsequently dismissed.

2. Disallowance of Rs. 15,66,180/- out of Interest Expenses:
Background: The Assessing Officer (AO) disallowed Rs. 15,66,180/- from the interest expenses on the grounds that the assessee had provided interest-free advances amounting to Rs. 1,30,51,504/- to 13 parties. The AO applied a 12% interest rate to calculate the disallowance, which was confirmed by the Commissioner of Income Tax (Appeals) [CIT(A)].

Assessee's Argument: The assessee argued that there was no nexus established between the borrowed funds and the interest-free advances. They relied on the ITAT Ahmedabad decision in Torrent Financiers v. Asstt. CIT [2001] 73 TTJ 624, which suggested that interest-free advances should not be disallowed to the extent of share capital and reserves being interest-free.

Tribunal's Analysis:
- The Tribunal noted that the CIT(A)'s observation concerning the Torrent Financiers case was incorrect. The ITAT's formula in Torrent Financiers had been implicitly approved by the Supreme Court in Munjal Sales Corpn. v. CIT [2008] 168 Taxman 43 and the Allahabad High Court in CIT v. Prem Heavy Engg. Works (P.) Ltd. [2006] 285 ITR 554/150 Taxman 90 (All.).
- Section 36(1)(iii) of the Income Tax Act was discussed in detail, emphasizing that the interest on borrowed capital is allowable only if the capital remains invested in the business.
- The Tribunal stressed that borrowed funds diverted for non-business purposes cannot be treated as a permissible deduction.
- The Tribunal acknowledged that if an assessee has sufficient interest-free funds to cover interest-free advances, no disallowance is warranted.

Conclusion: In this case, the assessee had sufficient interest-free funds (capital and reserves of Rs. 5.48 crores) against the interest-free advances (Rs. 1.30 crores). Therefore, the addition of Rs. 15,66,180/- was deleted.

3. Disallowance of Rs. 30,46,389/- as Prior Period Expenses:
This ground was not pressed by the assessee during the hearing and was dismissed.

4. Addition of Rs. 7,88,215/- on Account of Alleged Inflated Labour & Transportation Expenses:
Similarly, this ground was not pressed by the assessee during the hearing and was dismissed.

Final Judgment:
The appeal of the assessee was partly allowed, with the deletion of the disallowance of Rs. 15,66,180/- from the interest expenses. Other grounds were dismissed as they were not pressed during the hearing.