2012 (5) TMI 415 - AT - Income Tax

Interest of unsecured loans - utilization of borrowed funds - business nexus - Held that - A.O. has wrongly considered the amounts as on 31.03.2004 for making the disallowance on the basis of the statement of affairs without examining the fund flow or the payment of interest - A.O. has not made out a proper case for disallowance under section 36(1)(iii) by examining the funds borrowed on which interest was paid and its utilization in the business on which interest was claimed - A.O. also has not considered the interest received from some of the advances in calculating the proportionate disallowance - Appeal is allowed by way of remand the matter back to the file of the A.O. by setting aside the orders to examine assessee s contentions and to obtain a fund flow statement and see whether the borrowed funds were diverted for non-business purposes

Issues Involved:
1. Disallowance of interest under section 36(1)(iii) of the Income Tax Act.
2. Nexus between borrowed funds and their utilization for business purposes.
3. Proportionate disallowance of interest on borrowed funds used for non-business purposes.
4. Examination of fund flow and cash flow statements.
5. Consideration of interest received on advances in calculating disallowance.
6. Legal heirs to be brought on record after the death of an assessee.

Issue-Wise Detailed Analysis:

1. Disallowance of interest under section 36(1)(iii):
The primary issue in these appeals is the disallowance of interest under section 36(1)(iii) of the Income Tax Act. The Assessing Officer (A.O.) made disallowances on the grounds that the borrowed funds were not exclusively used for business purposes. The disallowances were confirmed by the Commissioner of Income Tax (Appeals) [CIT(A)].

2. Nexus between borrowed funds and their utilization for business purposes:
The A.O. and CIT(A) observed that the assessees failed to establish a clear nexus between the borrowed funds and their utilization for business purposes. The assessees argued that the borrowed funds were used for advancing loans, investing in partnership firms, and other business activities. However, the A.O. concluded that a proportionate disallowance was necessary as the assessees could not prove that the borrowed funds were exclusively used for business purposes.

3. Proportionate disallowance of interest on borrowed funds used for non-business purposes:
The A.O. calculated the disallowance based on the proportion of borrowed funds to total funds and the average rate of interest. For instance, in the case of Mr. Sudhir S. Chhajed, the A.O. disallowed Rs.213,429/- by considering 75.48% of borrowed funds used for non-business purposes. Similar calculations were made for other assessees, leading to proportionate disallowances.

4. Examination of fund flow and cash flow statements:
The Tribunal noted that the A.O. did not properly examine the fund flow and cash flow statements to determine the actual utilization of borrowed funds. The assessees contended that the borrowed funds were used for business purposes, and old investments were made from their own funds. The Tribunal emphasized the need for a detailed examination of the fund flow and cash flow statements to ascertain the utilization of borrowed funds.

5. Consideration of interest received on advances in calculating disallowance:
The Tribunal observed that the A.O. did not consider the interest received on advances while calculating the proportionate disallowance. For example, Mr. Sudhir S. Chhajed received Rs.2,99,759/- as interest on loans given, which was not considered by the A.O. in the disallowance calculation. The Tribunal directed the A.O. to consider the interest received while re-examining the disallowance.

6. Legal heirs to be brought on record after the death of an assessee:
In the case of Late Mr. Sanchalal C. Chhajed, the Tribunal noted that the CIT(A) passed the order after the death of the assessee without bringing the legal heirs on record. The Tribunal directed the A.O. to bring the legal heirs on record and re-examine the case.

Conclusion:
The Tribunal set aside the orders of the A.O. and CIT(A) in all the cases and remanded the matters back to the A.O. for fresh examination. The A.O. was directed to obtain fund flow statements, examine the utilization of borrowed funds, and consider the interest received on advances. The Tribunal emphasized that only if the borrowed funds were diverted for non-business purposes, the interest claim should be disallowed under section 36(1)(iii). The appeals were allowed for statistical purposes, and the assessees were to be given a proper opportunity to make submissions on facts and law.

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