2012 (9) TMI 506 - AT - Income Tax

Disallowance of interest expense AO is of view assessee paid higher interest on borrowings and gave those funds at lower rate of interest - Difference between interest paid and interest received was treated as expenditure not incurred for the purpose of business and disallowed Held that - Assessee having both interest free funds and interest bearing funds were used for the purpose of business of the assessee and there was necessity to borrow funds. Therefore with regard to the interest free funds having been given owing to commercial expediency also requires examination. Case remand back to AO.

Summary

Issues:
1. Disallowance of interest expenditure by the Assessing Officer.
2. Justification of the CIT(A) in upholding the disallowance of interest.

Issue 1: Disallowance of Interest Expenditure by the Assessing Officer:
The Assessing Officer (AO) disallowed interest expenditure of Rs.9,99,525 claimed by the assessee, reasoning that the interest paid on borrowings exceeded the interest received on advances made. The AO found a significant difference between interest paid and interest received, treating it as expenditure not incurred for business purposes. This disallowance was calculated based on the difference between interest paid and interest received, resulting in the disallowance of Rs.9,99,525.

Issue 2: Justification of the CIT(A) in Upholding the Disallowance of Interest:
The CIT(A) upheld the disallowance of interest by considering various factors. The CIT(A) observed an increase in unsecured loans and withdrawals from the OD account with Canara Bank. Additionally, loans were given to closely associated entities, including a sister company. The CIT(A) noted that interest claimed on loans far exceeded interest received. The CIT(A) scrutinized ledger accounts and identified discrepancies, indicating that interest claimed may not be genuine. The CIT(A) concluded that the AO's disallowance was reasonable due to the mismatch in transactions during the year.

The assessee contended that interest-free loans to the sister concern were for commercial expediency and justified by business transactions. Referring to legal precedents, the assessee argued that interest-free funds were used for investments when available. The Tribunal found that the CIT(A) did not adequately consider the availability of interest-free funds for advancing loans. Citing a Bombay High Court decision, the Tribunal directed a fresh examination by the AO, emphasizing the need to assess both interest-free and interest-bearing funds. The Tribunal stressed the importance of proving commercial expediency for interest-free loans, allowing the assessee an opportunity to establish the same.

In conclusion, the Tribunal set aside the AO's order and remanded the issue of interest disallowance for fresh consideration. The Tribunal directed the AO to reevaluate the disallowance in light of the availability of funds and commercial expediency for interest-free loans. The appeal by the assessee was treated as allowed for statistical purposes.