2013 (8) TMI 744 - AT - Income Tax

Disallowance the interest paid at the rate of difference between two average rates (of borrowing funds and lending funds from and to sister concerns) without going into details of utilization of funds borrowed and the purpose of giving of loans Held that - AO has not mentioned anything in the assessment order as to under which provision, he has made addition of the differential interest rate - AO has not brought out any detailed facts on record proving nexus of funds borrowed with the funds given as loan to establish that the borrowed funds were diverted at lesser rate of interest to sister concern or other than business purposes - On the face of these findings of fact recorded by the ld. CIT(A) even the part addition sustained by the ld. CIT(A) is not justified - CIT(A) even should not have sustained the part addition because the AO has not pointed out as to how the conditions of section 36(1)(iii) have been violated in this case Decided against the Revenue. In the case under consideration, the case of the A.O. is that there is a loss on account of interest paid and received. The CIT(A) has also wrongly accepted the A.O. s view without considering the section 36(1)(iii) of the Act. The loss in the interest account was on account of different rates charged from different parties on loans and advances taken and loans and advances given. For allowing deduction under section 36(1)(iii), it is to be seen whether conditions stated in section 36(1)(iii) has been satisfied or not. In the case under consideration, the assessee has satisfied all the conditions that the borrowed fund was used for the purpose of business as prescribed under section 36(1)(iii) of the Act. Also, it was not the case of the A.O. that the borrowed fund was not utilised for the purpose of business of the assessee.

Issues Involved:
1. Disallowance of interest paid by the assessee under Section 36(1)(iii) of the Income Tax Act.
2. Nexus of borrowed funds with loans given to sister concerns.
3. Computation of average rate of interest paid and received by the assessee.

Detailed Analysis:

1. Disallowance of Interest Paid by the Assessee under Section 36(1)(iii):

The Revenue challenged the order of the CIT(A) in restricting the addition to Rs.2,40,838/- against the AO's addition of Rs.38,79,887/- due to differences in the average rate of interest. The AO noted that the assessee paid interest at rates between 18% to 24% but received interest at lower rates from different parties, leading to a deemed non-business purpose payment of the interest difference. The CIT(A) found that the AO did not establish a detailed nexus between borrowed funds and loans given, nor did he provide a detailed working of the average interest rates. The CIT(A) concluded that the AO's method was not aligned with the Income Tax Act provisions or judicial precedents, including the Supreme Court's ruling in Munjal Sales Corporation vs. CIT, which requires establishing a nexus of borrowed funds for business purposes to claim deductions under Section 36(1)(iii).

2. Nexus of Borrowed Funds with Loans Given to Sister Concerns:

The CIT(A) examined the ledger accounts and found that loans given at interest rates ranging from 12% to 18% were sourced from funds borrowed at similar rates. The CIT(A) verified that loans to Shree Krishna Ship Breaking Industries and Neuromed Imaging Centre Pvt. Ltd. were given from borrowed funds deposited in the assessee's current account. The CIT(A) determined that loans given to Shree Krishna Ship Breaking Industries were for business purposes and at the same interest rate as the borrowed funds, thus no disallowance was needed. However, for Neuromed Imaging Centre Pvt. Ltd., the CIT(A) found no business purpose for the loan given at a lower interest rate than the borrowed funds, leading to a disallowance of interest on the differential rate.

3. Computation of Average Rate of Interest Paid and Received by the Assessee:

The AO computed the average rate of interest paid by considering only 48 parties out of 329, leading to an incorrect average rate. The CIT(A) noted that the AO's method of averaging interest rates without detailed utilization of borrowed funds was inappropriate. The CIT(A) conducted a thorough examination of the ledger accounts and found that the loans were given from funds borrowed at similar interest rates, except for one instance where funds borrowed at higher rates were lent at a lower rate without a business purpose, resulting in a partial disallowance of Rs.2,40,838/-.

Tribunal's Findings:

The Tribunal upheld the CIT(A)'s findings, noting that the AO did not provide evidence of the borrowed funds being diverted for non-business purposes. The Tribunal referenced its decision in the preceding assessment year, where it allowed the assessee's claim under Section 36(1)(iii), as the borrowed funds were used for business purposes. The Tribunal emphasized that the AO's role is to ensure compliance with Section 36(1)(iii) conditions and not to prescribe interest rates. The Tribunal concluded that the CIT(A) should not have sustained any part of the addition since the AO failed to demonstrate how Section 36(1)(iii) conditions were violated.

Conclusion:

The Tribunal dismissed the departmental appeal and allowed the assessee's cross-objection, setting aside the orders of the authorities below and deleting the entire addition. The judgment underscores the necessity of establishing a clear nexus between borrowed funds and their use for business purposes to justify disallowances under Section 36(1)(iii).

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