2014 (1) TMI 932 - AT - Income Tax

Addition made u/s 36(1)(iii) of the Act Suo moto enhancement without prior notice - Power of CIT(A) to enhance assessment u/s 251 Held that - The amount was investment prior to 1.4.2004, in the company Purifalir India P.Ltd. As on 31.3.2005 the assessee did not have any secured or unsecured loans - Thus it cannot be inferred that the investment made by the assessee in M/s Puriflair India P.Ltd. is out of borrowed funds - For the Assessment Year 2005-06, 2006-07, 2007-08 and 2008-09, no disallowance was made by the Assessing Officer u/s 36(1)(iii) of the Act. Similarly for the Assessment Year 2010-11 also no disallowance was made by the AO. There are advances on account of material sold and not interest free loans - The total interest free funds available with the assessee as against investment and advances relying upon CIT vs. Reliance Utilities and Power Ltd. 2009 (1) TMI 4 - HIGH COURT BOMBAY - when interest free funds are available, then the presumption would be that such interest free funds were invested or advanced as interest free loans/advances - deduction u/s 36(1)(iii) of the Act, one has to enquire whether the loan was given by the assessee as a measure of commercial expediency - The expression commercial expediency is one of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business - The expenditure may not have been incurred under any legal obligation, but yet it is allowable as business, expenditure if it, was incurred on grounds of commercial expediency - the disallowance made by the Assessing Officer u/s 36(1)(iii) of the Act set aside - The CIT(A) has made the enhancements without following the requirements of S.251(2) of the Act, as he has not given a show cause notice to the assessee on the enhancements - the enhancements made by the CIT(A) deleted Decided in favour of Assessee.

Summary

Issues Involved:
1. Disallowance under Section 36(1)(iii) of the Income Tax Act.
2. Enhancement of disallowance by the Commissioner of Income Tax (Appeals) without prior notice.
3. Disallowance under Section 14A of the Income Tax Act.

Detailed Analysis:

1. Disallowance under Section 36(1)(iii) of the Income Tax Act:
The assessee, a company engaged in manufacturing and selling compressed air dryers, filed its return of income for the Assessment Year 2009-10. The Assessing Officer (AO) completed the assessment by making an addition on account of disallowance under Section 36(1)(iii), which pertains to interest on borrowed capital. The First Appellate Authority upheld this disallowance and further enhanced it. The assessee contended that no interest-free loans were given to sister concerns and that the advances were for the supply of raw materials. The Tribunal found that the amounts in question were indeed advances for material supply and not interest-free loans. It was also noted that the investments in the subsidiary were made prior to 1.4.2004, and no disallowance was made in earlier or subsequent assessment years. The Tribunal applied the principle from the Bombay High Court's decision in CIT vs. Reliance Utilities and Power Ltd., which presumes that interest-free funds are used for interest-free advances when such funds are available. Consequently, the Tribunal concluded that no disallowance under Section 36(1)(iii) was warranted.

2. Enhancement of Disallowance by the Commissioner of Income Tax (Appeals) without Prior Notice:
The Commissioner of Income Tax (Appeals) enhanced the disallowance under Section 36(1)(iii) by Rs.1,55,976/- without giving prior notice to the assessee, which is required under Section 251(2) of the Income Tax Act. The Tribunal held that the enhancement was bad in law due to the lack of a show-cause notice. Additionally, on factual grounds, the Tribunal found that the enhancement was unjustified as the advances were for commercial purposes and not interest-free loans. Therefore, the enhancement made by the Commissioner of Income Tax (Appeals) was cancelled.

3. Disallowance under Section 14A of the Income Tax Act:
The AO also made a disallowance under Section 14A, which pertains to expenditure incurred in relation to income not includible in total income. The Commissioner of Income Tax (Appeals) granted partial relief to the assessee on this disallowance. The Tribunal, however, focused primarily on the disallowance under Section 36(1)(iii) and the enhancement issue, and did not provide a detailed analysis or ruling on the Section 14A disallowance in the provided text.

Conclusion:
The Tribunal allowed the appeal of the assessee, deleting the disallowance under Section 36(1)(iii) and cancelling the enhancement made by the Commissioner of Income Tax (Appeals) due to both procedural and factual inaccuracies. The order was pronounced in the Open Court on 12th July, 2013.