2014 (2) TMI 73 - HC - Income Tax

Interest paid for business purpose u/s 36(i)(iii) - Held that - Only the assessee company and not the other two guarantors has advanced the interest-free loan to the sister-concern - No commercial expediency was involved in the advancing of interest-free loan to the sister concern - It was simply advanced to reduce the profitability of the concern as only the assessee was the only profit-making concern - Relying upon the decision in CIT v. Abhishek Industries Ltd. 2006 (8) TMI 123 - PUNJAB AND HARYANA High Court - Interest has to be disallowed under section 36(1)(iii) in case advances have no direct nexus of the funds between borrowings of the funds and diversion thereof for non-business - Decided against assessee.

Issues Involved:
1. Commercial expediency in advancing interest-free loans.
2. Disallowance of interest under Section 36(1)(iii) of the Income-tax Act, 1961.
3. Nexus between borrowed funds and their use for business purposes.
4. Applicability of legal precedents (CIT v. Malayalam Plantations Ltd. and S. A. Builders Ltd. v. CIT).

Detailed Analysis:

1. Commercial Expediency in Advancing Interest-Free Loans:
The primary issue revolves around whether the interest-free loan advanced by the assessee to its sister concern, M/s. Luxmi Engineering Works, was for commercial expediency. The assessee argued that the loan was advanced due to the financial interdependence and common shareholding between the two entities, asserting that such transactions were in the interest of business under the brand name "Luxmi." However, the Assessing Officer (AO) concluded that there was no commercial expediency, as the loan was primarily a means to transfer profits from a profit-making entity to a loss-making one, thereby reducing the tax liability of the assessee.

2. Disallowance of Interest under Section 36(1)(iii):
The AO disallowed the interest amounting to Rs. 14,82,695 under Section 36(1)(iii) of the Act, which pertains to the deduction of interest on borrowed capital used for business purposes. The AO's decision was based on the observation that the borrowed funds were diverted to the sister concern without any interest, which was not for business purposes. This disallowance was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal.

3. Nexus Between Borrowed Funds and Their Use for Business Purposes:
The AO emphasized the necessity of a direct nexus between borrowed funds and their use for business purposes to claim deductions under Section 36(1)(iii). The AO and subsequent appellate authorities found that the funds were not used for the assessee's business but were instead diverted to the sister concern to reduce the assessee's taxable income. The Tribunal also noted that other guarantors of the loan to M/s. Luxmi Engineering Works, who were not profit-making, did not advance interest-free loans, further indicating the lack of business purpose in the assessee's actions.

4. Applicability of Legal Precedents:
The assessee cited CIT v. Malayalam Plantations Ltd. and S. A. Builders Ltd. v. CIT to argue that the loan was advanced out of commercial expediency. However, the Tribunal and the High Court found these precedents inapplicable, as the factual matrix demonstrated no commercial expediency. The High Court noted that the legal principles from these cases were well-recognized but did not apply due to the concurrent findings of the lower authorities that the loan lacked business purpose.

Conclusion:
The High Court upheld the findings of the AO, Commissioner of Income-tax (Appeals), and the Tribunal, concluding that there was no commercial expediency in the interest-free loan advanced by the assessee to its sister concern. The court found no perversity in the appreciation of material on record by the lower authorities. Consequently, the substantial question of law was answered against the assessee, and the appeal was dismissed.

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