2019 (3) TMI 1760 - AT - Income Tax

Disallowance of the interest expenditure u/s 36(1)(iii) - interest expenditure attributable to the application of the borrowed funds for non-business purposes - HELD THAT - As proceeded to determine the extent of reliance on borrowed capital for financing non-business advances ourselves rather than remitting the matter back for two reasons. First the amount involved is nominal and therefore remission would burden both the parties. Two we have already found that no borrowed capital is invested in the amount advanced as at the year-end while the firm is indebted to a much larger extent as at the beginning of the year so that it s being acutely short of interest-free capital at the beginning of the year is patent. The only presumption therefore is with regard to the date/s of the substitution of the borrowed capital with interest-free funds (in the form of trade credit) and which we have accordingly presumed as evenly during the year. The presumption gets validated with reference to the average interest rate on the borrowed capital which agrees with a minor difference with the interest rate applied so that the matter which some approximation gets resolved.

Summary

Issues Involved:
Disallowance of interest expenditure under section 36(1)(iii) of the Income Tax Act, 1961.

Issue-Wise Detailed Analysis:

1. Disallowance of Interest Expenditure:
The primary issue in this appeal is the disallowance of interest expenditure amounting to ? 3,83,761 under section 36(1)(iii) of the Income Tax Act, 1961. This disallowance was made by attributing the interest expenditure to the application of borrowed funds for non-business purposes.

2. Facts and Arguments:
The assessee, a firm engaged in the stone crushing and transport business, declared an income of ? 56.80 lacs for the year. During the assessment proceedings, it was found that the assessee had advanced ? 15.48 lacs to a family member, with previous advances amounting to ? 25.50 lacs. The purpose of these advances was personal, and the non-business use of the capital was admitted by the assessee. The assessee argued that no disallowance should be made for the current year for advances made in preceding years, especially since similar disallowance for the preceding year was deleted by the first appellate authority due to sufficient interest-free funds.

3. Balance-Sheet Analysis:
A detailed analysis of the balance-sheet was conducted to determine the sources and application of funds. The balance-sheet as of 31.03.2012 showed the proprietor's capital at ? 155.61 lacs and total non-business advances at ? 40.98 lacs. The assessee argued that sufficient interest-free capital was available to cover the non-business advances. The concept of fund-based liabilities and assets was discussed, emphasizing the importance of understanding the financing pattern of assets and the role of equity and borrowed capital.

4. Findings and Presumptions:
The tribunal found that the assessee did not have sufficient interest-free funds to cover the non-business advances. The balance-sheet revealed a net negative working capital of ? 108.95 lacs as of 31.03.2012. The assessee's argument based on the first appellate authority's finding for AY 2011-12 was dismissed, as it was based on a misreading of the decision in Gurdas Garg v. CIT. The tribunal emphasized that the sufficiency of funds must be examined with reference to the corresponding application of funds, not in isolation.

5. Determination of Interest Disallowance:
The tribunal determined the extent of reliance on borrowed capital for financing non-business advances. It was found that the firm was heavily overfinanced, with a significant portion of its fixed assets and non-current assets being met by trade credit, an interest-free source of finance. The average non-business advance for the year was calculated at ? 33.24 lacs, and applying the interest rate of 12% p.a., the disallowance was calculated at ? 1,99,450.

Conclusion:
The tribunal decided to partly allow the assessee's appeal, reducing the disallowance of interest expenditure to ? 1,99,450. The decision was based on a thorough analysis of the balance-sheet, financing patterns, and the availability of interest-free funds. The tribunal emphasized the importance of examining the sufficiency of funds with reference to their application and the dynamic nature of financing. The order was pronounced in the open court on March 20, 2019.