2016 (6) TMI 1395 - HC - Income Tax

Deduction u/s 36(1)(iii) - interest expenses relatable to interest free advances - ITAT allowed the deduction - HELD THAT - In the judgment in CIT v. V.I.Baby and Co. 2001 (10) TMI 58 - KERALA HIGH COURT a Division Bench of this court considered this provision and held that in a case where interest free advance was given by the assessee and deduction is claimed, the question to be considered is what is the benefit that is derived by the assessee by giving such interest free advance. It was also held that so long as the assessee is not the beneficiary of the investments made by the partners, their relatives and the sister concerns from out of the interest free advances, the Assessing Officer is perfectly justified in disallowing interest in proportion to the advances made. Subsequently, the Honourable Supreme Court also had occasion to consider the provisions of Section 36(1)(iii) in the judgment in S.A.Builders Ltd. v. CIT (Appeals) 2006 (12) TMI 82 - SUPREME COURT . In that case, after a detailed examination of the provisions, the Supreme Court held that when a claim for deduction under Section 36(1)(iii) is made, the authorities should enquire as to whether the interest free loan was given as a measure of commercial expediency and on facts if it is so found, deduction is liable to be allowed. The court also explained that the expression commercial expediency is an expression of wide import and includes such expenditure that a prudent businessman incurs for the purpose of business and that such expenditure may not have been incurred under any legal obligation. We set aside the orders impugned and answering the questions of law in favour of the revenue, these appeals are disposed of remitting the matter to the AO who shall reconsider the cases of the assessee, after issuing notice to the parties.

Summary

Issues:
Challenge to the orders passed by the Income Tax Appellate Tribunal regarding disallowance of interest expenses under Section 36(1)(iii) of the Income Tax Act. Question of law raised on whether the Tribunal was correct in allowing the deduction under Section 36(1)(iii).

Analysis:
The High Court considered the maintainability of the appeals based on Circular No.21/2015 issued by the CBDT, which stated that appeals with a tax effect less than 20 lakhs should be withdrawn. However, the court noted that the Supreme Court clarified that the High Court should not dismiss appeals solely based on the Circular, especially in cases with significant implications. It was held that the department should decide which appeals to withdraw or prosecute, and these appeals involving substantial questions of law should be considered on merits, rejecting the preliminary objection raised by the assessee.

Section 36(1) of the Income Tax Act allows deductions for interest paid in respect of capital borrowed for business purposes. Previous judgments, including CIT v. V.I.Baby and Co. and S.A.Builders Ltd. v. CIT (Appeals), were referenced to explain the interpretation of Section 36(1)(iii). The court emphasized that the interest free advances must be made for commercial expediency to qualify for deduction, and the term "commercial expediency" encompasses expenses incurred by a prudent businessman for business purposes.

The court reviewed the orders passed by the Assessing Officer, Commissioner of Income Tax (Appeals), and the Tribunal. It was observed that these orders did not properly apply the legal tests established by previous judgments to the facts of the cases. The Assessing Officer and the Commissioner made factual assumptions without basis, and the Tribunal did not sufficiently analyze whether the advances were made for business expediency. As a result, the court found all three orders to be unsustainable and set them aside, remitting the matter back to the Assessing Officer for reconsideration after issuing notice to the parties.

In conclusion, the High Court disposed of the appeals by setting aside the impugned orders and ruling in favor of the revenue, emphasizing the need for proper application of legal principles to determine the eligibility for deductions under Section 36(1)(iii) of the Income Tax Act.