2020 (2) TMI 1363 - HC - Income Tax

Interest expenditure claimed allowed u/s 36(1)(iii) - interest paid on the borrowed fund - modus of the respondent assessee is to borrow the funds of the group companies and invest in share of the group companies - HELD THAT - Funds borrowed by the respondent assessee were utilised for the purpose of its business. As found by both the authorities below that the transactions entered into by the assessee were the transactions entered by it in the normal course of business and it is not the case of the Revenue that the funds borrowed by the assessee company on interest was utilised for any purpose other than its business - it is not the case of the Revenue that the assessee utilised interest bearing funds for the purpose other than its business - interest expenditure claimed by the assessee has been rightly allowed under section 36(1)(iii) by the CIT(Appeals) as well as the Tribunal. In view of section 77 of the Companies Act, 1956, the assessee could not have invested in the shares of the group companies by utilising the borrowed funds, it would be necessary to refer to section 77 of the Companies Act which provides for restrictions on purchase by company or loans by company for purchase of its own or is holding company's shares. Sub-section(1) of section 77 is not applicable to the facts of the case as the assessee has not bought its own shares and sub-section(2) prohibits public company or private company which are subsidiaries giving financial assistance for purchasing the shares. Assessee has not given any financial assistance to any person for purchase of its shares.Section 77 cannot be made applicable in facts of the case because contravention, if any, may be in hands of the company who advanced money to the assessee company on interest. There is no infirmity in the impugned orders passed by both the authorities below as there is concurrent findings of fact so as to allow the interest expenditure claimed by the respondent assessee, as utilising the borrowed funds of the group companies for purchase of the shares of the groups companies are not fraudulent, sham and thereby not illegal - Decided in favour of assessee.

Issues Involved:
1. Whether the Appellate Tribunal was right in law in allowing the interest expenditure on the borrowed funds from the group companies, which funds were in turn utilized in purchasing the shares of the group companies.
2. Whether the Appellate Tribunal was right in law in holding that the modus of utilizing the borrowed fund from group companies in purchasing shares of group companies was not fraudulent, sham, and thereby, not illegal.

Detailed Analysis:

Issue 1: Allowing Interest Expenditure on Borrowed Funds
The Revenue challenged the order of the Income Tax Appellate Tribunal (ITAT) which allowed the assessee to claim interest expenditure on borrowed funds used for purchasing shares of group companies. The Assessing Officer had disallowed the interest payment of ?2,64,49,312 out of the total interest expenses claimed, treating it as a dubious transaction aimed at evading tax. However, the CIT(Appeals) allowed the appeal, holding that the borrowings were for the purpose of business and thus justified the interest expenses. The Tribunal upheld this view, noting that the assessee was engaged in the business of financing and trading in shares and securities and had no capital of its own. The Tribunal emphasized that the transactions were genuine and the interest was not paid in excess of the market rate. The Tribunal also referenced a similar case (Pinnacle Project and Infrastructure Pvt. Ltd.) to support its decision, where it was held that the transactions were not "colourable devices" or "dubious methods" as per the McDowell & Co. Ltd. v. CTO case. The Tribunal concluded that the interest expenditure was rightly allowed under Section 36(1)(iii) of the Income Tax Act.

Issue 2: Modus of Utilizing Borrowed Funds
The Revenue argued that the modus of borrowing funds from group companies and reinvesting them in the same group companies was a camouflage to evade tax. They contended that this practice was fraudulent, sham, and illegal, invoking the principles laid down in McDowell & Co. Ltd. v. CTO. However, the Tribunal found that the transactions were entered into in the normal course of business and were not fraudulent or sham. It was noted that the funds were used for the business purposes of the assessee, and there was no evidence to suggest that the transactions were "reverse bona fide" or merely for appearance. The Tribunal also addressed the applicability of Section 77 of the Companies Act, 1956, which restricts companies from buying their own shares or providing financial assistance for the purchase of their shares. It was concluded that this section was not applicable as the assessee had not bought its own shares nor provided financial assistance for the purchase of its shares.

Conclusion:
The High Court upheld the decisions of the CIT(Appeals) and the Tribunal, affirming that the interest expenditure claimed by the assessee was legitimate and allowable under Section 36(1)(iii) of the Income Tax Act. The court found no evidence of fraud or sham in the transactions and ruled that Section 77 of the Companies Act was not applicable in this case. Both substantial questions of law were answered in favor of the assessee and against the Revenue. The appeal was dismissed with no order as to costs.

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