2014 (11) TMI 1255 - HC - Income Tax

Disallowance of Interest - investment by assessee in the share capital of its 100% subsidiary company - profits of the entire business and the sale proceeds were all deposited in the mixed overdraft account - AO held that borrowed funds were utilized for the purpose of the aforesaid investment and therefore, interest at the rate of 18% amounting was disallowed - HELD THAT - Tribunal missed the fact that in case the assessee had put in the amount of income earned during the year, which in this case was ₹ 12 crores approximately, in a separate account which the assessee was entitled to do, the debit balance as at the last day of the accounting year would have been further increased by ₹ 12 crores. The fact that the liability on account of secured loan and unsecured loan increased is not ipso facto evidence of the fact that the company is running through an unhealthy financial position. When a profit making company has increased its liability on account of secured or unsecured loan, that may be a pointer to show that the company has increased its capital asset. In this case, there can be no denial that the company earned ₹ 12 crores which was offered for taxation. It cannot in the circumstances be said by looking at the secured or unsecured loan account or by the constant increase thereof that borrowed funds were utilized for the purpose of investment in question which was evidently for a sum of less than ₹ 1 crore. That can possibly be said if it is a loss making company. Therefore, it has to be held that the investment was made from out of the profits of the year and not from out of the overdraft account. There is, as such, no question of making any disallowance on account of any interest - in a case where the profit of the entire business including the sale proceeds were deposited in the mixed overdraft accounts and in case the investment is less than the amount of profit earned or which could reasonably be deemed to have been earned, regard being had to the date of expenditure, it has to be presumed that the investment was from out of the profits. Question raised is answered in the affirmative

Summary

Issues involved:
1. Utilization of borrowed funds for investment in shares.
2. Disallowance of interest expense.
3. Failure to furnish relevant information.
4. Interpretation of financial accounts and profit utilization.

Utilization of borrowed funds for investment in shares:
The case involved an investment of a significant amount in a subsidiary company's share capital, with the assessing officer disallowing interest expense claiming borrowed funds were used. The CIT(A) disagreed, citing substantial reserves and profits. However, the Tribunal reversed, stating the absence of evidence showing the investment was from company profits. The appellant's counsel referenced a previous judgment indicating that investments from profits should be presumed. The Tribunal focused on increased loans but overlooked that a profit-making company's increased liabilities may signify capital asset growth. The Court concluded that the investment was likely from profits, not loans, especially considering the company's substantial earnings, rejecting the need for interest disallowance.

Disallowance of interest expense:
The assessing officer disallowed interest expense on the grounds of utilizing borrowed funds for share investment. The CIT(A) disagreed, emphasizing the company's profits and reserves. However, the Tribunal reversed this decision due to the lack of evidence demonstrating the investment source. The appellant's counsel referred to a prior judgment suggesting investments from profits should be presumed. Ultimately, the Court ruled in favor of the appellant, determining that the investment was likely made from profits, not borrowed funds, given the company's substantial earnings.

Failure to furnish relevant information:
The Tribunal drew an adverse inference against the assessee for failing to provide necessary information despite requests. The Revenue argued that the Tribunal's decision was based on factual circumstances and differed from the case cited by the appellant. However, the Court disagreed, emphasizing the importance of considering the company's financial position and profit utilization in such cases.

Interpretation of financial accounts and profit utilization:
The Tribunal focused on increased loans as evidence of borrowed funds being used for investments, overlooking the company's profit generation. The Court highlighted that increased liabilities in a profit-making company could indicate capital asset growth. It was concluded that the investment was likely made from profits, not loans, especially considering the company's substantial earnings. The Court clarified that when profits are deposited in mixed accounts and investments are less than earned profits, it should be presumed that investments were made from profits. As a result, the Court ruled in favor of the appellant, rejecting the need for interest disallowance and affirming that the investment was likely sourced from profits.