2022 (2) TMI 1357 - AT - Income Tax

Addition u/s 36(1)(iii) - investments made in the shares is out of borrowed funds and the assessee has failed to prove commercial expediency - CIT-A deleted the addition - HELD THAT - An investment in equity of another company is materially different in nature and character from an interest free advance or loan to another company. The question of diversion of funds for non-business purposes would only come into play in the case of the latter and not for in the case of investment in another company. The very foundation of the impugned disallowance therefore, is vitiated in law, as it proceed on the basis that investment in share capital of another company would amount to diversion of funds for non-business purpose. Whether such an investment yields returns in the present year or not does not make a difference. It is pertinent to bear in mind fact that in the present case interest disallowance has been made on the premise that investment in share capital of another company amounts to diverting the borrowed funds for the business of another company but then as we noted earlier an equity investment as inherently and materially different vis-a-vis an interest-free loan and advance. That distinction has been lost sight of. In our considered view, therefore, CIT(A) was indeed justified in deleting the disallowance of interest. We approve the conclusion arrived by the learned CIT(A) and decline to interfere in the matter. Decided against revenue.

Summary

Issues:
Challenge to correctness of order under section 143(3) of the IT Act, 1961 for the assessment year 2017-18.

Analysis:
1. Issue: Disallowance under section 36(1)(iii)
- The Assessing Officer (AO) challenged the deletion of an addition made under section 36(1)(iii) by the Commissioner of Income Tax (Appeals) (CIT(A)).
- The AO contended that the investment in shares of a company out of borrowed funds lacked commercial expediency and business purpose.
- The AO disallowed the interest payment by the assessee, amounting to Rs. 4,47,93,169, as it was not related to profit earning or revenue generation.
- The AO emphasized the need for a nexus between advancing funds and the business interest of the assessee-firm.

2. Analysis of CIT(A) Decision:
- The CIT(A) deleted the disallowance based on the argument that the investment in the subsidiary was made out of commercial expediency.
- The CIT(A) noted that the holding company invested borrowed funds in its subsidiary, which was engaged in a similar business of toll collection.
- The CIT(A) held that there was a nexus between the expenditure and the purpose of business, emphasizing that the expression "for the purpose of business" is broader than "for the purpose of earning profits."
- Citing legal precedents, the CIT(A) concluded that the investment in the subsidiary was dictated by commercial expediency and, therefore, the interest expenditure was allowable under section 36(1)(iii) of the Act.

3. Appellate Tribunal Decision:
- The Appellate Tribunal noted that the investments were made in the ordinary course of the assessee's business and were in equity shares of a company in a similar line of activity.
- The Tribunal highlighted the distinction between equity investments and interest-free loans, stating that the disallowance was based on a misconception that investing in another company's share capital was diverting funds for non-business purposes.
- Upholding the CIT(A)'s decision, the Tribunal dismissed the appeal, emphasizing that as long as borrowed funds are used for business purposes, the interest thereon qualifies as a deduction under section 36(1)(iii) of the Act.

In conclusion, the Appellate Tribunal upheld the CIT(A)'s decision to delete the disallowance under section 36(1)(iii), emphasizing the commercial expediency and business purpose behind the investment in the subsidiary company. The Tribunal clarified the legal distinction between equity investments and interest-free loans, affirming that as long as funds are utilized for business activities, the interest deduction is permissible under the Income Tax Act.