2016 (4) TMI 1127 - AT - Income Tax

Disallowance of interest paid by the appellant to the bank as well as to the other parties - Held that - The assessee was able to establish that he had incurred the expenditure wholly and exclusively for the purpose of business and therefore there is no justification for the revenue to disallowance the interest component. The revenue cannot claim to put itself in the armchair of the businessman and decide how much is reasonable expenditure. The revenue is required to examine the issue from the perspective of the prudent businessmen rather from its own angle. Revenue authorities have failed to bring on record any cogent evidence and material to show that the borrowed funds have been utilized for the purposes of investment and were not used for the business purposes - Decided in favour of assessee

Issues Involved:
1. Disallowance of interest paid on loans due to alleged mis-utilization of borrowed funds.
2. Justification for the investment made in partnership firms and its impact on the business.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Paid on Loans:
The primary issue in this case revolves around the disallowance of ?48,85,314/- out of the interest paid by the assessee on loans. The Assessing Officer (AO) observed that the assessee company had invested substantial amounts in two firms, M/s. Mascot Footcare and M/s. Mascot Udhyog, where the directors of the assessee company were partners. The AO noted that the return on these investments was significantly lower (1.69%) compared to the interest rate (12%) paid on unsecured loans and bank loans. The AO concluded that if the assessee had not made these investments, it would have saved the interest paid on the loans, leading to the disallowance.

The AO's contention was that the borrowed funds were not utilized for business purposes, resulting in a mis-utilization of interest-bearing funds. The AO, therefore, added ?48,85,314/- to the income of the assessee by disallowing the interest on these loans.

2. Justification for Investment in Partnership Firms:
The assessee argued that the investments in the partnership firms were made in earlier years (1988-2000) and not in the year under consideration. The investments were claimed to be made out of internal accruals and not borrowed funds. The assessee further contended that the capital in these firms had increased over the years due to profits and interest accrued, and no borrowed funds were utilized for these investments during the relevant year.

The AO, however, did not accept the assessee's explanation, stating that the funds invested in the firms were not justified as they were not used for the purposes of the business. The AO also highlighted that the firms in which investments were made had further invested in equity shares of another group company, indicating that the funds were not utilized for business purposes.

Findings of the CIT (Appeals):
The CIT (Appeals) upheld the AO's decision, observing that the concerns in which the assessee company had made substantial investments fell within the ambit of specified persons as defined in section 40A(2)(b) of the IT Act. The CIT (Appeals) noted that the percentage of share of profits given to the company was disproportionate to the amount of investment made, and the interest payments made to the specified persons and banks were not justifiable in view of the utilization of the funds. The CIT (Appeals) also referenced judicial precedents to support the disallowance of interest paid on loans when funds were given to sister concerns without interest.

Tribunal's Analysis and Decision:
The Tribunal examined the rival contentions and the material on record. It was noted that the investments in the partnership firms were made prior to the assessment year 1999-2000 and had increased due to profits and interest. The Tribunal observed that no new investments were made in the year under consideration, and the AO failed to prove the nexus between the interest paid on borrowed funds and the investments made.

The Tribunal emphasized that the assessee had established that the expenditure was incurred wholly and exclusively for the purpose of business. It was held that the revenue authorities could not claim to decide how much expenditure was reasonable from their own perspective but must consider it from the viewpoint of a prudent businessman. The Tribunal found no material evidence to show that the borrowed funds were not used for business purposes and allowed the appeal of the assessee.

Supporting Judicial Precedents:
The Tribunal referred to the Supreme Court judgment in Hero Cycle Ltd. vs. CIT, which reiterated that the expression "commercial expediency" includes such expenditure as a prudent businessman incurs for business purposes. The Tribunal also cited the jurisdictional High Court's decision in CIT vs. Ram Kishan Verma, which held that the AO could not disallow interest if the nexus between interest-bearing loans and interest-free advances was not established.

Conclusion:
The Tribunal concluded that the revenue authorities failed to prove that the borrowed funds were not used for business purposes and allowed the appeal of the assessee, thereby overturning the disallowance of ?48,85,314/- out of the interest payments on loans. The decision was pronounced in the open court on 18/03/2016.

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