2016 (11) TMI 964 - HC - Income Tax

Deduction under section 36(1)(iii) - Interest expenses relatable to interest-free advances - ITAT allowed the claim - Held that - In the judgment in CIT v. V. I. Baby and Co. 2001 (10) TMI 58 - KERALA High Court 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, in the judgment in S. A. Builders Ltd. v. CIT (Appeals) 2006 (12) TMI 82 - 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. Reading of the order passed by the Tribunal would show that, it has held that its work is only to decide whether the borrowed capital is used for the purpose of business. Thereafter without any further discussion, it has concluded that the funds advanced to the sister concerns were out of business expediency. All the three orders are totally unsustainable for the reason that the test for extending the benefit of section 36(1)(iii) laid down by this court and the apex court were not applied to the facts of the cases. Answering the questions of law in favour of the Revenue

Summary

Issues:
Challenge to orders passed by Income-tax Appellate Tribunal regarding disallowance of interest expenses under section 36(1)(iii) of the Income-tax Act.

Analysis:

1. Maintainability of Appeals:
The counsel for the assessee raised a preliminary objection on the maintainability of the appeals based on Circular No. 21 of 2015 issued by the Central Board of Direct Taxes, which mandates withdrawal of appeals with tax effects less than 20 lakhs. However, the court rejected this objection citing precedents that emphasized the court's discretion in considering appeals involving substantial questions of law, especially those with cascading effects. The court highlighted the need for the Department to decide on withdrawing or prosecuting appeals, ultimately ruling that the appeals deserve consideration on their merits.

2. Interpretation of Section 36(1) of the Income-tax Act:
Section 36(1) allows deductions for various expenses, including interest paid on capital borrowed for business purposes. Previous judgments, such as CIT v. V. I. Baby and Co., emphasized that the benefit derived by the assessee from interest-free advances must be considered. The Supreme Court in S. A. Builders Ltd. v. CIT (Appeals) clarified that deductions under section 36(1)(iii) should be allowed if interest-free loans were given as a measure of commercial expediency. The term "commercial expediency" was defined broadly to include expenses incurred by a prudent businessman for business purposes, even if not legally obligatory.

3. Analysis of Impugned Orders:
The assessment order (Annexure A) disallowed deductions without considering if the assessee benefited from the interest-free advances or if they were made for commercial expediency. The Commissioner's order (Annexure B) made factual assumptions without proper examination, leading to an erroneous decision. The Tribunal's orders (Annexure C) failed to apply the legal tests laid down by previous judgments to the facts of the cases. Consequently, the court found all three orders unsustainable and set them aside, directing the Assessing Officer to reconsider the cases after issuing notices to the parties.

In conclusion, the High Court disposed of the appeals in favor of the Revenue, emphasizing the importance of applying legal principles to the facts of each case, especially concerning deductions under section 36(1)(iii) of the Income-tax Act.