2017 (2) TMI 221 - HC - Income Tax

Disallowance of the interest paid on its borrowed funds in excess of 12 per cent. u/s 36(1) - assessee company had utilised its own funds to advance loans at a lower rate of interest to sister concern - Held that - In the present case, financial condition of the sister concern was not good and to help those, for their smooth running, loan was advanced and a lesser rate of interest was charged. Both the sister companies are subsidiary of the assessee and there is nothing per se adverse. For the welfare and proper functioning of the sister companies, the assessee in its wisdom, if decided to advance loan so that ultimately the sister company may function properly, the assessee being holding company would also be benefitted. Thus, the loan advanced to sister companies was for commercial expediency and not for any charity, sentimental or personal reasons. We therefore, answer the question in favour of assessee and hold that assessee was entitled for deduction of interest under section 36(1)(iii) and the view taken by the Tribunal otherwise is not correct. - Decided in favour of assessee

Summary

Issues:
Dis allowance of interest paid on borrowed funds in excess of 12 per cent - Justification under section 36(1) of the Income-tax Act, 1961.

Analysis:
1. The case involved a reference under section 256(2) of the Income-tax Act, 1961, pertaining to the assessment year 1989-90. The primary issue was whether the dis allowance of interest paid by the assessee on borrowed funds in excess of 12 per cent was justified under section 36(1) of the Act. The question referred to the court by the Tribunal specifically addressed this concern.

2. The assessee had borrowed a significant amount and paid interest to the bank and others. The Assessing Officer disallowed the difference between the market interest rate of 16 per cent and the lower rate at which the assessee advanced loans to a sister subsidiary company. This dis allowance was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal, citing reasons related to commercial expediency and the availability of funds for the assessee's own business purposes.

3. The Tribunal and the Commissioner of Income-tax (Appeals) based their decisions on the premise that the assessee, being a profit-making company, should not have advanced loans at lower rates of interest. However, it was noted that there was no indication that the loans were for non-business purposes or lacked commercial expediency. The central question was whether the Revenue's approach was justified in disallowing the interest difference under section 36(1)(iii) of the Act.

4. Section 36 of the Income-tax Act allows for deductions, including interest paid in respect of capital borrowed for business or profession purposes. The court referred to the wider scope of the term "for the purpose of business" and emphasized the importance of commercial expediency in determining the deductibility of interest under section 36(1)(iii).

5. Legal precedents such as S. A. Builders Ltd. v. CIT and Hero Cycles P. Ltd. v. CIT were cited to establish the criteria for deductibility of interest paid on loans advanced for commercial expediency. The court emphasized that the test lies in whether the loans were advanced as a measure of commercial expediency, rather than for personal reasons or charity.

6. In the present case, it was concluded that the loans advanced to sister companies were for commercial expediency to ensure their smooth functioning, benefiting both the sister companies and the assessee as the holding company. Therefore, the court ruled in favor of the assessee, holding that the interest deduction under section 36(1)(iii) was justified, contrary to the Tribunal's decision.

7. The judgment resolved the issue in favor of the assessee, highlighting the importance of commercial expediency in determining the deductibility of interest paid on borrowed funds, ultimately disposing of the reference accordingly.