2017 (5) TMI 302 - HC - Income Tax

Interest free loans and advances - Held that - In the present case, the Assessing Officer did not carry out the necessary exercise. The Assessing Officer, in fact, granted partial relief and for the balance without carrying out the necessary exercise, he has disallowed the same and made an addition. The Commissioner of Income Tax (Appeals) found that this addition cannot be sustained both on facts and in law. The loans were given in the earlier year and there was sufficient general reserve available for investment. If the Assessing Officer did not make any efforts to show any nexus between the borrowing and the subsequent advancing of loans to the subsidiary company, then, the disallowance made by the Assessing Officer had to be deleted. We do not think that the Tribunal s exercise of maintaining the order of the Commissioner of Income Tax (Appeals) raises any substantial question of law. More so, when it was ascertained that no interest bearing funds were released for advancing the sums to the subsidiary company or its related company on account of share application money.The assessee had sufficient reserves. - Decided against revenue

Summary

Issues:
1. Disallowance of interest paid on loans and advances for non-business purposes.
2. Interpretation of Section 36(1)(iii) of the Income Tax Act, 1961.
3. Commercial expediency in advancing funds to sister concern.

Issue 1: Disallowance of interest paid on loans and advances for non-business purposes:
The Revenue's appeal challenged the order of the Income Tax Appellate Tribunal regarding the disallowance of interest paid on loans and advances for non-business purposes for the Assessment Years 1996-97 and 1997-98. The Tribunal dismissed the Revenue's ground of appeal, leading to the current appeal. The Revenue contended that certain loans and advances given by the assessee were not for business purposes, resulting in the disallowance of a portion of the interest paid. However, the Commissioner of Income Tax (Appeals) accepted the assessee's explanation for a part of the amount but disallowed the rest. The First Appellate Authority also supported the assessee's position, citing the decision of the Hon'ble Supreme Court regarding interest payments on borrowed funds advanced for commercial reasons to subsidiary companies. The Tribunal upheld the First Appellate Authority's decision, emphasizing the absence of any contrary facts to warrant interference.

Issue 2: Interpretation of Section 36(1)(iii) of the Income Tax Act, 1961:
The Hon'ble Supreme Court's judgment clarified the deduction of interest paid in respect of capital borrowed for business purposes under Section 36(1)(iii) of the Income Tax Act, 1961. The Court emphasized that the test for allowing such deductions is whether the transactions were conducted as a measure of commercial expediency. The Court highlighted that expenses voluntarily incurred for commercial expediency, even if benefiting a third party, are permissible deductions. The Court stressed the importance of examining the commercial expediency of advancing funds to sister concerns in each case, rather than applying a blanket rule based on previous judgments.

Issue 3: Commercial expediency in advancing funds to sister concern:
The judgment underscored the significance of assessing the commercial expediency of advancing funds to sister concerns on a case-by-case basis. It was noted that the Assessing Officer in the present case failed to establish a nexus between the borrowed funds and the subsequent loans to the subsidiary company. The Commissioner of Income Tax (Appeals) and the Tribunal found that the disallowance made by the Assessing Officer was unjustified, especially considering the availability of sufficient reserves for investment by the assessee. The Tribunal upheld the decision of the Commissioner of Income Tax (Appeals) based on the lack of interest-bearing funds used for advancing sums to the subsidiary company, thus affirming the deletion of the disallowance.

In conclusion, the High Court dismissed the appeal, stating that the factual findings were consistent with the evidence on record and did not warrant interference. The Court upheld the decisions of the lower authorities regarding the disallowance of interest paid on loans and advances for non-business purposes, interpreting Section 36(1)(iii) of the Income Tax Act, 1961, and emphasizing the importance of assessing commercial expediency in advancing funds to sister concerns on a case-specific basis.