2017 (12) TMI 1335 - AT - Income Tax

Proportionate disallowance of interest u/s.36(1)(iii) - business nexus and use of the said diverted funds for business purposes of the assessee - diversion of funds when excess interest free funds are available in the common kitty of the assessee firm - Held that - The funds diverted by the assessee are obviously lesser than the said amount of partners capital. It is clarified adequately that said amount of partners capital is not an interest bearing loans from the firms. Assessee never paid interest to the partners for all the years including the year under consideration. Therefore, it cannot be said that the partners capital is not an interest free funds of the assessee. Considering this fact, we are of the view that availability of interest free funds is much higher than the funds diverted by the assessee. There is no requirement for the assessee to establish utility of the said diverted funds for business purposes when said diverted funds are from the interest free funds in the kitty of the assessee firm. Accordingly, Ground No.1 raised by the assessee is allowed.

Summary

Issues Involved:
1. Disallowance of interest under Section 36(1)(iii) of the Income Tax Act, 1961.

Detailed Analysis:

Issue 1: Disallowance of Interest under Section 36(1)(iii)
The primary issue in this appeal is the disallowance of interest amounting to ?81,52,033 under Section 36(1)(iii) of the Income Tax Act, 1961. The assessee, a promoter and builder, filed a return declaring a total income of ?10.05 crores, which was assessed at ?11.60 crores by the AO. The AO observed that the assessee had granted interest-free advances/loans to related concerns/partners amounting to ?12.46 crores and questioned the diversion of interest-bearing funds for non-business purposes. The AO applied Rule 8D of the I.T. Rules, 1962, and disallowed the interest proportionately.

Upon appeal, the CIT(A) partially allowed the assessee's claim by considering the reduction of ?56,25,000 wrongly included under financial expenses and directed the AO to rework the disallowance on a proportionate basis. The CIT(A) acknowledged the business purpose of advances given to a partner who stood as a guarantor for loans availed by the firm, citing various judicial precedents supporting commercial expediency.

The assessee, dissatisfied with the partial relief, appealed to the ITAT. The assessee argued that sufficient interest-free funds were available, evidenced by the balance sheet showing partners' capital of ?36.61 crores, far exceeding the diverted funds. The assessee cited several judicial decisions, including CIT Vs. Reliance Utilities and Power Ltd. and CIT Vs. HDFC Ltd., which support the presumption that interest-free funds are utilized for interest-free advances when both types of funds are present.

The Revenue contended that the diverted funds lacked a commercial nexus and that partners' capital typically constitutes an interest-bearing liability. However, the assessee clarified that no interest was paid to partners, and the diverted funds were significantly lower than the available interest-free funds.

The ITAT, after considering the arguments and judicial precedents, concluded that the partners' capital was indeed interest-free and that the diverted funds were less than the interest-free funds available. It held that no disallowance under Section 36(1)(iii) was warranted, aligning with the decisions in CIT Vs. Reliance Utilities and Power Ltd. and CIT Vs. HDFC Ltd. The ITAT also referenced its decision in ACIT Vs. Kumar Urban Development Limited, reinforcing that no disallowance is required when diverted funds are less than available interest-free funds.

Conclusion:
The appeal was partly allowed, with the ITAT ruling in favor of the assessee on the issue of interest disallowance under Section 36(1)(iii), establishing that the diverted funds were covered by available interest-free funds, thereby negating the need for disallowance. The order was pronounced on December 13, 2017.