2018 (8) TMI 1621 - AT - Income Tax

Disallowance of interest u/s 36(1)(iii) - attributing the interest bearing funds of the assessee to have been used for advancing to the partner without interest by way of surplus withdrawals from capital account - Held that - If there is direct nexus between the trading receipts deposited in the said account and advance given to the partners, it can be safely presumed that the trading receipts had been used for making the said advances and in such circumstances, it can be safely held that the interest-free funds had been used for making advances to the partners warranting no disallowance of interest under section 36(1)(iii) of the Act. But we find that the facts in this regard need to be examined. Restore the issue to the Assessing Officer with the limited direction to examine the nexus, if any, between the trading receipts of the assessee deposited in the Hindu Co-operative Bank account maintained by the assessee and the amount advanced to the partner and direct that in the circumstances the nexus is found to exist, no disallowance of interest under section 36(1)(iii) of the Act be made to the extent pertaining to the amount so advanced. With this limited direction we restore the issue to the Assessing Officer to readjudicate the same. Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Status of the assessee as an association of persons versus a partnership firm.
2. Disallowance of interest paid to the bank under section 36(1)(iii) of the Income-tax Act, 1961.

Issue-Wise Detailed Analysis:

1. Status of the Assessee:
- The first issue raised by the assessee was regarding the status of the entity being assessed as an association of persons (AOP) instead of a partnership firm. This ground was not pressed by the assessee during the proceedings and was therefore dismissed.

2. Disallowance of Interest under Section 36(1)(iii):
- Facts of the Case: The assessee, a partnership concern involved in the liquor business, had a debit balance of ?5,68,42,578 in the capital account of one of its partners, Shri G. S. Sethi. The assessee paid interest of ?39,69,660 on a bank overdraft and claimed this as an expenditure. The Assessing Officer disallowed this interest, citing that the funds were used for interest-free advances to the partner, relying on the judgment in CIT v. Abhishek Industries Ltd. [2006] 286 ITR 1 (P&H).

- Contentions Before the Commissioner of Income-tax (Appeals): The assessee argued that it had sufficient own funds for the advance to the partner and that the other partners had sufficient credit balances. However, the Commissioner of Income-tax (Appeals) upheld the disallowance, noting that the funds were advanced from the overdraft account with Hindu Co-operative Bank, and thus, interest-bearing funds were used for non-business purposes.

- Findings of the Commissioner of Income-tax (Appeals): The Commissioner observed that the assessee advanced ?5,68,42,578 to the partner without interest while claiming a deduction for interest paid on overdraft facilities. The Commissioner concluded that the interest-bearing funds were used for non-business purposes, justifying the disallowance under section 36(1)(iii).

- Appeal Before the Tribunal: The assessee contended that it had sufficient interest-free funds amounting to ?6.3 crores and that the advances to the partner were from mixed funds, including trading receipts deposited in the Hindu Co-operative Bank account. The assessee argued that the turnover of ?18.55 crores deposited in the bank accounts could be attributed to the advances made.

- Tribunal's Analysis: The Tribunal noted that the assessee failed to demonstrate the availability of sufficient interest-free funds. However, it found merit in the contention that trading receipts deposited in the bank account could be used for advances to the partner. The Tribunal directed the Assessing Officer to examine the nexus between the trading receipts and the advances. If such a nexus is established, no disallowance under section 36(1)(iii) should be made.

Conclusion:
- The appeal was allowed for statistical purposes, with the issue remanded to the Assessing Officer to verify the nexus between trading receipts and the advances to the partner. The assessee is to provide necessary evidence, and the Assessing Officer is to afford adequate opportunity for the same.

Order Pronounced:
- The appeal filed by the assessee is allowed for statistical purposes, and the order was pronounced in the open court.