2018 (10) TMI 440 - HC - Income Tax

Disallowance u/s 36(1)(iii) - interest free advances to sister concerns - commercial expediency for granting such advances - Held that - The expression commercial expediency is again of wide import and includes such expenditure incurred for the purpose of business. Therefore, once it is established that there was a nexus between expenditure and purpose of business, which need not be the business of the assessee, deduction under Section 36(1)(iii) must be allowed. Revenue cannot assume the role and occupy armchair of a businessman to decide whether expenditure was reasonable. The Revenue cannot look at the matter from its own standpoint, but that of a businessman. Money borrowed, even when advanced to a sister concern for some business purpose, would qualify for deduction of interest. However, if the money borrowed is utilized by the assessee for personal benefit and not for business purpose, interest paid on that amount would not satisfy the test of commercial expediency. There is another glaring error by the Assessing Officer. Instead of disallowing interest paid on the borrowed fund, the Assessing Officer made an addition of ₹ 1,50,04,133/- by notionally computing interest @18% p.a. on ₹ 8,33,56,295/- i.e. the interest free advances given by the respondentassessee to the sister concerns. This is clearly impermissible and contrary to law. The Commissioner of Income Tax (Appeals) referring to the nexus principle approved in S.A. Builders (2006 (12) TMI 82 - SUPREME COURT) held that once link between the expenditure given by way of loans and the purpose of the business was established, Revenue cannot justifiably assume the role of the assessee to decide how much was reasonable expenditure having regard to the circumstances of the case. - decided in favour of assessee.

Summary

Issues:
1. Disallowance of interest-free advances under Section 36(1)(iii) of the Income Tax Act, 1961.
2. Application of the "commercial expediency" test in determining deductions.
3. Incorrect computation of interest by the Assessing Officer.
4. Interpretation of the "nexus principle" and "commercial expediency" as per legal precedents.

Issue 1: Disallowance of interest-free advances under Section 36(1)(iii) of the Income Tax Act, 1961:
The case involved an appeal by the Revenue regarding disallowance of interest-free advances amounting to ?8,33,56,295 given by the respondent-assessee to sister concerns. The Assessing Officer sought to determine the source of funds for these advances to assess "commercial expediency." The respondent-assessee's inability to prove the origin of funds led to the disallowance. However, the court noted that the Assessing Officer's approach was flawed as it misunderstood the concept of commercial expediency under Section 36(1)(iii) of the Act. The Supreme Court's ruling in S.A. Builders case clarified that if there is a nexus between expenditure and business purpose, even if a third party benefits, the deduction must be allowed. The court emphasized that the Revenue cannot judge the reasonableness of expenditure from its standpoint but must consider it from a businessman's perspective.

Issue 2: Application of the "commercial expediency" test in determining deductions:
The Commissioner of Income Tax (Appeals) applied the "nexus principle" established in the S.A. Builders case, stating that once a link between expenditure and business purpose is proven, the Revenue cannot question the reasonableness of the expenditure. The Commissioner found that the respondent-assessee had sufficient funds to provide interest-free loans, supported by evidence of sales, share capital, and reserves. Consequently, the addition of ?1,50,04,133 was directed to be deleted, as the Assessing Officer's reasoning was deemed incorrect.

Issue 3: Incorrect computation of interest by the Assessing Officer:
The Assessing Officer erroneously computed interest by notionally applying an 18% rate on the interest-free advances instead of disallowing the interest paid on borrowed funds. This approach was deemed impermissible and contrary to law, highlighting a clear error in the assessment process.

Issue 4: Interpretation of the "nexus principle" and "commercial expediency" as per legal precedents:
The Tribunal upheld the decision of the Commissioner of Income Tax (Appeals) based on the "nexus principle" and the concept of "commercial expediency" as outlined in the S.A. Builders case. Legal precedents, including Hero Cycles Private Limited and Munjal Sales Corporation cases, were cited to support the decision. The Tribunal found no merit in the Revenue's appeal and dismissed it, emphasizing the importance of following established legal principles in tax assessments.

In conclusion, the judgment clarified the application of the "commercial expediency" test in determining deductions under Section 36(1)(iii) of the Income Tax Act, highlighting the need for a nexus between expenditure and business purpose. The incorrect computation of interest and flawed reasoning by the Assessing Officer were rectified based on legal precedents, leading to the dismissal of the Revenue's appeal.