2018 (10) TMI 717 - AT - Income Tax

Revision u/s 263 - addition towards interest on advances to partners - advances given to partners - The assessee did not admit any interest / profit from these investments but paid the interest on partners capital accounts promptly - Held that - Payment of interest to the partners as at the end of the year and not collecting the interest from the partners on the amounts advanced to them for diversion of funds for non business purposes would distort the profits of the firm and as rightly observed the Ld.CIT(A) it is lopsided and does not reflect the true and correct picture of the profits of the firm. The assessee could not establish the business interest or availability of interest free funds to give advances to the partners in the guise of investment. Therefore, we consider it is fair and just to disallow the proportionate interest on the amounts advanced to the partners. Disallowance of interest for diversion of funds - Held that - Though the assessee stated that the assessee is following the cash system of accounting and would admit the income as and when it is received, the assessee has not proved with any evidence that the assessee has made any efforts to collect the advances along with interest till date. No attempt has been made by the assessee to collect the interest on advances given to debtor till date. This attitude clearly shows that the assessee has intentionally diverted interest bearing funds for non business purposes and has no intention to collect the interest to suppress the profits. Ld.CIT(A) has rightly confirmed the disallowance of interest for non-business purposes and enhanced the interest from 12% to 18%, since the assessee has borrowed loans for interest rate of 18%. Decided against the assessee.

Summary

Issues:
1. Disallowance of interest on advances to partners.
2. Disallowance of interest for diversion of funds given as advance to Nigam Developers.

Issue 1: Disallowance of interest on advances to partners:
The appeal was filed against the order of the Commissioner of Income Tax (Appeals) for the assessment year 2009-10. The Assessing Officer determined the total income against the returned income, leading to a revision by the CIT. The AO disallowed interest on advances to partners, leading to an appeal before the Ld.CIT(A) and subsequently before the Tribunal. The AO found that interest-bearing business funds were diverted for non-business purposes and directed to disallow proportionate interest. The Ld.CIT(A) confirmed the addition, stating that the accounting system did not reflect the true business picture. The Tribunal upheld the decision, emphasizing the need to collect interest from partners and not distort profits.

Issue 2: Disallowance of interest for diversion of funds to Nigam Developers:
The AO disallowed interest on a sum given as an advance to Nigam Developers for non-business purposes. The CIT(A) enhanced the addition, stating the amount was diverted from interest-bearing funds. The Tribunal heard arguments that the advance was for business purposes and interest should not be charged. However, the balance sheet showed no interest-free funds for such advances. The Tribunal found no evidence of business purpose for the advance, concluding that interest-bearing funds were diverted for non-business purposes intentionally. The CIT(A) decision to disallow interest for non-business purposes and enhance the rate was upheld by the Tribunal.

In conclusion, the Tribunal dismissed the appeal of the assessee regarding both issues. The judgment highlighted the importance of accurately reflecting business transactions and ensuring interest is collected on advances to partners to prevent profit distortion and tax evasion.