2018 (12) TMI 332 - HC - Income Tax

Allowance of interest expenditure under Section 37 - investment made by the partners in the sister concerns and the income derived by way of more interest - speculative computation of interest earned based on the investment made, but on different grounds - Held that - A camouflage or not, the assessee had arranged the affairs in such a manner as no interest being earned directly by the assessee firms through the investments made by its partners. The assessee had accepted deposits from the public and also made advances to its partners. In any event, the partners were entitled to take advances from the firm on payment of interest, which cannot be taken to be a business carried on by the assessee-firms. The advances obtained by the partners were not in the nature of business carried on by the assessee and, hence, there could be no claim of business expenditure insofar as the interest paid to the depositors, the public. We, hence, answer the other questions of law framed against the assessee and in favour of the Revenue. We delete the order of the Tribunal insofar as the allowance of interest expenditure u/s 37. The order of the AO disallowing the expenditure on interest paid to the depositors is sustained on the grounds herein above mentioned as distinguished from the view taken by the AO. The appeals would stand partly allowed.

Summary

Issues:
1. Interference with substantive and protective additions by the Tribunal.
2. Allowance of interest paid on deposits under Section 37(1) of the IT Act.
3. Characterization of withdrawals from the firm by partners as loans for business purposes.

Analysis:

Issue 1: Interference with Substantive and Protective Additions
The appeals arose from orders of the Income Tax Appellate Tribunal regarding the Tribunal's interference with substantive and protective additions. The respondent-assessees operated a Multi Speciality Hospital and a Real Estate business. The Tribunal found that the interest income earned by the assessees was not directly earned through investments made by partners, leading to deletion of speculative computations. The Tribunal also allowed the appeals filed by the Revenue, recognizing a business relationship between the assessees and partners, permitting the expenditure claimed. The High Court upheld the Tribunal's decision, emphasizing that no addition could be made under Section 145, ruling in favor of the assessees against the Revenue on substantive additions made to interest income.

Issue 2: Allowance of Interest Paid on Deposits
The assessees claimed set off of interest paid to depositors under Section 37(1) of the IT Act. The Assessing Officer disallowed the claimed expenditure on interest payments, stating that the assessees were not engaged in a finance business. The first appellate authority sustained the addition to income but deleted the expenditure claimed. The Tribunal ultimately deleted the addition made, finding that the assessees did not have a finance business, and the partners' advances were not part of the assessees' business. The High Court concurred, citing a Supreme Court decision to support the conclusion that the advances obtained by partners were not part of the assessees' business, leading to disallowance of interest expenditure under Section 37.

Issue 3: Characterization of Withdrawals as Loans for Business
The withdrawals made by partners from the firms were scrutinized to determine if they could be considered loans for business purposes. The AO found that the partners' advances and investments in sister concerns were not reflective of a genuine finance business. The High Court agreed, emphasizing that the assessees did not carry on a finance business, and the partners' advances were not part of the business activities. Therefore, the interest paid to depositors was disallowed as a business expenditure. The High Court ruled in favor of the Revenue on this issue, upholding the AO's disallowance of interest paid to depositors.

In conclusion, the High Court upheld the Tribunal's decision to delete the additions made to the interest income, disallowing the claimed expenditure on interest payments, as the assessees were not engaged in a finance business. The characterization of partners' withdrawals as loans for business purposes was rejected, leading to the disallowance of interest expenditure under Section 37.