2019 (4) TMI 570 - HC - Income Tax

Addition u/s 36(1)(iii) - Assessee had advanced interest bearing fund without charging any interest to its associate concerns - 'Matching Principles' - whether the lower interest paid on the borrowings made by the assessee company from the sister concerns or the group companies is for the purpose of its business or not? - scope of commercially expediency - HELD THAT - Whether it is commercially expedient or not for the Assessee cannot be decided by the Revenue authorities and unless a decision taken in the usual course of business by the Assessee can be held to be arbitrary or motivated, deliberately taken to defeat the purpose of the Revenue, it cannot be held that the lower interest rate paid to the borrowers on the borrowings made by the assessee company is disallowable under Section 36 (1) (iii). No such finding of fact has been recorded by the Tribunal. On the contrary, in Para 7 of the Tribunal's order, quoted above, the Tribunal, in our opinion, rightly held that when the cash system of accounting was adopted by the Assessee, an Investment Company, whose business is only to borrow and lend or invest, the same cannot be said to be not in the business interest or commercially expedient for the purpose of business and the concept of 'Matching Principles', which has been applied by the Assessing Authority and the CIT (A) in the present case, was not really applicable. It is not for the Revenue authorities to substitute their own wisdom or notion about the rate of interest agreed to between the parties, including the group companies and, as such, the finding of fact about commercial expediency or absence thereof is a finding of fact, out of which, no substantial question of law can be said to be arising, requiring our consideration under Section 260A - Decided against revenue.

Summary

Issues Involved:
1. Disallowance of interest under Section 36(1)(iii) of the Income Tax Act.
2. Application of 'Matching Principles' by the Assessing Authority and CIT (A).
3. Commercial expediency of interest paid on borrowed funds.

Issue-wise Detailed Analysis:

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

The Revenue filed an appeal challenging the Tribunal's decision to delete the disallowance of interest claimed by the Assessee under Section 36(1)(iii) of the Income Tax Act. The Tribunal allowed the Assessee's appeal, setting aside the addition of alleged excessive interest paid to its Group Companies. The Revenue argued that the Assessing Authority and the Commissioner of Income Tax (Appeals) had rightly disallowed the interest claim as the Assessee had advanced interest-bearing funds without charging any interest to its associate concerns, contrary to the agreement clause which provided for an interest rate up to 12% per annum.

2. Application of 'Matching Principles' by the Assessing Authority and CIT (A):

The Revenue contended that the 'Matching Principles' were correctly applied by the Assessing Authority and CIT (A), as the Assessee had borrowed sums from its Group Concerns and paid lesser interest. However, the Tribunal found that the Assessee, following a cash basis of accounting, recorded only the actual interest paid and received. The Tribunal emphasized that in a cash basis accounting system, the 'Matching Principles' are not applicable. The Tribunal noted that the disparity in interest received and paid arose due to the cash basis system and not selective charging of interest.

3. Commercial expediency of interest paid on borrowed funds:

The Tribunal and the High Court referred to previous judgments, including CIT v. Shriram Investments (Firm) and S.A. Builders Ltd. v. Commissioner of Income Tax (Appeals), which held that interest on borrowed capital is deductible if it is for the purpose of business or profession, irrespective of whether the capital was used to acquire a revenue asset or a capital asset. The High Court reiterated that the commercial expediency of the Assessee's decision to pay lower interest cannot be questioned by Revenue authorities unless it is shown to be arbitrary or motivated to defeat the purpose of the Revenue. The Tribunal found no such arbitrariness or motivation in the Assessee's actions.

Conclusion:

The High Court upheld the Tribunal's decision, stating that no substantial question of law arose in the present case. It affirmed that the Assessee's adoption of the cash basis of accounting and the interest payments made were commercially expedient and in the business interest. The appeal by the Revenue was dismissed, maintaining the Tribunal's finding that the disallowance of ?1,65,81,384/- was unjustified. The High Court emphasized that the Revenue authorities cannot substitute their own judgment regarding the rate of interest agreed upon between the parties, including group companies.