2020 (2) TMI 206 - AT - Income Tax

Disallowance of interest expenses for the reason that the interest bearing funds were diverted for purchase of a land - DR submitted that by virtue of amendment by Finance Act, 2003 with effect from 01/04/2004, proviso to section 36(1)(iii) was introduced, whereby the interest on borrowed funds till the asset was to be used cannot be allowed as deduction - HELD THAT - As rightly pointed out by the Ld. DR, amendment to Finance Act, 2003 w.e.f. 01/04/2004 has inserted proviso to section 36(1)(iii) which clearly states that interest on borrowed funds in respect of capital borrowed for acquisition of an asset shall not be allowed as deduction till the date on which the said asset was put to use for the purpose of business. In the instant case, amounts borrowed have been diverted for purchase of an asset which belongs to the assessee s firm. Admittedly, the said asset was not put to use even as on date of hearing of this appeal. Therefore, going by the proviso to section 36(1)(iii) of the I.T. Act, interest expenses on capital borrowed for purchase of asset cannot be allowed as deduction. In other words, interest expenditure has to be necesssarily capitalised. The judicial pronouncements relied on by the Ld. AR relates to the case laws prior to the introduction of proviso to section 36(1)(iii). Admittedly, the proviso to section 36(1)(iii) of the Act is applicable during the relevant assessment year, namely 2008-09 and since the asset (land) has not been put to use by the assessee, the interest expenditure for acquiring the same cannot be allowed as a deduction - Decided against assessee.

Summary

Issues Involved:
1. Justification of the addition of ?12 lakhs by the Assessing Officer due to disallowance of interest expenses on the grounds of diversion of interest-bearing funds for the purchase of land.

Detailed Analysis:

Issue 1: Justification of the Addition of ?12 Lakhs by the Assessing Officer

Facts of the Case:
The assessee, a firm, filed a return of income for the assessment year 2008-09 declaring an income of ?3,45,850. During the scrutiny assessment, the Assessing Officer (AO) noticed that the assessee had purchased land worth ?1 crore using funds from its overdraft (OD) account. The AO issued a show cause notice proposing to disallow proportionate interest on the ?1 crore used for the land purchase, arguing that it constituted a diversion of funds not wholly and exclusively for business purposes. The AO concluded that the interest expenditure related to this amount should be disallowed and added back to the total income.

First Appellate Authority (CIT(A)) Findings:
The assessee contended before the CIT(A) that the land purchase was intended as a business asset and would be used for business purposes. However, the CIT(A) rejected this argument, noting that the asset had not been registered in the firm's name and had not been used for business purposes even after ten years. The CIT(A) upheld the AO's decision, citing a precedent from the Punjab & Haryana High Court which held that funds advanced without interest and without a business purpose should have the interest disallowed under Section 36(1)(iii) of the Income Tax Act.

Tribunal's Analysis:
The Tribunal reviewed the submissions from both the assessee and the Revenue. The assessee argued that the funds were used to purchase land intended for business use, citing various legal precedents to support the claim that such expenditure should be considered under "commercial expediency." The assessee referenced the Supreme Court case of S.A. Builders Ltd. vs. CIT(A), which defined "commercial expediency" as including expenditures a prudent businessman incurs for business purposes, even if not under legal obligation.

The Revenue, represented by the DR, countered that the proviso to Section 36(1)(iii) of the Income Tax Act, introduced by the Finance Act, 2003, disallows interest on borrowed funds for capital assets until the asset is put to use. The DR supported this argument with a precedent from the Chennai Bench of the Tribunal in the case of M/s. Narasu’s Spinning Mills vs. ACIT.

Tribunal's Conclusion:
The Tribunal upheld the CIT(A)'s decision, agreeing that the proviso to Section 36(1)(iii) applies. Since the land was not put to use for business purposes as of the hearing date, the interest expenditure must be capitalized and cannot be allowed as a deduction. The Tribunal noted that the judicial pronouncements cited by the assessee were relevant to periods before the introduction of the proviso and thus did not apply. Consequently, the appeal was dismissed, and the addition of ?12 lakhs was upheld.

Pronouncement:
The appeal of the assessee was dismissed, and the decision was pronounced in the open court on 03-02-2020.