2021 (7) TMI 439 - AT - Income Tax

Interest disallowance u/s 36(1)(iii) - CIT-A justification in treating the interest income from debentures to be taxed under the head income from other sources‟ as against income from business‟ offered by the assessee - HELD THAT - There is absolutely no dispute that the borrowed funds from IBFSL had been utilized in investment in convertible debentures of M/s KA Hospitality Pvt Ltd (sister concern) of the assessee company. At the outset, we find that the borrowings were made in Asst Year 2012-13 and utilization of the same by way of making investment in convertible debentures of M/s KA Hospitality Pvt Ltd was also made in Asst Year 2012-13. The assessee had paid interest for the period 19.3.12 to 31.3.12 relevant to Asst Year 2012-13 and received interest income on debentures of ₹ 10,849/- in Asst Year 2012-13. The net interest paid for Asst Year 2012-13 was disallowed by the ld AO u/s 36(1)(iii) of the Act which was deleted by the ld CIT-A. As pointed out that the revenue could not prefer any appeal before this tribunal against this order on the ground of low tax effect on disputed issue due to circular issued by CBDT. Accordingly, we hold that the issue of allowability of interest paid on loans need to be examined independently in Asst Year 2013-14 dehors the fact of non-filing of appeal by the revenue before us for Asst Year 2012-13. CIT-A had enhanced the income by treating the interest income on debentures to be taxed under the head income from other sources and disallow the entire gross interest paid on loans u/s 36(1)(iii) of the Act. Since the aforesaid issue of allowability of interest paid is set aside to the file of the ld CITA this interconnected issue of interest income on debentures getting taxed as income from other sources is also set aside to the file of ld CITA for fresh adjudication in the light of aforesaid directions. Grounds raised by the assessee allowed for statistical purposes.

Issues Involved:
1. Justification of interest disallowance under Section 36(1)(iii) of the Income Tax Act.
2. Classification of interest income from debentures under the correct income head.

Issue-wise Detailed Analysis:

1. Justification of Interest Disallowance under Section 36(1)(iii):

The primary issue is whether the Commissioner of Income Tax (Appeals) [CIT(A)] was justified in upholding the interest disallowance made under Section 36(1)(iii) of the Income Tax Act. The assessee, a private limited company dealing in garments, had taken a loan of ?33 crores from Indiabulls Financial Services Ltd (IBFSL) and paid interest of ?4,68,55,519/-. The company invested in debentures of KA Hospitality Pvt Ltd and earned interest income of ?99,00,000/-. The assessee claimed a net interest deduction of ?3,69,55,519/- (?4,68,55,519 - ?99,00,000) under Section 36(1)(iii). The Assessing Officer (AO) disallowed this interest, arguing that the borrowings were used for non-business purposes.

In the first appeal, the CIT(A) upheld the AO's decision, disallowing the interest under Section 36(1)(iii) and treating the interest income from debentures as "income from other sources." The assessee argued that the investment in convertible debentures was a business decision to eventually participate in the equity of KA Hospitality Pvt Ltd, which was engaged in the hospitality business. The assessee cited previous assessments and judicial precedents to support its claim that the borrowings were for business purposes.

The Tribunal noted that the borrowed funds were indeed used to invest in convertible debentures of KA Hospitality Pvt Ltd. However, it questioned the business prudence of borrowing at an approximate rate of 14% and investing in debentures yielding only 3% interest. The Tribunal emphasized the need to examine whether the investment benefited the assessee or its sister concern. The Tribunal found that the CIT(A) did not provide sufficient findings to establish that the funds received from the assessee were used for business purposes by KA Hospitality Pvt Ltd. Consequently, the Tribunal set aside the issue to the CIT(A) for a holistic re-examination.

2. Classification of Interest Income from Debentures:

The interconnected issue is whether the CIT(A) was justified in treating the interest income from debentures as "income from other sources" instead of "income from business." The Tribunal noted that the assessee earned interest income at a rate of 3% per annum from the debentures. The Tribunal found that the CIT(A) had not adequately addressed whether the investment in debentures was a business decision or merely a financial arrangement.

The Tribunal directed the CIT(A) to re-examine the classification of the interest income from debentures, considering the overall benefit derived by the assessee from the investment. The Tribunal highlighted the need for a categorical finding on whether the funds were used for business purposes and whether the investment in debentures was prudent and beneficial for the assessee.

Conclusion:

The Tribunal set aside both issues to the CIT(A) for fresh adjudication, directing a holistic examination of the allowability of interest paid on loans and the taxability of interest income from debentures. The Tribunal emphasized the need for a detailed analysis and findings on whether the investment in debentures was a prudent business decision and whether it benefited the assessee or its sister concern. The appeals were allowed for statistical purposes, and the assessee was granted the opportunity to present fresh evidence.

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