2021 (9) TMI 1033 - AT - Income Tax

Addition u/s 36(1)(iii) - assessee has diverted its interest bearing funds towards non-interest bearing advances to a related concern - CIT(A) upheld the action of the AO disregarding the argument of the assessee that loan had been advanced on account of commercial expediency - HELD THAT - Hon ble Bombay High Court in the case of CIT vs. Reliance Communications Infrastructure Ltd. 2012 (5) TMI 160 - BOMBAY HIGH COURT has held that where the assessee, for furthering its business had utilized borrowed funds for making investments in its subsidiary company and for making interest free advances to a related company, no disallowance of interest paid on borrowed funds could be made Also in the case of Hero Cycle 2015 (11) TMI 1314 - SUPREME COURT has held that once it is established that there is nexus between expenditure and purpose of business, Revenue cannot justifiably claim to put itself in the arm chair of businessman or in position of Board of Directors and assume role to decide how much is reasonable expenditure having regard to circumstances of case. Where interest free advances made to a wholly owned subsidiary company, no disallowance of interest paid on borrowed fund could be made. Since, in the instant case, admittedly, the assessee has extended funds to its wholly owned subsidiary company for the purpose of business, therefore, in view of the decisions cited supra, I hold that no interest paid on borrowed funds could have been disallowed u/s 36(1)(iii) - Decided in favour of assessee.

Summary

Issues:
Disallowance of interest expenses under section 36(1)(iii) of the IT Act for advancing interest-free loans to wholly owned subsidiary company.

Analysis:

Issue 1: Disallowance of interest expenses under section 36(1)(iii) of the IT Act
The assessee, a company with investments in wholly owned subsidiaries, advanced interest-free loans to its subsidiary company using interest-bearing funds borrowed from other companies. The Assessing Officer (AO) disallowed interest expenses of ?10,88,438 under section 36(1)(iii) due to diversion of interest-bearing funds towards non-interest bearing advances. The CIT(A) upheld the AO's decision. The assessee argued that the loans were extended for business purposes. The counsel cited the case of CIT vs. Tulip Star Hotels Ltd., where interest paid on borrowed capital for acquiring control of a new asset was allowed under section 36(1)(iii). The counsel also referred to the case of Hero Cycle (P.) Ltd., emphasizing that if there is a nexus between expenditure and business purpose, disallowance should not be made. Additionally, the case of CIT vs. Reliance Communications Infrastructure Ltd. was cited to support that no disallowance should be made for utilizing borrowed funds for subsidiary companies. The Tribunal held in favor of the assessee, citing precedents and directing the AO to delete the disallowance of ?10,88,438. The appeal by the assessee was allowed.

This detailed analysis covers the key issue of disallowance of interest expenses under section 36(1)(iii) of the IT Act, providing a comprehensive understanding of the judgment and the legal principles applied in reaching the decision.