2022 (1) TMI 930 - AT - Income Tax

Disallowance made u/s. 36(1)(iii) - assessee had diverted interest bearing funds, without charge of any interest, and such diversion of funds shall be squarely covered by section 36(1)(iii) - CIT-A deleted the addition - HELD THAT - We find that an identical issue has been considered by the Tribunal for immediately preceding assessment year 2014-15 2019 (7) TMI 1698 - ITAT CHENNAI where the Tribunal by following its decision in assessee's own case for assessment year 2013-14 2018 (7) TMI 1476 - ITAT CHENNAI deleted additions made by the Assessing Officer towards disallowance of interest expenses u/s. 36(1)(iii) of the Act as held assessee has been considered as an investment company and making investments was part of its business - deduction u/s.36(1) (iii) of the Act had to be allowed in respect of interest paid, if capital was borrowed for the purpose of business or profession. We further noted that the Hon'ble Jurisdictional High Court of Madras 2020 (10) TMI 1160 - MADRAS HIGH COURT has affirmed findings of the Tribunal in deleting additions made by the Assessing Officer towards disallowance of interest expenses u/s. 36(1)(iii) of the Act - Decided in favour of assessee.

Issues Involved:
1. Deletion of disallowance made under Section 36(1)(iii) of the Income Tax Act, 1961.
2. Application of the test of commercial expediency as per the Supreme Court's decision in the case of M/s. S A Builders.
3. Alleged diversion of interest-bearing funds to sister concerns.
4. Minimal interest income reported by the assessee.
5. Alleged stage-managed transactions to minimize tax liability.
6. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962.

Issue-wise Detailed Analysis:

1. Deletion of Disallowance under Section 36(1)(iii):
The Revenue contended that the CIT(A) erred in deleting the disallowance of interest expenses under Section 36(1)(iii) of the Income Tax Act, 1961, arguing that the assessee had diverted interest-bearing funds without charging any interest. The CIT(A) deleted the disallowance by following the decision of ITAT, Chennai, and the Hon'ble Jurisdictional High Court of Madras in the assessee's own case for earlier assessment years. The Tribunal upheld this deletion, noting that the issue was covered in favor of the assessee by the decisions of the higher courts, which had affirmed that no disallowance could be made under Section 36(1)(iii) for debit balances in the partner's capital account and loans & advances to group companies.

2. Application of the Test of Commercial Expediency:
The Revenue argued that the test of commercial expediency, as laid down by the Hon'ble Supreme Court in the case of M/s. S A Builders (288 ITR 1), was not satisfied. However, the Tribunal found that the assessee had followed the cash system of accounting, where interest was credited as income upon receipt and debited as expenses upon payment. The Tribunal noted that the disparity between interest received and paid arose not from selective charging of interest but from the cash basis of accounting, which is permissible under the statute.

3. Alleged Diversion of Interest-bearing Funds to Sister Concerns:
The Revenue claimed that the assessee had diverted interest-bearing funds to its sister concerns, resulting in a lower interest income. The Tribunal observed that the assessee's business involved providing financial support to group concerns and that the transactions were part of its business operations. The Tribunal upheld the CIT(A)'s finding that the interest expenses were incurred for business purposes and were allowable under Section 36(1)(iii).

4. Minimal Interest Income Reported by the Assessee:
The Revenue contended that the assessee reported minimal interest income while claiming full interest deduction, suggesting manipulation to reduce taxable income. The Tribunal, however, found that the assessee had followed the cash system of accounting, which justified the reported interest income and expenses. The Tribunal noted that the assessee's financial transactions were consistent with its business model and upheld the CIT(A)'s decision.

5. Alleged Stage-managed Transactions to Minimize Tax Liability:
The Revenue argued that the assessee's transactions were engineered to minimize tax liability. The Tribunal rejected this argument, noting that the assessee's financial operations were in line with its business activities and that there was no evidence of arbitrary or motivated actions to defeat the purpose of the Revenue. The Tribunal upheld the CIT(A)'s findings and dismissed the Revenue's appeal.

6. Disallowance under Section 14A read with Rule 8D:
The Assessing Officer had made a disallowance of ?1,03,840 under Section 14A read with Rule 8D of the Income Tax Rules, 1962, which the CIT(A) sustained. The Tribunal noted that the CIT(A) had correctly followed the provisions of the law and upheld the disallowance made by the Assessing Officer. The Tribunal found no reason to interfere with the CIT(A)'s decision on this matter.

Conclusion:
The Tribunal dismissed the Revenue's appeal, upholding the CIT(A)'s order that deleted the disallowance of interest expenses under Section 36(1)(iii) and sustained the disallowance under Section 14A read with Rule 8D. The Tribunal's decision was consistent with the findings of the Hon'ble Jurisdictional High Court of Madras and the ITAT, Chennai, in the assessee's own case for earlier assessment years. The Tribunal emphasized that the assessee's financial transactions were part of its business operations and were conducted in accordance with the permissible accounting methods.

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