2022 (2) TMI 478 - AT - Income Tax

Addition u/s 36(i)(iii) - interest on advances made - Disallowance of interest made on the opening balance/amount - HELD THAT - As stated by the Ld. DR, and rightly so, as the assessee had during the year under consideration continued to pay interest on the interest bearing loans raised from the banks in the preceding years, therefore, there being a direct nexus between the outstanding balance of the interest free loans that were advanced to the aforementioned party and the said interest bearing funds, there can be no justification in not disallowing the interest corresponding to such interest free advance during the year under consideration, for the reason, that the amount of such advance was merely in the form of Opening balance and had not been given during the year under consideration. As part of the interest expenditure claimed as deduction by the assessee during the year under consideration pertained to the interest bearing loans that were raised by the assessee in the immediately preceding year and, continued as such during the year under consideration, therefore, we are unable to comprehend as to on what basis the assessee is claiming that no disallowance of the interest expenditure was called for with respect to the opening balance of the outstanding interest free advance that was given to the aforementioned party. Accordingly, we are unable to persuade ourselves to subscribe to the aforementioned claim of the assessee, and thus, reject the same. Whether no disallowances u/s 36(1)(iii) is called for to the extent the assessee was found to be in possession of interest free funds during the year under consideration and as the assessee had funds in the form of capital deployed by the partners on which interest was being paid @3% per annum, therefore, the disallowances, if any, u/s 36(1)(iii) of the Act was to be restricted in the backdrop of availability of the aforementioned amount of concessional interest bearing funds to 3% p.a. and not 8% p.a as worked out by the AO - As interest free funds are available with the assessee, then, a presumption would arise that the investments made were from its interest free funds. See RELIANCE UTILITIES POWER LTD. 2009 (1) TMI 4 - BOMBAY HIGH COURT As the assessee was admittedly having interest free funds of ₹ 16,99,632.68 i.e. unsecured loans raised from family members, therefore, no disallowance to the said extent qua the loan/advances given by the assessee to M/s. Khaira Trading company was called for - We, thus, vacate the disallowance of the interest expenditure u/s 36(1)(iii) qua the aforementioned amount. As regards the balance amount of the interest free advance given by the assessee firm to the aforementioned party, viz. M/s. Khaira Trading Company i.e. ₹ 37,00,367.32 ₹ 54,00,000/- (-) ₹ 16,99,632.68 , we are of the considered view that as the assessee firm had sufficient amount of capital of the partners of ₹ 1.54 crore on which interest was being paid @3% per annum, therefore, the disallowance u/s 36(1)(iii) with respect to the aforesaid balance of amount of ₹ 37,00,367.32 was to be restricted to 3% per annum and not 8% per annum as had been worked out by the AO. We, thus, in terms of our aforesaid deliberations modify the disallowance worked out by the AO u/s 36(1)(iii) of the Act.Grounds of appeal Nos. 2 to 3 are partly allowed

Issues Involved:
1. Legality of the CIT(A)'s order dated 10.04.2017.
2. Disallowance of ?6,48,000/- under Section 36(1)(iii) of the Income Tax Act.
3. Admission of additional grounds of appeal regarding the disallowance of interest on the opening balance/amount.

Detailed Analysis:

1. Legality of the CIT(A)'s Order:
The assessee contested the order passed by the CIT(A), Jalandhar, stating it was against the law and facts of the case. The Tribunal examined the merits of the CIT(A)'s decision and found no infirmity in the approach taken by the CIT(A). The CIT(A) had upheld the disallowance of ?6,48,000/- made by the AO under Section 36(1)(iii) of the Income Tax Act, which was challenged by the assessee.

2. Disallowance of ?6,48,000/- Under Section 36(1)(iii):
The primary issue was the disallowance of interest expenditure amounting to ?6,48,000/- under Section 36(1)(iii) of the Income Tax Act. The AO observed a debit balance of ?54 lakh towards M/s. Khaira Trading Company in the assessee's balance sheet. This amount was an interest-free advance given in the preceding year, with no business transactions occurring in the current or previous year. The AO disallowed the interest expenditure, concluding that the interest-bearing funds were diverted for non-business purposes. The CIT(A) upheld this disallowance.

The assessee argued that the amount was an opening balance from the previous year, and no disallowance should be made for the current year. Additionally, the assessee claimed that it had sufficient interest-free funds, including unsecured loans from family members and partner capital, justifying no disallowance or a reduced disallowance rate of 3% instead of 8%.

The Tribunal considered these arguments and found that the assessee's claim regarding the opening balance was untenable, as the interest-bearing loans continued to incur interest during the current year. However, the Tribunal acknowledged that the assessee had interest-free funds available, which should be considered to reduce the disallowance. The Tribunal referred to the judgments of the Bombay High Court in HDFC Bank Ltd vs. ACIT and Reliance Utilities and Power Ltd., which supported the presumption that investments made were from interest-free funds if available.

3. Admission of Additional Grounds of Appeal:
The assessee raised additional grounds, arguing that no disallowance of interest could be made on the opening balance. The Tribunal admitted this additional ground, citing the Supreme Court judgment in National Thermal Power Company Ltd Vs. CIT, which allowed for the consideration of purely legal issues based on facts already on record.

Conclusion:
The Tribunal partly allowed the appeals for the assessment years 2012-13, 2013-14, and 2014-15. It vacated the disallowance of interest expenditure to the extent of ?16,99,632.68, representing the interest-free funds available with the assessee. For the remaining balance of ?37,00,367.32, the disallowance was restricted to 3% per annum, aligning with the interest rate on partner capital. The Tribunal dismissed the general grounds of appeal as not pressed. The detailed analysis and reasoning were applied mutatis mutandis to the appeals for the subsequent assessment years. The order was pronounced in the open court on 24/12/2021.

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