2022 (2) TMI 642 - AT - Income Tax

Disallowance u/s.36(1)(iii) - interest on various loans and advances - assessee company had also advanced loans and advances to groups/subsidiary companies, but not charged any interest on such loans - whether loans and advances given to groups/subsidiary companies is out of interest free funds or out of interest bearing funds, which warrants disallowance of proportionate interest u/s. 36(1)(iii) ? - AO has disallowed proportionate interest on the ground that the assessee had diverted interest bearing funds for non-business purpose -HELD THAT - We do not subscribe to the reasons given by the AO to disallow proportionate interest expenses for the simple reason that once it is an established fact that there is a business connection between the assessee and its groups/subsidiary companies, then merely for the reason that the assessee has not charged any interest on loans and advances given to those groups/subsidiary companies, interest paid on borrowed money, cannot be disallowed u/s. 36(1)(iii). It is a well-established principles of law that when there is a business expediency, then the assessee is at liberty to deal with its finance in accordance with its business requirements. AO cannot sit in arms chair of the businessman to decide its business affairs and direct how to deploy its funds. As long as the assessee establishes the business connection or commercial expediency, then it is free to deal with its affairs in accordance with its requirements and thus, we are of the considered view that the AO cannot disallow proportionate interest expenses u/s. 36(1)(iii) of the Act merely for the reason that no interest has been charged on loans and advances given to groups/subsidiary companies. In this case, the assessee had filed necessary evidences to prove that there is a business connection between the assessee and the company to whom loans and advances were given. Once it is an established fact that there is a commercial expediency, no interest can be disallowed u/s. 36(1)(iii) of the Act. Assessee has placed all evidences to prove that interest free loans given to groups/subsidiary companies is out of interest free funds available with the assessee at the relevant point of time, which is evident from the fact that when the loans and advances given in the FYs ended 31.03.2011 31.03.2012, the assessee had raised fresh funds in form of share capital of ₹ 25 Crs. and out of which, it had given loans to its groups/subsidiary companies for business purpose. Therefore, we are of the considered view that on this count also, interest disallowance made by the AO u/s. 36(1)(iii) of the Act, is not correct. Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance of interest u/s. 36(1)(iii) of the Income Tax Act for diversion of funds to sister concern.

Analysis:

1. Disallowance of Interest:
The case involved the disallowance of interest under section 36(1)(iii) of the Income Tax Act for diverting funds to a sister concern without charging interest. The Assessing Officer (AO) disallowed a specific amount of interest, which the assessee contested, claiming that the loans were given out of interest-free funds for commercial expediency. The AO's contention was that borrowed funds were used for interest-free loans to sister concerns for non-business purposes. The Commissioner of Income Tax (Appeals) upheld the AO's decision, stating that advancing interest-free funds to sister concerns while incurring significant interest expenses on borrowed funds was not justifiable. However, the Tribunal disagreed with this reasoning. The Tribunal emphasized the business connection and commercial expediency between the assessee and the sister concerns, stating that the absence of interest charges on the loans did not warrant disallowance of interest under section 36(1)(iii) of the Act. The Tribunal highlighted the principle that as long as there is a business connection or commercial expediency, the assessee has the freedom to manage its finances accordingly. It concluded that the AO's disallowance of interest was unfounded, given the established commercial expediency and business connection. Additionally, the Tribunal noted that the interest-free loans were provided from interest-free funds raised by the assessee, further supporting the legitimacy of the transactions. Consequently, the Tribunal set aside the CIT(A)'s decision and directed the AO to delete the additions made towards interest under section 36(1)(iii) of the Act, ultimately allowing the appeal filed by the assessee.

This comprehensive analysis outlines the key issues, arguments presented, judicial interpretations, and the final decision rendered by the Tribunal, providing a detailed understanding of the legal judgment.