2022 (3) TMI 1242 - AT - Income Tax

Disallowance on account of proportionate interest attributable to capital work-in-progress - Since the interest paid on the capital borrowed for acquisition of asset in the form of capital work-in-progress was not an allowable deduction as per the proviso to Section 36(1)(iii) of the Act, the assessee was called upon by the Assessing Officer to explain as to why the proportionate interest attributable to the capital borrowed for capital work-in-progress should not be disallowed being capital expenditure - HELD THAT - DR has not raised any material contention to dispute this position. He, however, has contended that neither the Assessing Officer nor the learned CIT(A) has given any specific finding on this aspect of the matter on the basis of overall financial position of the assessee-company and the matter may, therefore, be sent back to the Assessing Officer for such verification. We are inclined to accept this contention of the learned DR. The impugned order of the learned CIT(A) on this issue is accordingly set aside and the matter is restored to the file of the AO to decide the same afresh after verifying overall financial position of the assessee-company in order to ascertain whether the investment in capital work-in-progress was made by the assessee-company out of its own interest free funds or interest-bearing borrowed funds. AO is accordingly directed to decide this issue afresh after such verification and after giving the assessee proper and sufficient opportunity of being hear. Disallowance on account of proportionate interest attributable to the borrowed funds allegedly utilized by the assessee for giving interest free advances to its subsidiary company - HELD THAT - The case of the assessee as made out before the authorities below and specifically before the Tribunal is that sufficient interest free funds in the form of share capital, reserve surplus and internal accruals were available at the relevant time to give interest free advance to the subsidiary company and there being the case of mixed funds maintained by the assessee-company, this issue is required to be considered having regard to the overall financial position of the assessee-company and not by applying the direct nexus theory. Following our conclusion drawn on the issue raised in Ground No.2, we restore this issue also to the file of the Assessing Officer for deciding the same afresh after verifying the overall financial position of the assessee-company in order to ascertain as to whether the interest free advance was given by the assessee-company out of interest free funds available at the relevant time or from the interest-bearing borrowed funds. Appeals of the assessee treated as allowed for statistical purposes.

Summary

Issues Involved:
1. Disallowance of ?3,04,193/- on account of proportionate interest attributable to capital work-in-progress for AY 2013-14.
2. Disallowance of ?35,70,587/- on account of proportionate interest attributable to borrowed funds allegedly utilized for giving interest-free advances to a subsidiary company for AY 2013-14.
3. Disallowance of ?90,85,891/- on account of proportionate interest attributable to interest-bearing borrowed funds allegedly utilized for giving interest-free advances to a subsidiary company for AY 2014-15.

Detailed Analysis:

1. Disallowance of ?3,04,193/- on account of proportionate interest attributable to capital work-in-progress for AY 2013-14:

The assessee, a company engaged in manufacturing specialty chemicals and wind power generation, filed its return of income for AY 2013-14 declaring total income of ?40,43,110/-. During scrutiny, the Assessing Officer (AO) noticed an amount of ?41,52,223/- as capital work-in-progress and disallowed ?3,04,193/- as interest on borrowed funds used for this capital work-in-progress, citing Section 36(1)(iii) of the Act. The assessee argued that no fresh loans were taken during the year and that existing loans were used for assets already in use. However, the AO found that payments for capital work-in-progress were made from a Cash Credit Account and no evidence was provided to show that interest-free funds were used. The learned CIT(A) confirmed the disallowance, noting a direct nexus between borrowed funds and capital work-in-progress.

Upon appeal, the Tribunal noted that the assessee had sufficient interest-free funds and that the direct nexus theory should not apply in cases of mixed funds. The Tribunal set aside the CIT(A)'s order and remanded the matter to the AO to verify the overall financial position of the assessee to determine if interest-free funds were used for capital work-in-progress.

2. Disallowance of ?35,70,587/- on account of proportionate interest attributable to borrowed funds allegedly utilized for giving interest-free advances to a subsidiary company for AY 2013-14:

The assessee debited ?3,05,28,877/- as interest expenses in the Profit and Loss account and had given an interest-free advance of ?4,34,34,1459/- to its subsidiary, Diamines Speciality Chemicals Private Limited. The AO disallowed ?35,70,587/- as interest on borrowed funds used for this advance, as the assessee failed to prove the advance was made from internal accruals. The CIT(A) upheld the disallowance, noting a direct nexus between borrowed funds and the interest-free advance, and rejected the assessee's reliance on the Supreme Court decision in SA Builders, citing lack of business exigency.

The Tribunal observed that this issue was similar to the first issue and noted that the assessee had sufficient interest-free funds. It remanded the matter to the AO for verification of the overall financial position to determine if interest-free funds were used for the advance.

3. Disallowance of ?90,85,891/- on account of proportionate interest attributable to interest-bearing borrowed funds allegedly utilized for giving interest-free advances to a subsidiary company for AY 2014-15:

For AY 2014-15, the issue was similar to the second issue for AY 2013-14. The AO and CIT(A) disallowed ?90,85,891/- on account of interest on borrowed funds used for interest-free advances to the subsidiary. The Tribunal followed its conclusion from AY 2013-14 and remanded the matter to the AO for verification of the overall financial position to determine if interest-free funds were used for the advance.

Conclusion:

In both appeals, the Tribunal remanded the matters to the AO for fresh verification of the overall financial position of the assessee to ascertain whether interest-free funds were used for capital work-in-progress and interest-free advances to the subsidiary. The appeals were treated as allowed for statistical purposes.