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Issues involved: Disallowance of interest paid by the assessee on cash credit account with the Bank of Baroda.
Summary: The assessee, a firm dealing in crockery items, tiles, and sanitary wares, appealed against the disallowance of interest paid on a cash credit account with Bank of Baroda. The ITO disallowed the interest, alleging diversion of funds borrowed from the bank to a sister concern owned by relatives of the partners. The CIT(A) directed the disallowance to be calculated based on the day-to-day fund usage, resulting in a reduced disallowance amount. The assessee argued that since the borrowed funds were for business purposes, the interest should be fully deductible u/s 36(1)(iii), emphasizing the loan's business purpose and security against goods. The Departmental Representative claimed a direct nexus between the borrowed funds and interest-free advances to the sister concern, citing a Delhi Bench decision. Upon review, the Tribunal found no direct correlation between the borrowed funds and advances to the sister concern, noting the mixed funds in the bank account and business transactions routed through it. The Tribunal referenced a Gujarat High Court decision emphasizing that as long as borrowed capital is for business purposes, the specific application is immaterial u/s 36(1)(iii). Considering the substantial interest-free funds and lack of nexus, the Tribunal canceled the sustained disallowance, directing the full interest amount to be allowed as a deduction. Therefore, the assessee's appeal was allowed.
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