2009 (2) TMI 238 - AT - Income Tax

Summary

Issues Involved:
1. Disallowance of interest expenditure due to diversion of interest-bearing funds to interest-free loans.
2. Justification of interest-free advances as a measure of commercial expediency.

Summary:

Disallowance of Interest Expenditure:

The Revenue filed an appeal against the order of the CIT(A)-IV, Kochi, for the assessment year 2003-04, challenging the deletion of disallowance of interest expenditure. The assessee, a builder, had availed interest-bearing loans and advanced interest-free funds to its partners, resulting in a proposed disallowance of interest expenditure by the AO. The AO found that the partners had overdrawn funds for personal purposes and for other firms like M/s Century Films, which did not benefit the assessee firm. Consequently, the AO disallowed Rs. 17,23,568 of interest expenditure, relying on the judgment in CIT vs. V.I. Baby & Co. (2002) 254 ITR 248 (Ker).

Justification of Interest-Free Advances:

The CIT(A) deleted the disallowance, concluding that the advances were for business expediency, citing the Supreme Court's decision in S.A. Builders Ltd. vs. CIT(A) (2007) 288 ITR 1 (SC). The CIT(A) found that the operational and financial association with M/s Century Films was necessary for the assessee's business. However, the Tribunal examined the facts and found no functional nexus between the assessee's business and the activities of the associate concerns. The Tribunal held that the CIT(A) had erred in deleting the disallowance, emphasizing that the diversion of funds must serve the business purpose of the assessee to justify the interest expenditure. The Tribunal restored the AO's disallowance, stating that the inherent benefit of a trade name does not constitute business expediency for claiming interest expenditure.

Conclusion:

The Tribunal allowed the Revenue's appeal, reinstating the disallowance of Rs. 17,23,568 made by the AO.