2010 (5) TMI 53 - HC - Income Tax

Disallowance of interest - diversion of the funds borrowed by the assessee - AO disallowed the interest paid by the assessee firm to the extent of ₹ 30,92,266/-, taking the rate of interest at 14.45% per annum, which was the rate at which interest was being paid by the assessee firm to the bank in CC 40 account - CIT(A) held that interest free advances were given out of the cash from account with the bank, which had debit balance, on which the assessee firm was required to pay interest and, therefore, there was a direct nexus between the interest bearing funds borrowed by the assessee and interest free advances given by it to its sister concern. He rejected the explanation that interest free advances were made out of interest free funds available with the assessee firm, as he found that the advances were made out of the overdraft bank account maintained with Punjab Sind Bank. He, accordingly, upheld the disallowance made by the Assessing Officer. - The Tribunal did not find any commercial expediency in making interest free advances to the sister concern. It was noted by the ITAT that no material had been brought to its notice to show that the interest free advances had been given for the purpose of business or that by giving interest free advance, the business of the assessee would be served better. The Tribunal rejected the argument of the assessee that there was business connection. Held that . The commercial expediency, in our view, would include such purpose as is expected by the assessee to advance its business interest and may include measures taken for preservation, protection or advancement of its business interests. The business interest of the assessee has to be distinguished from the personal interest of its directors or partners, as the case may be. In other words, there has to be a nexus between the advancing of funds and business interest of the assessee firm - Some business objective should be sought to have been achieved by extending such interest free advance when the assessee firm/company itself is borrowing funds for running its business. It may not be relevant as to whether the advances have been extended out of the borrowed funds or out of mixed funds which included borrowed funds. - Assessee fails to pass the test - decided in favor of revenue.

Issues Involved:
1. Disallowance of interest paid by the assessee firm due to alleged diversion of interest-bearing funds to a sister concern.
2. Determination of whether the interest-free advances were made for commercial expediency.
3. Application of legal principles from prior judgments relevant to the case.

Detailed Analysis:

1. Disallowance of Interest Paid by the Assessee Firm:
The appellant/assessee firm paid Rs.80,93,749/- towards net interest, which included Rs.84,30,252/- to banks and Rs.1,34,334/- to partners. The Assessing Officer noted a debit balance in the account of M/s. Kesho Ram Industries, a sister concern, and concluded that there was a diversion of borrowed funds to this sister concern. Consequently, the Assessing Officer disallowed Rs.30,92,266/- of the interest paid by the assessee firm, arguing that interest-bearing funds had been diverted to the sister concern.

2. Determination of Commercial Expediency:
The CIT(A) upheld the disallowance, agreeing with the Assessing Officer that there was a direct nexus between the borrowed funds and the interest-free advances to the sister concern. The Income Tax Appellate Tribunal (ITAT) also upheld this view, noting no commercial expediency in the interest-free advances to the sister concern. The Tribunal emphasized that no material was presented to show that the advances were for business purposes or that they served the business interests of the assessee.

3. Application of Legal Principles:
The judgment referred to the Supreme Court's decision in S.A. Builders Ltd. v. Commissioner of Income-Tax (Appeals) & Another, which held that the test for allowing interest on borrowed funds under Section 36(1)(iii) of the Income Tax Act is whether the advances were made for commercial expediency. The Supreme Court emphasized that commercial expediency includes expenses incurred by a prudent businessman for business purposes, even if not under a legal obligation.

The High Court noted that the assessee did not claim commercial expediency before the Assessing Officer or CIT(A) and only raised this argument before the ITAT. The Tribunal found no evidence of commercial expediency and concluded that the interest-free advances were not made for the business purposes of the assessee firm.

Conclusion:
The High Court dismissed the appeal, agreeing with the Tribunal's findings that the interest-free advances were not made for commercial expediency. The Court emphasized that the Tribunal's findings were not perverse and could not be interfered with under Section 260A of the Income Tax Act. The judgment also discussed other relevant cases but found them not applicable to the present case due to the lack of evidence of commercial expediency.

Summary:
The High Court upheld the disallowance of interest paid by the assessee firm, concluding that the interest-free advances to the sister concern were not made for commercial expediency. The Court emphasized the need for a nexus between the advances and the business interests of the assessee, which was not established in this case. The appeal was dismissed, with no substantial question of law arising for consideration.

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