2024 (11) TMI 74 - AT - Income Tax

Disallowance made on account of proportionate interest paid on loans which were advanced - interest incurred on loans borrowed for the purpose of advancing such loan to AAIPL was allowable as business expenditure u/s 36(1)(iii) HELD THAT - From the facts on record, we observe that, the assessee is engaged in the business of real estate development and in furtherance of its business, it had set-up an Indian subsidiary in the name of AAIPL in which it held 87.5% along with one Mr. JH who held 12.5% for undertaking real estate projects abroad. It is further observed that AAIPL had accordingly set-up subsidiaries in Sri Lanka Dubai which were undertaking real estate projects in the respective countries. We further note that the monies advanced by the assessee to AAIPL to further fund the step-down subsidiaries abroad was in the course and for the purposes of its business. Having considered these facts and circumstances, we find merit in the Ld. CIT(A) s findings that, on the given facts, it was commercial prudence that, the AAIPL would not be able to realize interest from the foreign subsidiaries and thus the assessee will also not be able to realize interest due on the loans advanced to AAIPL. The assessee is in the real estate business and so was its subsidiary AAIPL and step down foreign subsidiaries. The loans were infused into the step down foreign subsidiaries through the aegis of AAIPL for the reason that the Banks required the promoter to infuse funds as their commitment to the real estate project, which sufficiently proved that the funds were advanced for the business purposes. These loans originally carried interest which were serviced as well. For the reasons discussed above viz., serious litigation between partners and financial distress in foreign subsidiary, the assessee decided not to charge interest from this year in order to protect its overall business interests as well as principal loan amount. As has been discussed above, it is not necessary to show that the said deployment of borrowing always results in income to the assessee. The assessee have sufficiently established that the loans were advanced to AAIPL for the business purposes and therefore, even if the loans did not yield interest income during the year, yet the interest paid on borrowings has to be considered to be admissible for the purpose of Section 36(1)(iii) - we do not find any infirmity in the order of CIT(A). Therefore, we are inclined to uphold the same by dismissing the appeal of the Revenue.

Summary

Issues Involved:

1. Disallowance of proportionate interest on loans advanced to a subsidiary.
2. Commercial expediency and business purpose of interest-free loans.
3. Justification for not charging interest on loans to the subsidiary.
4. Applicability of Section 36(1)(iii) of the Income Tax Act.
5. Consideration of notional interest income on loans.

Detailed Analysis:

1. Disallowance of Proportionate Interest:

The primary issue in this appeal was the disallowance of Rs. 46,27,18,547/- as interest expense by the Assessing Officer (AO) on loans advanced to M/s AA Infra Properties Pvt. Ltd. (AAIPL), a subsidiary of the assessee. The AO contended that since the loans were advanced interest-free, the corresponding interest paid on borrowed funds should be disallowed. The AO's decision was based on the observation that AAIPL had the financial capability to pay interest, as it had earned interest income from its foreign subsidiaries.

2. Commercial Expediency and Business Purpose:

The assessee argued that the loans to AAIPL were advanced as a measure of commercial expediency. The funds were used to support real estate projects in Sri Lanka and Dubai, undertaken by AAIPL's step-down subsidiaries. The decision to not charge interest was made due to financial distress faced by these subsidiaries, exacerbated by the COVID-19 pandemic, litigation issues, and a downturn in the real estate market. The assessee claimed that the decision was a prudent business move to protect its principal investment and ensure the sustainability of the projects.

3. Justification for Not Charging Interest:

The assessee justified the non-charging of interest based on the financial hardships of the foreign subsidiaries and ongoing litigations. The financial position of the subsidiaries had deteriorated significantly, and they were unable to service interest costs. The Board of Directors resolved not to charge interest for the AY 2019-20, considering the extraordinary financial crisis and to protect the principal investment.

4. Applicability of Section 36(1)(iii) of the Income Tax Act:

The Ld. CIT(A) allowed the appeal, stating that the interest expense was allowable under Section 36(1)(iii) of the Income Tax Act. It was held that the loans were advanced for business purposes, and the decision to waive interest was commercially expedient. The judgment relied on precedents set by the Hon'ble Supreme Court in cases like S.A. Builders Ltd vs. CIT and Hero Cycles (P) Ltd vs. CIT, which established that the expression "for the purposes of business" should be interpreted from the viewpoint of commercial expediency.

5. Consideration of Notional Interest Income:

The Revenue argued that notional interest income should be taxed on the loans advanced to AAIPL. However, the Ld. CIT(A) and the Tribunal found that this was not the AO's original contention. The AO had focused on disallowing the interest expense, not on taxing notional income. The Tribunal upheld that the loans were advanced for business purposes, and the non-charging of interest was a business decision driven by commercial considerations.

Conclusion:

The Tribunal upheld the decision of the Ld. CIT(A) to delete the disallowance of interest, affirming that the loans were advanced for business purposes and the decision to waive interest was based on commercial expediency. The appeal of the Revenue was dismissed, and it was concluded that the interest expense was allowable under Section 36(1)(iii) of the Income Tax Act. The judgment emphasized that tax authorities should not interfere with business decisions made in good faith and based on commercial prudence.