2024 (11) TMI 1312 - AT - Income Tax

Addition u/s 36(1)(iii) - assessee had advanced interest-free loans while incurring significant interest expenses on unsecured borrowings - AO held that the assessee failed to establish a nexus of these advances with interest-free funds and did not demonstrate any business purpose - HELD THAT - We find that the assessee had sufficient interest-free funds which were more than adequate to cover the interest-free advances - CIT(A) did not address the assessee s submission that no disallowance was made in earlier years despite similar advances. The principle of consistency was disregarded. CIT(A) s emphasis on the absence of a fund flow statement is unjustified, as the assessee s financial statements clearly indicated the sufficiency of interest-free funds. CIT(A) s reliance on S.A. Builders 2006 (12) TMI 82 - SUPREME COURT is misplaced. While that case emphasizes the requirement of commercial expediency, the principles laid down in CIT v. Reliance Industries Ltd. 2019 (1) TMI 757 - SUPREME COURT a subsequent Hon ble Supreme Court s decision, clarify that where sufficient interest-free funds are available, the presumption arises that such advances are made from those funds. Following the principle established in CIT v. Reliance Industries Ltd. (supra), it is presumed that such advances are made from interest-free funds. The Revenue has failed to establish a direct nexus between borrowed funds and these advances. Therefore, the disallowance of interest expenses u/s 36(1)(iii) cannot be sustained. Disallowance on account of sundry balances written off, citing non-compliance with Section 36(2) - The write-off pertains to non-recoverable advances given to employees, which are incidental to the assessee s business operations. Such advances, though not strictly satisfying Section 36(2) qualify as deductible business expenses u/s 37. Considering the nominal amount involved, disallowance on this account is unwarranted. Appeal of the assessee is allowed.

Summary

Issues:
1. Disallowance of interest expense under Section 36(1)(iii) for interest-free advances.
2. Disallowance of sundry balance written off under Section 36(2) of the Act.

Analysis:
The case involved an appeal by the assessee against the order of the Commissioner of Income Tax (Appeals) regarding disallowances made by the Assessing Officer. The primary issues were the disallowance of interest expense and the disallowance of sundry balance written off.

Interest Expense Disallowance:
The Assessing Officer disallowed Rs. 65,86,200 under Section 36(1)(iii) due to interest-free loans given by the assessee without establishing a business purpose or nexus with interest-free funds. The CIT(A) upheld this disallowance, emphasizing the failure to prove a business purpose or nexus. However, the Tribunal found that the assessee had sufficient interest-free funds to cover the advances, as evidenced by financial statements. The Tribunal noted the inconsistency in disallowance despite similar advances in prior years and relied on the principle established in a Supreme Court judgment that advances from sufficient interest-free funds are presumed to be made from those funds. The Tribunal ruled in favor of the assessee, stating that the disallowance was unsustainable.

Sundry Balance Written Off Disallowance:
The AO disallowed Rs. 8,002 under Section 36(2) for sundry balance written off, citing non-compliance. The assessee argued that this amount was a business expenditure under Section 37 due to advances given to an employee during normal business operations. The Tribunal agreed with the assessee, stating that the write-off was incidental to business operations and qualified as a deductible expense. Considering the nominal amount involved, the Tribunal deemed the disallowance unwarranted.

Conclusion:
The Tribunal allowed both grounds of the appeal in favor of the assessee, overturning the disallowances made by the lower authorities. The Tribunal's decision was based on the adequacy of interest-free funds for advances and the business nature of the written-off amount. The appeal was allowed, and the order was pronounced in open court in November 2024 at Ahmedabad.