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2025 (1) TMI 1286 - AT - Income TaxDisallowance of interest expenses - assessee provided interest-free advances while having interest-bearing loans was justified -whether there was commercial expediency in giving interest free advances or loans? - HELD THAT - We notice that the advances have been given to these three companies during the course of carrying on business for business purposes i.e. these payments have been given in connection with business ventures with the expectation of profits from the deal that will be entered by the respective parties. Accordingly the Ld CIT(A) has held that there was commercial expediency in giving these advances without charging interest since the assessee is expected to get the share of profits from the deal. Further these three advances continue from the earlier years and the AO did not make any disallowance of interest in the earlier years. CIT(A) was justified in deleting the proportionate interest disallowance. For the other parties all these balances have been brought forward from earlier years and no disallowance of interest was made in those years. Secondly the interest free funds available with the assessee are in far excess of these outstanding amounts. Accordingly we are of the view that there is no requirement of disallowing any interest expenses vis- -vis these outstanding balances. Also account has been brought forward from earlier years and no disallowance of interest was made in those years. Advances have been given in the earlier years and no disallowance of interest was made in those years. Since these advances have been given for business purposes we are of the view that the Ld CIT(A) has rightly deleted the disallowance of proportionate interest in respect of both these advances. Some advances have been given on commercial expediency during the course of carrying on of its real estate business. And sufficient interest free funds were also available with the assessee. Decided in favour of assessee. Disallowance of the provision for expenses - HELD THAT - There is no dispute that the assessee is following mercantile system of accounting. Under that system it is mandatory for the assessee to make provision for all known expenses and losses even if the payments in respect of those expenses have not been made. Unless such kind of provision for expenses are made in the books as at the year end the financial statements cannot be considered to reflect true and fair view of the company. The provision for expenses is usually made on some scientific basis at the year end since the concerned bills would not have been received by the assessee at the time of finalization of accounts. Hence the assessee would not be in a position to furnish relevant bills in respect of all items. AR submitted that the provision for expenses are made every year in a routine manner in order to provide for all known expenses and losses in accordance with accounting principles. In the earlier years the AO had accepted claim of the provision for expenses. Accordingly we are of the view that the AO was not justified in disallowing the provision for expenses made by the assessee. Appeal filed by the revenue is dismissed.
ISSUES PRESENTED and CONSIDERED
The primary issues considered in this judgment were:
ISSUE-WISE DETAILED ANALYSIS Interest Disallowance on Interest-Free Advances Relevant Legal Framework and Precedents: The Court examined the principles established in the Supreme Court case of S A Builders Ltd vs. CIT, which emphasized the concept of "commercial expediency" in determining the allowability of interest on borrowed funds. According to Section 36(1)(iii) of the Income Tax Act, interest paid on capital borrowed for business purposes is deductible. The Court also referenced the Bombay High Court decision in Reliance Utilities and Power, which established a presumption that investments are made from interest-free funds if such funds are available. Court's Interpretation and Reasoning: The Court upheld the principle that if there is commercial expediency in providing interest-free advances, the interest expenditure on borrowed funds could still be deductible. It emphasized that the business purpose and the potential for indirect benefits justify such advances. Key Evidence and Findings: The Court reviewed various Memorandums of Understanding (MOUs) and agreements that demonstrated the business purpose behind the advances. It was noted that these advances were made in connection with real estate business ventures, with expectations of future profits. Application of Law to Facts: The Court applied the principle of commercial expediency to the facts, concluding that the advances were made for business purposes and that the assessee had sufficient interest-free funds to cover these advances. Treatment of Competing Arguments: The Court considered the AO's argument that interest should be disallowed due to the lack of interest charged on advances. However, it found the assessee's explanations and the existence of commercial expediency more persuasive. Conclusions: The Court concluded that the disallowance of interest expenses was not justified as the advances were made for business purposes and were supported by sufficient interest-free funds. Disallowance of Provision for Expenses Relevant Legal Framework and Precedents: The Court referred to the Supreme Court decisions in Indian Molasses Co. (P.) Ltd. v. CIT and Rotork Controls India (P.) Ltd. v. Commissioner of Income-tax, which clarified the conditions under which provisions for expenses can be recognized and deducted. Court's Interpretation and Reasoning: The Court emphasized that under the mercantile system of accounting, it is necessary to make provisions for known expenses to reflect a true and fair view of the company's financial position. The provision for expenses must be based on a reliable estimate of the obligation. Key Evidence and Findings: The Court found that the assessee had made provisions for expenses based on incurred liabilities, even if the actual payments had not been made, aligning with accepted accounting principles. Application of Law to Facts: The Court applied the principles of accounting and tax law to determine that the provision for expenses was justified and should not have been disallowed by the AO. Treatment of Competing Arguments: The AO's argument that the provisions were unsupported by vouchers was countered by the Court's recognition of the necessity of such provisions under the mercantile system. Conclusions: The Court concluded that the disallowance of the provision for expenses was not justified, as the provisions were in line with accounting standards and past practices. SIGNIFICANT HOLDINGS Preserve Verbatim Quotes of Crucial Legal Reasoning: The Court reiterated the principle from S A Builders Ltd: "The expression 'commercial expediency' is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business." Core Principles Established:
Final Determinations on Each Issue: The Court upheld the decision of the CIT(A) to delete the disallowance of interest expenses and the provision for expenses, emphasizing the importance of commercial expediency and adherence to accounting principles.
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