2011 (12) TMI 134 - HC - Income Tax

Addition on account of dis-allowance of interest and financial charges u/s 36(1)(iii) Revenue contention that there is no co-relation between the utilization of borrowed funds and investments( selling off a segment of business to subsidiary & getting shares of it) made by it - Held that - The Assessing Officer while disallowing the payment of interest and financial charges had failed to notice and given due credence to the fact that there was increase in interest payment this year, but the term loan and the credit facility had continued from the last year. Further, the assessee had declared a loss of Rs.1.88crs in the return filed for the assessment year in question. Lastly there are contradiction in the finding recorded by the Assessing Officer that involvement of the respondent in subsidiary company cannot be regarded as on account of business consideration.- Decided against the Revenue.

Summary

Issues:
1. Interpretation of Section 36(1)(iii) of the Income Tax Act regarding the deduction of interest paid in respect of capital borrowed for business purposes.
2. Assessment of the addition made by the Assessing Officer on account of interest and financial charges.
3. Determination of the relationship between the loan taken and the investments made by the respondent.
4. Analysis of the decision of the CIT (Appeals) and the tribunal regarding the deletion of the addition made by the Assessing Officer.

Issue 1: Interpretation of Section 36(1)(iii)
The Revenue appealed against the addition of Rs.1,59,28,955/- made by the Assessing Officer on the grounds that the interest paid should be disallowed under Section 36(1)(iii) of the Income Tax Act. The Assessing Officer considered the transaction as a colorable device by the assessee company to support its subsidiary company, raising doubts on the business prudence of the decision. However, the CIT (Appeals) and the tribunal upheld the deletion of the addition, emphasizing that there was no correlation between the loan taken and the investments made by the respondent, and the interest payment was in line with previous years' transactions.

Issue 2: Assessment of Addition
The Assessing Officer added Rs.1,59,28,955/- on account of interest and financial charges, alleging that the transaction was aimed at reducing the tax burden and was not a genuine business consideration. However, the CIT (Appeals) disagreed and deleted the addition, a decision that was upheld by the tribunal. The tribunal observed that the Assessing Officer failed to consider the continuity of the term loan and credit facility from the previous year, the declared loss in the current assessment year, and the lack of business correlation between the loan and investments made by the respondent.

Issue 3: Relationship between Loan and Investments
The respondent had borrowed money for term loans and working capital requirements, but the investments made in subsidiary companies and joint ventures did not show a direct nexus with the borrowed funds. The tribunal noted that the investments made by the respondent did not align with the loan and credit facilities for which interest and financial charges were paid. This lack of correlation led to the deletion of the addition by the CIT (Appeals) and the tribunal.

Issue 4: Decision of CIT (Appeals) and Tribunal
Both the CIT (Appeals) and the tribunal concurred that there was no business justification for disallowing the interest payment under Section 36(1)(iii) of the Act. They highlighted the mismatch between the loan utilization and the investments made by the respondent, ultimately leading to the dismissal of the Revenue's appeal. The decision emphasized the importance of establishing a clear correlation between borrowed funds and investments to claim deductions under the Income Tax Act.