2014 (10) TMI 110 - HC - Income Tax

Interest on borrowed funds disallowance - interest free loan given to sister concerns - Whether the Tribunal was correct in holding that due to an award passed in Arbitration Proceedings between M/s.K. Raheja Development Corporation and M/s.Unique Estates Development Corporation and M/s.Sea-Crust Properties Pvt. Ltd. where the Assessee was not a party, interest was paid due to compelling reasons and therefore allowable deduction Held that - The explanation offered by the assessee is that the interest could not be charged due to certain disputes among certain members of Raheja Group Concern - The explanation was not accepted by the assessing authority as well as the Appellate Commissioner - it is not their opinion that in every case interest on borrowed loan has to be allowed if a assessee advances it to a sister concern - the assessee received payment from its clients and it deposited the same in the account and subsequently, the said amount were paid to the sister concern - No interest was charged for the amounts so advanced to the sister concern - the assessee borrowed the fund from the bank and lent it to the sister concern as interest free loan. The test in such a case is really whether this was done as a measure of commercial expediency - If the interest free loan was given to the sister company as a commercial expediency, then such interest paid on such capital could have to be allowed - interest on borrowed loan advanced to its sister concern cannot be claimed as deduction automatically - the sister concern has returned a substantial portion of the amount borrowed - Merely because they got into litigation and suffered arbitration award is not a justification for not paying the interest for the amount borrowed - The sister concern getting into litigation or involving itself in a arbitration proceedings to which the holding company is nowhere responsible, cannot be made a ground for allowing deduction Decided in favour of revenue.

Summary

Issues:
1. Disallowance of interest on borrowed funds.
2. Whether interest on borrowed funds advanced to sister concern is allowable as deduction.

Analysis:
1. The appeal was filed by the Revenue challenging the deletion of disallowance of interest on borrowed funds by the Tribunal. The assessee, a real estate development firm, had received money through capital introduction and loans, on which interest was paid. However, the assessing authority disallowed the interest charged to profit and loss account on funds diverted for non-business purposes where no interest was earned. The Commissioner of Income Tax (Appeals) affirmed this order, but the Tribunal overturned it based on evidence of disputes between partners and the judgment in S.A.Builders Ltd. v. CIT case. The Tribunal held that interest was not chargeable due to compelling reasons and allowed the disallowance claim of the assessee.

2. The substantial question of law considered was whether interest on borrowed funds advanced to a sister concern is allowable as deduction, based on an arbitration award where the assessee was not a party. The material on record showed that the assessee borrowed funds but lent them to the sister concern without charging interest due to disputes within the Raheja Group. The Tribunal relied on the S.A.Builders case, stating that interest deduction depends on commercial expediency. However, the High Court found the Tribunal's understanding of the judgment incorrect, stating that disputes and arbitration involving the sister concern do not justify not paying interest on borrowed funds. The High Court ruled in favor of the Revenue, setting aside the Tribunal's order and restoring the Assessing Authority and Appellate Commissioner's decisions.

In conclusion, the High Court held that interest on borrowed funds advanced to a sister concern cannot be automatically claimed as deduction. The Court found that the Tribunal's reasoning based on the S.A.Builders case was flawed, as disputes and arbitration involving the sister concern were not valid justifications for not paying interest on borrowed funds. Therefore, the High Court ruled in favor of the Revenue, setting aside the Tribunal's decision and restoring the earlier orders of the Assessing Authority and the Appellate Commissioner.