2016 (4) TMI 958 - AT - Income Tax

Disallowance u/s 36(1)(iii) - of interest paid to the bank on C/C account - Held that - It is an undisputed fact that loan was given way back in 1990 and that too out of surplus funds and therefore, there was no nexus between loan advanced and interest paid. Therefore, no disallowance could have been made u/s 36(1)(iii) of the Act. As regards argument of learned DR that why this amount was not written off in the year 2004-05 itself we find that the order of Registrar of Co-operative Society placed at (PB-8) is for appointment of a liquidator whereby the liquidator takes charge of any sick society. The assessee may be in the hope of recovering part of its dues from the liquidator had not written off in its books. However, the fact remains that the said loan was given way back in 1990-91 and at that point of time there was temporary availability of funds as is mentioned in the resolution itself and therefore loan was given out of surplus funds. The incurring of expenditure on account of interest on funds used for making payments to Cane growers cannot be said to be for non business purposes only on the basis that the assessee was not able to recover its dues from a loanee to whom loan was given out of its surplus funds in earlier years. The Hon ble Punjab & Haryana High Court in the case of CIT vs. Suraj Dev Dada (2014 (5) TMI 625 - PUNJAB & HARYANA HIGH COURT ) has held that where the recovery of principal amount was difficult the addition on account of notional interest on account of loan to said company cannot be made u/s 36(1)(iii) of the Act. In view of the above, entire facts and circumstances we hold that there was no nexus between interest paid and loans made by assessee and therefore, the disallowance made by Assessing Officer and partly confirmed by learned CIT(A) is not justified. - Decided in favour of assessee Charging of penal interest - Held that - From the nature of penal interest charged by the Bank from assessee it is found that the charges are compensatory in nature as assessee has not violated any law but the extra payment has been made for lower valuation of stocks pledge with Bank. Therefore, we hold that the penal interest was in the nature of compensatory payment and allowable u/s 37(1) - Decided in favour of assessee

Summary

Issues Involved:
1. Disallowance of interest paid to the bank on a cash credit account.
2. Nexus between interest paid on the cash credit account and advances made to Zira Cooperative Sugar Mills and investment in shares of Sugarfed.
3. Non-recovery of debt from Zira Cooperative Sugar Mills and its impact on interest disallowance.
4. Disallowance of penal interest as a non-admissible expense.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Paid to the Bank on Cash Credit Account:
The appellant challenged the CIT(A)'s decision to restrict the disallowance of interest paid to the bank on a cash credit account on a proportionate basis concerning the interest receivable from Zira Cooperative Sugar Mills and investment in Sugarfed shares. The appellant argued that the interest paid to the bank was for financing stock and had no nexus with the advances or investments. The tribunal found that the interest was indeed incurred for business purposes, supported by a bank certificate indicating that the interest was charged on cash credit limits for clearing cane payments. The tribunal concluded that there was no justification for disallowing the interest under Section 36(1)(iii) of the Act.

2. Nexus Between Interest Paid on Cash Credit Account and Advances to Zira Cooperative Sugar Mills and Investment in Sugarfed Shares:
The appellant contended that the investments in Sugarfed were made from surplus funds provided by the Punjab Government and not from borrowed funds. The tribunal noted that the investments were made in earlier years, and no disallowance had been made in those years under Section 36(1)(iii). The tribunal emphasized that the investments were made out of commercial expediency, as Sugarfed was the controlling body for all cooperative sugar mills in Punjab. Citing the Supreme Court's decision in Hero Cycles (P) Ltd. vs. CIT, the tribunal held that the investments were for business purposes and disallowance of interest was not warranted.

3. Non-recovery of Debt from Zira Cooperative Sugar Mills:
The appellant argued that the loan to Zira Cooperative Sugar Mills was given in 1990-91 from surplus funds and had become non-recoverable after the mill went into liquidation in 2004-05. The tribunal found that the loan was given as per the society's resolution and was not linked to bank borrowings. The tribunal agreed that it was inappropriate to charge interest on a loan that had become bad and was not recoverable. The tribunal referenced the Punjab & Haryana High Court's decision in CIT vs. Suraj Dev Dada, which held that notional interest could not be disallowed when the recovery of the principal was in doubt. Thus, the tribunal concluded that the disallowance of interest under Section 36(1)(iii) was not justified.

4. Disallowance of Penal Interest:
The appellant contended that the penal interest charged by the bank was compensatory in nature and not a penalty for violating any law. The tribunal found that the penal interest was a contractual payment due to the lower valuation of pledged stocks and not a penalty for legal infractions. Citing the Punjab & Haryana High Court's decision in Jamna Auto Industries vs. CIT, the tribunal held that compensatory damages for breach of contract are deductible expenses. Therefore, the tribunal allowed the penal interest as a deductible expense under Section 37(1) of the Act.

Conclusion:
The tribunal allowed the appeal filed by the assessee, concluding that the disallowance of interest and penal interest by the Assessing Officer and partly upheld by the CIT(A) was not justified. The tribunal emphasized the lack of nexus between the borrowed funds and the investments/loans in question and recognized the compensatory nature of the penal interest. The order was pronounced in the open court on 28.3.2016.