2017 (3) TMI 746 - HC - Income Tax

Claim of interest expenditure under section 36(1)(iii) - Held that - Each assessment year being a separate unit the disallowance of interest expenditure in such circumstances cannot be based on the closing balance of interest free loan in a given year. Rather the Assessing Officer may examine the amount of interest free loan given in the previous year relevant to the assessment year in question and only if the Assessing Officer is satisfied that the assessee had not available to it sufficient own funds to give such a loan in that year he may invoke section 36(1)(iii) of the Act and disallow such interest expenditure as may be warranted and not otherwise. An assessee who had available to him sufficient own funds or interest free funds in any previous year and had given the interest free loans in that previous year itself would only be burdened to establish only that much i.e. he advanced the said loan/s from such interest free advances or surplus funds and no more. Once this is established no disallowance under section 36(1)(iii) of the Act would be warranted against interest paid on business borrowings for reason of having given interest free loans. Thus while the Tribunal has found 39, 45, 705/- were available by way of interest free advance with the assessee and that disallowance under Section 36(1)(iii) of the Act commensurate to such deposit was not warranted yet there is a total lack of any finding as to the amount of interest free loan given by the assessee in the previous year relevant to the assessment year 2010-11 both by the Tribunal and also by the CIT (Appeals). We are therefore of the view that the questions of law raised in the memo of appeal deserve to be answered partially in favour of the assessee to the extent that in view of the finding recorded by the Tribunal as to availability of 39, 45, 705/- by way of interest free advance the Tribunal was further required to record a finding as to the amount interest free loan given by the assessee in the previous year relevant to the assessment year 2010-11.

Summary

Issues Involved:
1. Legality of ITAT's decision to uphold the CIT(A)'s directive to recompute the disallowance of interest.
2. Justification of ITAT's partial upholding of CIT(A)'s order despite the availability of interest-free funds with the assessee.

Issue-wise Detailed Analysis:

1. Legality of ITAT's Decision to Uphold the CIT(A)'s Directive to Recompute the Disallowance of Interest:

The assessee, engaged in trading auto bikes, contested the disallowance of interest expenditure under Section 36(1)(iii) of the Income Tax Act, 1961, for the assessment year 2010-11. The Assessing Officer had disallowed ?5,00,000 out of the interest paid on ?58,00,000 borrowed for business purposes, arguing that the assessee had given interest-free loans amounting to ?92.75 lacs for non-business purposes.

The CIT (Appeals) required the assessee to justify the purpose of these loans, which the assessee claimed were given for business purposes. Despite the assessee's explanation and reference to the Allahabad High Court judgment in CIT Vs. Sahu Enterprises (P) Ltd., the CIT (Appeals) rejected the claim, emphasizing that the test to be applied was the purpose of the loans, not the source of the funds.

Upon further appeal, the Tribunal directed the Assessing Officer to recompute the disallowance, considering the interest-free advances available to the assessee. However, the Tribunal did not record a finding on the total interest-free loans given during the relevant assessment year. The High Court observed that the Tribunal's incomplete findings necessitated a remand to record specific findings on the interest-free loans given in the relevant year.

2. Justification of ITAT's Partial Upholding of CIT(A)'s Order Despite the Availability of Interest-Free Funds with the Assessee:

The High Court noted that the Tribunal had accepted the availability of ?39,45,705 as interest-free advances from customers but failed to determine the exact amount of interest-free loans given during the relevant year. The Tribunal's reliance on the total loan amount of ?92.75 lacs, which included loans from previous years, was deemed incorrect.

The High Court referred to several precedents, including CIT Vs. M/s Radico Khaitan, CIT Vs. Krishna Murari Lal Agarwal, and CIT Vs. M/S Appolo Trade Links, which established that disallowance of interest under Section 36(1)(iii) is not warranted if the assessee had sufficient non-interest-bearing funds to cover the interest-free loans. The Supreme Court's ruling in Hero Cycles Private Ltd. Vs. CIT Central Ludhiana further reinforced this principle.

The High Court concluded that the Tribunal erred by not fully applying the law as expounded by the Supreme Court and previous judgments. It directed the Tribunal to record a specific finding on the interest-free loans given during the relevant year and to pass consequential orders based on the established legal principles.

Conclusion:

The High Court partially allowed the appeal, remitting the matter to the Tribunal to record specific findings on the interest-free loans given during the relevant assessment year and to pass orders in accordance with the legal principles discussed. The Tribunal was directed to complete this exercise within six months from the date of the High Court's order.