2017 (5) TMI 245 - AT - Income Tax

Disallowance on account of interest expenses under Section 36(1)(iii) - Held that - It is an admitted fact that the assessee paid interest amounting to ₹ 48,92,072/- which comprises of two parts i.e. ₹ 24,36,353/- on the working capital loan from the bank which had been directly used for the business purpose and ₹ 24,60,749/- paid in respect of unsecured loans of ₹ 5,06,36,314/- received from M/s Sudha Apparels Ltd. which was utilized in the fixed deposits on which the assessee earned interest amounting to ₹ 39,73,387/-. Therefore, the expenditure relating to the interest paid was directly linked with the business of the assessee, so no disallowance could have been made u/s 37 of the Act as interest expenses incurred during the year had direct nexus with the income of the assessee and was fully allowable as per the provisions of Section 36(1)(iii) of the Act. In the present case, the AO disallowed a sum of ₹ 13,89,951/- out of the expenses claimed on account of interest which was paid by the assessee for the business exigency. In my opinion the action of the AO was not justified and the ld. CIT(A) without appreciating the fact in right perspective, sustained the disallowance made by the AO. As regards to the interest free advances given by the assessee to M/s Aggarwal Industries and M/s Discover Industries Pvt. Ltd. is concerned, it is noticed that the assessee was having sufficient own funds available with it during the year under consideration which is evident from page no. 9 of the assessee s paper book which is the copy of the balance sheet as on 31.03.2012 and reveals that share capital and reserves and surplus were to the extent of ₹ 6,31,74,469/- which were more than the interest free advances of ₹ 1,15,82,925/-. Therefore, the AO was not justified in presuming that the interest @ 12% was to be disallowed of ₹ 1,15,82,925/- when the loans raised by the assessee were utilized for the business purposes and the advances given to m/s Aggarwal industries and M/s Discover Industries Pvt. Ltd. amounting to ₹ 1,82,925/- and ₹ 1,14,00,000/- respectively were out of the own funds available with the assessee. In that view of the matter, the disallowance made by the AO and sustained by the ld. CIT(A) is deleted. - Decided in favour of assessee

Summary

Issues Involved:
1. Confirmation of disallowance of ?13,89,951/- made by the AO on account of interest expenses under Section 36(1)(iii) of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Confirmation of Disallowance of Interest Expenses

Facts:
The assessee filed its return of income declaring a loss of ?8,96,782/-. During scrutiny, the AO noticed that the assessee had debited ?84,12,080/- as finance cost, including ?48,97,072/- as interest paid on working capital. The AO found that the assessee had given short-term loans and advances totaling ?1,15,82,925/- without charging interest while incurring interest expenses on borrowed funds. Consequently, the AO disallowed interest expenses of ?13,89,951/- under Section 36(1)(iii).

Assessee's Submission:
The assessee argued that the loans and advances were given out of its own capital and not from borrowed funds. It was contended that the interest-free advances were made due to uncertainty of realization and no interest was claimed on these amounts. The assessee supported its claim with various judicial precedents, including Reliance Utilities & Power Ltd., HDFC Bank Ltd., and others, asserting that interest-free advances from own funds do not warrant disallowance of interest expenses under Section 36(1)(iii).

CIT(A)'s Observations:
The CIT(A) upheld the AO's disallowance, noting that the assessee had borrowed funds on which interest was paid and simultaneously advanced interest-free loans for non-business purposes. The CIT(A) relied on the judgment of the Hon’ble Delhi High Court in Punjab Stainless Steel Industries Vs CIT, asserting that interest expenses should be disallowed to the extent of interest-free advances.

Tribunal's Decision:
The Tribunal considered the submissions and judicial precedents cited by the assessee. It noted that the assessee's own funds (?6,31,74,469/-) were more than the interest-free advances (?1,15,82,925/-). The Tribunal observed that the interest expenses incurred had a direct nexus with the business income, as the borrowed funds were utilized for business purposes, including earning interest on fixed deposits. The Tribunal held that the disallowance made by the AO and sustained by the CIT(A) was not justified, as the interest-free advances were made out of the assessee's own funds. Consequently, the disallowance of ?13,89,951/- was deleted.

Conclusion:
The Tribunal allowed the appeal of the assessee, deleting the disallowance of ?13,89,951/- made on account of interest expenses under Section 36(1)(iii) of the Income-tax Act, 1961. The decision emphasized that when own funds are sufficient to cover interest-free advances, no disallowance of interest expenses is warranted.