2020 (10) TMI 1160 - HC - Income Tax

Disallowance u/s 36(1)(iii) - assessee had advanced interest bearing funds without charging any interest - Whether Tribunal was right in not considering the fact that the matching principle in terms of income and expenditure is not applicable when cash system of accounting is followed as sine qua non for allowability of expenditure there should be nexus between the income and expenditure reported for the year in question as applicable in terms of Sections 36 and 37 ? - HELD THAT - As decided in own case 2019 (4) TMI 570 - MADRAS HIGH COURT when the cash system of accounting was adopted by the Assessee, an Investment Company, whose business is only to borrow and lend or invest, the same cannot be said to be not in the business interest or commercially expedient for the purpose of business and the concept of 'Matching Principles', which has been applied by the Assessing Authority and the CIT (A) in the present case, was not really applicable. It is not for the Revenue authorities to substitute their own wisdom or notion about the rate of interest agreed to between the parties, including the group companies and, as such, the finding of fact about commercial expediency or absence thereof is a finding of fact, out of which, no substantial question of law can be said to be arising, requiring our consideration under Section 260A of the Act. Moreover, since in the case of Assessee company itself, this Court has only decided on similar facts earlier and dismissed the Revenue's Appeal, we do not find any reason to take a different view of the matter for the Assessment Years in question before us. - Decided against revenue.

Summary

Issues Involved:
1. Whether the Tribunal was right in deleting the disallowance made under Section 36(1)(iii) of the Income Tax Act when the assessee had advanced interest-bearing funds without charging any interest.
2. Whether the Tribunal was right in not considering that the matching principle in terms of income and expenditure is not applicable when the cash system of accounting is followed, as there should be a nexus between the income and expenditure reported for the year in question as applicable under Sections 36 and 37 of the Income Tax Act.

Issue-wise Detailed Analysis:

Issue 1: Deletion of Disallowance under Section 36(1)(iii)
The revenue's appeal challenged the Tribunal's decision to delete the disallowance of interest under Section 36(1)(iii). The revenue argued that the assessee had borrowed sums from its Group Concerns and paid lesser interest, which was contrary to the Agreement Clause (10) of one of the Deeds of Partnership, stipulating an interest rate of up to 12% per annum. The revenue contended that the difference in interest paid and received should be added back under Section 36(1)(iii).

However, the Tribunal found that the assessee, an investment company, followed a cash basis of accounting, recording actual interest paid and received. The Tribunal noted that in a cash basis system, there is no question of applying the matching principle. Interest is credited as income upon receipt and debited as expenses upon payment. The Tribunal observed that the disparity in interest received and paid arose from the cash basis system and not from selective charging of interest. The Tribunal also referenced a previous decision in the assessee's case for the assessment year 2009-2010, where it was held that the assessee's investments were part of its business, and the interest paid on borrowed capital for business purposes was deductible under Section 36(1)(iii).

Issue 2: Applicability of Matching Principle under Cash System of Accounting
The revenue argued that the matching principle, which requires a nexus between income and expenditure, is not applicable under the cash system of accounting. The revenue cited previous judgments, including the Supreme Court's decision in S.A. Builders Ltd. v. Commissioner of Income Tax (Appeals), to support its position.

The Tribunal, however, upheld that under the cash system of accounting, the actual amount of interest paid and received is recorded, and the matching principle does not apply. The Tribunal reiterated that the disparity between interest received and paid was due to the cash basis system and not selective interest charging. The Tribunal also referred to the assessee's previous cases where similar issues were decided in favor of the assessee, allowing the deduction under Section 36(1)(iii) for interest paid on borrowed capital used for business purposes.

Conclusion:
The High Court upheld the Tribunal's findings, agreeing that the cash system of accounting does not necessitate the application of the matching principle. The Court emphasized that the revenue authorities cannot substitute their judgment for the business decisions made by the assessee unless such decisions are arbitrary or intended to defeat revenue purposes. The Court noted that the Tribunal's findings were factual and did not raise substantial questions of law. Consequently, the appeal by the revenue was dismissed, and the substantial questions of law were answered against the revenue. The Court also referenced its previous decisions in similar cases involving the assessee, reinforcing the consistency of its rulings.

Final Judgment:
The Tax Case appeals were dismissed, and the substantial questions of law were answered against the revenue. No costs were awarded.