2021 (8) TMI 634 - AT - Income Tax

Interest free loan - interest on borrowed funds - the assessee has sufficient own funds being share capital, reserves and balance in profit loss account, which is sufficient to cover loans given to related parties without any interest and hence, no interest could be disallowed for diversion of funds to related parties - HELD THAT - In assessee s own case for assessment year 2004-05 2019 (5) TMI 1895 - ITAT CHENNAI where the Tribunal by following mixed funds theory in light of the decision in the case of CIT Vs. Reliance Utilities Power Ltd. 2009 (1) TMI 4 - BOMBAY HIGH COURT , held that when interest free loan is extended they are firstly sourced out of interest free funds and if it is not sufficient to cover up the entire extent of interest free loan, the balance is met out of interest bearing funds. Tribunal further noted that in the present case, the assessee has sufficient own funds being share capital, reserves and balance in profit loss account, which is sufficient to cover loans given to related parties without any interest and hence, no interest could be disallowed for diversion of funds to related parties. We are of the considered view that there is no error in the findings recorded by the CIT(A) to delete disallowances made by the Assessing Officer towards proportionate interest and hence, we are inclined to uphold findings of the CIT(A) and dismiss appeal filed by the Revenue.

Summary

Issues:
- Disallowance of interest by the CIT(A)
- Consideration of general reserve and balances in Profit and Loss account as liquid cash
- Source of interest-free advances from CC account
- Applicability of mixed funds theory

Analysis:

The appeal filed by the Revenue challenged the order of the CIT(A) regarding the disallowance of interest amounting to a substantial sum. The Revenue contended that the CIT(A) erred in deleting the interest disallowance without considering that interest-bearing funds were diverted to related parties for non-business purposes. The Revenue argued that the general reserve and balance in the Profit and Loss account should not be considered as liquid cash available for immediate disbursement. However, the assessee's representative argued that the issue was settled in favor of the assessee in a previous case for the assessment year 2004-05, where it was held that loans and advances given out of mixed funds are presumed to be from the assessee's own funds, thus no disallowance should be made towards proportionate interest expenses.

The Tribunal examined the facts and legal precedents cited by both parties. It noted that the assessee had sufficient own funds, including share capital, reserves, and profits, to cover the loans given to related parties without charging any interest. The Tribunal referred to the mixed funds theory and held that when interest-free loans are extended, they are presumed to be sourced from interest-free funds first. If those funds are insufficient, the balance is met from interest-bearing funds. The Tribunal emphasized that the identity of funds gets mixed up when pooled together, and in such cases, there is a presumption that interest-free loans are sourced from interest-free funds.

Citing decisions of the Hon'ble Bombay High Court and the Hon'ble Madras High Court, the Tribunal concluded that in the absence of evidence showing that borrowed funds were used for interest-free loans, the presumption is that the loans were given from the assessee's own funds. Therefore, the Tribunal upheld the CIT(A)'s decision to delete the disallowance of proportionate interest and dismissed the Revenue's appeal. The Tribunal found no error in the CIT(A)'s findings and upheld the decision based on the principles of the mixed funds theory and legal precedents.

In conclusion, the Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s decision to delete the disallowance of interest expenses related to loans given to related parties, based on the application of the mixed funds theory and the sufficiency of the assessee's own funds to cover the interest-free loans.