2024 (12) TMI 1049 - AT - Income Tax

Disallowing interest expenditure claimed as deduction against interest income from partnership firm - interest free investments were made out of interest-bearing borrowed funds - HELD THAT - Assessee has sourced funds from both interest bearing loans and non-interest bearing funds and that the same is majorly invested in the capital of the partnership firms. There is no dispute that the investment made by the assessee in partnership firms is for the purpose of business. AO in assessment order has observed that the investment in partnership firms is not earning any income to the assessee except one firm, and therefore the claim of interest paid u/s 36(1)(iii) is not allowable. In this regard it is relevant to consider the following observations in the case of Suresh Sreeram 2021 (2) TMI 169 - ITAT BANGALORE wherein held reasoning of the CIT(A) that the interest expense would be expenditure incurred for the purpose of earning income from the partnership firm in the form of share income and therefore the expenditure would be not allowable in terms of sec.14A of the Act is incorrect because admittedly the firm incurred loss and the assessee did not receive any exempt income in the form of share of profits from the firm. For the purpose of allowability of interest under section 36(1)(iii), the commercial expediency has to be looked into as has been held in various judicial pronouncements. In assessee's case, there is no contention in this regard is raised by the revenue and the reason for disallowance is that the assessee is not earning any interest income from the investment made in the partnership firms. This in our considered view is not correct reason for making the disallowance under section 36(1)(iii) in assessee's case. Further from the perusal of the above funds flow statement, it is noticed that the loans and advances given during the year is coming out of the pool of funds which includes capital withdrawn from partnership firms, and without a one-to-one match being established by the revenue, it cannot be said that the borrowed funds are used for giving interest free loans and advances. As submitted during the course of hearing that some of the loans extended are earning interest and not the entire loans and advances are interest free - we are of the view that the disallowance made under section 36(1)(iii) is not sustainable - Appeal of the assessee is allowed.

Summary

Issues Involved:

1. Disallowance of interest expenditure claimed under Section 36(1)(iii) of the Income Tax Act, 1961.
2. Alternative disallowance of interest expenditure under Section 37(1) of the Income Tax Act, 1961.

Detailed Analysis:

1. Disallowance of Interest Expenditure under Section 36(1)(iii):

The primary issue revolves around the disallowance of Rs. 69,53,573/- claimed by the assessee as interest expenditure under Section 36(1)(iii) of the Income Tax Act, 1961. The Assessing Officer (AO) observed that the assessee utilized interest-bearing borrowed funds for making investments in partnership firms, which did not yield any interest income. The AO contended that the borrowed funds were used for non-interest earning investments, thus disallowing the interest expenditure claimed. The CIT(A) upheld this disallowance, emphasizing that the appellant's own capital was insufficient to fund the non-interest yielding investments, indicating that interest-bearing funds were indeed utilized for such investments.

The assessee argued that the investments in partnership firms were business investments, and the interest expenditure should be allowable irrespective of whether any income was earned from those investments. The assessee also contended that the funds for loans and advances were sourced from a mix of interest-bearing and non-interest-bearing funds, without a specific allocation from borrowed funds.

The Tribunal examined the case in light of judicial precedents, including the Supreme Court's decision in CIT v. Ramniklal Kothari, which allows deductions for interest paid on borrowings used for business purposes. The Tribunal concluded that the absence of interest income from partnership firms should not bar the deduction of interest paid on borrowings for contributing capital to those firms. It was noted that the funds flow statement indicated a mix of sources, and without a one-to-one match, it could not be definitively concluded that borrowed funds were used for interest-free loans and advances. Thus, the Tribunal found the disallowance under Section 36(1)(iii) unsustainable and directed the AO to delete the disallowance.

2. Alternative Disallowance under Section 37(1):

The CIT(A) also upheld the AO's alternative argument for disallowance under Section 37(1) of the Income Tax Act, 1961. This section pertains to general deductions for business expenses that are wholly and exclusively incurred for business purposes. The AO had argued that the interest expenditure was not justified as it was not incurred solely for business purposes, given the non-interest yielding investments.

The assessee maintained that the interest expenditure was revenue in nature and incurred wholly and exclusively for business purposes, thus qualifying for deduction under Section 37(1). The Tribunal, aligning with its findings under Section 36(1)(iii), did not find merit in the alternative disallowance under Section 37(1), as the interest expenditure was indeed for business purposes, and the AO's reasoning lacked substantiation.

Conclusion:

The Tribunal allowed the appeal of the assessee, directing the deletion of the disallowance of interest expenditure under both Section 36(1)(iii) and Section 37(1) of the Income Tax Act, 1961. The decision emphasized the principle that business investments in partnership firms, even if not yielding immediate income, qualify for interest deduction if the borrowings are for business purposes. The order was pronounced in the open court on 21-11-2024.