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TMI Blog2002 (6) TMI 175X X X X Extracts X X X X X X X X Extracts X X X X ..... charged any interest on the debit balance, whereas it was paying interest on the credit balance of the loans and advances taken by it. The Assessing Officer required the assessee to explain as to why no interest was being charged on the debit balances. Vide reply dated 29-3-1994, it was stated on behalf of the assessee that the interest has not been accounted for on accrual basis for the reasons that the advances made were not interest bearing. It was also submitted that the principal amount of Rs. 8,78,012 was itself doubtful of its recovery and was, therefore, likely to be written off and, thus, no purpose would be served if the interest is charged on it and, thereafter it is written off. 5. The Assessing Officer did not accept this plea of the assessee and observed that if one has paid interest on the borrowed money, he is supposed to charge the interest. The Assessing Officer after making reference to the decision of Karnataka High Court in the case of CIT v. Salgaoncar Bros (P.) Ltd. [1992] 198 ITR 738 and to the decision in the case of CIT v. C. Kulandaivelu Konar [1975] 100 ITR 629 (Mad.) and the decision in the case of Addl. CIT v. A.K. Laxmi [1975] 113 ITR 368 (Mad.) d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 3,61,496. Referring to para 6 of the paper book, it was submitted by him that total amount of other loan taken by the assessee was at Rs. 6,44,154-38, on which no interest was paid. 9. On the basis of balance sheet as on 31st March, 1991, it was shown by him that the entire loan related to, earlier years. This was illustrated by him by pointing out that in assessment year 1989-90, the secured loan was at Rs. 18,23,795-99 and unsecured loan was at Rs. 5,83,414-31, total Rs. 37,46,910-30 whereas in assessment year 1990-91 the secured loans were at Rs. 14,85,464-24 and unsecured loans at Rs. 7,45,126-90, the total Rs. 35,70,29-14. He also pointed out that there was similar decrease in the current liability as compared to earlier year, which was reduced from Rs. 17,26,796-51 in assessment year 1989-90 to Rs. 9,31,277-45 in assessment year 1990-91. In view of these figures, the ld. Counsel submitted that no loans were advanced during this year, rather the liability on account of loans was reduced by paying of some bad debts and further pleaded that the assessee had, on the other hand, taken interest free advances/loans from others. According to the ld. Counsel, therefore, the ld. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he purpose of business and interest has not been paid on the same. 15. The ld. CIT(A) has rejected this plea by saying that no prudent men would borrow interest bearing funds for one division, while it advanced interest free loans on advances to other. According to him, there was no commercial expediency involved such an Act either. The ld.CIT(A), however, has not recorded any finding on the following issues: (i) Whether any part of borrowed funds was diverted for non-business purposes by making advances to some persons without charging interest. (ii) Whether the assessee had borrowed funds for business purposes and whether any part of such borrowed funds was diverted or utilized for non-business purposes or for making interest free advances. (iii) Whether the assessee had non-interest bearing funds available with it and whether such non-interest bearing funds were more than the advances made free of interest or not. Since the averments of the assessee on the above-mentioned issues were very specific and further since these averments have not been found to be incorrect, it can safely be inferred that the assessee was in possession of deposits/credits or funds, which were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly, it must have been borrowed for the purposes of the business, profession or vocation of the assessee; and, thirdly, the assessee should have paid this amount as an allowance under that clause. This clause makes no distinction between the capital borrowed in order to acquire a revenue asset and the amount borrowed to acquire a capital asset, and it does not provide that for the purposes of business the borrowing of capital should have been necessary, so that if at the time of borrowing the assessee had sufficient money of his own to invest in the business then the deduction cannot be allowed. Again, the interest paid is also not subject to the test of reasonableness. When the Income-tax Officer finds that the borrowing transaction was not illusory or colourable and that the capital was borrowed by the assessee for the purposes of the business and the amount of interest was paid, then the claim made by the assessee for deduction on account of the interest paid on borrowed capital has to be allowed. 20. The above-mentioned three decisions were considered by Hon'ble Bombay High Court in the case of CIT v. Bombay Samachar [1969] 74 ITR 723. In that case, the assessee-company which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Cama Norton Co., in the calendar year 1954, did not constitute any loan advanced by the assessee to Messrs Cama Norton and Co., but constituted the outstandings in connection with certain business transactions. The capital borrowed by the assessee from outsides on the other hand was admittedly used by the assessee for the purpose of its business and it was also undisputed that no part of the borrowed capital had been utilized for the purpose of advancing loans either to Messrs. Bombay Chronicle Pvt. Ltd. or to Messrs. Cama Norton Co. In these circumstances, it is difficult to see how the assessee's claim for the interest actually paid by it could be disallowed." 21. The issue relating to necessary conditions for allowing the claim of deduction under section 10(2)(iii) and 10(2)(xv) of Income-tax Act also came for consideration before the Hon'ble Supreme Court of India in the case of Madhav Prasad Jatia v. CIT [1979] 118 ITR 200. In that the case, the assessee had donated a sum of Rs. 10,00,000 to an Engineering College and she paid a sum of Rs. 5,00,000 after borrowing the same from Bank. The remaining amount of Rs. 4.5 lakhs was shown as loan of the institution. The Hon'bl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he overseas business and, thus, Income-tax Authorities were not justified in disallowing any part of Bank interest paid by the assessee in India on its bank overdrafts. It was held by the Hon'ble Calcutta High Court that the inference of the Tribunal that remittances to the U.K. came out of profits earned in India and the Bank overdrafts in India, had in fact, been utilized in carrying on assessee's business was sustainable in law and on such inference of findings of fact, the Tribunal was right in holding that the Income-tax Authorities was not justified in disallowing any part of Bank's interest on the overdrafts. 23. The Hon'ble Allahabad High Court also considered the issue relating to interest on advances and foregoing of interest in the case of Triveni Engg. Works Ltd. v. CIT [1987] 167 ITR 742. In that case, the assessee had claimed deduction on account of interest on the amounts borrowed from the bank and also on the interest of arrears of Cane Purchase Tax and Interest on advances foregone by the assessee. The I.T.A.T. in that case held that the interest on advances foregone by the assessee was not deductible and a part of the interest on borrowed capital was also disall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t years. The company might have borrowed large amounts for the purpose of its business every year, but that did not explain the huge advances to the directors/shareholders. Had this money been not advanced to the directors, it would have been available to the assessee for its business purposes and to that extent it might no have been necessary to borrow from the bank. Therefore, the Income tax Officer was right in disallowing the difference between interest paid to the banks and interest recovered from the directors under section 36(1)(iii) of the Income-tax Act, 1961." 25. It may be pointed out that in the case H.R. Sugar Factory (P.) Ltd there was a direct nexus between the borrowed funds and the funds advanced at a very low rate to its directors. After examining the scheme and device adopted by the assessee and also the volume of advances made by it and rate of interest charged from directors, it was found that the amount of interest paid each year payable on account of the loans to Directors, was substantial and by the compromise decree, the limit of amounts to be lent to the Directors was further raised and at the same time the rate of interest was also drastically reduced. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case of Saraya Sugar Mills (P.) Ltd. on the facts of the case, it was found that there was a company, which had taken overdraft from the Bank, part of which was diverted to the Directors and other firms, in which the Directors of the company were substantially interested. On such advances, no interest was charged from the Directors. The Assessing Authority held that the amount was advanced to the Directors and the firms by the assessee-company from the overdraft for non-business purposes and, therefore, the interest paid by the company to the Bank was disallowed to that extent. Following its earlier decision, in the case of Saraya Sugar Mills (P.) Ltd. the issue was decided in favour of the Revenue and against the assessee by the Hon'ble High Court. It may be pointed out that as in the case of H.R. Sugar Factory (P.) Ltd. in the two cases of Saraya Sugar Mills (P.) Ltd. referred to above a direct nexus was found to have been established between the borrowed funds and the advances made free of interest by the assessee and there was a categoric and clear finding by the Income-tax Authorities that a part of the borrowed money was diverted towards interest free advances or for non ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ather than latter to have been utilized for the non-business or personal expenses." 31. The issue also came before the Hon'ble Delhi High Court in the case of Regal Theatre v. CIT [1997] 225 ITR 205. In that case, the assessee-firm, which was carrying on cinema theatre business and was also running a Restaurant, claimed deduction under section 36(1)(iii) of the Income-tax Act, 1961, of a sum of Rs. 26,108 being interest paid on capital borrowed for the purpose of business. The Income-tax Act disallowed deduction to the extent of Rs. 23,166 on the ground that partners' account showed debit balances and no interest was charged on these debit balances. The explanation of the assessee-firm was that originally a loan was taken in order to purchase machinery etc. and that there were debit balances, because of depreciation allowed in earlier years on the fixed assets and that according to the terms of agreement, amongst partners, no interest was to be charged on these debit balances. The contention of the assessee was rejected by the ITO, who held that the assessee should have returned loans to the creditors instead of permitting the partners to draw excess money in their account and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The ld. CIT(A) upheld the disallowance. On further appeal, the Tribunal held that the interest paid cannot be subject-matter of the test of reasonableness and hence the ITO was in error to determine as to what rate of interest should have been charged. The Tribunal also held that the borrowing transactions were not unreal and that the capital was borrowed by the assessee for the purpose of business and the amount of interest was paid as claimed and, therefore, there was no scope for determining the rate of interest, which would be reasonable. The Hon'ble Delhi High Court upheld the view taken by the Tribunal and declined to answer the question referred to it. 33. In the case of Dalmia Cement (B) Ltd., the assessee had borrowed moneys from financial institutions and paid interest of Rs. 14,59,816 thereon. The Assessing Officer made a reduction in the allowance of interest on the basis that the deposits had been collected by the sole selling agent towards disputed sales-tax and the deposits had been allowed by the assessee to be retained by the sole selling agent. The CIT allowed the claim for deduction of interest in full on the admitted position that the sole selling agent was ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... borrowed funds have been diverted partly for non-business purposes, therefore, the Assessing Officer was justified in making disallowance. It has been further found by CIT(A) that in view of the fact that the assessee was also having interest free loans, the disallowance made by the Assessing Officer cannot be sustained in totality. Therefore, it was concluded by ld. CIT(A) that interest has to be disallowed only in respect of amount representing the difference between the interest free advances made by assessee and interest free funds available to the assessee and accordingly amount was calculated and the disallowance was restricted to Rs. 1,38,492. We uphold the above view of CIT(A) with an exception about the interest free loans available with the assessee is to be considered, with this modification, the finding of ld. CIT(A) is confirmed. The entire interest-face funds include owner's own capital, accumulated profits and other interest free creditors and loans, if total interest free advances including debit balances of partners do not exceed the total interest free funds available with the assessee, no interest is disallowable on account of utilization of fund for non busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the borrowed amount and must have claimed it as a deduction. (ii) If the assessee makes a claim of deduction in terms of section 36 of the Act for the purpose of computation of income, referred to in section 28 of the Act, he has to place material in support of his claim of entitlement to the deduction. It, therefore, follows that the assessee has a legal obligation to satisfy the assessing authority that he is entitled to obtain deduction in accordance with the taxing statute. In other words, the burden to establish that the borrowed fund was utilized exclusively for the business purpose is on the assessee. This proposition is supported by the decision on Hon'ble Orissa High Court in the case of Indian Metals and Ferro Alloys Ltd. v. CIT [1992] 193 ITR 344. (iii) The ITO concerned has to examine the issue relating to the utilization of the borrowed funds by taking into account the time of borrowing, the purpose of borrowing and purpose for which borrowed funds were utilized. (iv) If it is found that the entire borrowed funds were utilized for business purposes alone and no part of such fund was diverted for non-business purpose, the deduction claimed by the assessee should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion and the inquiry is to be limited only to the increase in the year in question. This approach will also be in consonance with the rule of consistency and definiteness, because the Revenue cannot be allowed to re examine the nature of accounts maintained by the assessee and concluded assessments should not be ignored without actually reopening the assessment. (x) The test to be applied for considering part of borrowed advances used for interest free advances is as to whether or any part of the advances made free of interest, is out of borrowed funds and if it is so, then the disallowance can be made only in relation to the advance made out of or from the borrowed funds. (xi) The entire interest free funds include owner's own capital, accumulated profits and other interest free credits and loans. If total interest free advances including debit balances of partners do not exceed the total interest free funds available with the assessee, no interest is disallowable on account of utilization of funds for non-business purposes and if it exceeds, the proportionate disallowance cart be made. This view is supported by the decision of Hon'ble Calcutta High Court in the case of the Ti ..... X X X X Extracts X X X X X X X X Extracts X X X X
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