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TMI Blog2006 (7) TMI 515X X X X Extracts X X X X X X X X Extracts X X X X ..... head "Income from other sources" and in thereby disallowing an amount of Rs. 1,23,84,617 in respect of interest. The learned CIT(A) ought to have directed the Assessing Officer to allow the full deduction of Rs. 2,01,64,247 in respect of interest. 3. The learned CIT(A) erred in confirming the disallowance of Rs. 75,00,000 in respect of professional fees. 4. The learned CIT(A) erred in holding that the payment of professional fees of Rs. 75,00,000 had no direct nexus with the business of the appellant. 5. The learned CIT(A) erred in holding that the professional fees of Rs. 75,00,000 were in the nature of capital expenditure. 6. Each one of the above grounds of appeal is without prejudice to the other." 2. It is evident on bare perusal of the aforesaid ground of appeal that two issues arise for adjudication in the present appeal. First issue (ground Nos. 1 and 2) relates to the disallowance of interest amounting to Rs. 1,23,85,617 out of total claim of Rs. 2,01,64,247 made by the assessee while second issue (Ground Nos. 3 to 5) relates to the disallowance of Rs. 75,00,000 in respect of professional fees claimed by the assessee. Disallowance of interest amounting to Rs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Ltd. ("Vibhadeep") as interest-free advance allegedly towards subscription of shares. Proportionate amount of interest relatable to the investments made in purchasing the shares of Gujarat Gas Carbon Ltd. has been allowed by the Assessing Officer under section 57( iii ) following the judgment of the Hon ble Supreme Court in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 . He however disallowed the proportionate amount of interest relatable to the interest-free advance given to Vibhadeep during the previous year relevant to the assessment year under appeal, i.e. , assessment year 1997-98 which is the subject-matter of Ground Nos. 1 and 2 in the present appeal. ( d )It is the case of the assessee that it had given the remaining amount of interest bearing advance (Rs. 19,35,00,000) as interest-free advance to Vibhadeep allegedly towards subscription of shares. The assessee admitted before the Assessing Officer (page 4 of the assessment order) that there was direct nexus between the interest-bearing advance received from MIL and interest-free advance given to Vibhadeep in the words as follow : ". . . we are to state that the advance subscription received from Mafatlal Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,35,00,000 given to Vibhadeep. 4. It is in the aforesaid factual matrix of the case that the Assessing Officer considered the claim of the assessee but did not allow the deduction on account of interest to the extent of Rs. 1,23,85,617 with the following observations : "I have considered the submissions of the assessee and find it not tenable. M/s. Mafatlal Industries Ltd. (MIL), M/s. Vibhadeep Investment and Training Ltd. (Vibhadeep) and President (Finance) of Mafatlal Industries Ltd., Shri Praful R. Amin is President Corporate Affairs of M/s. Mafatlal Industries Ltd., Shri Praful R. Amin is also Director of M/s. Vibhadeep Investment and Trading Ltd. This shows that all these companies are managed by the same group of persons. The assessee has not received loan from M/s. Mafatlal Industries Ltd., but it was just advances for subscription of shares. The company is not supposed to pay any interest on advance subscription of shares. The character of money was same i.e., advance subscription but the assessee diverted the same funds as advance subscription for shares to M/s. Vibhadeep Investment and Trading Ltd., and M/s. Gujarat Gas Carbon Ltd. The assessee has himself admit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee as in the Balance Sheet it is shown under head "Advances". Similarly, the assessee has not allotted shares to MIL, as it is shown under the head "Advance subscription towards shares". The assessee has further stated, without prejudice that if interest is not allowable under section 36(1)( iii ), then it should be allowed under section 57( iii ). This contention would be acceptable if it is held that payment of interest on advance received against subscription of shares should be allowable. It is held that such transactions are not bona fide as on the same nature of transactions, at one hand, the assessee is paying interest and on other hand, the assessee is not receiving interest. The assessee has attempted to reduce the incidence of tax as there was huge dividend income. The dividend income has been earned on such fund, which were share capital and Reserve Surplus. Even if we consider that interest should be allowed, there is no corresponding income, which should justify the allowability. The stand of the assessee that such interest can be set off against Dividend income is also not tenable as there cannot be dividend income during the year in the absence of allotment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e under section 36(1)( iii ) of the Act. It was in the said context, their lordship of Madras High Court in the said case of K. Somasundaram Bros. ( supra ) have observed as under : "Under section 36(1)( iii ) of the Act amounts diverted not being used for the purposes of the business, interest relating to the operation diverted cannot be treated as an item of permissible deduction in the computation of income. The submission of counsel for the assessee is that once the amount borrowed is found to have been used for sometime in the business, the subsequent diversion is of no consequence cannot be accepted. The words used in the statutory provisions are borrowed for the purposes of the business. The amount borrowed must continue to be used for the purposes of the business and the fact that it was used for some point of time, but later diverted would not entitle the assessee to claim the interest paid on the borrowing as a deduction even after such diversion. In cases where diversion occurs immediately after the borrowing and the borrowed amounts are not invested in the business at all, but diverted for other purposes, there can be no doubt that interest paid on such borrowe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee had borrowed funds for making investments and consequently paid interest on such borrowings. It was pointed out that the amount in question was received from MIL as advance subscription towards issue of shares but the assessee could not allot the shares to MIL against the aforesaid advances and consequently treated the said advance as interest-bearing. It was argued that the assessee was an investment company and hence borrowal of money was a normal incident of its business. He submitted that the borrowings were used for the purpose of the business and hence the interest claimed by the assessee on such borrowings ought to be allowed in full. In this connection, he referred to the decisions in CIT v. Bombay Samachar Ltd. [1969] 74 ITR 723 (Bom.) and unreported orders of this Tribunal in Surekha Holdings (P.) Ltd. v. Dy. CIT [IT Appeal No. 1672 (Mum.) of 1999], Mafatlal Holdings Ltd. v. Addl. CIT [IT Appeal No. 2935 (Mum.) of 2002] and Asstt. CIT v. Aftaab Investment Co. Ltd. [IT Appeal Nos. 1656 (Mum.) of 1998, 1560 to 1564/Mum./1994]. 8. In the alternative, he submitted that the claim of the assessee should be allowed under section 57( iii ) of the I.T. Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll Electrics Ltd. v. CIT [2005] 277 ITR 549 . 10. We have heard the parties and considered their submissions including the judicial authorities cited by them. The assessee has made its claim for deduction of interest under section 36(1)( iii ) failing which it submits that its claim should be considered under section 57( iii ). We shall first take up the assessee s claim for deduction under section 36(1)( iii ). The legal position with regard to the allowability of interest on borrowed capital under section 36(1)( iii ) of the Income-tax Act is fairly well-settled. Section 36 occurs in Chapter IV, which deals with the computation of income under the head "Profits and gains of business or profession". The deduction contemplated by the section is in relation to the expenditure, which can properly be regarded as legitimate for the purpose of the business or profession. Expenditure incurred on account of commercial expediency for the purpose of business would be allowable under this provision. The expenditure to be allowed must therefore have a direct and proximate nexus with the business of the assessee and of none else. If the expenditure incurred is ostensibly for the busines ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... est on an amount, which is no longer in the business, but had been diverted from the business. The Hon ble High Court has further observed that this provision cannot, therefore, be construed as enabling an assessee to burden the business with interest when the amount was initially borrowed for the business but subsequently taken out of the business by diverting it as interest-free loans to relatives of the partners. The learned CIT(A) has very aptly relied upon the observations [reproduced by the CIT(A) in his order] made by the Hon ble Madras High Court in the aforesaid case. 12. In Triveni Engg. Works Ltd. v. CIT [1987] 167 ITR 742 (All.), the legal position with regard to allowability of interest under section 36(1)( iii ) has been explained as under : "In other words, borrowing of capital should be genuine and not colourful or illusory transaction. Interest on such loans can be allowed under the aforesaid provision only if it is proved that the loans were utilised in the accounting year for the assessee s own business. If the loan was incurred not for the purpose of the assessee s business but for the benefit of someone else, the interest on such loans cannot legitim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e that the company borrows large amounts for the purpose of its business every year, but that does 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 may not have been necessary to borrow from the banks. We are, therefore, of the opinion that the Income-tax Officer was right in disallowing the difference of interest under section 36(1)( iii ) of the Income-tax Act and that the Tribunal s approach is not only superficial but too naive." In Indian Metals Ferro Alloys Ltd. v. CIT [1992] 193 ITR 344, the Orissa High Court held : ". . . it may be pointed out that, in a hypothetical case, an assessee can earn profits only after the date of investment and advance. It cannot be said that because, in the concerned assessment year, the profit was more than the investment and advance, those came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee." Yet again in CIT v. H.R. Sugar Factory Pvt. Ltd. [1991] 190 ITR 643 (All.), B.P. Jeevan Reddy, C.J. (as his ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity for interest thereon. Having thus taken and retained the interest- bearing funds, the assessee thereafter diverted a substantial part (Rs. 19.35 crores) of the same as interest-free advance to a sister-concern namely, Vibhadeep. There is no material before us to hold that it is the business of the assessee to raise interest-bearing advance and then to divert the same as interest-free advance. There is no material before us to indicate the employment of interest-bearing advances for earning the income from business assessable under section 28. The assessee itself has declared dividend income as income from other sources under section 56 and hence the earning of dividend cannot be said to be income from business under section 28. Since the dividend income is admittedly not a part of the business income of the assessee under section 28, any interest liability incurred on borrowals made for purchasing the shares and earning dividend thereon cannot be considered for deduction under section 36(1)( iii ). It can at the most be considered for deduction under section 57( iii ) provided the statutory conditions prescribed therein are satisfied. That apart, the assessee has given interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... advance without there being any business necessity. Having perused the order of the learned CIT(A) in the light of the rival submissions made by the parties, we are of the considered view that the learned CIT(A) has correctly appreciated all the relevant factual and legal aspects of the case in his well-reasoned order which we do not propose to repeat here for the sake of brevity. We are in complete agreement with his reasoning and decision in this behalf. His order is duly covered by well-established legal propositions governing the allowability of interest under section 36(1)( iii ). We see no valid reason to take a view different from the one taken by the CIT(A) in this behalf and hence we endorse and confirm the same. 16. We shall now consider the alternative claim of the assessee that it should be allowed deduction for interest under section 57( iii ) of the Act. Section 57 occurs in Chapter IV-F. - Income from other sources. Clause ( iii ) of section 57 provides for deduction of any "expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income." In Seth R Dalmia v. CIT [1977] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at ( i ) it has incurred the impugned expenditure solely and exclusively for the purpose of earning income or making profit and ( ii ) a clear nexus between the expenditure incurred and the income sought to be earned. At the outset, it needs to be clarified that there is a marked difference between advance towards subscription money and subscription money itself. Shares cannot be subscribed unless they are issued. It is the claim of the assessee that Vibhadeep had issued only 11,50,000 preference shares in February 1997 which were allotted in February and March, 1997 for a total sum of Rs. 1,15,00,000. Interest-free advance will continue to retain its character till it is converted into subscription money or till it is actually invested for purchasing the shares. Likewise, interest-free advance, which is not converted into subscription money or is not utilized for purchasing the shares, will continue to remain interest-free advance. The amount given to Vibhadeep was initially in the nature of interest-free advance. It is an admitted position that the amount was given interest-free and hence the obvious purpose was that no interest would be charged and accordingly no interest was ch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch of the two assessees paid interest on the monies borrowed but did not receive any dividend on the shares purchased with those monies." Thus, crucial fact in that case was that the assessees had made investments and purchased the shares out of borrowed money but the shares so purchased did not fetch any dividend. To put it alternatively the assessee had planted and nurtured a tree but the tree did not bear the fruit. It is in this context that the Hon ble Supreme Court has observed : "The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of income." It is again in the circumstances of that case that the Hon ble Supreme Court has cited with approval the observation of Lord Thankerton in Hughes v. Bank of England that "it does not require the presence of a receipt on the credit side to justify the deduction of an expense." What the judgment lays down is that an assessee would be entitled to deduction under section 57( iii ) in respect of the interest on interest bearing funds to the extent it is actually utilized for purchasing the shares notwithstanding that the shares so purchased have not yielded any dividend. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bearing advance to Vibhadeep on which assessee will not be entitled to any deduction either under section 57( iii ) or section 36(1)( iii ). The matter is therefore restored to the file of ld. CIT(A) with the aforesaid directions for adjudicating upon the alternative claim of the assessee for deduction of interest under section 57(1)( iii ) after verification of facts. 20. In view of the foregoing, while the claim of the assessee for deduction under section 36(1)( iii ) is rejected, its claim for deduction under section 57( iii ) is restored to the file of the learned CIT(A) for consideration and adjudication in accordance with law keeping in view the directions given earlier in this order. Consequently, Ground No. 1 is dismissed while Ground No. 2 is treated as allowed for statistical purposes. Disallowance of professional fee amounting to Rs. 75,00,000 21. Facts of the case, in brief, are that the assessee had claimed deduction for a sum of Rs. 75,14,500 on account of legal expenses. The Assessing Officer examined the details of legal expenses and observed that a sum of Rs. 75,00,000 was paid to Mafatlal Industries Ltd., a sister concern, in connection with the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... afatlal Group (AMG)] appointed McKinsey Co. Inc. to advise on the corporate strategy and restructuring plan for MIL and its group companies. According to him, McKinsey Co. carried out the exercise of reviewing the business of the group and made several recommendations in pursuance of which the assessee-company also disposed of certain investments in shares and bonds amounting to Rs. 68,54,78,317. It was claimed that the disposal of shares and bonds was effected by the assessee pursuant to the restructuring plans of the group concerns recommended by the McKinsey Co. and hence it could not be said that the impugned expenditure was incurred for the purposes other than the purposes of business of the assessee. 25. In reply the learned DR supported the orders of the Departmental Authorities. 26. We have considered the rival submissions including the judicial authorities cited by them. Section 37 of the Income-tax Act allows deduction for any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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