Interest on diverted borrowed funds is not deductible, and disallowance may be computed proportionately at the borrowing rate

Interest on borrowed funds diverted to interest-free advances for directors' non-business use is not deductible to that extent. The disallowance is to be computed proportionately by applying the same rate of interest that the assessee paid on the borrowings. On that basis, the Tribunal's approach to disallow interest at the borrowing rate was upheld, and the assessee's claim failed.

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Issues: Whether interest relatable to borrowed funds diverted as interest-free advances to directors was allowable as a deduction while computing business income, and whether such disallowance had to be made at the same rate at which the assessee had borrowed the funds.

Analysis: The diversion of borrowed funds to the extent of the interest-free advances was an admitted finding of fact. Interest attributable to such non-business use was therefore not deductible. The disallowance was to be worked out on a proportionate basis by applying the same rate of interest as was payable on the borrowed loans.

Conclusion: The Tribunal was justified in directing disallowance of interest at the same rate at which the assessee had paid interest on its borrowings. The question was answered in the affirmative, against the assessee and in favour of the Revenue.

Final Conclusion: The reference was answered in support of proportional disallowance of interest on diverted borrowed funds used for interest-free advances, and the assessee did not succeed.

Ratio Decidendi: Interest on borrowed funds diverted for non-business, interest-free advances is not deductible to that extent, and the disallowance may be computed proportionately at the borrowing rate.

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