Section 40A(3) and interest disallowance fail where land deal was uncompleted and non-interest-bearing funds were sufficient.

Cash payment for a proposed land purchase was not disallowed under section 40A(3) because the record showed a cancellation agreement, the transaction was not proved to have been completed, and the revenue produced no material to rebut the assessee's explanation. Interest was also not disallowed for alleged diversion of borrowed funds, as the assessee's non-interest-bearing funds were sufficient to cover the advances and the revenue failed to establish a direct nexus with interest-bearing borrowings. On these facts, both additions were deleted in favour of the assessee.

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Issues: (i) Whether the cash payment of Rs. 1 crore towards purchase of land attracted disallowance under section 40A(3) of the Income-tax Act, 1961. (ii) Whether the disallowance of interest on the footing that interest-bearing funds were diverted for non-business advances was sustainable.

Issue (i): Whether the cash payment of Rs. 1 crore towards purchase of land attracted disallowance under section 40A(3) of the Income-tax Act, 1961.

Analysis: The payment was supported by a cancellation agreement and the assessee asserted that the transaction did not materialise. The revenue did not bring any material to show that the apparent position was not real, nor was the original agreement proved or the other party examined to rebut the assessee's explanation. On the facts, the record did not establish that the sum represented an expenditure for a completed purchase so as to attract section 40A(3).

Conclusion: The disallowance under section 40A(3) was not sustainable and was deleted in favour of the assessee.

Issue (ii): Whether the disallowance of interest on the footing that interest-bearing funds were diverted for non-business advances was sustainable.

Analysis: The assessee's capital and other non-interest-bearing funds were sufficient to cover the advances and investments in question. No nexus was brought on record by the revenue to show that borrowed interest-bearing funds had actually been used for the impugned advances. In a mixed-funds situation, the available non-interest-bearing funds were treated as having been used first for the non-interest-bearing advances.

Conclusion: The interest disallowance was not justified and was deleted in favour of the assessee.

Final Conclusion: The appeal succeeded, with both substantive additions set aside and the consequential interest grounds left to follow the final outcome.

Ratio Decidendi: A cash payment cannot be disallowed under section 40A(3) unless it is shown to be an expenditure on a completed transaction, and interest cannot be disallowed for alleged diversion of borrowed funds where the assessee has sufficient non-interest-bearing funds and the revenue fails to prove a direct nexus with the borrowings.

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