2012 (7) TMI 128 - AT - Income Tax

Tribunal directs recalculation of interest disallowance under section 36(1)(iii)

The Tribunal partly allowed the appeal, directing the Assessing Officer to recalculate the disallowance of interest under section 36(1)(iii) based on the ... Disallowance of interest expenditure under section 36(i)(iii) - AO stated that the assessee has diverted interest bearing funds to the sister concern without interest - Held that:- As regards the contention of the assessee that the interest free loans/advances were not given out of borrowed funds the advances to the sister concerns is not acceptable as the assessee has failed to furnish any evidence to prove as the money was received back in the next F.Y. and the amount was given on account of mutual understanding - the assessee's claim that the advance was given for some deal but he failed to furnish any documentary evidence in support of the contention - nothing has been brought on record that the sale deed for the purpose of which ostensibly the money was advanced has been executed as merely filing a sale agreement of third party and saying they have deposited sale deed against the advance is not acceptable as no other evidence has been filed. Share application money and sundry creditors shall also be available with the assessee as interest free - Held that:- share application money as interest free is not acceptable as the assessee is a private limited company and share application money has been kept as a trustee of that application money - as the Sundry Creditors is pertaining to the business of the assessee, therefore, it cannot be said to be interest free own capital or reserve available with the assessee for giving interest free advance - as decided in CIT vs. Radico Khaitan Limited [2004 (9) TMI 37 (HC)] if the assessee is having sufficient capital and reserve fund, to that extent interest free advance given to the sister concern cannot be disallowed. In case of otherwise position proportionate disallowance is warranted - on perusal of Balance Sheet and P&L Account for the year under consideration, the interest free own fund in the form of capital and reserve after reducing loss available with the assessee is only Rs.21,02,941/- (35,09,000 – 14,06,059) - remit the matter back to the file of the AO to make necessary calculation of amount of disallowance on proportionate basis - partly allowed in favour of assessee. Issues Involved:1. Disallowance of Rs. 6,86,000/- out of interest expenditure under section 36(1)(iii) of the Income Tax Act, 1961.Detailed Analysis:1. Disallowance of Interest Expenditure under Section 36(1)(iii):The main issue in this appeal is the disallowance of Rs. 6,86,000/- out of interest expenditure claimed by the assessee under section 36(1)(iii) of the Income Tax Act, 1961. The Assessing Officer (AO) noted that the assessee had diverted interest-bearing funds to sister concerns without charging interest. Consequently, the AO made a proportionate disallowance of the interest claimed.The AO's calculation of the disallowance was based on the interest rates paid to various parties, such as Bharat Trust (15%), shareholders and directors (8%), and others (12%). The total disallowance was computed at Rs. 6,86,000/-.The Commissioner of Income Tax (Appeals) [CIT(A)] confirmed the AO's order, stating that the assessee failed to provide details showing that the interest-free loans/advances were not given out of borrowed funds. The CIT(A) emphasized that the assessee's own funds and borrowed funds were mixed in a common account, making it difficult to segregate the sources of the interest-free loans. Furthermore, the CIT(A) noted that the advances to sister concerns were not for the assessee's business needs but for the needs of the sister concerns.The CIT(A) analyzed individual cases where advances were given to sister concerns and concluded that no business expediency was established. For instance, in the case of M/s Farah Ice & Cold Storage Pvt. Ltd., the money was advanced for the sister concern's business needs and not for the assessee's business. Similarly, in the case of M/s KP Buildwell Pvt. Ltd., the advance was given on account of mutual understanding without any business consideration. Other cases, such as M/s Singhal Wire & Insulation Pvt. Ltd., Gulab Buildwell Pvt. Ltd., and Shri Rajendra Chand Jain, also lacked evidence of business expediency.The assessee's representative argued that the interest-free advances were made for business purposes and that the assessee had sufficient own funds to cover these advances. The representative cited various judicial decisions to support the contention that interest disallowance is not warranted when sufficient own funds are available. Additionally, it was argued that the AO failed to establish a nexus between the borrowed funds and the interest-free advances.The Tribunal examined the balance sheet and profit & loss account of the assessee. It was noted that the assessee had claimed interest on loans amounting to Rs. 7,27,924/-. The Tribunal found that the assessee failed to substantiate that the advances were given for business purposes. The Tribunal also noted that the assessee did not provide sufficient evidence to support the claim that the advances were covered by own funds.The Tribunal referred to the principles laid down by the jurisdictional High Court in CIT vs. Radico Khaitan Limited and the Bombay High Court in CIT vs. Reliance Utilities & Power Ltd. These judgments establish that if an assessee has sufficient own funds, interest disallowance on advances to sister concerns is not warranted. However, if own funds are insufficient, proportionate disallowance is justified.The Tribunal concluded that the assessee had own interest-free funds amounting to Rs. 21,02,941/-. The Tribunal directed the AO to calculate the disallowance of interest on a proportionate basis, considering the available own funds. The matter was remanded to the AO for this purpose, with instructions to provide the assessee an opportunity of hearing.Judgment:The appeal of the assessee was partly allowed. The Tribunal directed the AO to recalculate the disallowance of interest under section 36(1)(iii) based on the proportionate availability of own interest-free funds. The AO was instructed to provide an opportunity of hearing to the assessee before finalizing the disallowance.