Deduction allowed for interest on mutual fund investments from own funds; prior-period mercantile expense upheld for consistent treatment

Bombay HC held against the Revenue on two points: first, deduction for interest paid was allowable because the assessee's investments in mutual funds were made from own (interest-free) funds, borrowed funds having been used to repay a higher-rate loan, and there is no legal requirement to maintain separate accounts to prove source of funds. Second, a prior-period expenditure claimed under the mercantile system was allowable where the liability crystallized only on receipt of the bill and had been consistently treated in earlier assessments; the Revenue must adopt a consistent approach.

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Issues:
1. Disallowance of interest under Section 36(1)(iii) of the Income Tax Act
2. Disallowance of prior period expenses

Issue 1: Disallowance of interest under Section 36(1)(iii) of the Income Tax Act:

The Revenue contested the disallowance of Rs.76.76 lacs made by the Assessing Officer under Section 36(1)(iii) of the Income Tax Act. The Assessing Officer disallowed the expenditure as interest on borrowed funds used for investment in mutual funds. However, the CIT (Appeals) and the Tribunal found that the investment in mutual funds was made from the respondent's own funds and not from borrowed funds. The Tribunal relied on the decision in CIT vs. Reliance Utility and Powers Limited to support the presumption that investments were made from interest-free funds when available. The Revenue argued that since the respondent did not maintain separate accounts for borrowed and own funds, the disallowance was justified. The Court upheld the findings of fact by the lower authorities, stating that the investment was indeed made from the respondent's own funds, and no borrowed funds were used. Therefore, the appeal was dismissed based on established facts and legal precedent.

Issue 2: Disallowance of prior period expenses:

The Revenue challenged the disallowance of Rs.92.81 lacs claimed by the respondent as prior period expenses for the assessment year 2004-05. The Assessing Officer disallowed the expenses, stating that under the mercantile system of accounting, expenses from an earlier year cannot be deducted in the current assessment year. However, the CIT (Appeals) and the Tribunal found that the respondent consistently accounted for expenses when bills were received, even if the work was done in a previous year. They noted that the Revenue had accepted this method in previous assessments. The Tribunal upheld the consistent practice followed by the respondent, allowing the prior period expenses claimed during the assessment year when bills were received. The Revenue argued that expenses should be accounted for when the work was done, not when bills were received. The Court upheld the findings, stating that the liability crystallized when bills were received in the current assessment year, and the consistent approach should be maintained. As it was a factual finding supported by past practices and not shown to be incorrect, the appeal was dismissed without costs.

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