2014 (1) TMI 1225 - AT - Income Tax

Tribunal rules in favor of assessee, disallowance overturned under Income Tax Act

The Tribunal allowed the appeal in favor of the assessee, setting aside the disallowance of Rs. 92,86,667 under Section 36(1)(iii) of the Income Tax Act, ... Disallowance u/s 36(1)(iii) of the Act – Proportionate interest expenditure – Validity of investments made in sister concern – Held that:- It cannot be said that the assessee used borrowed funds for non-business purposes - The Department contended that instead of making interest free investment in M/s. GSPL, the assessee should have used the same for the purpose of clearing loans and it could have very well saved the interest payment - When the assessee not used borrowed funds for the purpose of investment, the Department cannot say that interest free funds availed by the assessee should have been used for the purpose of clearing the existing loans - It is the prerogative of the assessee to take a business decision in what manner the assessee has to deploy its funds. Relying upon SSPDL Ltd. vs. DCIT [2013 (7) TMI 18 - ITAT HYDERABAD] - unless and until borrowed funds are used as investment in sister concern, disallowance of interest is not possible - The Revenue cannot decide what the assessee has to do and cannot compel the assessee to maximise the profit so as to pay higher income tax - The assessee is engaged in the business of real estate - Same is the position with the sister concern, M/s. GSPL - There are common interests among the companies - the assessee advanced the interest free funds to the sister concern which is received from M/s. PPPL - Being so, the interest bearing funds were not at all diverted by the assessee to make investment in the sister concern – thus, no disallowance could be made on notional basis and it cannot be disallowed even if it has not resulted in any income to the assessee – Decided in favour of Assessee. Issues Involved:1. Disallowance of proportionate interest expenditure under Section 36(1)(iii) of the Income Tax Act, 1961.2. Enhancement of disallowance by the Commissioner of Income Tax (Appeals) [CIT(A)].3. Justification of investment in subsidiary companies as part of business activity.4. Levy of interest under Section 234B of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Disallowance of Proportionate Interest Expenditure:The Assessing Officer (AO) disallowed proportionate interest expenditure of Rs. 55,11,275 under Section 36(1)(iii) of the Income Tax Act, 1961, on the grounds that the borrowed funds were not utilized wholly and exclusively for the purpose of the assessee's business but were diverted to acquire equity shares in sister concerns. The AO concluded that Rs. 11,24,75,000 of the borrowed funds were used for such investments and, therefore, the interest on these funds did not qualify for deduction.2. Enhancement of Disallowance by CIT(A):On appeal, the CIT(A) observed that the assessee unjustifiably diverted interest-bearing borrowed funds for investments in related companies, leading to a net interest outgo of Rs. 92,86,667. The CIT(A) directed the AO to enhance the disallowance by an additional Rs. 37,75,392, making the total disallowance Rs. 92,86,667. The CIT(A) reasoned that the investments did not yield any business benefit and should be capitalized if they were part of the business, which was not established by the assessee.3. Justification of Investment in Subsidiary Companies:The assessee argued that the investments in the shares of sister companies were out of commercial expediency and were part of the business activity as enunciated in the memorandum of association. The assessee cited the Supreme Court decision in S.A. Builders vs. CIT (288 ITR 1), which held that interest on borrowed funds cannot be disallowed if the funds were advanced to a sister concern out of commercial expediency. The assessee provided details of transactions showing that the funds used for investment were received as interest-free loans from another company, M/s. PPPL, and were not from the borrowed funds on which interest was paid.4. Levy of Interest under Section 234B:The assessee denied liability for the levy of interest under Section 234B amounting to Rs. 3,19,397. This issue, however, was not elaborated upon in the judgment.Conclusion:The Tribunal found merit in the assessee's contention that the interest-free funds received from M/s. PPPL were used for investments in M/s. GSPL, and not the interest-bearing borrowed funds. The Tribunal held that the Revenue cannot dictate how the assessee should deploy its funds and cannot compel the assessee to maximize profits for higher tax payments. The Tribunal concluded that no disallowance of interest expenditure was warranted on a notional basis as the borrowed funds were not used for non-business purposes. Consequently, the Tribunal allowed the appeal in favor of the assessee, setting aside the disallowance of Rs. 92,86,667.Order Pronouncement:The appeal of the assessee was allowed, and the order was pronounced in the open Court on 22nd January 2014.