2016 (2) TMI 632 - HC - Income Tax

High Court upholds disallowance of interest component claimed by assessee under Income Tax Act

The High Court upheld the Assessing Officer's disallowance of the interest component claimed by the assessee under Section 36(1)(iii) of the Income Tax ... Addition on interest paid on loans - loan advanced to the several companies at lower rate of interest - Held that:- We do not find that the Assessing Officer applied the principles analogous to Section 40A(2) of the Act by holding that the interest paid by the assessee was excessive. In fact the Assessing Officer applied the deduction to the extent the rate of interest at which the advances were made by the assessee. However, the action of the assessee company to make advances at a lower rate of interest than the interest liability discharged by the assessee company in borrowing such funds was not shown to be in any manner actuated by business expediency. The Assessing Officer was perfectly justified in disallowing such component of interest. - Decided in favour of revenue Issues Involved:1. Disallowance of interest claimed by the assessee under Section 36(1)(iii) of the Income Tax Act, 1961.2. Application of the principle of 'for the purpose of business' versus 'for the purpose of earning income.'3. Assessment of business expediency in borrowing and lending transactions.4. Application of Section 40A(2) of the Income Tax Act.Detailed Analysis:1. Disallowance of Interest Claimed by the Assessee:The primary issue in this case was the disallowance of interest claimed by the assessee company under Section 36(1)(iii) of the Income Tax Act, 1961. The assessee had borrowed substantial amounts from various group companies at a higher interest rate and subsequently advanced a significant portion of these funds to other companies at a lower interest rate. The Assessing Officer (AO) disallowed the differential portion of the interest, amounting to Rs. 91.41 lakhs, on the grounds that the borrowed funds were not utilized for the purpose of the assessee's business but were instead advanced to other companies at a lower interest rate.2. Principle of 'For the Purpose of Business' vs. 'For the Purpose of Earning Income':The Tribunal observed that the expression 'for the purpose of the business' used in Section 36(1)(iii) of the Act is broader in scope than 'for the purpose of earning income.' The Tribunal opined that only if the capital borrowed is used for a purpose other than that of the business, the assessee's claim for interest could be disallowed. However, the Tribunal's application of this principle was deemed abstract by the High Court, which emphasized that business expediency must be demonstrated.3. Assessment of Business Expediency:The AO and the CIT (Appeals) concluded that the assessee company acted merely as a conduit and failed to demonstrate any business expediency for advancing loans at a lower interest rate than the rate at which it borrowed funds. The Tribunal reversed this decision, stating that the AO had allowed part of the interest claimed by the assessee and could not disallow a portion of it based on the rate of interest. However, the High Court held that the assessee failed to provide any evidence or justification for the business expediency of such transactions.4. Application of Section 40A(2):The Tribunal held that the AO had applied principles analogous to Section 40A(2) of the Act, which deals with disallowing excessive or unreasonable expenditure. The Tribunal argued that the AO could either allow or disallow the entire interest component but could not disallow a portion of it. The High Court disagreed, stating that the AO did not apply Section 40A(2) but rather disallowed the interest component due to the lack of business expediency in lending at a lower interest rate than the borrowing rate.Conclusion:The High Court concluded that the Tribunal committed errors in reversing the decisions of the revenue authorities. The Tribunal applied the principle of 'for the purpose of business' in abstract and failed to consider the necessity of demonstrating business expediency. Additionally, the Tribunal's interpretation of the AO's application of Section 40A(2) was incorrect. The High Court upheld the AO's disallowance of the interest component, answering the question in favor of the revenue and allowing the appeal. The judgment of the Tribunal on this issue was reversed, and the appeal was disposed of accordingly.