Average cost of debt governs interest disallowance in mixed-funds cases; duplicated adjustments are barred in section 80IC recomputation.
In a mixed-funds situation, interest disallowance for funds diverted to an exempt unit was required to be recomputed by reference to the assessee's average cost of debt, not the borrowing rate alone. Notional interest on capital work in progress also had to follow the average-cost basis, but no separate disallowance was warranted for fixed assets created and put to use within the year. Web/software development expenditure was treated as part of a depreciable computer software asset and depreciation was allowed accordingly. For section 80IC recomputation, common expenses had to be rationally allocated across units, while any further adjustment could not result in double disallowance of the same expenditure.
Issues: (i) Whether disallowance of interest attributable to funds diverted from the head office to the exempt unit had to be computed at the average cost of debt in a mixed-funds situation; (ii) whether notional interest relatable to capital work in progress and fixed asset additions could be disallowed on the facts of the case; (iii) whether web/software development expenditure was required to be capitalised and depreciated; (iv) whether common expenses were to be allocated among the units while recomputing deduction under section 80IC, and whether such recomputation could result in double disallowance.
Issue (i): Whether disallowance of interest attributable to funds diverted from the head office to the exempt unit had to be computed at the average cost of debt in a mixed-funds situation.
Analysis: The assessee had both borrowed funds and interest-free funds. The authorities had applied the borrowing rate on the diverted funds, but the record showed that the case involved mixed funds and the disallowance was only required to the extent of interest-free advances made out of such mixed funds. The reasoning adopted recognised that the cited authority on mixed funds did not lay down the rate to be applied, and that the appropriate basis in such a situation was the assessee's average cost of debt.
Conclusion: The issue was decided in favour of the assessee and the disallowance was to be recomputed by applying the average cost of debt.
Issue (ii): Whether notional interest relatable to capital work in progress and fixed asset additions could be disallowed on the facts of the case.
Analysis: For capital work in progress, the interest component was held to be relevant, but again the computation had to proceed on the basis of average cost of debt. For fixed assets that were created and put to use within the year itself, no separate capitalisation of interest for the period of creation to use was warranted on these facts.
Conclusion: The issue was partly in favour of the assessee. Interest relatable to fixed asset additions was not disallowed, while the capital work in progress aspect remained subject to recomputation on the average-cost basis.
Issue (iii): Whether web/software development expenditure was required to be capitalised and depreciated.
Analysis: The expenditure on web/software development was treated as part of the cost of a depreciable asset, since computer software was brought within the relevant asset classification for depreciation purposes. On that basis, the allowance of depreciation at the prescribed rate was accepted and the net capitalisation addition was upheld.
Conclusion: The issue was decided against the assessee.
Issue (iv): Whether common expenses were to be allocated among the units while recomputing deduction under section 80IC, and whether such recomputation could result in double disallowance.
Analysis: The expenses had to be allocated among all the units on a rational basis after considering the turnover and expenses of each unit, including the trading unit. At the same time, the recomputation of taxable income and deduction under section 80IC could not produce a second disallowance on the same items already adjusted elsewhere.
Conclusion: The issue was partly in favour of the assessee. Reallocation was directed, but double disallowance was barred.
Final Conclusion: The appeal succeeded only to a limited extent, with recomputation directed on certain issues and one major addition upheld, resulting in partial relief to the assessee.
Ratio Decidendi: In a mixed-funds case, interest disallowance for diverted interest-free advances should be computed by reference to the assessee's average cost of debt, and recomputation of unit-wise deductions must avoid duplicative disallowance of the same expenditure.
TaxTMI 
AI Drafter ✕
TaxTMI 
