2009 (1) TMI 4 - HC - Income Tax

Interest deduction allowed on borrowed funds when sufficient interest-free funds available for investments

The Bombay HC upheld the CIT(A) and ITAT's decision allowing interest deduction on borrowed funds. Revenue argued that shareholder funds were used for ... Sufficiency of Interest-Free Funds for Investments and Disallowance of Interest on Borrowed Funds - Revenue contend that the shareholders funds were utilised for the purpose of fixed assets (investments) - C.I.T. (A) & ITAT have given a clear finding that the assessee had interest free funds of its own - HELD THAT:- If there be interest free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest free funds available. In our opinion the Supreme Court in East India Pharmaceutical Works Ltd.[1997 (3) TMI 5 - SUPREME COURT] had the occasion to consider the decision of the Calcutta High Court in Wool combers of India Ltd.[1981 (2) TMI 36 - CALCUTTA HIGH COURT], where a similar issue had arisen. Before the Supreme Court it was argued that it should have been presumed that in essence and true character the taxes were paid out of the profits of the relevant year and not out of the overdraft account for the running of the business and in these circumstances the appellant was entitled to claim the deductions. The Supreme Court noted that the argument had considerable force, but considering the fact that the contention had not been advanced earlier it did not require to be answered. It then noted that in Woolcomber's case (Supra) the Calcutta High Court had come to the conclusion that the profits were sufficient to meet the advance tax liability and the profits were deposited in the over draft account of the assessee and in such a case it should be presumed that the taxes were paid out of the profits of the year and not out of the overdraft account for the running of the business. It noted that to raise the presumption, there was sufficient material and the assessee had urged the contention before the High Court. The principle therefore would be that if there are funds available both interest free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest free fund generated or available with the company, if the interest free funds were sufficient to meet the investments. In this case this presumption is established considering the finding of fact both by the C.I.T. (Appeals) and I.T.A.T. Thus, in our opinion, there is no merit in this appeal which is accordingly dismissed. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Court were:(A) Whether the Tribunal was justified in holding that the Assessee Company had sufficient interest-free funds of its own to make investments in sister concerns without resorting to interest-bearing borrowed funds, despite the Balance Sheet as at 31.03.1999 showing no reserves or own funds for such investments, thereby rendering the Assessing Officer's disallowance of interest on borrowed funds improper.(B) Whether the advances made to sister concerns were for business purposes, given that the Assessee Company was not in the business of investments and there was no record suggesting that such advances were business-related. (This issue was not pressed and hence not admitted for appeal.)2. ISSUE-WISE DETAILED ANALYSISIssue (A): Sufficiency of Interest-Free Funds for Investments and Disallowance of Interest on Borrowed FundsRelevant Legal Framework and Precedents: The dispute centers on the applicability of Section 36(1)(iii) of the Income Tax Act, which allows deduction of interest on borrowed capital if the borrowed funds are used for business purposes. The question is whether the interest on borrowed funds can be disallowed if the investments were made from interest-free funds available with the company. The Court relied on precedents including the Calcutta High Court decision in Woolcombers of India Ltd. vs. Commissioner of Income-tax and the Supreme Court approval of that view in East India Pharmaceutical Works Ltd. vs. Commissioner of Income-Tax.Court's Interpretation and Reasoning: The Court emphasized that the relevant balance sheet for assessing the availability of interest-free funds is that as on 31st March, 2000, not 31st March, 1999 as argued by the Revenue. The Court rejected the Revenue's contention that shareholder funds as per the 1999 balance sheet were fully utilized for fixed assets, noting that neither the balance sheet nor the profit and loss account explicitly show such utilization. The Court held that the mere presence of fixed assets in the balance sheet does not conclusively prove that shareholder funds were tied up and unavailable for investments.The Court noted that both the CIT (Appeals) and the Tribunal had recorded clear findings that the Assessee had sufficient interest-free funds generated during the financial year starting 1st April, 1999. The balance sheet as on 31st March, 2000 showed total interest-free funds amounting to Rs. 398.19 crores, comprising share capital, reserves & surplus, and depreciation reserves, which exceeded the amount invested in sister concerns.Key Evidence and Findings: The Assessee's balance sheet as at 31st March, 2000 demonstrated substantial interest-free funds. The Assessee's operational income and cash flows further supported the availability of such funds. The Assessing Officer's finding that Rs. 213 crores were invested from own funds and Rs. 147 crores from borrowed funds was challenged on the basis that the borrowed funds were not used for investments but for capital expenditure and inter-corporate deposits.Application of Law to Facts: The Court applied the principle that where both interest-free funds and borrowed funds are available, and the interest-free funds are sufficient to cover investments, a presumption arises that investments were made out of interest-free funds. This principle was drawn from the Supreme Court's endorsement of the Calcutta High Court's reasoning in the Woolcombers case. The Court found that this presumption was established by the facts and findings recorded by the CIT (Appeals) and the Tribunal.Treatment of Competing Arguments: The Revenue's argument rested on an assumption that shareholder funds were already utilized for fixed assets as per the 1999 balance sheet, which the Court found unsubstantiated and irrelevant since the 2000 balance sheet was the pertinent document. The Assessee's argument that it had discretion to apply available funds, and that investments were made from interest-free funds, was accepted based on the evidence and legal precedent.Conclusions: The Court concluded that the Tribunal and CIT (Appeals) rightly held that the Assessee had sufficient interest-free funds to make the investments without resorting to borrowed funds. Consequently, the disallowance of interest on borrowed funds was unwarranted.Issue (B): Whether Advances to Sister Concerns Were for Business PurposesThis question was raised by Revenue but was not pressed at the hearing in view of the Supreme Court judgment in S.A. Builders Ltd. vs. Commissioner of Income-tax. Accordingly, the Court did not admit the appeal on this issue and did not analyze it further.3. SIGNIFICANT HOLDINGSThe Court held:'If there be interest free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest free funds available.''The finding of fact recorded by C.I.T. (Appeals) and I.T.A.T. as to availability of interest free funds really cannot be faulted.''The argument that shareholders funds were utilized for fixed assets as per the balance sheet as on 31st March, 1999 is fallacious and irrelevant since the relevant balance sheet is that as on 31st March, 2000.'Core principles established include:The relevant financial statement for assessing availability of funds is the balance sheet nearest to the date of investment, not an earlier one.Where both interest-free funds and borrowed funds exist, and interest-free funds are sufficient, a presumption arises that investments are made from interest-free funds.The burden to prove that borrowed funds were used for investments lies on the Revenue, which was not discharged here.The discretion to allocate funds for business investments lies with the Assessee, provided sufficient interest-free funds exist.Final determination:The appeal was dismissed, affirming the Tribunal's order that no disallowance of interest on borrowed funds was justified as the Assessee had sufficient interest-free funds for making investments in sister concerns.