Direct nexus between borrowed funds and interest-free related-party advance justified disallowance of interest deduction.

Interest on overdraft borrowings was held not deductible where the borrowed funds were directly routed as interest-free advances to a related party for non-business purposes. The factual inquiry established a clear nexus between the interest-bearing borrowing and the advance, and the available interest-free capital could not be relied on because it had already been deployed; exempt income from a different period also did not alter that result. The presumption that interest-free funds were used was therefore unavailable once direct utilisation of borrowed funds was shown, and the related interest disallowance under section 36(1)(iii) was sustained.

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Issues: Whether interest expenditure on overdraft funds was allowable as a deduction when the borrowed funds were directly used to make interest-free advances to a related party for non-business purposes.

Analysis: The assessee had used overdraft facilities from a co-operative bank and had advanced funds interest-free to her husband. The factual inquiry showed a direct nexus between the interest-bearing borrowing and the advance, and the advance was not supported by any business exigency. The plea that the assessee had sufficient interest-free capital and exempt income was rejected on the facts, as the available capital had already been deployed and the exempt income related to a different point of time. The rule in favour of a presumption of utilisation of interest-free funds did not apply where direct nexus with borrowed funds was established.

Conclusion: The disallowance under section 36(1)(iii) was correctly sustained and the claim for deduction of the related interest was rejected.

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