Interest disallowance for interest-free advances upheld where borrowed funds were not shown to be used for business purposes.

Interest deduction under Section 36(1)(iii) is available only for borrowed funds used for business purposes. Where an assessee with interest-bearing borrowings makes interest-free advances for non-business purposes, the assessee must explain the use of borrowed money and justify allowance of interest. The common-pool approach was applied, and a direct nexus between specific borrowings and specific advances was not accepted as a basis to avoid disallowance. The burden to establish facts within the assessee's knowledge was treated as resting on the assessee under Section 106 of the Indian Evidence Act, and the disallowance of interest was upheld.

---

---

Issues: Whether the disallowance of interest on borrowed funds was justified where the assessee had made interest-free advances to other parties and the nexus between borrowings and such advances was not established.

Analysis: Deduction of interest under Section 36(1)(iii) of the Income-tax Act is available only where borrowed funds are used for business purposes. When an assessee, while carrying interest-bearing borrowings, advances funds without interest for non-business purposes, the burden lies on the assessee to explain the use of borrowed money and to justify the claim that interest should nevertheless be allowed. The Court applied the principle that funds in a business entity form a common pool and rejected the theory of direct nexus between specific borrowings and specific advances as a basis to avoid disallowance. It further held that the assessee had the special burden to establish the facts within its knowledge, consistent with Section 106 of the Indian Evidence Act.

Conclusion: The disallowance of interest was upheld and the question was answered in favour of the Revenue and against the assessee.

---