Interest disallowance for diverted borrowed funds sustained where assessee failed to prove a lower cost of funds.
ITAT Ahmedabad held that where borrowed funds are diverted to interest-free advances, the assessee must substantiate a lower cost of funds to reduce disallowance under section 36(1)(iii); on the record, the Assessing Officer's average borrowing cost of 11.45% was found consistent with the borrowing pattern and the assessee's lower rate was not supported, so the disallowance was sustained. It also accepted that the Covid-19 lockdown created exceptional circumstances justifying exclusion of the lockdown period for computing the time limit for pronouncement under rule 34(5)(c), making the delayed pronouncement permissible.
Issues: (i) Whether the disallowance of interest under section 36(1)(iii) of the Income-tax Act, 1961, on the basis of diversion of borrowed funds to interest-free loans and advances was justified and whether the rate of interest applied was correct. (ii) Whether the order could be pronounced beyond the normal time limit prescribed in rule 34(5)(c) of the Income-tax (Appellate Tribunal) Rules, 1963, in view of the lockdown caused by Covid-19.
Issue (i): Whether the disallowance of interest under section 36(1)(iii) of the Income-tax Act, 1961, on the basis of diversion of borrowed funds to interest-free loans and advances was justified and whether the rate of interest applied was correct.
Analysis: The assessee accepted that interest was to be disallowed to the extent borrowed funds were diverted as interest-free advances. The dispute was confined to the rate to be applied. The record showed that borrowings were substantially at 12%, with some borrowings at 15% and 10.5%, and the average cost of funds computed by the Assessing Officer at 11.45% was found to be consistent with the facts. The claimed rate of 8.73% was not supported by the borrowing pattern shown on record.
Conclusion: The disallowance computed by the Assessing Officer was sustained and the assessee's challenge failed.
Issue (ii): Whether the order could be pronounced beyond the normal time limit prescribed in rule 34(5)(c) of the Income-tax (Appellate Tribunal) Rules, 1963, in view of the lockdown caused by Covid-19.
Analysis: The prevailing lockdown created an unprecedented disruption in judicial functioning. In that situation, the period during which the lockdown was in force was treated as liable to exclusion while computing the period for pronouncement of orders, and the exceptional circumstances justified pronouncement beyond the ordinary time limit.
Conclusion: The delayed pronouncement was treated as permissible in the circumstances.
Final Conclusion: The appeal did not succeed on the substantive tax issue, and the order was validly pronounced despite the exceptional delay arising from the lockdown period.
Ratio Decidendi: Where borrowed funds are shown to have been diverted for interest-free advances, and the assessee fails to establish a lower applicable cost of funds, the average borrowing cost reasonably determined on record may be adopted for disallowance under section 36(1)(iii); exceptional lockdown circumstances may justify delayed pronouncement of the order.
TaxTMI 
AI Drafter ✕
TaxTMI 
