2022 (7) TMI 1152 - AT - Income Tax

Court upholds disallowance of interest expenses in financial transactions due to lack of evidence

Madhav Cotton Ginning And Pressing Factory Versus ITO, Ward-2 (3), Bhavnagar

The court upheld the disallowance of interest expenses claimed by the assessee in financial transactions with M/s. Om Kailash Cotton due to discrepancies ... Interest disallowance computed at 12% in respect of financial transactions with M/s Om Kailash Cotton - HELD THAT:- As correctly noted by the Ld. CIT(A) in the appellate proceedings, the assessee has not been able to demonstrate that interest-free funds were available with the assessee during the year under consideration out of which interest-free advances had been given to M/s Om Kailash Cotton. Also, we note that Ld. CIT(Appeals) also observed specifically that the interest disallowance on account of financial transactions with M/s Om Kailash Cotton offered for taxation by the assessee is also not reliable for the reason that it has taken the opening balance of ₹ 5,24,388/- instead of ₹ 3,07,80,727/- for which no justification has been given. The argument of the assessee that the opening balance of ₹ 3,07,80,727/-should not be considered for disallowance of interest is also not acceptable since firstly, the assessee has been unable to demonstrate that a part of this relates to trading transactions with M/s Om Kailash Cotton despite being given several opportunities and secondly, since assessee has been unable to demonstrate with any supporting evidence that interest-free funds were utilised for giving advances to M/s Om Kailash Cotton, and since the assessee has claimed deduction of interest on the aforementioned interest bearing funds made available to M/s Om Kailash Cotton during the impugned assessment year, interest on the same is liable to disallowed. In the result, we are of the view, that in the instant set of facts, the assessee’s appeal is liable to be dismissed. Issues:1. Disallowance of interest expenses on financial transactions with M/s. Om Kailash Cotton.2. Consideration of alternative contentions such as interest-free funds and current year's profit.3. Failure to provide bifurcation between financial and trading transactions.4. Conversion of closing balance in 'Loans and Advances' to 'Sundry Debtors' without justification.5. Disallowance of interest expense and subsequent appeal proceedings.Analysis:Issue 1: Disallowance of interest expenses on financial transactions with M/s. Om Kailash CottonThe assessing officer disallowed interest expenses claimed by the assessee due to discrepancies in the treatment of funds transferred from 'Loans and Advances' to 'Sundry Debtors.' The AO noted interest-bearing loans given without charging interest to M/s. Om Kailash Cotton, leading to the disallowance of interest expenses. The Ld. CIT(A) partially upheld the disallowance, considering the lack of evidence regarding the utilization of interest-free funds for advances. The AO reconfirmed the disallowance in the appeal effect order, leading to further proceedings.Issue 2: Consideration of alternative contentionsThe assessee argued for the availability of interest-free funds and current year's profits to justify the financial transactions with M/s. Om Kailash Cotton. However, the Ld. CIT(A) rejected these contentions, emphasizing the lack of supporting details and relevance to the transactions made during the year. The assessee's failure to demonstrate the source of funds for interest-free advances weakened their case.Issue 3: Failure to provide bifurcation between financial and trading transactionsThroughout the proceedings, the assessee failed to produce a clear bifurcation between financial and trading transactions with M/s. Om Kailash Cotton. Despite multiple opportunities, the assessee could not justify the treatment of funds and the nature of transactions, leading to uncertainties in the assessment.Issue 4: Conversion of closing balance without justificationThe AO observed the conversion of the closing balance in 'Loans and Advances' from the previous year to 'Sundry Debtors' without a valid reason, suggesting a motive to evade tax. This conversion raised concerns about the accurate representation of funds and transactions, contributing to the disallowance of interest expenses.Issue 5: Disallowance of interest expense and subsequent appeal proceedingsThe appeal process involved multiple rounds, with the Ld. CIT(A) directing the AO to rework the interest disallowance based on financial transactions excluding trading activities. Despite these directions, the assessee's failure to provide necessary bifurcations and justifications led to the dismissal of the appeal by the ITAT. The lack of evidence regarding the utilization of interest-free funds and the discrepancies in balance amounts further supported the decision to uphold the disallowance.In conclusion, the judgment highlights the importance of substantiating financial transactions, providing clear bifurcations, and demonstrating the source of funds in tax assessments to avoid disallowances and uphold the principles of natural justice.