2023 (6) TMI 389 - AT - Income Tax

Appeals granted on interest disallowance, limits set on loans, under Income Tax Act

The Tribunal partly allowed the appeals, directing the AO to delete the interest disallowance on loans to certain parties and restrict it to Rs. 3.21 ... Allowability of interest paid on borrowed funds u/s.36(1)(iii) - alternatively allowability of interest u/s.37 - HELD THAT:- It is incorrect on the part of the CIT(A) to say that no evidences were furnished by the assessee to prove the financial sickness of these four parties. The financial statements of these four parties are reflected clearly. Assessee company in its notes on accounts in Schedule 14 had duly stated that the loans given by it includes Rs.15204.62 Lakhs given to companies having negative net worth and Rs.25.25 lakhs given to a company where legal action has been initiated for recovering the loan and accordingly no provision has been made as against these loans. This fact is also qualified by the statutory auditor in his statutory audit report stating that - subject to this non-provision of doubtful advances, financial statements of the assessee company is true and fair. Reliance placed by the ld.AR on the decision of Sarabhai Holdings (P) Ltd [2008 (10) TMI 12 - SUPREME COURT] squarely supports the case of the assessee. We hold that assessee was duly justified in not charging interest in respect of these four parties during the year under consideration. Hence, AO is hereby directed to delete the disallowance of interest on proportionate basis in respect of loans given to these four parties. Remaining loans outstanding from parties we find that the total loan outstanding of these parties worked out to Rs.10.75 Crores. In this regard on perusal of the balance sheet of the assessee company, we find that assessee has got own funds Rs.58.02 Crores (Rs.61.60 – Rs.8.58 Crores), which would cover the interest free advances given to the aforesaid parties. Hence, by placing reliance on the decision of Reliance Utilities and Power Ltd . [2009 (1) TMI 4 - BOMBAY HIGH COURT] and HDFC Bank Ltd. [2014 (8) TMI 119 - BOMBAY HIGH COURT] we direct the ld. AO to delete the interest disallowance made in respect of advances given to parties listed in Sr.No.7,8,11,12,13,16, 17 & 18 of the table above. Issues Involved:1. Allowability of interest paid on borrowed funds under Section 36(1)(iii) of the Income Tax Act, 1961.2. Alternatively, allowability of interest under Section 37 of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Allowability of Interest Paid on Borrowed Funds under Section 36(1)(iii):The core issue in these cross appeals is whether the interest paid on borrowed funds by the assessee is allowable under Section 36(1)(iii) of the Income Tax Act, 1961, or if it should be disallowed due to the alleged diversion of borrowed funds for non-business purposes. The assessee, engaged in manufacturing pharmaceutical products, had declared a loss of Rs. 4,75,10,750/- for A.Y. 2002-03. During the assessment proceedings, it was observed that the assessee had given interest-free loans and advances to various parties, while simultaneously paying interest on borrowed funds amounting to Rs. 6.52 Crores.The Assessing Officer (AO) disallowed the entire interest expenditure, considering it a diversion of borrowed funds for non-business purposes. The assessee contended that it had charged interest on most loans and advances, earning Rs. 12.08 Crores as interest income in A.Y. 2001-02, and had offered it for tax. The assessee argued that the advances were given to companies with negative net worth, making the recovery of interest income doubtful. The decision not to charge interest was based on the financial position of the borrowing companies and was documented in Board Resolutions and correspondences.The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the disallowance of interest for certain parties but agreed that the interest on term loans (Rs. 1.93 Crores) and the interest income earned (Rs. 1.38 Crores) should be excluded from the disallowance. The CIT(A) directed the AO to restrict the disallowance to Rs. 3.21 Crores.2. Alternatively, Allowability of Interest under Section 37:The assessee argued, on a without prejudice basis, that even if the interest disallowance under Section 36(1)(iii) was upheld, the interest on term loans and the interest income earned should be excluded, reducing the disallowance to Rs. 3.21 Crores. The CIT(A) accepted this argument and directed the AO accordingly.Detailed Analysis:3.1-3.2:The AO observed that the assessee had paid interest on borrowed funds while giving interest-free advances to various parties, amounting to Rs. 1,58,82,29,226/-. This was considered a diversion of borrowed funds for non-business purposes, leading to the disallowance of Rs. 6.52 Crores under Section 36(1)(iii).3.3-3.4:The assessee contended that it had charged interest on most advances and earned substantial interest income. The decision not to charge interest for certain parties was due to their poor financial health, making recovery doubtful. The assessee provided Board Resolutions and correspondences to support this claim.3.5:The assessee argued that Rs. 1.93 Crores paid as interest on term loans should not be considered for disallowance, as these funds were not used for granting interest-free loans. Additionally, Rs. 1.38 Crores earned as interest income should be credited while considering the disallowance, reducing it to Rs. 3.21 Crores.3.6-3.7:The CIT(A) admitted additional evidence regarding the financial health of the borrowing companies and the subsequent merger of some companies, leading to the resumption of interest payments from A.Y. 2005-06 onwards. The CIT(A) upheld the disallowance for certain parties but agreed to reduce the disallowance to Rs. 3.21 Crores.3.8-3.10:The CIT(A) observed that the financial health of the borrowing companies was poor, and the assessee had advanced further loans despite this. The CIT(A) concluded that the advances were for non-business purposes, warranting proportionate interest disallowance under Section 36(1)(iii).3.11-3.12:The CIT(A) agreed that interest on term loans and interest income earned should be excluded from the disallowance, directing the AO to restrict it to Rs. 3.21 Crores.3.13-3.16:The Tribunal found that the assessee had justified not charging interest due to the financial sickness of the borrowing companies. The Tribunal directed the AO to delete the disallowance of interest on the opening balance of loans given to certain parties, citing the Karnataka High Court's decision in CIT vs. Sridev Enterprises.3.17:For other loans, the Tribunal observed that the assessee had sufficient own funds to cover the interest-free advances, relying on the decisions of the Jurisdictional High Court in Reliance Utilities and Power Ltd. and HDFC Bank Ltd. The AO was directed to delete the interest disallowance for these advances.Conclusion:The Tribunal partly allowed the appeals of both the assessee and the Revenue, directing the AO to delete the disallowance of interest on loans given to certain parties and restrict the disallowance to Rs. 3.21 Crores for others. The decision was pronounced on 20/10/2022.