2022 (3) TMI 1650 - AT - Income Tax

Assessee's interest deduction under Sec. 36(1)(iii) restored where loans were prima facie used for share trading, no diversion proved

Ashita Kishor Janani Versus ITO – 19 (1) (2) Mumbai

ITAT MUMBAI - AT allowed the appeal and set aside the disallowance of interest under Sec. 36(1)(iii). The assessee, a medical practitioner who also traded ... Disallowing interest by invoking the provisions of Sec. 36(1)(iii) - assessee is a doctor by profession and specializing in the field of radiologist and has a private clinic - HELD THAT:- Assessee is doctor by profession and has disclosed income from profession along with income from sale of shares, income from House Property and income from other Sources. Assessee was engaged in trading in equity shares and investments, and the income has been offered to tax, which is not disputed. On perusal of the facts of Loans, referred at page 2 of the assessment order, the loan amounts pertains to NBFC and national banks. Contention of the assessee before the lower authorities that the funds have been utilized for the purpose of trading in shares and the assessee has received the dividend income and also earned profit on share transactions which was offered to tax and was disclosed in the income tax return. Prima facie the assessee has utilized this funds for the purpose of business and the revenue could not make out a case supporting with any evidence that the barrowed funds have been diverted for other purposes. We considering the facts, circumstances, and the income offered by the assessee are of the opinion that the disallowance cannot be sustained - Appeal filed by the assessee is allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether interest expenditure claimed on borrowed funds is disallowable under Section 36(1)(iii) when the Assessing Officer concludes that borrowed funds were not utilized for the purpose of the profession/business. 2. Whether the revenue discharged the evidentiary burden to show that borrowed funds were diverted away from business use, thereby breaking the nexus between the borrowing and the income-earning activity. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Disallowance of interest under Section 36(1)(iii) where AO finds borrowed funds not used for business Legal framework: Section 36(1)(iii) allows deduction of interest paid or payable on borrowed capital where such interest is wholly and exclusively for the purpose of the business or profession. The statutory test requires a causal nexus between borrowing and income-earning business activity; absence of such nexus permits disallowance. Precedent Treatment: No prior judicial precedents were relied upon by the authorities in the record. The Tribunal did not cite any binding precedent and decided the issue on factual and legal analysis of nexus and evidence. Interpretation and reasoning: The Tribunal examined the material on record - the assessee's profit and loss account, returns disclosing income from profession, trading in shares, dividends and other sources, and submissions by the assessee regarding utilisation of borrowed funds for share trading. The Tribunal found that the assessee had offered to tax income arising from activities (dividend income and profit on trading in shares) for which the borrowed funds were assertedly used. The Assessing Officer and the CIT(A) had not produced independent evidentiary material demonstrating diversion of the borrowed funds to non-business purposes or breaking of the requisite nexus. On the facts, the Tribunal concluded that the assessee's explanation of utilisation for business/trading activity was prima facie plausible and remained unrebutted by the revenue. Ratio vs. Obiter: Ratio - Where an assessee demonstrates that borrowed funds were used for income-earning business/professional activities and the income so generated is offered to tax, the revenue must produce cogent evidence of diversion or lack of nexus before disallowing interest under Section 36(1)(iii). Obiter - Observations on the type of lending institutions (NBFCs and banks) and general acceptability of such loans as business borrowings are incidental to the primary factual holding. Conclusions: The Tribunal allowed the appeal on this ground, setting aside the disallowance. The decision establishes that, absent affirmative evidence by the revenue showing diversion of funds or absence of nexus, interest claimed on borrowings utilised for taxable business/professional activity cannot be disallowed under Section 36(1)(iii). Issue 2 - Burden of proof and evidentiary standard for establishing diversion of borrowed funds Legal framework: The principles of burden and standard of proof in assessment proceedings require the revenue to substantiate adjustments it proposes. For a disallowance under Section 36(1)(iii) predicated on non-utilisation or diversion of borrowed funds, the AO must establish, on the basis of material evidence, that funds were not applied to the income-producing purpose. Precedent Treatment: The record contains no authority shifting the evidentiary standard; the Tribunal applied the conventional evidentiary approach - factual findings must be supported by material on record. No prior decisions were followed, distinguished or overruled in the judgment. Interpretation and reasoning: The Tribunal emphasized that the revenue failed to point to documentary or material evidence proving diversion or non-application of borrowed funds to the declared business activities. The assessee's books and returns evidenced income from activities alleged to have been financed by the borrowings. In such circumstances, the AO's subjective dissatisfaction, without corroborative evidence, was insufficient to sustain disallowance. Ratio vs. Obiter: Ratio - The revenue bears the onus to produce evidence of diversion or lack of nexus when seeking disallowance of interest under Section 36(1)(iii); mere suspicion or unsupported conclusion by the AO/CIT(A) cannot justify disallowance. Obiter - Comments on the completeness of the assessee's explanations and adequacy of submissions before the authorities are ancillary to the main evidentiary ruling. Conclusions: The Tribunal directed deletion of the addition, holding that the evidentiary burden remained unmet by the revenue and therefore the disallowance could not be sustained. Cross-references and operative outcome Cross-reference: Issues 1 and 2 are interlinked - the legal viability of a disallowance under Section 36(1)(iii) depends on whether the revenue has proved absence of nexus or diversion (Issue 2), which in turn controls the correctness of the disallowance (Issue 1). Operative conclusion: On the facts and evidence before it the Tribunal allowed the appeal, set aside the disallowance of interest of Rs. 8,56,125 under Section 36(1)(iii), and directed the Assessing Officer to delete the addition, because the revenue did not discharge the burden of proving that borrowed funds were not used for the assessee's taxable business/professional activities.