Interest on borrowings for investment in subsidiaries allowed as business deduction under s. 36(1)(iii); AO disallowance deleted

ITAT Chennai allowed the assessee's appeal and deleted the disallowance of interest under s. 36(1)(iii). The AO had disallowed interest on borrowed funds used to invest in shares of subsidiary companies, treating it as diversion of interest-bearing funds for non-business purposes. ITAT held that, since the subsidiaries were engaged in the same line of business and the investments were made for strategic and commercial expediency, the borrowed capital was used for business purposes. The AO could not substitute its business judgment for that of the assessee. Consequently, interest on such borrowings was held fully deductible under s. 36(1)(iii).

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether a delay of three days in filing the appeal before the Tribunal was liable to be condoned on showing reasonable cause.

1.2 Whether disallowance of interest under section 36(1)(iii) was justified on the ground that borrowed funds were allegedly diverted as investments/advances to subsidiary/group companies for non-business purposes.

1.3 Whether investments in subsidiary/group companies in the same line of business constituted "commercial expediency" so as to allow deduction of interest on borrowed capital under section 36(1)(iii).

1.4 Whether reliance placed by the first appellate authority on a decision relating to reopening of assessment was relevant to sustain disallowance of interest under section 36(1)(iii).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Condonation of delay of three days in filing the appeal

Interpretation and reasoning

2.1 The Tribunal examined the petition and affidavit explaining that the assessee received the appellate order on 03.11.2021 and, being away on official duties, could not file the appeal within the prescribed period, leading to a three-day delay. The delay was asserted to be neither intentional nor wilful.

2.2 The Department opposed condonation, contending that the reasons did not constitute reasonable or bona fide cause.

2.3 The Tribunal held that the explanation fell within "reasonable cause" as contemplated under the Act for condonation of delay and that advancement of substantial justice warranted condonation.

Conclusion

2.4 The delay of three days in filing the appeal was condoned and the appeal was admitted for adjudication.

Issue 2 & 3: Disallowance of interest under section 36(1)(iii) on funds invested in subsidiary/group companies; commercial expediency

Legal framework (as discussed)

2.5 The Tribunal noted that section 36(1)(iii) permits deduction of interest on capital borrowed for the purposes of the business, and that if borrowed funds are not utilized for business purposes, such interest cannot be allowed.

2.6 The first appellate authority referred to the principle laid down in S.A. Builders Ltd. that the allowability of interest depends on whether the advances to subsidiary/associated concerns were made as a measure of "commercial expediency", and that such expediency is of wide import and covers expenditure incurred by a prudent businessman for business purposes, even without a legal obligation. At the same time, it was recognized that interest is not automatically allowable in every case of advance to sister concerns.

Interpretation and reasoning

2.7 The Assessing Officer held that borrowed funds had been used for investments and interest-free advances to group/subsidiary concerns and concluded that the assessee had failed to establish business/commercial expediency or nexus between such investments and its business. On this premise, notional interest at 12.7% was computed on such investments and disallowed under section 36(1)(iii).

2.8 The first appellate authority affirmed the disallowance on the basis that: (i) the assessee had borrowed funds on which interest was paid; (ii) amounts were advanced to sister concerns without interest; (iii) no specific justification or material was furnished to establish commercial expediency or proximate nexus with the assessee's business; and (iv) generalized assertions of common management or unity and control were insufficient.

2.9 Before the Tribunal, the assessee contended that investments in subsidiary/group companies were made for strategic business purposes and commercial expediency, and that both the assessee and its subsidiaries were engaged in similar business, conferring substantial business advantage. Reliance was placed on the jurisdictional High Court decision holding that interest on borrowed funds used for strategic investments in group companies could not be disallowed under section 36(1)(iii), and on a coordinate bench decision following this principle.

2.10 The Department supported the disallowance, invoking the principle that diversion of interest-bearing funds for non-business purposes attracts disallowance under section 36(1)(iii).

2.11 On evaluation of the material, the Tribunal found as a fact that the assessee had made investments in shares of subsidiary companies and that such subsidiaries were engaged in a similar line of business. On the basis of details placed on record, the Tribunal held that there was business expediency and a strategic business purpose in making these investments, resulting in business advantage to the assessee.

2.12 The Tribunal held that, once business connection and commercial expediency in relation to such investments are established, the Assessing Officer cannot disallow interest merely because borrowed funds were used for investments in subsidiary/group companies. It also applied the principle that the Assessing Officer cannot sit in the armchair of a businessman to dictate deployment of funds when commercial expediency is demonstrated.

2.13 The Tribunal followed the jurisdictional High Court ruling that interest paid on borrowed funds utilized for investment in group companies for strategic business purposes is not disallowable under section 36(1)(iii), and a coordinate bench decision adopting the same line, holding that once commercial expediency is shown, the assessee is free to manage its finances.

Conclusions

2.14 The Tribunal concluded that the investments in subsidiary/group companies were made out of commercial expediency for strategic business purposes in the same line of business, thereby satisfying the requirement of "for the purposes of the business" under section 36(1)(iii).

2.15 The disallowance of interest under section 36(1)(iii) on the basis of alleged diversion of borrowed funds to subsidiaries/group concerns was held to be unsustainable.

2.16 The Assessing Officer was directed to delete the entire addition made towards disallowance of interest under section 36(1)(iii).

Issue 4: Relevance of precedent relied upon by the first appellate authority

Interpretation and reasoning

2.17 The first appellate authority had relied on a decision of the jurisdictional High Court in support of sustaining the disallowance.

2.18 The Tribunal examined that decision and found that the question of law answered therein related to the validity of reassessment proceedings under section 147, and not to the disallowance of interest under section 36(1)(iii) on interest-free advances to group companies.

2.19 The Tribunal therefore held that the ratio of the said decision did not apply to the facts or the specific issue involved in the present case regarding commercial expediency and allowability of interest.

Conclusion

2.20 The precedent relied upon by the first appellate authority was held to be inapposite to the controversy under section 36(1)(iii) and could not justify the impugned disallowance.

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