Preference share investment cannot be treated as a loan for notional interest absent sham evidence; own funds protect related-party advances.

An apparent investment in redeemable preference shares could not be re-characterised as an interest-free loan for transfer pricing purposes absent material showing a sham or fictitious arrangement, so notional interest on the outstanding balance was deleted. Where the assessee had substantial own interest-free funds and advances to sister concerns and subsidiaries were made in a materially unchanged factual setting, the presumption applied that such advances came from own funds rather than borrowed funds; accordingly, the interest disallowance under section 36(1)(iii) was also deleted. The note records that only the undisputed or consequential parts of the assessment survived.

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Issues: (i) Whether the outstanding redeemable preference share investment in the associated enterprise could be re-characterised as an interest-free loan and notional interest could be imputed for transfer pricing purposes; (ii) Whether interest expenditure was disallowable under section 36(1)(iii) where the assessee had sufficient own funds and advances to related concerns were made from such funds.

Issue (i): Whether the outstanding redeemable preference share investment in the associated enterprise could be re-characterised as an interest-free loan and notional interest could be imputed for transfer pricing purposes.

Analysis: The adjustment was based on treating subscription to preference shares as a loan transaction and imputing interest on the outstanding balance. The issue was already concluded in the assessee's own earlier years, where the transaction was held to be an investment in shares and not a sham arrangement capable of re-characterisation as debt. The consistent view was that, absent material showing concealment or a fictitious transaction, transfer pricing provisions do not permit substitution of the apparent share investment with a deemed loan merely to enlarge the adjustment base. That view had also attained finality in the assessee's favour in earlier appellate proceedings.

Conclusion: The re-characterisation of preference shares as an interest-free loan was held to be invalid and the notional interest adjustment was deleted, in favour of the assessee.

Issue (ii): Whether interest expenditure was disallowable under section 36(1)(iii) where the assessee had sufficient own funds and advances to related concerns were made from such funds.

Analysis: The record showed substantial interest-free own funds and surplus available with the assessee, while the advances were made to sister concerns and subsidiaries. The settled principle applied was that, where both borrowed funds and sufficient own funds coexist, advances are presumed to have been made from own funds unless a direct nexus with borrowed funds is shown. The assessee's earlier years had followed the same approach, and the factual matrix for the year under consideration remained materially unchanged.

Conclusion: The disallowance under section 36(1)(iii) was deleted, in favour of the assessee.

Final Conclusion: The assessment was sustained only to the limited extent of issues not pressed or rendered consequential, while the two substantive additions relating to notional interest on preference shares and interest disallowance on advances to related concerns were deleted.

Ratio Decidendi: An apparent share investment cannot be re-characterised as a loan for imputing notional interest absent material showing sham or exceptional circumstances, and where the assessee has sufficient own funds, advances to related concerns are presumed to have been made from those funds rather than borrowed funds.

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