Interest deduction allowed on loans to subsidiary for real estate business despite no interest income under section 36(1)(iii)

ITAT Kolkata allowed interest deduction u/s 36(1)(iii) on loans advanced to subsidiary AAIPL for real estate business purposes. The assessee, engaged in real estate development, had advanced funds to its 87.5% subsidiary AAIPL, which further invested in foreign subsidiaries for overseas real estate projects. Despite no interest income from AAIPL due to commercial prudence and financial distress in foreign subsidiaries, the tribunal held that interest on borrowings remained allowable as business expenditure since loans were advanced for legitimate business purposes. Revenue's appeal was dismissed, upholding CIT(A)'s order.

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Issues Involved:

1. Disallowance of proportionate interest on loans advanced to a subsidiary.
2. Commercial expediency and business purpose of interest-free loans.
3. Justification for not charging interest on loans to the subsidiary.
4. Applicability of Section 36(1)(iii) of the Income Tax Act.
5. Consideration of notional interest income on loans.

Detailed Analysis:

1. Disallowance of Proportionate Interest:

The primary issue in this appeal was the disallowance of Rs. 46,27,18,547/- as interest expense by the Assessing Officer (AO) on loans advanced to M/s AA Infra Properties Pvt. Ltd. (AAIPL), a subsidiary of the assessee. The AO contended that since the loans were advanced interest-free, the corresponding interest paid on borrowed funds should be disallowed. The AO's decision was based on the observation that AAIPL had the financial capability to pay interest, as it had earned interest income from its foreign subsidiaries.

2. Commercial Expediency and Business Purpose:

The assessee argued that the loans to AAIPL were advanced as a measure of commercial expediency. The funds were used to support real estate projects in Sri Lanka and Dubai, undertaken by AAIPL's step-down subsidiaries. The decision to not charge interest was made due to financial distress faced by these subsidiaries, exacerbated by the COVID-19 pandemic, litigation issues, and a downturn in the real estate market. The assessee claimed that the decision was a prudent business move to protect its principal investment and ensure the sustainability of the projects.

3. Justification for Not Charging Interest:

The assessee justified the non-charging of interest based on the financial hardships of the foreign subsidiaries and ongoing litigations. The financial position of the subsidiaries had deteriorated significantly, and they were unable to service interest costs. The Board of Directors resolved not to charge interest for the AY 2019-20, considering the extraordinary financial crisis and to protect the principal investment.

4. Applicability of Section 36(1)(iii) of the Income Tax Act:

The Ld. CIT(A) allowed the appeal, stating that the interest expense was allowable under Section 36(1)(iii) of the Income Tax Act. It was held that the loans were advanced for business purposes, and the decision to waive interest was commercially expedient. The judgment relied on precedents set by the Hon'ble Supreme Court in cases like S.A. Builders Ltd vs. CIT and Hero Cycles (P) Ltd vs. CIT, which established that the expression "for the purposes of business" should be interpreted from the viewpoint of commercial expediency.

5. Consideration of Notional Interest Income:

The Revenue argued that notional interest income should be taxed on the loans advanced to AAIPL. However, the Ld. CIT(A) and the Tribunal found that this was not the AO's original contention. The AO had focused on disallowing the interest expense, not on taxing notional income. The Tribunal upheld that the loans were advanced for business purposes, and the non-charging of interest was a business decision driven by commercial considerations.

Conclusion:

The Tribunal upheld the decision of the Ld. CIT(A) to delete the disallowance of interest, affirming that the loans were advanced for business purposes and the decision to waive interest was based on commercial expediency. The appeal of the Revenue was dismissed, and it was concluded that the interest expense was allowable under Section 36(1)(iii) of the Income Tax Act. The judgment emphasized that tax authorities should not interfere with business decisions made in good faith and based on commercial prudence.

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