Interest expense disallowance under Section 36(1)(iii) rejected when sufficient interest-free funds available for advances

ITAT Ahmedabad allowed the assessee's appeal regarding disallowance under Section 36(1)(iii) for interest expenses on unsecured borrowings while advancing interest-free loans. The tribunal found assessee had sufficient interest-free funds exceeding the advances made. Following CIT v. Reliance Industries Ltd., where adequate interest-free funds exist, presumption arises that advances are made from such funds. Revenue failed to establish direct nexus between borrowed funds and advances. The tribunal also allowed deduction for sundry balances written off as employee advances, treating them as deductible business expenses under Section 37 despite non-compliance with Section 36(2).

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Issues:
1. Disallowance of interest expense under Section 36(1)(iii) for interest-free advances.
2. Disallowance of sundry balance written off under Section 36(2) of the Act.

Analysis:
The case involved an appeal by the assessee against the order of the Commissioner of Income Tax (Appeals) regarding disallowances made by the Assessing Officer. The primary issues were the disallowance of interest expense and the disallowance of sundry balance written off.

Interest Expense Disallowance:
The Assessing Officer disallowed Rs. 65,86,200 under Section 36(1)(iii) due to interest-free loans given by the assessee without establishing a business purpose or nexus with interest-free funds. The CIT(A) upheld this disallowance, emphasizing the failure to prove a business purpose or nexus. However, the Tribunal found that the assessee had sufficient interest-free funds to cover the advances, as evidenced by financial statements. The Tribunal noted the inconsistency in disallowance despite similar advances in prior years and relied on the principle established in a Supreme Court judgment that advances from sufficient interest-free funds are presumed to be made from those funds. The Tribunal ruled in favor of the assessee, stating that the disallowance was unsustainable.

Sundry Balance Written Off Disallowance:
The AO disallowed Rs. 8,002 under Section 36(2) for sundry balance written off, citing non-compliance. The assessee argued that this amount was a business expenditure under Section 37 due to advances given to an employee during normal business operations. The Tribunal agreed with the assessee, stating that the write-off was incidental to business operations and qualified as a deductible expense. Considering the nominal amount involved, the Tribunal deemed the disallowance unwarranted.

Conclusion:
The Tribunal allowed both grounds of the appeal in favor of the assessee, overturning the disallowances made by the lower authorities. The Tribunal's decision was based on the adequacy of interest-free funds for advances and the business nature of the written-off amount. The appeal was allowed, and the order was pronounced in open court in November 2024 at Ahmedabad.

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