Business nexus for interest on customer advances defeats disallowance under Section 36(1)(iii) in a real estate business.

Interest on customer advances used in a real estate development business was treated as business expenditure where the funds had a business nexus and were supported by commercial expediency. The record did not establish diversion of borrowed funds for non-business purposes, and even assumed advances to group concerns were found to relate to business activity. On that basis, disallowance of finance charges under Section 36(1)(iii) was held unsustainable, and the addition was deleted in favour of the assessee.

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Issues: Whether the disallowance of finance charges / interest under Section 36(1)(iii) of the Income-tax Act, 1961, on the premise of diversion of funds for non-business purposes was sustainable.

Analysis: The assessee was engaged in real estate development and had received customer advances under memoranda of understanding providing for payment of interest in the event of delay. The finance charges represented interest paid on such customer advances. The record showed business use of the funds, and the material did not support a finding that the advances were diverted for non-business purposes. Even on the hypothesis of advances to group concerns, the activity was found to bear a business nexus and commercial expediency.

Conclusion: The disallowance of finance charges was not justified, and the addition made under Section 36(1)(iii) was directed to be deleted, in favour of the assessee.

Ratio Decidendi: Interest paid on customer advances incurred in the ordinary course of a real estate business, where the funds are used for business purposes or bear a commercial nexus, cannot be disallowed as non-business expenditure under Section 36(1)(iii) in the absence of a valid finding of diversion for non-business use.

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