2025 (3) TMI 294 - AT - Income Tax

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

The Deputy Commissioner of Income–tax, Central Circle–2 (3), Ahmedabad Versus Kandla Exports Corporation, Kutch And (Vice-Versa)

ITAT Ahmedabad ruled in favor of the assessee on multiple issues. Regarding interest disallowance u/s 36(1)(iii), the tribunal found that AO failed to ... Disallowance of interest u/s 36(1)(iii) - assessee had made interest free advance out of interest bearing funds - CIT(A) deleted addition - HELD THAT:- We find that the provisions of section 36 (1) (iii) of the Act, are enabling provisions, whereby interest claimed is required to be allowed, as a deduction to the assessee, provided the claim is genuine. AO made unverified and wrong statement that 'no interest-free funds were available with the assessee' and irrelevant statement that 'the assessee has also not furnished any details or evidence to establish that impugned advances were given for business expediency'. AO has failed to realize that the obligation to establish business expediency would arise on the part of the assessee only when the assessing officer has discharged his obligation to show ( provided the assessee has filed all documents and evidences, as required by the assessing officer, to explain the interest free funds) that any part of interest-bearing loans have been diverted for non-business purposes. We find that the issue of disallowance u/s.36 (1) (iii) out of the claim of interest, arose in the assessment proceedings, on account of the report of the Special Auditor, who had only mentioned that the assessee has taken loans from Banks/Financial institutions and has paid interest.When the Spl. Auditor was able to provide such information/ledger accounts from the books of account, obviously he had scanned through the entire ledger meticulously and thoroughly. However, while he could find the accounts listed by him, his discerning eye failed him to find accounts reflecting huge interest-free receipts by assessee from sister concerns, despite there being ledger accounts of sister concerns, reflecting interest free funds provided to the assessee. As noticed that as a matter of fact, considering the amount due to these two parties in trading accounts, interest payable to them worked out to more Rs. 62,46,112/-, than the interest disallowed by the AO. Therefore, even on facts, the disallowance of Rs. 40,49,780/- is the result of lack of inquiry by the assessing officer. Further, scanning of the entire ledger and picking up and choosing only such accounts (of interest-free advances) by the Spl. Auditor, again failed him to notice the accounts of other sister concerns providing huge interest-free funds to assessee. It is also a settled-principle that ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of his business. As decided in the case of Sassoon J David and Co. (P) Ltd [1979 (5) TMI 3 - SUPREME COURT] expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction for the same. It is not the case of the assessing officer that the interest free advances given by the assessee were withdrawn by the sister concern and utilized for personal purpose such as buying of property by the directors or making donations or gifts, as is the case, in many of the decisions cited by the assessing officer. In fact, short term advances to meet with urgent requirements of sister concerns with whom regular business is also transacted on daily basis, is squarely covered under the phrase 'for the purpose of business” occurring in section 36(1)(iii) as well as 37(i) of the Act. Thus, there is no tax-avoidance angle also, there can be no justification for assessing officer to have made a disallowance when firstly advance is made out of interest free funds and secondly the interest-bearing loans are deployed for the purposes for which the funds are borrowed and also there is manifest business expediency, and assessing officer has not demonstrated the personal or non-business or purely charitable use by the recipient - Decided in favour of assessee. Disallowance of claim for the interest - It is a settled principle of law that business or commercial expediency has to be judged from the perspective of the businessman and not of the Revenue, since it is the businessman who is being benefited from the services rendered and also it is he who knows to what extent the benefit ensures to him. Based on these facts and circumstances, we allow the ground pressed by the assessee. Disallowance of under valuation of stock of Rapeseeds DOC and salt - there were some errors in valuation of closing stock on FIFO basis - CIT(A) deleted addition partly - HELD THAT:- while the assessee submitted before the assessing officer that the valuation is based on the average cost price of opening stock plus purchases, the same could not be substantiated by the assessee, in a proper way. Moreover, ld CIT(A) noticed that the method of valuation for the year under reference adopted is not consistent with the method adopted for preceding and the subsequent years. Even by assessee's own submission, the valuation for the year under reference would need to be revised upwards by Rs. 24 per,mt. though it is also submitted by the assessee that such an action is uncalled for in view of the fact that in subsequent year also, the tax rate is same. Therefore, ld CIT(A) made an addition of Rs. 50,63,472/- @ of Rs. 24 per,mt. The ld CIT(A) noticed that this addition is obviously called for, so as to, maintain the consistency, as also the matching principle. Thus, out of the total addition of Rs. 4,46,25,539/-, on account of valuation of closing stock, an amount of Rs. 50,63,472/- was upheld while the balance amount of Rs. 3,95,62,067/- ( Rs. 4,46,25,539- Rs. 50,63,472) was deleted, by ld. CIT(A). Therefore, after having regard to the given facts and circumstances of the case, in our considered view, the action of the ld.CIT(A) does not warrant any interference. Accordingly, the ground of appeal of Revenue is dismissed. Disallowance of handling/ spillage/wastage loss - HELD THAT:-We find that it is a natural phenomenon that due to loading, unloading wind, washing, rain and even inaccuracy in quantification of purchase and sale, a reasonable claim of wastage/spillage is bound to be there and cannot be disputed without any adverse material brought on record. Considering the fact that the stock of salt is kept in open and obviously there are spillages and wastages on account of loading, unloading wind, washing, rain and even inaccuracy in quantification of purchase and sale, a reasonable claim of wastage/spillage is bound to be there and cannot be disputed without any adverse material brought on record. Similarly, the ld CIT(A) also found favour with the submission of the assessee that during the course of the search, no discrepancy in the stock or evidences with regard to wrong claim of wastage/spillage or of unaccounted sales have been found or seized. Moreover, no such disallowance has even been considered by the assessing officer in any of the other years, that is, in previous years or subsequent years. In view of this, the assessee was right in his submission that the rejection of claim is arbitrary and not justified in law. Accordingly, it was held by ld. CIT(A) that there is no merit in the action of the assessing officer and therefore the addition was correctly deleted by ld CIT(A). 1. ISSUES PRESENTED and CONSIDEREDThe core legal issues considered in this judgment were:(a) Whether the disallowance of interest under Section 36(1)(iii) of the Income Tax Act, 1961, due to interest-free advances made by the assessee from interest-bearing funds, was justified.(b) Whether the addition on account of alleged undervaluation of closing stock of Rapeseeds DOC and salt was warranted.(c) Whether the disallowance of handling/spillage/wastage loss claimed by the assessee was appropriate.2. ISSUE-WISE DETAILED ANALYSIS(a) Disallowance of Interest under Section 36(1)(iii)Relevant legal framework and precedents: Section 36(1)(iii) of the Income Tax Act allows for the deduction of interest paid on capital borrowed for business purposes. The burden of proof lies on the assessing officer to establish that borrowed funds were not used for business purposes if disallowance is to be invoked.Court's interpretation and reasoning: The Tribunal found that the assessee had sufficient interest-free funds to cover the interest-free advances made. The assessing officer failed to establish a direct nexus between the interest-bearing funds and the advances made. The Tribunal relied on several precedents, including the judgment of the Hon'ble Supreme Court in S.A. Builders v. CIT, which emphasized that the commercial expediency of a business decision should be judged from the perspective of the businessman.Key evidence and findings: The assessee demonstrated that it had substantial interest-free funds available, which were utilized for the advances. The Tribunal noted that the assessing officer did not adequately consider the evidence provided by the assessee.Application of law to facts: The Tribunal applied the principles from relevant case law to conclude that the disallowance of interest was not justified, as the assessee had shown the availability of interest-free funds.Treatment of competing arguments: The Tribunal considered the revenue's argument that the assessee failed to prove commercial expediency but found that the evidence supported the assessee's position.Conclusions: The Tribunal upheld the CIT(A)'s decision to delete the disallowance of interest, finding no merit in the revenue's appeal.(b) Alleged Undervaluation of Closing StockRelevant legal framework and precedents: The valuation of closing stock should be consistent with the accounting principle of 'cost or market price, whichever is lower,' and should be consistently applied.Court's interpretation and reasoning: The Tribunal found that the assessing officer's revaluation of the closing stock was inconsistent, as it did not adjust the opening stock of the subsequent year. The Tribunal emphasized the need for consistency in stock valuation.Key evidence and findings: The Tribunal noted that the assessee consistently followed the FIFO method for stock valuation and that the assessing officer's approach was not in line with established accounting principles.Application of law to facts: The Tribunal applied the principle of consistency in stock valuation and concluded that the assessing officer's adjustments were not justified.Treatment of competing arguments: The Tribunal considered the revenue's argument for revaluation but found that the assessee's method was consistent and in line with accounting standards.Conclusions: The Tribunal upheld the CIT(A)'s decision to delete most of the addition for undervaluation, except for a small adjustment to maintain consistency.(c) Disallowance of Handling/Spillage/Wastage LossRelevant legal framework and precedents: Claims for wastage or spillage must be substantiated with evidence, but reasonable claims consistent with business practices should be allowed.Court's interpretation and reasoning: The Tribunal found that the assessee's claim of 2.17% wastage was reasonable given the nature of the business and the storage conditions of salt.Key evidence and findings: The Tribunal noted that the assessee's business involved keeping salt in open heaps, which naturally led to some wastage. The claim was consistent with past practices.Application of law to facts: The Tribunal applied the principle that reasonable wastage claims consistent with business practices should be allowed, finding the assessing officer's disallowance unjustified.Treatment of competing arguments: The Tribunal considered the revenue's lack of evidence for disputing the wastage claim and found the assessee's explanation credible.Conclusions: The Tribunal upheld the CIT(A)'s decision to delete the addition for handling/spillage/wastage loss.3. SIGNIFICANT HOLDINGSCore principles established:- The burden of proof lies on the assessing officer to establish that borrowed funds were used for non-business purposes when disallowing interest under Section 36(1)(iii).- Consistency in stock valuation methods is crucial, and adjustments must be applied consistently across accounting periods.- Reasonable claims for wastage or spillage consistent with business practices should be allowed unless the revenue provides evidence to the contrary.Final determinations on each issue:- The Tribunal dismissed the revenue's appeals regarding the disallowance of interest and the alleged undervaluation of closing stock.- The Tribunal allowed the assessee's cross-objection regarding the disallowance of interest claims.- The Tribunal upheld the CIT(A)'s decision to delete the addition for handling/spillage/wastage loss.