2025 (6) TMI 383 - AT - Income Tax

ITAT allows assessee's appeal on interest disallowance under section 36(1)(iii) and multiple tax issues

M3M India (P) Ltd. Versus ACIT Central Circle-2 Faridabad And DCIT Central Circle-2, Faridabad Versus DCIT Central Circle-2, Faridabad

ITAT Delhi-AT allowed assessee's appeal on multiple issues. Interest disallowance under section 36(1)(iii) was deleted as advances to subsidiaries/group ... Disallowance of interest u/s 36(1)(iii) - assessee has used interest bearing funds for the purpose of giving interest free advances to its subsidiaries/group concerns - Scope of expressions ‘for the purpose of business’ occurring in sec 36(1)(iii) - HELD THAT:- The presumption of utilisation of interest free funds for advances to group concerns would be required to be entertained. Hence no proportionate disallowance in the circumstances would be permissible. Besides, the advance to subsidiary does not call for such nexus as the purpose of lending money to subsidiary would automatically promote the business interests of the holding co. The commercial expediency is also established in the wake of profits arising in subsequent years by virtue of such advance to group cos. When all the aspects are seen individually and cumulatively, the approach of the Revenue to reject the claim of interest expenditure incurred appears fallacious on the face of it. The availability of sufficient interest free funds itself transcends other consideration. This apart, the amount advanced to wholly owned subsidiary company for the furtherance of its business is nothing but furtherance of the business of the assessee company itself. Thus advances to subsidiary companies clearly attracts onus of far lower pedestal to establish the requirement of ‘for the purpose of business’. The plea of the assessee that the advance to group concerns is for the purpose of business is fortified by MoU and staggering profit in the later years by atleast one of the many companies to whom the advances made. As long as the aim and object of the money advanced is for furtherance of business, actual yield in the subsequent years, although desirable is not wholly necessary. The money advanced to subsidiary companies and group concerns are sufficiently supported to be for the purpose of business. Thus merely because the money has been advanced to such subsidiaries/group companies would by itself cannot entitle the assessee to claim deduction towards interest expenditure. Thus, availability of surplus funds as well as existence of commercial expediency in such advances, the proportionate disallowance of interest under s. 36(1)(iii) is not justified. Disallowance of expenditure incurred on foreign traveling by the assessee company - AO made disallowance on estimated basis representing 50% of the expenditure incurred on foreign travelling by the assessee company on the ground that part of expenses pertain to family members of the directors/employees and the purpose of all the visits could not be substantiated by the assessee - HELD THAT:-As assessee could not substantiate that the expenditure incurred towards visits of family members is for the purpose of business, part additions confirmed. Disallowance of cost debited and claimed as expenditure while computing the income under PoCM method of Accounting adopted by the assessee company which method was accepted in the order of assessment by the AO - HELD THAT:- In the light of judgement of Majestic Auto Ltd. [2009 (8) TMI 16 - PUNJAB AND HARYANA HIGH COURT] and ONGC Videsh Ltd. [2009 (10) TMI 76 - ITAT DELHI-F] such abortive expenditure incurred by the assessee is allowable business expenditure u/s. 37(1) of the Act. We thus reverse the action of the CIT(A) and direct the AO to delete the additions. Disallowance representing expenditure incurred on obtaining approval for construction of road on the property owned by M/s. Mikado Realtors Ltd. eligible for deduction while computing income of the assessee for instant year - AO has disallowed the expenditure towards approval on the ground that no such condition is mentioned in the MoU submitted by the assessee - contention of the assessee that the requirements of obtaining approval have to be seen in the natural perspective - HELD THAT:- The shares of Mikado could not be transferred by the assessee to Tata Group without obtaining approval. Thus to facilitate the transfer of shares, the expenditure for approval was incurred. Otherwise the value of land giving rise to fair price on sale of shares would have correspondingly decreased. Thus, the cost of approval incurred has a direct bearing on the sale price of Mikado shares. The shares have been transferred to party of high repute and therefore, the exigencies for incurring such expenses should be left to the wisdom of the assessee. The expenses incurred has direct relation to the value of shares transferred. The contentions raised showing the necessity for incurring approval expenses is plausible. The expenses incurred whether voluntarily or under legal obligation is allowable as long as it is incurred in connection with the transfer of shares. The assessee would have either fetched lesser value agreed for transfer of Mikado shares or could not have sold the shares in the absence of such approval as contended on behalf o the assessee. The expenses incurred requires to be allowed without any demur. MAT - adjustment on account of impairment of Goodwill while computing the ‘book profit’ u/s 115JB - HELD THAT:- In the instant case, cost of goodwill incurred on acquisition of assets by way of amalgamation was entered in the books to corresponding match the assets acquired with the fair market value of the assets. The assessee has charged the impairment of cost of such goodwill to the Profit & Loss Account on appropriate basis. Explanation (1) to s. 115JB enumerates specific situations where the ‘books profit’ declared in the audited financial accounts can be increased suitably. The debits towards impairment of goodwill do not fall in any of the clauses. The impairment cost debited in the Profit & Loss Account is also not in the nature of provision for diminution in the value of any assets. CIT(A) has discussed such facts in length and rightly applied the ratio of Apollo Tyres Ltd. [2002 (5) TMI 5 - SUPREME COURT] in the facts of the case. The AO was thus not entitled to adjust the book profit without showing the debits towards impairment cost to be inconsistent with any clauses of Explanation (1) to s.115JB of the Act. Addition representing purported ‘On Money’ received on the booking of flats/units by the assessee company - AO made a lumpsum addition on the ground that variation in the rates of booking of flats/units is not justified - CIT(A) took note of the arguments that in the absence of any enquiry made from the persons who have booked the space and in the absence of any corroborative evidence, the sale proceeds recorded in the books cannot be said to be suppressed - HELD THAT:- There can be valid reasons for offering different discounts to different persons. Mere variation in the rate of bookings of different units cannot ipso facto give rise to assumption of existence of ‘On Money’. The findings of the CIT(A) is based on sound principles and thus does not call for any interference. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in this appeal and cross-appeal arising under the Income Tax Act, 1961, for Assessment Year 2018-19, include:Whether the disallowance of interest expenditure under section 36(1)(iii) on interest-free advances made to wholly owned subsidiaries and group companies is justified, particularly considering the availability of interest-free funds and the commercial expediency of such advances.The appropriate quantum and rate of interest to be applied for disallowance under section 36(1)(iii) on such advances.The validity of disallowance of expenditure on foreign travel incurred by the assessee.The correctness of disallowance of costs debited and claimed under the Percentage of Completion Method (PoCM) of accounting for projects not materialized.The allowability of expenditure incurred on obtaining approval for construction of road on property owned by a third party, in connection with sale of shares.The correctness of addition on account of impairment of goodwill while computing book profit under section 115JB of the Act.The validity of addition on account of alleged 'On Money' received on booking of flats/units by the assessee.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Disallowance of Interest Expenditure under Section 36(1)(iii) on Interest-Free Advances to Subsidiaries and Group CompaniesRelevant Legal Framework and Precedents: Section 36(1)(iii) allows deduction of interest paid on capital borrowed for the purpose of business. The key test is whether the borrowed funds were used for business purposes. The Supreme Court in S.A. Builders Ltd. v. CIT held that the expression 'commercial expediency' is broad, encompassing expenditures incurred by a prudent businessman for business purposes, even if not legally obligatory. Further, judgments such as CIT vs Reliance Industries and CIT vs Raghuvir Synthetics emphasize that if interest-free funds are available, a presumption arises that interest-free advances are made from such funds, not borrowed funds, thus interest disallowance is unwarranted.Court's Interpretation and Reasoning: The Tribunal noted that the assessee incurred interest expenditure on borrowings but also held substantial interest-free funds (share capital, security premium, reserves, and advances from customers). The advances to wholly owned subsidiaries (approx. Rs. 442.25 crore) and group companies (approx. Rs. 515.29 crore) totaling Rs. 957.54 crore were interest-free. The AO disallowed interest proportionate to these advances at 18.75%. The CIT(A) reduced the disallowance by applying a 15% rate on an average advance amount of Rs. 835.32 crore.The Tribunal emphasized that advances to wholly owned subsidiaries are inherently for business purposes, as the holding company has a direct interest in the subsidiaries' profits. The advances to group companies were also supported by Memoranda of Understanding (MoUs) demonstrating commercial expediency and future revenue sharing. The Tribunal rejected the Revenue's contention that the share premium and capital reserves were not actual funds available, noting that impairment of goodwill and advances from customers also constitute interest-free funds.Key Evidence and Findings: Detailed financial data showed substantial interest-free funds exceeding the interest-free advances. MoUs substantiated the commercial purpose of advances. No adverse findings existed regarding diversion for personal use.Application of Law to Facts: The Tribunal applied the principle that if interest-free funds are available in excess of interest-free advances, the borrowed funds are presumed not to be used for such advances, negating disallowance. The advances to subsidiaries were held to be for business purposes by virtue of ownership and commercial expediency. Advances to group companies were similarly justified.Treatment of Competing Arguments: The Revenue argued non-availability of actual funds represented by share premium and capital reserves, and alleged direct use of borrowed funds for advances. The Tribunal rejected these, relying on accounting principles and judicial precedents. The Revenue's reliance on res judicata was also dismissed due to prior assessments being under different circumstances.Conclusions: The Tribunal allowed the assessee's appeal on this issue, holding that proportionate disallowance of interest under section 36(1)(iii) was not justified.Issue 2: Disallowance of Foreign Travel ExpensesRelevant Legal Framework: Business expenditure must be substantiated as incurred wholly and exclusively for business purposes.Court's Reasoning: The AO disallowed 50% of foreign travel expenses on an estimated basis, suspecting personal expenses and lack of substantiation. The CIT(A) allowed part of the expenses (Rs. 14,35,697) and disallowed the remainder.Findings and Application: The assessee failed to substantiate the business purpose of expenses related to family members' travel. The Tribunal upheld the CIT(A)'s partial disallowance.Conclusion: Both the assessee's and Revenue's grounds on this issue were dismissed.Issue 3: Disallowance of Costs under Percentage of Completion Method (PoCM) for Projects Not MaterializedLegal Framework: Under section 37(1), expenditure incurred wholly and exclusively for business is deductible, including abortive or abandoned project costs if genuine.Court's Reasoning: The AO disallowed Rs. 1.01 crore for costs related to projects not materialized due to lack of details. The CIT(A) upheld the disallowance.Findings: The Tribunal referred to judgments of Punjab & Haryana High Court and Delhi High Court holding abortive expenditure as allowable business expenditure.Application: The Tribunal held that the expenditure was part of audited accounts and genuine, thus allowable.Conclusion: The Tribunal allowed the assessee's appeal and directed deletion of the addition.Issue 4: Allowability of Expenditure on Approval for Construction of Road on Property Owned by Third Party in Connection with Share SaleLegal Framework: Expenditure incurred in connection with transfer of capital asset is allowable against capital gains.Facts and Reasoning: The assessee sold shares of a company owning the land and incurred Rs. 1.4 crore for approval to construct a road as per share transfer agreement. The AO disallowed the expenditure, noting no legal obligation in MoU.The assessee demonstrated that such approval was a condition precedent for share transfer and necessary to realize full sale value. The Tribunal accepted that the expenditure had direct nexus to sale and was allowable.Conclusion: The Tribunal allowed the expenditure as deductible against capital gains.Issue 5: Disallowance of Impairment of Goodwill while Computing Book Profit under Section 115JBLegal Framework: Section 115JB requires computation of book profit with certain adjustments enumerated in Explanation 1. The Supreme Court in Apollo Tyres Ltd. held that the Assessing Officer must accept accounts prepared under Companies Act unless adjustments are mandated by Explanation 1.Court's Reasoning: The AO disallowed impairment of goodwill (Rs. 155.71 crore) in book profit computation, treating it as a provision for diminution or revaluation reserve, relying on a Supreme Court decision on revaluation reserve (Indo Rama Synthetics).The CIT(A) found that the impairment was debited to profit and loss account, not a reserve or provision, and related to goodwill arising from amalgamation approved by the High Court. The Tribunal upheld CIT(A)'s reasoning, distinguishing the facts from Indo Rama Synthetics and relying on Apollo Tyres Ltd. and other judgments.Findings: The Tribunal noted the impairment was genuine, debited in audited accounts, and not covered by Explanation 1 clauses requiring add-back. The share premium and goodwill accounting were in accordance with scheme of amalgamation and Companies Act.Application: The Tribunal held that the AO was not justified in increasing book profit by the impairment amount for MAT purposes.Conclusion: The Tribunal dismissed Revenue's appeal and upheld the allowance of impairment of goodwill deduction.Issue 6: Addition on Account of Alleged 'On Money' Received on Booking of Flats/UnitsLegal Framework: Income must be substantiated and additions cannot be made on mere suspicion without corroborative evidence.Court's Reasoning: The AO made an addition of Rs. 50 lakh on estimation basis alleging receipt of 'On Money' due to variation in booking rates and discounts. The CIT(A) deleted the addition for lack of evidence and no inquiry from alleged parties.Findings and Application: The Tribunal agreed that varying discounts are commercially plausible and no concrete evidence was produced to show suppression.Conclusion: The Tribunal dismissed Revenue's appeal on this issue.3. SIGNIFICANT HOLDINGS'The expression 'commercial expediency' is an expression of wide import and it would include such expenditure, a prudent businessman incurred for the purpose of business. It may not be a legal obligation but it is allowable if it is incurred on the grounds of 'commercial expediency'.''If there are funds available, both interest free and interest bearing (overdraft, loans etc.), then a presumption would arise that funds deployed in corresponding non-earning investments/ advances is out of interest free funds available.''The expression 'for the purpose of business' under section 36(1)(iii) is far wider than 'for the purpose of making or earning such income' employed in section 57(iii) of the Act.''The Assessing Officer while computing the income under Section 115JB has only the power of examining whether the books of account are certified by the authorities under the Companies Act as having been properly maintained in accordance with the Companies Act. The Assessing Officer thereafter has the limited power of making increases and reductions as provided for in the Explanation to the said section. The Assessing Officer does not have the jurisdiction to go behind the net profit shown in the profit and loss account except to the extent provided in the Explanation to Section 115JB.''Mere variation in the rate of bookings of different units cannot ipso facto give rise to assumption of existence of 'On Money'.'Final determinations:The disallowance of interest expenditure under section 36(1)(iii) on advances to subsidiaries and group companies was not justified; the appeal of the assessee was allowed, and Revenue's appeal dismissed on this issue.The disallowance of foreign travel expenses was partly upheld; both parties' appeals dismissed.The disallowance of costs for projects not materialized under PoCM was disallowed; assessee's appeal allowed.The expenditure on approval for road construction related to share sale was allowed; assessee's appeal allowed.The addition on impairment of goodwill for MAT purposes was disallowed; Revenue's appeal dismissed.The addition on account of alleged 'On Money' was disallowed; Revenue's appeal dismissed.