Interest disallowance on sister concern advances fails where sufficient interest-free funds exist and diversion of borrowed funds is not proved.

Where an assessee has substantial non-interest-bearing funds in the form of share capital and reserves exceeding the amount advanced to a sister concern, a presumption arises that the advance was made out of those free funds. As the Revenue did not rebut the availability of interest-free funds, the borrowed funds were not shown to have been diverted for non-business purposes, and the disallowance of interest expenditure under section 36(1)(iii) was deleted.

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Issues: Whether the disallowance of interest expenditure under section 36(1)(iii) of the Income-tax Act, 1961 was sustainable where the assessee claimed to have advanced funds to a sister concern out of non-interest-bearing funds.

Analysis: The assessee showed substantial non-interest-bearing funds in the form of share capital and reserves and surplus far exceeding the amount advanced to the sister concern. The Revenue did not rebut these figures. Applying the presumption that advances are made out of interest-free funds where such funds are available, the Tribunal held that the borrowed funds were not shown to have been diverted for non-business purposes.

Conclusion: The disallowance of interest expenditure under section 36(1)(iii) was deleted.

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