2025 (8) TMI 1688 - AT - Income Tax

Unsecured loans treated as unexplained cash credits under s.68 and taxed under s.115BBE; s.14A deleted; s.36(1)(iii) interest disallowed

Manglayatan Projects Pvt. Ltd. Versus Addl. CIT, Special Range-04, New Delhi

ITAT upheld the assessment treating unsecured loans as unexplained cash credits under s.68, holding the assessee liable to prove source and taxing the ... Addition u/s 68 - unsecured loans treated as unexplained cash credit - HELD THAT:- Higher onus is required to be placed on such companies to also prove the source of money, in the hands of such persons or business enterprises making payment or receiving funds. If the company fails to discharge the onus, the sum should be treated as income of the company and added to its income. Therefore, it is imperative for the assessee company to provide that the nature and source of any sum credited, as unsecured loan in its books, and the same can be treated as explained, only if the source of funds is also explained by the assessee company. The treatment of the amount as unexplained cash credit as per the provisions of section 68 of the Act has been done correctly in the assessment order and accordingly, it was correctly treated as income of the assessee company and taxed as per the provisions of section 115BBE of the Income Tax Act, 1961. Accordingly, the action of the Ld. CIT(A) is affirmed and Ground no. 1 is decided against the assessee. Addition u/s 14A - as per expenditure in relation to exempt income would be disallowed irrespective of the fact whether any exempt income is earned by the assessee - HELD THAT:- While making the said addition, the AO has failed to appreciate the ruling of Delhi High Court in the case of Cheminvest Limited [2015 (9) TMI 238 - DELHI HIGH COURT] wherein, it has been held that 'No disallowance u/s 14A can be made in a year in which no exempt income has been earned or received by the assessee'. Hence, in the present case, no exempt income was earned, thus, no addition should have been made u/s 14A of the Act. Accordingly, we delete the addition sustained by the Ld. CIT(A). Disallowing interest expenses u/s. 36(1)(iii) - interest-free advances to sister concerns - AR contention that funds borrowed were also given to the group concerns in earlier years but there had not been any disallowance of interest in the immediately preceding year - HELD THAT:- There is no 'commercial expediency'. Simply by saying that investment has been made for expansion of business or the ultimate company acquired by it is in the same business is not good enough to prove commercial expediency. The appellant has not been able to explain commercial expediency in advancing the money to the two sister concerns without charging any interest and there is no material on record to show that the appellant has derived any business benefit by way of such investment. The expression 'Commercial Expediency' is an expression of wide import and includes such expenditure as a prudent business entity incurs for the purpose of business. It is noted by the Hon'ble Supreme Court in S.A. Builders Ltd. [2006 (12) TMI 82 - SUPREME COURT] by holding that the correct approach to the issue of grant of deduction u/s 36(1)(iii) would be to examine whether the amount advanced to the subsidiary or associated company or any other party was advanced as a measure of commercial expediency and not from the point of view whether the amount was advanced for earning profits. It needs to be examined whether the amounts in question that were advanced to sister concerns without any interest were justified by reasons of commercial expediency or not. The assessee has provided justification in very casual and mechanical manner in its written submissions filed during appellate proceedings - Decided against the assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether unsecured amounts of Rs. 2,00,00,000 received from a related private company can be treated as unexplained cash credit under Section 68 where the purported creditor's bank deposits immediately precede issuance of cheques and the creditor did not charge interest despite paying substantial interest on its borrowings. 2. Whether disallowance under Section 14A (read with Rule 8DD) can be made for expenditure in relation to exempt income when no exempt income was earned in the relevant assessment year, in the light of administrative circulars and subsequent judicial rulings. 3. Whether interest deduction under Section 36(1)(iii) is allowable where borrowed funds on which interest is paid were advanced interest-free to group concerns/sister concerns, and whether such advances satisfy the test of 'commercial expediency' for allowing interest as business expenditure. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Treatment of Rs. 2,00,00,000 as unexplained cash credit under Section 68 Legal framework: Section 68 places onus on assessee to explain nature and source of any sum credited in its books as 'cash credit'; if explanation is not satisfactory, amount may be treated as unexplained cash credit and added to income. Special scrutiny is applied where transactions involve closely held companies and related parties. Precedent treatment: The Court applied established principles that in cases of closely held companies and related-party transactions, a higher onus lies on the assessee to prove genuineness and source of funds. Reference was made to the general approach of treating unexplained credits as income where onus is not discharged. Interpretation and reasoning: The Tribunal assessed contemporaneous facts: substantial cash deposits in the creditor's bank account just prior to issuance of cheques; unconvincing explanations by the creditor's director about source of funds; creditor had paid large interest on its own borrowings yet charged no interest on the alleged unsecured loan to the assessee; lack of documentary explanation by the assessee addressing specific issues raised by tax authorities. The Tribunal reasoned that no prudent business entity would forgo substantial interest income while paying interest on borrowings, and that transactions among entities under control of known persons warrant a stringent standard of proof regarding source of funds. Ratio vs. Obiter: Ratio - where related/closely held entities engage in large transfers and the creditor's own records show deposits just before transfers, combined with failure to provide satisfactory source explanations and absence of interest charged despite interest-bearing borrowings, the onus under Section 68 is not discharged and the amounts can be treated as unexplained cash credit. Obiter - general observations about higher onus in closely held company situations and commercial improbability of foregoing interest. Conclusion: The addition of Rs. 2,00,00,000 as unexplained cash credit under Section 68 was affirmed and taxed accordingly under Section 115BBE; Ground No. 1 decided against the assessee. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Disallowance under Section 14A when no exempt income arose Legal framework: Section 14A disallows expenditure incurred in relation to income which does not form part of total income (exempt income). Rule 8DD provides a methodology for computation of disallowance. Administrative directions (CBDT circulars) may guide departmental approach but are subject to judicial interpretation. Precedent treatment: The Tribunal noted a later judicial ruling by the jurisdictional High Court holding that no disallowance under Section 14A can be made in a year in which no exempt income has been earned or received. The administrative circular relied upon by the AO (which suggested disallowance irrespective of earning exempt income) was considered in light of that judicial pronouncement. Interpretation and reasoning: On facts, the assessee had investments but did not earn exempt income in the year under consideration. The Tribunal followed the High Court ruling that the statutory requirement (disallowance relates to expenditure in relation to exempt income) requires that if no exempt income is earned in the year, no disallowance can be made. The Tribunal treated the judicial decision as controlling over the departmental circular for this factual matrix. Ratio vs. Obiter: Ratio - where no exempt income is earned in the relevant year, no disallowance under Section 14A can be made for that year. Obiter - remarks concerning the timing and applicability of administrative circulars vis-à-vis judicial pronouncements. Conclusion: The Section 14A disallowance of Rs. 9,39,766 was deleted; Ground No. 2 decided in favour of the assessee. ISSUE-WISE DETAILED ANALYSIS - Issue 3: Disallowance of interest under Section 36(1)(iii) where borrowed funds were advanced interest-free to sister concerns Legal framework: Section 36(1)(iii) permits deduction of interest on capital borrowed 'for the purpose of business'. Precedent requires the assessee to prove that loans were raised for business purposes and that the claimed interest corresponds to borrowing used for business. The doctrine of 'commercial expediency' governs allowability where amounts are advanced to subsidiaries/associates; interest deductibility depends on whether advances were made as a prudent business measure. Precedent treatment: The Tribunal relied on Supreme Court jurisprudence establishing that advances to subsidiaries/associated companies may qualify if advanced out of commercial expediency and used for business purposes (the 'measure of commercial expediency' test). Earlier High Court cases were discussed historically; the Tribunal acknowledged that the law requires examination of business prudence from a prudent businessman's viewpoint. Interpretation and reasoning: Factually, the assessee paid interest on borrowed funds but advanced material amounts interest-free to two group concerns. The assessee's explanations - advances against intended land purchases that did not materialize, and alleged business need/temporary loans with intended commercial purpose - were found casual and inadequately supported. There was no material demonstrating that the advances produced any business benefit or were made as prudent commercial measures. The Tribunal held that merely asserting expansion or business relation is insufficient; the assessee bears heavy onus to show commercial expediency when borrowed funds are lent interest-free to related entities. Ratio vs. Obiter: Ratio - where an assessee borrows interest-bearing funds and advances those funds interest-free to related concerns without adequate evidence of commercial expediency or business benefit, interest deduction under Section 36(1)(iii) can be disallowed to the extent attributable to such advances. Obiter - discussion of relevant precedent history and principles governing 'commercial expediency' and onus of proof. Conclusion: The disallowance of interest amounting to Rs. 2,20,500 under Section 36(1)(iii) was affirmed; Ground No. 3 decided against the assessee. OVERALL RESULT The appeal was partly allowed: Section 68 addition upheld; Section 14A addition deleted; Section 36(1)(iii) disallowance upheld.