2006 (8) TMI 123 - HC - Income Tax

Interest deductions under section 36(1)(iii) disallowed for borrowings diverted as interest-free advances; sales-tax subsidy held revenue

HC allowed the Revenue's appeal, holding that interest deductions under section 36(1)(iii) are disallowable to the extent borrowings were diverted as ... Disallowance made on account of interest on interest free advances given to the sister concern for non-business purpose - addition on account of sales tax subsidy - Held that:- Once it is borne out from the record that the assessee had borrowed certain funds on which liability to pay tax is being incurred and on the other hand, certain amounts had been advanced to sister concerns or others without carrying any interest and without any business purpose, the interest to the extent the advance had been made without carrying any interest is to be disallowed under section 36(1) (iii) of the Act. Such borrowings to that extent cannot possibly be held for the purpose of business but for supplementing the cash diverted without deriving any benefit out of it. Accordingly, the assessee will not be entitled to claim deduction of the interest on the borrowings to the extent those are diverted to sister concerns or other persons without interest. Assessee will not be entitled to claim deduction of the interest on the borrowings to the extent those are diverted to sister concerns or other persons without interest; and the kind of sales tax subsidy received by the assessee in the present case is held to be revenue receipt and not capital in nature. It is evident from paragraph 5 of the order of assessment that initially while filing the return of income, the assessee treated the sales tax subsidy as a revenue receipt. Even though a revised return was filed by the assessee on August 12, 1994, still no claim was made for treating the sales tax subsidy as capital receipt as against revenue receipt, admittedly treated by the assessee in the return of income as revenue receipt. However, it was only at the time of framing of the assessment that the assessee changed its stand, where vide letter dated February 29, 1996, a plea was sought to be raised that the sales tax subsidy was inadvertently treated as a revenue receipt. Whether a plea in this manner, which runs contrary to the stand taken in the return filed by the assessee, could be taken without even filing the revised return within the time permitted, is a debatable issue. However, since the same is not under consideration before us in the present appeal, we are not opining thereon. Accordingly, the appeal of the Revenue is accepted and the substantial question, referred to above, is answered in favour of the Revenue and against the assessee, holding that the Tribunal was not right in deleting the additions on account of sales tax subsidy claimed by the assessee as capital receipt. Issues Involved:1. Disallowance of interest on interest-free advances to sister concerns for non-business purposes.2. Treatment of sales tax subsidy as capital receipt versus revenue receipt.Issue-wise Detailed Analysis:1. Disallowance of Interest on Interest-Free Advances to Sister Concerns for Non-Business Purposes:The primary issue was whether the interest on loans taken by the assessee and subsequently advanced interest-free to sister concerns should be disallowed under Section 36(1)(iii) of the Income-tax Act, 1961. The court noted that the assessee claimed that the advances were made from its own funds, not borrowed funds. However, the court emphasized that the entire money in a business entity comes into a common kitty and does not retain its original source identity. The court held that the assessee must prove that the borrowed funds were used for business purposes to claim interest deductions. The court observed that the loans raised by the assessee were used to supplement capital for setting up the industry, and if the share capital was surplus, it should have been used for the project itself rather than being lent interest-free to sister concerns.The court cited several precedents, including CIT v. Orissa Cement Ltd. and CIT v. Radico Khaitan Ltd., and concluded that the onus was on the assessee to prove the nexus between the borrowed funds and their use for business purposes. The court rejected the assessee's plea that the funds advanced were out of its own funds, noting that such a claim would amount to a camouflage. It held that the interest on borrowings to the extent diverted to sister concerns without interest should be disallowed, as such borrowings cannot be considered for business purposes.2. Treatment of Sales Tax Subsidy as Capital Receipt Versus Revenue Receipt:The second issue was whether the sales tax subsidy received by the assessee should be treated as a capital receipt or revenue receipt. The court referred to the provisions of Rule 4-A of the Punjab General Sales Tax (Deferment and Exemption) Rules, 1991, and the Supreme Court's judgment in Sahney Steel and Press Works Ltd. v. CIT. The court noted that the subsidy was available to the assessee after it came into production and was not linked to the creation of capital assets. The court observed that the subsidy was operational in nature, provided to assist the industry during its early days to become viable and competitive.The court emphasized that the subsidy was not for setting up the industry but to aid in its operation after production commenced. It cited several judgments, including CIT v. Chhindwara Fuels and CIT v. Ponni Sugars and Chemicals Ltd., to support its conclusion that such subsidies are revenue in nature. The court held that the sales tax subsidy received by the assessee was a revenue receipt and not a capital receipt.Maintainability of Appeal:The court addressed the issue of maintainability of the appeal based on the tax effect. It held that even if the tax effect was nil, the appeal was maintainable as the disputed amount could affect future taxability and revenue. The court referred to various judgments, including CIT v. Cameo Colour Co. and CIT v. Hero Cycles P. Ltd., to conclude that circulars prescribing limits for filing appeals are not binding on the Tribunal or courts, and the appeal should be decided on its merits.Conclusion:The court accepted the appeal of the Revenue, setting aside the Tribunal's order. It held that the assessee was not entitled to claim deduction of interest on borrowings diverted to sister concerns without interest and that the sales tax subsidy received was a revenue receipt, not a capital receipt. The court also criticized the Tribunal for not adequately considering the facts and legal principles in its decision.