TaxTMI 
TaxTMI 
2025 (12) TMI 667
X X X X Extracts X X X X
X X X X Extracts X X X X
....11.2016 declaring total income of Rs. 7,69,25,170/-. The case was selected for scrutiny and statutory notices were issued from time to time. After considering the material placed on record and after examining the withdrawals made by two of the partners from the overdraft account of the firm, the Assessing Officer determined the total income at Rs. 10,57,38,760/-, making a principal addition of Rs. 2,88,13,592/- under section 36(1)(iii) of the Act on account of alleged diversion of borrowed funds for non-business purposes. The Assessing Officer also initiated penalty proceedings under section 270A and computed interest chargeable under sections 234A, 234B, 234C and 234D. 2.2 The Assessing Officer noted in the assessment order that substantial withdrawals during the year were made by two partners, namely Smt. Ranjanben M. Patel and Shri Bhavya M. Patel, from the overdraft account maintained by the assessee with the bank. According to the Assessing Officer, these withdrawals were not supported by any business purpose, and the firm had not charged any interest on such drawings. The Assessing Officer traced the date wise utilisation of overdraft limits and concluded that the impugned....
X X X X Extracts X X X X
X X X X Extracts X X X X
....o- ordinate Benches in case of Xebec Exports [126 TTJ 190] (2009) - Delhi ITAT and in case of Torrent Financiers [73 TTJ 624] - Ahmedabad ITAT, to emphasise that no disallowance can be made if interest free funds available with the assessee exceed the interest free advances. 2.4 The assessee also argued before the CIT(A) that on a net basis, after adjusting interest receivable from one partner and interest notionally chargeable to others at 7.95 percent, the firm was required to pay net interest of only Rs. 56.58 lakh to partners, which demonstrated that interest bearing funds were not diverted. The assessee explained that the Assessing Officer had chosen to consider only the debit balances of two partners without appreciating that the firm had not paid interest to the partner who maintained a credit balance throughout the year. It was submitted that principles of equity required netting of interest receivable and interest payable. The assessee also relied upon the principle that when interest free funds and interest-bearing funds are mixed, a presumption arises that interest free funds are utilised first, as held in various judgments including the judgement of Hon'ble Supreme C....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d to be quashed and set-aside. 4. In law and in the facts and circumstances of the case of the Appellant, the Ld. CIT(A)- NFAC has erred in confirming addition of Rs. 2,88,13,592/- under section 36(1)(iii) of the Act without considering the availability of interest free funds available with the appellant. 5. Without prejudice to above, in law and in the facts and circumstances the Ld. CIT(A)- NFAC erred in confirming the levy of interest under section 234A/B/C/D. 6. Without prejudice to above, in law and in the facts and circumstances the Ld. CIT(A)- NFAC erred in initiating proceedings under section 270A of the Act. 7. The appellant craves leave to add to alter, amend and/or withdraw any ground or grounds of appeal either before or during the course of hearing of the appeal." 4. During the course of the appellate proceedings before us, the learned Authorised Representative (AR) invited our attention to the detailed financial workings and explanatory statements placed in the paper book, including Tables A, B and C as reproduced in the submissions before the lower authorities. It was submitted that these workings were already before the Assessi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ssment order but nevertheless treated the debit balances as an adverse factor for making the impugned disallowance, ignoring the non-cash nature of the diminution entry and the assessee's suo motu disallowance of the provision. 4.4 Proceeding further, the learned AR invited our attention to Table C reproduced at page 6 of the paper book, wherein the revised partners' capital balances have been tabulated after neutralising the diminution loss entry. It was pointed out that upon removing the non-cash diminution adjustment, the cumulative partners' capital as on 01.04.2015 stood at Rs. 97,46,33,899 and this figure increased to Rs. 1,22,07,59,057 as on 31.03.2016. It was therefore submitted that the assessee had substantial positive partners' capital both at the beginning and at the end of the year, and there was no factual basis for the conclusion reached by the Assessing Officer that interest bearing funds were diverted. 4.5 The learned AR then drew our attention to Annexure 2 placed at page 63 of the paper book, containing day-wise computation of interest free funds vis-à-vis withdrawals made by partner Smt. Ranjanben M. Patel. The learned AR explained that the assessee....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... business of ship recycling and that it has earned net profit of Rs. 5,43,19,491/- during the relevant previous year. It is also an admitted position emerging from the assessment order as well as the submissions recorded by the learned CIT(A) that the assessee incurred total interest expenditure of Rs. 10.63 crores and simultaneously earned interest income of Rs. 7.97 crores, leaving a net interest outgo of about Rs. 2.66 crores only. The Assessing Officer has not doubted the genuineness of the borrowings or their utilisation for business operations. The disallowance has been made solely on the footing that withdrawals by two partners, namely Smt. Ranjanben M. Patel and Shri Bhavya M. Patel, from the overdraft account resulted in negative balances in their capital accounts and that the interest paid to the bank on the overdraft to that extent was not for the purpose of business. 6.2 From the assessment order it is evident that the Assessing Officer has primarily proceeded on a comparison between the overdraft balance and the debit balances in the capital accounts of the two partners. The focus of the Assessing Officer is only on withdrawals during the year. While computing the n....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ree funds available on that date, being the aggregate of these three components, are thus Rs. 2,06,80,01,543/-. As on 31.03.2016 the corresponding figures are Rs. 90,44,18,032/- Rs. 90,04,162/- and Rs. 1,17,97,64,245/- respectively, aggregating to Rs. 2,09,31,86,439/-. These figures are not in dispute and are drawn from the very balance sheet which has been relied upon by the Assessing Officer for making the disallowance. The impugned withdrawals by the two partners, even taking the peak debit balances, are only a fraction of the aforesaid interest free funds. 6.5 The Assessing Officer as well as the learned CIT(A) have, however, treated the opening negative capital balances of two partners as an indicator that partners' capital as a whole was not available as interest free funds. In this regard the assessee has brought on record an important piece of factual explanation which, in our view, has considerable bearing on the controversy. Table B explains that the negative capital balance at the beginning of the year is on account of the book entry passed in financial year 2014-15 for permanent diminution in the value of investments amounting to Rs. 31,63,41,024/-. This diminution l....
X X X X Extracts X X X X
X X X X Extracts X X X X
....gain as a basis to infer that partners' capital stood eroded so as to deny deduction of interest on borrowings which are otherwise for the purposes of business. For the limited purpose of examining the availability of interest free funds in the context of section 36(1)(iii), what is relevant is the real pool of own funds and non-interest-bearing liabilities and not a notional reduction arising from a non- cash book entry. 6.8 We also find force in the submission of the learned authorised representative that both the Assessing Officer and the learned CIT(A) have unduly emphasised only the withdrawals from the capital accounts without giving due regard to the credits and additions therein during the year. The partners' capital accounts placed on record, including the summary extracted in the audited financial statements, show that besides the brought forward balances, substantial credits have arisen during the year on account of share of profit and, in the case of at least one partner, additional capital introduced. These credits have remained in the business and have not been treated as interest bearing loans. When partners' capital is seen on a holistic basis, comprising opening....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nstead, he has relied heavily on decisions, which primarily dealt with different factual situations such as tax avoidance through complex restructuring or advances to sister concerns without proof of commercial expediency. In all those cases the fundamental factual finding was that borrowed funds had indeed been diverted for non-business purposes and that the assessee had failed to demonstrate any nexus with business requirements. In the present case, the foundational fact itself is different. Here the assessee has demonstrated, through uncontroverted balance sheet figures and day wise workings, that it possessed ample interest free funds at all material times. The question of lifting the corporate veil or of examining commercial expediency in the context of advances to third parties does not arise in the same manner where the issue is simply whether partners' drawings can, by themselves, result in disallowance of interest even when the firm's own funds are adequate. 7. On the other hand, the principle emerging from the judicial precedents relied upon by the assessee, including the decisions of the jurisdictional High Court which have been cited before the learned CIT(A), is tha....