Income Tax Appellate Tribunal - Lucknow
Meenakshi Synthetics (P) Ltd. vs Assistant Commissioner Of Income Tax on 21 June, 2002
Equivalent citations: [2003]84ITD563(LUCK), (2003)79TTJ(LUCK)423
ORDER
P.N. Parashar, J.M.
1. This appeal has been filed by the assessee against the order of the CIT(A), dt. 17th Nov., 1994, for the asst. yr. 1991-92.
2. Shri Rakesh Garg, advocate, appeared on behalf of the assessee, whereas Shri D.K. Shrivastava and Shri B.K. Bharadwaj, Sr. Departmental Representatives, represented the Department.
3. Ground Nos. 1, 2 and 3 are directed against the sustenance of disallowance of Rs. 1,31,701 on account of claim of deduction towards payment of interest.
4. The facts concerning this disallowance are as under :
The assessee-company had paid interest of Rs. 3,61,034 on the loans and advances taken by it and claimed deduction of this amount. On examination of the records of assessee, the AO found that as per Schedule VIII annexed to the balance sheet, the opening debit balances under the head "Loans and advances" was of Rs. 10,09,583 and the closing debit balance was at Rs. 8,78,012. The assessee had not charged any interest on the debit balance, whereas it was paying interest on the credit balance of the loans and advances taken by it. The AO required the assessee to explain as to why no interest was being charged on the debit balances. Vide reply dt. 29th March, 1994, it was stated on behalf of the assessee that the interest has not been accounted for on accrual basis for the reasons that the advances made were not interest-bearing. It was also submitted that the principal amount of Rs. 8,78,012 was itself doubtful of its recovery and was, therefore, likely to be written off and, thus, no purpose would be served if the interest is charged on it and, thereafter it is written off.
5. The AO did not accept this plea of the assessee and observed that if one has paid interest on the borrowed money, he is supposed to charge the interest. The AO after making reference to the decision of Karnataka High Court in the case of CIT v. V.N. Salgoancar (1992) 198 ITR 738 (Kar) and to the decision in the case of CIT v. Colandyve Colam (1975) WO ITR 629 (Mad) and the decision in the case of Addl. CIT v. A.K Laxmi (1978) 113 ITR 368 (Mad) disallowed the claim of the assessee relating to interest chargeable by the assessee on the debit balances of Rs. 8,78,012 @ 15 per cent p.a. on which the rate of interest the assessee was paying interest to the bank. On this basis, the AO disallowed the claim of the assessee to the extent of Rs. 1,31,701 out of interest paid by it on the borrowed money.
6. In appeal, it was contended before the CIT(A) that the assessee-company had two divisions, i.e., rubber division and warehousing division. It was demonstrated that the loans were taken in the rubber division for the business of retreading of tyres. It was also shown that the loans taken from Shri Vishwanath Gupta and Kashinath Gupta, HUF, were utilized for payment to Indag Rubbers Limited, whose franchisee the assessee held. Thus, it was pointed out that the loans taken were utilized for business purposes only and, therefore, no disallowance ought to have been made.
7. The learned CIT(A), however, did not accept the plea and confirmed the disallowance by observing as under :
"The argument placed on behalf of the appellant appears to be acceptable and convincing prima facie. But I do not agree with the same for the reason that no prudent businessman would borrow interest-bearing funds for one division while it advanced interest-free loans and advances to others. There is no commercial expediency involved in such an act either. Therefore, I fully agree with the action of AO on his issue. I also rely upon the Allahabad High Court decision in the case of CIT v. H.R. Sugar Factory (P) Ltd (1991) 187 ITR 363 (All). The disallowance made is hereby upheld. No interference is called for."
8. Before us, the learned counsel for the assessee, Shri Rakesh Garg pointed out that during this assessment year, no fresh advance was made. He also pointed out that in the earlier year also no disallowance was made as is evident on perusal from the order of learned CIT(A), dt. 27th May, 1994, for asst. yr. 1990-91, which is available at pp. 34 to 38 of the paper book. The learned counsel also invited our attention to the details of interest account for the year ending on 31st March, 1991, available at p. 5 of the paper book, according to which a sum of Rs. 3,51,351 was paid to the bank on term loan and vehicle loan and a sum of Rs. 10,115 was also paid. Thus, total interest paid during this year was at Rs. 3,61,496 (sic, 3,61,466). Referring to para 6 of the paper book, it was submitted by him that total amount of other loan taken by the assessee was at Rs. 6,44,154.38 on which no interest was paid.
9. On the basis of balance sheet as on 31st March, 1991, it was shown by him that the entire loan related to earlier years. This was illustrated by him by pointing out that in asst. yr. 1989-90, the secured loan was at Rs. 18,23,795.99 and unsecured loan was at Rs. 5,83,414.31, total Rs. 37,46,910.30, whereas in asst. yr. 1990-91, the secured loans were at Rs. 14,85,464.24 and unsecured loans at Rs. 7,45,126.90, the total Rs. 35,70,290.14 (sic 22,30,571.14). He also pointed out that there was similar decrease in the current liability as compared to earlier year, which was reduced from Rs. 17,26,796.51 in asst. yr. 1989-90 to Rs. 9,31,277.45 in asst. yr. 1990-91. In view of these figures, the learned counsel submitted that no loans were advanced during this year, rather the liability on account of loans was reduced by paying of some bad debts and further pleaded that the assessee had, on the other hand, taken interest-free advances/loans from others. According to the learned counsel, therefore, the learned CIT(A) was not justified in confirming the disallowance.
10. In support of his arguments, he placed reliance on the following decisions:
(1) ITO v. Naresh Ram (2000) 75 TTJ (Jd) 386;
(2) CIT v. Dalmia Cement (P) Ltd. (2002) 254 ITR 377 (Del);
(3) Torrent Financiers v. Asstt. CIT (2001) 73 TTJ (And) 787;
(4) Netherlands Steam Navigation Co. Ltd. v. CIT (1969) 74 ITR 72 (SC);
(5) CIT v. Sahni Silk Mills (P) Ltd. (2002) 253 ITR 294 (Del);
(6) G.R. Agencies v. ITO, a decision of Tribunal, Lucknow Bench rendered in ITA No. 625/All/1998 [reported at (2003) 79 TTJ (Lucknow) 426--Ed.].
11. On the other hand, learned Sr. Departmental Representative, submitted that if in earlier year, the disallowance was not made against the claim of deduction on account of interest, this by itself cannot bind the AO as each assessment year is a separate and independent assessment year.
12. In support of this contention, the learned senior Departmental Representative placed reliance on the following decisions :
(a) CIT v. H.R. Sugar Factory (P) Ltd. (1991) 187 ITR 363 (All);
(b) CIT v. Saraya Sugar Mills (P) Ltd. (1992) 193 ITR 575 (All);
(c) CIT v. Saraya Sugar Mills (P) Ltd. (1993) 201 ITR 181 (All);
(d) CIT v. Saiaya Sugar Mills (P) Ltd- (1993) 201 ITR 711 (All);
13. According to the learned Sr. Departmental Representative, in view of the decision of Allahabad High Court in the case of CIT v. H.R. Sugar Factories (supra), the claim of the assessee for deduction on account of interest is not allowable.
14. We have carefully considered the facts and circumstances relating to this matter, the material to which our attention was invited and the rival submissions. The claim of the assessee as put in the written submission dt. 10th Oct., 1994, before the learned CIT(A), (page Nos. 1 to 4 of the paper book), was that the funds borrowed on which interest were paid have all been utilized by the rubber division and have nothing to do with the loans and advances made by the assessee. It was further explained that the rubber division was mainly having loans and advances from the bank and outside parties, whereas the loans and advances made amounting to Rs. 8,78,012 pertained to mostly warehousing division, where no borrowed funds were utilised. It was also informed that even if the funds have been borrowed in the warehousing division, the same were interest-free and it is out of the interest-free funds that interest-free loans and advances have been made. It was also stated that there is no controversy or dispute that the loans borrowed have not been borrowed for the purpose of business and interest has not been paid on the same.
15. The learned CIT(A) has rejected this plea by saying that no prudent men would borrow interest-bearing funds for one division, while it advanced interest-free loans on advances to others. According to him, there was no commercial expediency involved in such an act either. The learned CIT(A), however, has not recorded any finding on the following issues :
(i) Whether any part of borrowed funds was diverted for non-business purposes by making advances to some persons without charging interest
(ii) Whether the assessee had borrowed funds for business purposes and whether any part of such borrowed funds was diverted or utilized for non-business purposes or for making interest-free advances
(iii) Whether the assessee had non-interest bearing funds available with it and whether such non-interest-bearing funds were more than the advances made free of interest or not Since the averments of the assessee on the above-mentioned issues were very specific and further since these averments have not been found to be incorrect, it can safely be inferred that the assessee was in possession of deposits/credits or funds, which were non-interest bearing. Neither the AO nor the learned CIT(A) have given finding that interest-bearing funds were diverted for non-business purposes or that there was a nexus between the borrowed interest-bearing funds and advance of interest-free loans.
16. In the light of the above facts, we have to decide the issue relating to disallowance of a sum of Rs. 1,31,701 out of interest of Rs. 3,61,034 claimed by the assessee.
17. The issue relating to allowability of claim of deduction on account of interest paid by the assessee under Section 36(1)(iii) of the Act has been considered by various Courts. Under the old Act of 1922, similar provisions existed under Section 10(2)(iii) of the old Act. This issue arose in the case of Calico Dyeing & Printing Works v. CIT (1958) 34 ITR 265 (Bom). In that case, it was held by the Hon'ble Bombay High Court that where the assessee claims deduction of interest paid on capital borrowed under Section 10(2)(iii) of IT Act, all that the assessee had to show is that the capital, which was borrowed, was used for the purposes of the business of the assessee in the relevant year of accounts.
18. In the case of Amna Bai Hajee Issa v. CIT (1964) 51 ITR 835 (Mad), it was held by the Hon'ble Madras High Court that in deciding the claim for interest on borrowing, the fact that the assessee had ample resources at its disposal and need not have borrowed, is not a relevant matter for consideration. According to the Hon'ble Court, the matter to be decided is whether the amount of interest was paid, in fact, in respect of capital borrowed for business.
19. In the case of Rama Krishna Oil Mills v. CIT (1965) 56 ITR 186 (MP), the Hon'ble Madhya Pradesh High Court held that the only conditions required to be satisfied in order to enable the assessee to claim a deduction in respect of interest under Section 10(2)(iii) are, firstly, that money must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business and thirdly, the assessee must have paid interest on the said amount and claimed it as a deduction.
A relevant part of the observation of the Hon'ble High Court is being reproduced below :
"Under Section 10(2)(iii) for a claim for deduction of interest under that provision all that is necessary is that, first, the money, that is capital, must have been borrowed by the assessee; secondly, it must have been borrowed for the purposes of the business, profession or vocation of the assessee; and, thirdly, the assessee should have paid this amount as an allowance under that clause. This clause makes no distinction between the capital borrowed in order to acquire a revenue asset and the amount borrowed to acquire a capital asset, and it does not provide that for the purposes of business the borrowing of capital should have been necessary, so that if at the time of borrowing the assessee had sufficient money of his own to invest in the business then the deduction cannot be allowed. Again, the interest paid is also not subject to the test of reasonableness, When the ITO finds that the borrowing transaction was not illusory or colourable and that the capital was borrowed by the assessee for the purposes of the business and the amount of interest was paid, then the claim made by the assessee for deduction on account of the interest paid on borrowed capital has to be allowed."
20. The above-mentioned three decisions were considered by Hon'ble Bombay High Court in the case of CIT v. Bombay Samachar Ltd. (1969) 74 ITR 723 (Bom). In that case, the assessee-company which was carrying on business as a publisher of Gujarati newspaper called "Bombay Samachar" had borrowed certain funds and paid interest on the same. The assessee claimed deduction on account of payment of interest. It was found that there was amount due to the assessee from M/s Cama Norton & Co.. Likewise, the assessee made advances to another company, namely, Bombay Chronicle (P) Ltd. The ITO disallowed the claim of deduction on the grounds that the assessee should not have advanced money to Bombay Chronicle without charging interest and should have collected the amount from the other company, namely, M/s Cama Norton & Co. to reduce its liability of interest. The learned CIT(A) justified the disallowance of interest. The contention of the assessee, before the Tribunal was that no specific item of borrowal was relatable to the advances to Bombay Chronicle (P) Ltd. As regards Cama Norton & Co., it was claimed that the balances to the credit of the assessee arose on account of business transaction in paper. The Department's case was that the borrowings on which interest was paid would have been partly or wholly unnecessary, if these large amounts were not due from or had been repaid by Bombay Chronicle (P) Ltd. or Cama Norton & Co., as the case may be. The Tribunal, after considering the facts and conditions of the case, held that when loans have been outstanding for several years and when the interest was paid only on the same and when there is no proof of any borrowed amount having been diverted for any non-business purposes, the assessee is held to be eligible for the claim for deduction of interest. The Hon'ble Bombay High Court upheld the view taken by the Tribunal. A part of the relevant observation of the Hon'ble Court is being reproduced below :
"In our opinion the view taken by the Tribunal is correct and must be upheld. From the facts which have been already stated, it will be clear that the balance due from the Bombay Chronicle (P) Ltd. was not in respect of any loans advanced by the assessee to it, as considered by the ITO and the AAC(P). The said balance was in respect of the common account between the parties in connection with the expenditure in relation to the business agreed to be incurred in common and allocated in shares at the end of the year. Similarly the amount due from M/s Cama Norton & Co., in the calendar year 1954, did not constitute any loan advanced by the assessee to M/s Cama Norton & Co., but constituted the outstandings in connection with certain business transactions. The capital borrowed by the assessee from outsides on the other hand was admittedly used by the assessee for the purpose of its business and it was also undisputed that no part of the borrowed capital had been utilized for the purpose of advancing loans either to M/s Bombay Chronicle (P) Ltd. or to M/s Cama Norton & Co. In these circumstances, it is difficult to see how the assessee's claim for the interest actually paid by it could be disallowed."
21. The issue relating to necessary conditions for allowing the claim of deduction under Section 10(2)(iii) and 10(2)(xv) of IT Act also came for consideration before the Hon'ble Supreme Court of India in the case of Madhav Prasad Jatia v. CIT (1979) 118 ITR 200 (SC). In that the case, the assessee had donated a sum of Rs. 10,00,000 to an engineering college and she paid a sum of Rs. 5,00,000 after borrowing the same from bank. The remaining amount of Rs. 4.5 lakhs was shown as loan of the institution. The Hon'ble Supreme Court of India affirmed the view of Hon'ble Allahabad High Court and held that the borrowing of Rs. 5.5 lakhs was made by the assessee to meet her obligation and not the obligation of her business and as such the expenditure incurred by the assessee by way of interest thereon was not for carrying on the business or in her capacity as a person carrying on that business. Regarding the necessary conditions for allowability of deduction, the Hon'ble Court observed as under :
"Proceedings to consider the claim for deduction made by the assessee under Section 10(2)(iii) or Section 10(2)(xv), we may point out that under Section 10(2)(iii) three conditions are required to be satisfied in order to enable the assessee to claim deduction in respect of interest on borrowed capital, namely, (a) that money (capital) must have been borrowed by the assessee, (b) that it must have been borrowed for the purpose of business, and (c) that the assessee must have paid interest on the said amount and claimed it as a deduction."
22. The scope of term "the purposes of business" appearing in Section 10 of old Act, 1922, was considered by the Hon'ble Calcutta High Court in the case of CIT v. Tingri Tea Company (1971) 79 ITR 294 (Cal). In that case, the assessee, a sterling company, which owned tea garden in India and was a non-resident company remitted profits from time to time to the United Kingdom for the purposes of declaration of dividend to its shareholders and the surplus balance, after paying dividends was kept with the bank in the United Kingdom deposit. During, the relevant accounting years, the assessee-company paid interest accruing on its overdrafts to the banks in India and claimed deduction of the amounts paid, as interest paid on money borrowed for the purpose of its business. This claim was rejected on the ground that overdrafts from the bank were not incurred wholly and exclusively for the assessee's business. The AAC also found that the company had made remittances to U.K. by taking overdrafts from the banks in India and the borrowings from the banks in India were partly invested in earning interest income in United Kingdom The Tribunal was of the opinion that correct way to interpret the transaction would be that the remittances to the United Kingdom came out of profits in India and the bank overdrafts in India had, in fact, been utilized in carrying on the overseas business and, thus, IT authorities were not justified in disallowing any part of bank interest paid by the assessee in India on its bank overdrafts. It was held by the Hon'ble Calcutta High Court that the inference of the Tribunal that remittances to the U.K. came out of profits earned in India and the bank overdrafts in India, had in fact, been utilized in carrying on assessee's business was sustainable in law and on such inference of findings of fact, the Tribunal was right in holding that the IT authorities was not justified in disallowing any part of bank's interest on the overdrafts.
23. The Hon'ble Allahabad High Court also considered the issue relating to interest on advances and foregoing of interest in the case of Tnveni Engg. Works Ltd. v. CIT (1987) 167 ITR 742 (All). In that case, the assessee had claimed deduction on account of interest on the amounts borrowed from the bank and also on the interest of arrears of cane purchase tax and interest on advances foregone by the assessee. The Tribunal in that case held that the interest on advances foregone by the assessee was not deductible and a part of the interest on borrowed capital was also disallowed, because it was found that it represented a loan given by the assessee to another concern. The Hon'ble High Court observed that the assessee had not been able to prove that the disputed part of the amount taken as loan from the bank was used for business purposes or that the advance to the other concerns had been made for business purpose. In view of this finding, the disallowance of part of interest was found to be justifiable. So far as the interest, which was claimed to have been foregone for reasons of commercial expediency, the matter was remanded to the Tribunal on the ground that the Tribunal had not brought all the necessary facts on record showing what commercial expediency the assessee had in mind.
24. The other important case in which the issue was considered by the Hon'ble Allahabad High Court was that of CIT v. H R. Sugar Factory (P) Ltd. (supra). In that case, the assessee, a private limited company, which carried business of manufacturing of sugar, had advanced huge amounts of loan to its directors at the rate of 5 per cent p. a. whereas it was paying interest at the rate of 8 per cent p.a. on the moneys borrowed by it from banks. In the previous year relevant to asst. yr. 1963-64, the interest payable by the directors on the amounts borrowed by them from the assessee was reduced to 2.5 per cent in pursuance of a compromise decree of civil Court. The bank continued to charge interest @ 8 per cent on the loans advanced to the assessee. The ITO as well as the first appellate authority held that the difference between the interest paid to the bank and interest recovered from the directors on the loans advances to them could not be said to have been incurred on the capital borrowed for purposes of business and disallowed the difference between the interest paid to the bank and interest recovered from the directors The Tribunal, however, deleted the disallowance. On reference, the disallowance of interest was upheld by the Hon'ble High Court by observing as under :
"Held, that the assessee was not a finance company. It was engaged in the manufacture of sugar. No business purpose was served by the advances to its directors. The amount of interest payable in each year on account of the loans to the directors was very large and this fact could not be glossed over by saying that the amount was not substantial in each of the relevant years. The company might have borrowed large amounts for the purpose of its business every year, but that did not explain the huge advances to the directors/shareholders. Had this money been not advanced to the directors, it would have been available to the assessee for its business purposes and to that extent it might not have been necessary to borrow from the bank. Therefore, the ITO was right in disallowing the difference between interest paid to the banks and interest recovered from the directors under Section 36(1)(iii) of the IT Act, 1961."
25. It may be pointed out that in the case H.R. Sugar Factory (P) Ltd. (supra); there was a direct nexus between the borrowed funds and the funds advanced at a very low rate to its directors. After examining the scheme and device adopted by the assessee and also the volume of advances made by it and rate of interest charged from directors, it was found that the amount of interest paid each year payable on account of the loans to directors, was substantial and by the compromise decree, the limit of amounts to be lent to the directors was further raised and at the same time the rate of interest was also drastically reduced. The Hon'ble High Court also observed that in view of these facts, it is clear that the directors/shareholders were taking unfair advantage of their control over the assessee and they were exploiting it for their private ends. It was also held that what has happened in this case was self-evident i.e., the assessee was made to pay huge amounts by way of interest on account of heavy amounts advanced to its directors bearing no relation whatsoever with the business purpose of the assessee.
26. It may also be pointed out that in the case of H.R. Sugar Factory (P) Ltd. (supra), it was not the case of the assessee that it had other funds with it, which were interest-free or it had advanced loans to the directors, which were not out of the borrowed funds. Thus, there was clear-cut nexus between the borrowed funds and funds advanced to the directors on which lesser rate of interest was charged. The present case is, therefore, distinguishable on facts, inasmuch as in this case the specific plea of the assessee was that interest-bearing funds were utilized for business purposes and advances without charging interest were made out of interest-free amount available with it.
27. The decision in the case of H.R, Sugar Factory (P) Ltd. (supra) was considered by the Hon'ble Allahabad High Court in the case of CIT v. Saraya Sugar Mills (P) Ltd. (1992) 193 ITR 575 (All). In that case, the assessee had claimed deduction of amount paid by it towards interest on borrowed funds. The ITO found that out of the money so borrowed from the bank, a substantial portion was lent to the directors free of interest. Similar loans were also extended to a firm in which the directors of the assessee were interested. The ITO was of the opinion that interest relatable to the amount lent to the firm cannot be granted deduction, because it cannot be said that money to that extent was borrowed for the purpose of the said company. The Tribunal reduced the disallowance of interest. The Hon'ble Allahabad High Court held that since the amounts advanced were quite substantial and it was a continuing course of conduct and was not an isolated transaction, under these circumstances, the principle laid down in the decision of H.R Sugar Factory (supra) clearly applies. The matter again came for consideration before the Hon'ble Allahabad High Court in the case of CIT v. Saraya Sugar Mills (P) Ltd. (1993) 201 ITR 181 (All). On the facts of the case, it was found that there was a company, which had taken overdraft from the bank, part of which was diverted to the directors and other firms, in which the directors of the company were substantially interested. On such advances, no interest was charged from the directors, The assessing authority held that the amount was advanced to the directors and the firms by the assessee-company from the overdrafts for non-business purposes and, therefore, the interest paid by the company to the bank was disallowed to that extent. Following its earlier decision, in the case of CIT v. Saraya Sugar Mills (P) Ltd (1992) 193 ITR 575 (All), the issue was decided in favour of the Revenue and against the assessee by the Hon'ble High Court. It may be pointed out that as in the case of H.R. Sugar Factory (supra), in the two cases of Saraya Sugar Mills (P) Ltd. (supra) referred to above, a direct nexus was found to have been established between the borrowed funds and the advances made free of interest by the assessee and there was a categoric and clear finding by the IT authorities that a part of the borrowed money was diverted towards interest-free advances or for non-business purposes. To reiterate, it was not the claim of the assessee in these cases that it had its own funds or deposits or free of interest capital, which was advanced to the directors or the firms without charging interest. Thus, the abovementioned cases are distinguishable on facts from the cases where it is a positive assertion of the assessee that interest-free advances are given out of interest-free capital available with the assessee.
28. The issue relating to interest on borrowed capital was also considered by the Hon'ble Madhya Pradesh High Court (Indore Bench ) in the case of D&H Secheron Electrodes (P) Ltd. v. CIT (1983) 142 ITR 528 (MP). In that case, part of interest was disallowed by the Tribunal on the ground that no interest was charged by the assessee on the advances made to the sister concern. The Tribunal had not recorded any finding that capital borrowed was not for the purposes of business. The Hon'ble Madhya Pradesh High Court held that this ground alone cannot justify disallowance of interest if other conditions required under Section 36(1)(iii) are satisfied.
29. In the case of CIT v. Hotel Savera (1999) 239 ITR 795 (Mad), the Hon'ble Madras High Court also considered the issue. In that case, the Tribunal found that the total amount in the partners' capital and current account was greater than the amount advanced to the private company, It was also found that the amount borrowed by the firm was mixed up with its own funds. Under these circumstances, the Tribunal raised a presumption that the amount had been advanced by the firm from its own fund. On this presumption, the Tribunal allowed the entire amount of interest on borrowed capital. The finding of the Tribunal that no part of interest should be disallowed, specially in absence of any finding that the borrowed money was advanced to the private limited company free of interest was upheld by the Hon'ble Madras High Court. In taking this view, the Hon'ble Madras High Court also followed the decision of Hon'ble Gujarat High Court in the case of Shree Digvijay Cement Co. Ltd v. CIT (1982) 138 ITR 45 (Guj).
30. In that case, reference has also been made to the observation of Sampath lyengar's Law of Income-tax, 9th Edition, p. 2349, which is as under :
"For the same reason a presumption appears to be permissible that where the assessee has his own capital as also the borrowed funds, the former rather than latter to have been utilized for the non-business or personal expenses."
31. The issue also came before the Hon'ble Delhi High Court in the case of Regal Theatre v. CIT (1997) 225 ITR 205 (Del). In that case, the assessee-firm, which was carrying on cinema theatre business and was also running a restaurant, claimed deduction under Section 36(1)(iii) of the IT Act, 1961, of a sum of Rs. 26,108 being interest paid on capital borrowed for the purpose of business. The IT Act disallowed deduction to the extent of Rs. 23,166 on the ground that partners' account showed debit balances and no interest was charged on these debit balances. The explanation of the assessee-firm was that originally a loan was taken in order to purchase machinery, etc. and that there were debit balances because of depreciation allowed in earlier years on the fixed assets and that according to the terms of agreement amongst partners, no interest was to be charged on these debit balances. The contention of the assessee was rejected by the ITO, who held that the assessee should have returned loans to the creditors instead of permitting the partners to draw excess money in their account and that since the assessee had been paying interest @ 12 per cent on borrowed money, interest at this rate of average debit balances in the capital account could not be deducted. The learned CIT{A) modified the figures by working out the figure of diversion of loans for non-business purposes. The Tribunal, however, agreed with the ITO and held that since a major part of borrowings had been diverted by the assessee to its non-business purposes, the deduction was justifiable. Hon'ble Delhi High Court, however, reversed the view taken by the Tribunal by observing as under :
"Held, that the finding arrived at by the Tribunal that a part of the borrowings had been diverted by the assessee to its non-business purposes was not a finding of fact, but was an inference drawn by the Tribunal on the basis that the interest paid on the capital borrowed was not in law an allowable deduction from the profit, in case the profit minus depreciation was not in excess of the withdrawals made by the partners and in such a case, the withdrawals should be deemed to be in part from the capital account and would mean that the original borrowings were utilized for other purposes and not for business purposes. The Tribunal ignored the law laid down by the Supreme Court in Madhav Prasad Jatia v. CIT (1979) 118 ITR 200 (SC) and the Bombay High Court in CIT v. Bombay Samachar Ltd. (1969) 74 ITR 723 (Bom) that once the three conditions laid down in Section 36(1)(iii) were satisfied, the deduction under the section must be given. Again, the contention that the correct amount of debit balance to the account of the partners should be taken on Rs. 1,73,643 instead of Rs. 1,93,049 as calculated by the ITO was again a figure arrived at as a matter of law. Therefore, the Tribunal was not correct in holding that a part of the borrowings had been diverted by the assessee for its non-business purposes and that the assessee was not entitled to claim deduction of the interest on those borrowings under Section 36(1)(iii) of the Act."
32. In the case of CIT v. Sahni Silk Mills (P) Ltd. (supra), the assessee had charged interest at 12 per cent from 3 parties to whom advances were made. It was found that the assessee had paid interest at 16 per cent on its borrowed funds. The ITO disallowed Rs. 51,528 being the difference between the interest on advance at 12 per cent and interest on borrowings at 16 per cent. The learned CIT(A) upheld the disallowance. On further appeal, the Tribunal held that the interest paid cannot be subject-matter of the test of reasonableness and hence the ITO was in error to determine as to what rate of interest should have been charged. The Tribunal also held that the borrowing transactions were not unreal and that the capital was borrowed by the assessee for the purpose of business and the amount of interest was paid as claimed and, therefore, there was no scope for determining the rate of interest, which would be reasonable. The Hon'ble Delhi High Court upheld the view taken by the Tribunal and declined to answer the question referred to it.
33. In the case of CIT v. Dalmia Cement (P) Ltd. (2002) 254 ITR 377 (Del), the assessee had borrowed moneys from financial institutions and paid interest of Rs, 14,59,816 thereon. The AO made a reduction in the allowance of interest on the basis that the deposits had been collected by the sole selling agent towards disputed sales-tax and the deposits had been allowed by the assessee to be retained by the sole selling agent. The CIT(A) allowed the claim for deduction of interest in full on the admitted position that the sole selling agent was handling sales-tax returns which were filed by it and sales-tax assessments Were made on it and the deposits collected were either to be refunded to the customers or paid to the Government. The Tribunal affirmed the decision of the CIT(A). On a reference, the Hon'ble High Court affirmed the decision of Tribunal and held that if all the requisite conditions in Section 36(1)(iii) for allowance of interest were fulfilled, it was not possible and open for the Revenue to make a part of disallowance, unless there was a positive finding recorded that a part of the amount borrowed was not used for the purpose of the assessee's business.
34. It may be pointed out that in this case, the Hon'ble Delhi High Court has considered various decisions including the decision in the case of Bombay Samachar (supra), and the decision in the case of Madhav Prasad Jatia (supra), the reference to which have been made out above and in view of the ratio of the decision of Hon'ble Supreme Court in the case of Madhav Prasad Jatia (supra), observed that the scope for allowing a deduction under Section 36(1)(iii) is much wider than the one available under Section 57(iii) of the Act.
35. In the case of the CIT v. Sridevi Enterprises (1991) 59 Taxman 439 (Kar), the Hon'ble Karnataka High Court has held that if on the balance from a person no interest was charged against that advance and even if the person to whom the advance was made was having close relationship with the assessee, then also the deduction cannot be disallowed to the extent of interest-free advances standing in the name of person in whose name advance was made on the ground that the amount borrowed was not utilized by the assessee for its own business. It was also held that if no addition has been made in earlier year, the opening balance could not be considered in the year in question and the inquiry had to be limited only to the increase in the year in question,
36. The Tribunal Ahmedabad 'A' Bench also considered this issue in the case of Torrent Financiers v. Asst CIT (2001) 73 TTJ (And) 624. The Bench after considering the various cases including the decisions of Hon'ble Allahabad High Court in the case of Triveni Engg, Works (supra) and H.R. Sugar Factory Ltd (supra), has observed as under :
"10. We have heard the representatives of both the parties. Perused the records and gone through the cases referred/cited by both the parties. Under the facts and circumstances, the learned CIT(A) has found that borrowed funds have been diverted partly for non-business purposes, therefore, the AO was justified in making disallowance. It has been further found by CIT(A) that in view of the fact that the assessee was also having interest-free loans, the disallowance made by the AO cannot be sustained in totality. Therefore, it was concluded by learned CIT(A) that interest has to be disallowed only in respect of amount representing the difference between the interest-free advances made by assessee and interest-free funds available to the assessee and accordingly amount was calculated and the disallowance was restricted to Rs. 1,38,492. We uphold the above view of CIT(A) with an exception about the interest-free loans available with the assessee is to be considered, with this modification, the finding of learned CIT(A) is confirmed. The entire interest-free funds include owner's own capital, accumulated profits and other interest-free creditors and loans, if total interest-free advances including debit balances of partners do not exceed the total interest-free funds available with the assessee, no interest is disallowable on account of utili2ation of fund for non-business purposes and if it exceeds, the proportionate disallowance can be made."
The Ahmedabad Bench of Tribunal in the above-mentioned case placed reliance on the judgment of Hon'ble Calcutta High Court in the case of CIT v. Tingri Tea Co. Ltd. (supra), and held that profits earned, own capital and interest-free loans received, can be given advances as interest-free advances and to that extent question of disallowance of interest on borrowed funds does not arise.
37. The Tribunal, LucKnow Bench, has also considered the issue in the case of G.R. Agencies v. ITO, Ward 2 and vide its order, dt. 31st Oct., 2002, rendered in ITA No. 625/A11/98 (supra) and after considering the facts of that case, the claim of the assessee was allowed on the ground that advances made to various parties were prior to the borrowings and the Department was not able to prove that the borrowed funds were not utilized for business purposes and no nexus could be established by the Department between the borrowed funds and the advances made by the assessee free of interest.
38. On the basis of ratio of decisions referred to above, it can be said that non-charging of interest on loans given by the assessee cannot by itself be a sufficient ground for disallowing the interest paid by the assessee on the loans taken by it in absence of any nexus having been brought on record between the borrowed capital and interest-free advances or in absence of any finding that borrowed funds or part thereof, was diverted towards interest-free advances made by the assessee.
The above view is also supported by the orders of the Hon'ble Benches of Tribunal in the following cases :
(a) Oswal Industries v. Asstt. CIT (2000) 109 Taxman 279 (Mum);
(b) Dy. CIT v. Shivalik Agro Poly Products Ltd. (2000) 108 Taxman 219 (Chd);
(c) Smt Tara Devi v. ITO (2000) 68 TTJ (Jd) 361; and
(d) Dy. CIT v. Ganesh Chhababhai Valabhai Patel Family Trust (2000) 108 Taxman 78 (Ahd).
39. On the basis of analytical study and examination of propositions laid down in the above-mentioned decisions and relevant material including the provisions contained under Section 36(1)(iii) of IT Act, 1961, the following guiding postulates may be logically deduced and laid down :
(i) The requisite conditions for allowability of the claim under Section 36(1)(iii) of the Act are that-
(a) that the capital must have been borrowed by the assessee;
(b) it must have been borrowed for the purpose of business; and
(c) the assessee must be paid interest on the borrowed amount and must have claimed it as a deduction.
(ii) If the assessee makes a claim of deduction in terms of Section 36 of the Act for the purpose of computation of income referred to in Section 28 of the Act, he has to place material in support of his claim of entitlement to the deduction. It, therefore, follows that the assessee has a legal obligation to satisfy the assessing authority that he is entitled to obtain deduction in accordance with the taxing statute. In other words, the burden to establish that the borrowed fund was utilized exclusively for the business purpose is on the assessee. This proposition is supported by the decision of Hon'ble Orissa High Court in the case of Indian Metals and Ferro Alloys Ltd. v. CIT (1992) 193 ITR 344 (On).
(iii) The ITO concerned has to examine the issue relating to the utilization of the borrowed funds by taking into account the time of borrowing, the purpose of borrowing and purpose for which borrowed funds were utilized.
(iv) If it is found that the entire borrowed funds were utilized for business purposes alone and no part of such fund was diverted for non-business purpose, the deduction claimed by the assessee should not be disallowed.
(v) If it is found that the assessee while paying interest on borrowed funds also advanced loans to family members, friends, relations, partners of the firm, directors or sister concerns or others, then it is to be seen as to whether these non-interest bearing funds were advanced out of interest-bearing loans or out of interest-free deposits, loans or profits available with the assessee. In case the assessee succeeds in showing that at the time of making interest-free advances, it/he had more interest-free deposits or funds than advanced by it, then no disallowance of the claim of interest should be made merely because the assessee had any past borrowed funds and by not advancing interest-free loan, it could have reduced interest liability, unless it is found that the motive of the assessee was to take undue advantage by diverting its funds for non-business purposes.
(vi) So far as charging of interest or the rate of interest on advance funds is concerned, each case should be examined in the factual background and the context of business expediency. Since the rate of interest is based on various conditions generally, there should be no scope to determine the reasonableness of the rate of interest. This view was also taken by Hon'ble Delhi High Court in the case of Sahni Silk Mitts (P) Ltd. (supra).
(vii) So far as old interest-bearing borrowings or old interest-free advances are concerned, the justification for continuing the same can be given by the assessee by explaining circumstances and business expediency,
(viii) If the interest-free advances were made prior to the interest-bearing borrowings, then the mere fact that the interest-free advances were not recovered by the assessee should, by itself, not be a sufficient ground to disallow the claim of deduction of interest on subsequent borrowings. For disallowing the claim on this basis, the version of the assessee should be considered properly. This view is supported by the decision of Tribunal, Lucknow Bench in the case of G.R. Agencies rendered in ITA No. 625/All/98, dt. 31st Oct., 2001 (supra).
(ix) No disallowance should be made when money had been advanced in earlier years and no addition was made in the earlier years on such advances on account of interest-free advances in earlier years. As held in the case of Sridevi Enterprises (supra), if no addition has been made in earlier years, then the opening balance should not be considered in the year in question and the inquiry is to be limited only to the increase in the year in question. This approach will also be in consonance with the rule of consistency and definiteness, because the Revenue cannot be allowed to re-examine the nature of accounts maintained by the assessee and concluded assessments should not be ignored without actually reopening the assessment.
(x) The test to be applied for considering part of borrowed advances used for interest-free advances is as to whether or any part of the advances made free of interest, is out of borrowed funds and if it is so, then the disallowance can be made only in relation to the advance made out of or from the borrowed funds.
(xi) The entire interest-free funds include owner's own capital, accumulated profits and other interest-free credits and loans. If total interest-free advances including debit balances of partners do not exceed the total interest-free funds available with the assessee, no interest is disallowable on account of utilization of funds for non-business purposes and if it exceeds, the proportionate disallowance can be made. This view is supported by the decision of Hon'ble Calcutta High Court in the case of CIT v. Tingri Tea Co. Ltd. (supra) and also by the decision of Tribunal Ahmedabad, 'A' Bench in the case of Torrent Financiers v. Asstt. CIT (supra).
(xii) It may be clarified that while applying the above propositions, the facts and circumstances of each case including entire, relevant position of accounts books of the assessee should be thoroughly examined to find out the nexus between the borrowed funds and the interest-free advances. After the assessee claims and proves that borrowed funds were utilized only for business purposes, the burden will shift to the Department to disprove such claim and for doing so the Department has to establish clear nexus between the borrowed funds and the interest-free advances. In this regard, the Department may also bring on record the collusive conduct of the assessee and design of tax evasion on his or its part by bringing on record the true nature of transactions, the colourable device, if any, and for that purpose, positive findings based on cogent material should be recorded.
40. Viewed in the context of the above propositions, it has to be seen as to whether the interest-free advances made by the assessee during the current year are out of the borrowed funds or out of the other interest funds available with the assessee, Since the assessee has placed the photocopies of the account books before us, to justify the claim that the interest-free advances were made out of the interest-free funds available with it, we have to allow the claim, of the assessee subject to the condition that the facts and figures placed before us, are verified by the AO. In case it is found that at the time of making interest-free advances, the assessee had more interest-free funds available with it than the interest-free advances made by it and it is also found that no part of borrowed capital were diverted towards interest-free advances, then the claim of assessee for deduction of interest is to be allowed. In view of the above, the claim of the assessee is to be considered subject to verification and in the light of above propositions. This ground is, therefore, decided accordingly.
Ground No. 441. This ground challenges the sustenance of disallowances of Rs. 2,432, Rs. 6,930 and Rs. 2,200. The assessee claimed that these payments were made to M/s Mallick Fire Service for purchase of raw materials. So far as the amount of Rs. 2,200 is concerned, as observed by the learned CIT(A) in para 11 of his order, the learned counsel for the assessee accepted that this payment has been debited twice in the books of account. Thus, this amount was rightly upheld by the learned CIT(A). The amount of Rs. 6,930 comprised of three bills of Rs. 2,832, Rs. 2,532 and Rs. 1,566. These bills could not be produced by the assessee and, therefore, the disallowance was rightly made by the learned CIT(A). The last amount of Rs. 2,432 was disallowed, because proper verification could not be made regarding this payment. It was also found that the Mallick Tyres Ltd. also did not maintain any books of account.
42. The learned counsel for the assessee pleaded before us that the payments are not held to be bogus nor excessive and, therefore, could not have been disallowed. After going through para 11 of the order of the learned CIT(A), we find that he has rightly upheld the disallowances. The AO has observed that the assessee had not been able to reconcile the discrepancies in relation to these payments. Since the assessee could not produce the bills in respect of these payments and further since these payments were not verifiable, the AO was justified in disallowing the payments and treating the same as bogus payment. The learned CIT(A), thus, has rightly upheld the action of the AO. We, therefore, do not find any scope to interfere in the findings recorded by the learned CIT(A). This ground is, therefore, decided against the assessee.
Ground No. 5143. This ground is directed against the sustenance of disallowance of sum of Rs. 3,412 claimed as depreciation on television purchased for a sum of Rs. 13,650.
44. The learned CIT(A) has considered the issue in paras 9 and 10 of his order. The claim of the assessee was that the television was purchased for displaying tyre process in the market. The AO rejected the plea of the assessee and held that since the television was being used for personal work and not for business work of the assessee, the depreciation claimed on the television to the extent of Rs. 3,412 was not allowable.
45. Before the learned CIT(A), it was claimed that a special audio visual cassette was prepared for displaying the process of retreading the tyres to prospective customers in smaller town and, thus, the television was used for business purposes only. The learned CIT(A) rejected the plea of the assessee and agreeing with the AO, he affirmed the disallowance by observing as under:
"10. I have considered the argument placed before me but I would agree with the AO that a television set alone cannot play audio visual cassettes without VCR attachment. The total expenditure on the purchase of television is shown at Rs. 13,650 only, from which it is obvious that it does not include the cost of a VCR. Therefore, the argument placed on behalf of the appellant" that the television was used for business purposes is not acceptable. The action of the AO is justified and calls for no interference."
46. Before us, the submission of the learned counsel for the assessee that television was a business necessity and is a part of customer's relationship.
47. The learned Sr. Departmental Representative, on the other hand, pointed out that the arguments that the video was hired for making demonstration was not taken before the AO and is an afterthought.
48. We have considered the entire relevant material. The assessee has not been able to give any details of demonstration or display of any programme relating to business activities of the assessee. Hence, the business necessity for purchasing the television has not been established and proved. We, therefore, uphold the view taken by the learned CIT(A). Consequently, ground No. 5 is rejected.
Ground No. 649. Ground No. 6 is directed against the sustenance of disallowance of Rs. 10,000 in respect of use of cars by the directors. The assessee had claimed a sum of Rs. 1,65,887 under the head "Administration and General Expenses". This also included travelling expenses The directors were allowed free use of the car by the assessee-company. The AO was of the view that the personal use of the car by the directors cannot be ruled out. On that ground, he made a disallowance of Rs. 10,000 under Section 40A(2) of the IT Act, 1961, which was upheld by the learned CIT(A).
50. Before us, the contention of the learned counsel for the assessee was that in the case of the company, the disallowance was not legally maintainable under Section 40A(2) of the Act, because company is a separate person and cannot do anything personally. According to the learned counsel for the assessee, addition on account of personal user of the car may be made by treating it as perquisite in the hands of directors and not in the hands of the company. In this regard, reliance was also placed by him on CBDT Circular No. 66 of 1968.
51. The learned Sr. Departmental Representative, on the other hand, placed reliance on para 12 of the order of learned CIT(A).
52. We have considered the facts and circumstances relating to this issue. As pointed out by the auditors, the company had allowed free use of the car by the directors. Thus, this was the facility given to the directors by the company and was a perquisite in their hands. In view of this position, disallowance cannot be sustained in the hands of the assessee-company. We, therefore, accept the argument of the learned counsel for the assessee and delete this disallowance. Thus, ground No. 6 is allowed in favour of the assessee.
Ground Nos. 7 & 853. These grounds are directed against upholding of disallowance of Rs. 14,000 being retainership fee paid to the tax advisers.
54. The assessee had paid a sum of Rs. 24,000 to the retainers. Since it was beyond the limit of Rs. 10,000 prescribed under Section 40A(12), the excess amount of Rs. 14,000 was disallowed by the AO under Section 40A(12) and the same was added to the income of the assessee.
55. In appeal, the learned CIT(A) upheld the action of the AO.
56. Before us, the learned counsel for the assessee submitted that the retainership fee falls under the head "business expenditure" and, therefore, the limit laid down under Section 40A(12) was not applicable. In support of his contention, he placed reliance on the decision of K.L. Poddar & Sons (P) Ltd. v. CIT (1991) 191 ITR 365 (Kar). In the case of K.L Poddar & Sons (P) Ltd. (supra), the Hon'ble Karnataka High Court has allowed a similar claim of the assessee observing as under :
"It is a well-known fact that retainer fees are paid towards general consultations, may be under particular legislation. A counsel is retained so that the assessee may have the benefit of proper legal advice as and when problems arise. The assessee may also resort to a consultation with the tax consultant for the purpose of tax planning. There may be other questions arising in the course of the assessee's business touching upon the taxation laws. These problems cannot be separated itemwise nor can the fee paid to the consultant regarding income-tax cases before the authorities and fee paid regarding other matters be apportioned. The retainer fee is to be considered as one entity for the entire services kept ready by counsel as and when the assessee seeks the advice.
In the instant case, the Department has not questioned the genuineness of the payment. The question involved is under what head the deduction is to be granted. If the payment is attributable to the expenditure referred to under Section 37, the same cannot be partially disallowed by shifting a portion as falling under Section 80VV. In the instant case, that is what has been done."
57. In view of the decision, the claim of deduction of the assessee was allowable. The learned CIT(A) has not considered the issue from the angle of business expenditure. Hence, we reverse his finding and allow the claim of the assessee by following the decision of Karnataka High Court in the case of K.L. Poddai & Sons (supra) against which no other authority was cited by the learned Sr. Departmental Representative. Thus, the disallowance of Rs. 14,000 is deleted. These grounds are allowed in favour of the assessee.
58. In the result, the appeal is partly allowed.