Commissioner of Income Tax vs Marudhar Chemicals and Pharmaceuticals P. Ltd.

Satish Kumar Mittal, J.—This order shall dispose of Income Tax Appeals Nos. 296, 341, 342 and 553 of 2007. In these appeals, the common questions of law and fact are involved. Out of these four appeals, three appeals, i.e., I. T. As. Nos. 296, 341 and 342 of 2007 have been filed by the Revenue, in which the following substantial question of law has been raised:

Whether, on the facts and circumstances of the case, the Income Tax Appellate Tribunal is right in law in upholding the order of the Commissioner of Income Tax (Appeals) in deleting the addition made by the Assessing Officer on account of notional interest on the money advanced by the assessee to their sister concerns, without charging any interest, in contradiction with the judgment of this Court in Commissioner of Income Tax-I Vs. Abhishek Industries Ltd., .

In the appeal, filed by the assessee, i.e., I. T. A. No. 553 of 2007, the following substantial question of law has been raised:

Whether, in the facts and circumstances of the case, the Income Tax Appellate Tribunal was right in disallowing the interest u/s 36(1)(iii) of the Income Tax Act on interest free loans granted to the sister concern, contrary to the judgment of the hon''ble Supreme Court in S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another,

The brief facts of the four appeals are as under:

I. T. A. No. 296 of 2007:

This appeal pertains to the M/s. Marudhar Chemicals and Pharmaceuticals Pvt. Ltd., Chennai, the assessee-company, for the assessment years 1997-98.

In this case, the assessee-company advanced an amount of Rs. 17,45,000 to the family members of its directors. No interest was charged from any of them, though the assessee-company itself paid interest of Rs. 6,30,108 on certain borrowings. The Assessing Officer, by calculating the interest on the aforesaid amount at 14 per cent., disallowed interest to the extent of Rs. 2,44,317, while holding that the advances made to those persons were for non-business purposes. On an appeal filed by the assessee, the Commissioner of Income Tax (Appeals), (hereinafter referred to as "the CIT(A)), Faridabad, deleted the said addition, while observing that since the Assessing Officer could not establish any nexus between advances given to the directors and their family members and to the CC limits availed of by the assessee-company, as the advances have been out of non-interest bearing credits available to the company. Therefore, in the facts and circumstances of the case, disallowance of interest paid to the bank to the extent of Rs. 2,44,317 made by the Assessing Officer was held to be not justifiable. The appeal against the said order filed by the Revenue has been dismissed by the Income Tax Appellate Tribunal, (hereinafter referred to as "the ITAT"), Delhi Bench "C", New Delhi.

T. A. Nos. 341 and 342 of 2007:

These two appeals pertain to the Palwal Co-operative Sugar Mills, Palwal, the assessee-company, for the assessment years 1996-97 and 1997-98.

In the assessment year 1997-98, the assessee-company had advanced a loan of Rs. one crore to M/s. Panipat Co-operative Sugar Mills Ltd., a sister concern, for a short period and no interest was charged on the said amount. It was also noticed that the assessee, by following the judgment of Commissioner of Income Tax-I Vs. Abhishek Industries Ltd., , borrowed a fund or raised loan on interest from financial institutions. The Assessing Officer held that the assessee-company has not given any reason for-non-charging of an interest on the aforesaid advance to its sister concern, therefore, the proportionate amount of interest on the said amount was disallowed out of interest charges claimed by the assessee and, consequently, an addition of Rs. 4,66,666 was made for the assessment year 1996-97. On the same reasoning, an addition of Rs. 8 lakhs was made for the assessment year 1997-98. The Commissioner of Income Tax (Appeals), Faridabad, deleted these additions while holding that the Assessing Officer was not correct in attributing interest income merely on notional basis to the assessee and it was incumbent upon him to establish income, substantially. It was further held that the Assessing Officer had not examined details of borrowed funds, the purpose for which funds were borrowed and the purpose for which the borrowed funds were utilized. It was further ''held that the Assessing Officer has not examined as to whether the interest-free advances were made by the assessee for business purposes or not. In fact, no finding to the effect that borrowed funds were utilized for non-business purposes was recorded. In view of these findings, it was held that the additions made by the Assessing Officer to the income of the assessee on notional basis were not justifiable. On appeal filed by the Revenue, the Income Tax Appellate Tribunal, Delhi Bench "C", New Delhi, has affirmed the order of the Commissioner of Income Tax (Appeals), Faridabad.

I. T. A. No. 553 of 2007:

This appeal pertains to Industrial Organics and Pharmaceuticals Ltd., Ludhiana, the assessee company, for the assessment year 1996-97.

In this case, the assessee advanced interest-free loan to its two sister concerns, namely, M/s. Himalayan Spinning and Weaving Mills Ltd. and M/s. Abhishek Industrial Corporation Ltd. The assessee claimed that these advances were being made out of share application money received in the earlier year and cash accruals of the company. The Assessing Officer rejected the contention of the assessee, while observing that all the accruals were deposited in the same CC account and payment of the loan was also made from this very account. Therefore, it was held that any non-business use of these balances would adversely affect the loan repayment and would thus increase the assessee''s interest liabilities. With this finding, an addition of Rs. 2,56,358 was made to the assessee''s income u/s 36(1)(iii) of the Income Tax Act, 1961 (hereinafter referred to as "the Act").

On appeal, filed by the assessee, the Commissioner of Income Tax (Appeals), Ludhiana, by following the decision of the Tribunal in the case of the assessee, pertaining to the previous year, deleted the said addition made on account of interest free advances made by the assessee to its sister concerns. Feeling aggrieved against the said order, the Revenue filed appeal before the Income Tax Appellate Tribunal, Chandigarh Bench (B), Chandigarh, prayed for setting aside of the order of the Commissioner of Income Tax (Appeals), Ludhiana, while relying upon the decision of this Court in (2006) 101 ITD 353 and the Income Tax Appellate Tribunal, Chandigarh Bench, Chandigarh, has set aside the order of the Commissioner of Income Tax (Appeals), Ludhiana, while observing as under:

Before us it was a common ground between the parties that the issue in question is liable to be decided in the light of the binding decision of the hon''ble jurisdictional High Court in the case of (2006) 101 ITD 353 . In this case, as is evident from the extract of the assessment order reproduced above, the assessee has not been able to substantiate that the amounts advanced free of interest were out of non-interest bearing funds. The hon''ble High Court in the case of (2006) 101 ITD 353 has held that once it is borne out from the record that the assessee had borrowed certain funds on which liability of interest is incurred and on the other hand, certain amounts had been advanced to sister concern or others without carrying any interest and without any business purpose, the interest to the extent of interest-free advance is disallowable u/s 36(1)(iii) of the Act. The said ratio is squarely applicable to the facts of the present case. Consequently, the stand of the Revenue deserves to be upheld. The decision of the Tribunal in the assessee''s own case for the assessment years 1993-94 and 1994-95 also does not help the assessee since the subsequent decision of the jurisdictional High Court in the case Commissioner of Income Tax-I Vs. Abhishek Industries Ltd., has to be applied. In the result, we set aside the order of the Commissioner of Income Tax (Appeals) and restore that of the Assessing Officer.

Mr. Yogesh Putney, Advocate, counsel for the Revenue, argued that the controvery raised in the aforesaid appeals has already been answered by this Court in (2006) 101 ITD 353 in favour of the Revenue. He submitted that u/s 36(1) (iii) of the Act, the assessee can claim deduction of interest on loans raised by him for the purposes. Once the assessee claims such deduction the onus lies on him to satisfy the Assessing Officer that whatever loans were raised by him were used for business purpose. In case, during the process of examination, it transpires that the assessee had advanced certain funds to its sister concern or any other person without any interest, then heavy onus lies on the assessee to establish that in spite of pending term loans and working capital loans on which the assessee is incurring liability to pay interest, there was justification to advance loans to sister concerns for business purposes. Learned Counsel submitted that this Court in Commissioner of Income Tax-I Vs. Abhishek Industries Ltd., has held that there must be a nexus between the use of the borrowed funds for the purpose of business to claim deduction u/s 36(1)(iii) of the Act and that being the position, there is no escape from the finding that interest being paid by the assessee to the extent the amounts are diverted to sister concerns on interest free basis are to be disallowed. Counsel argued that it was further held that a plea of the assessee that the amount advanced to its sister concerns free of interest was out of its capital would not be acceptable, when loan had been raised by the assessee at the time of disbursement of funds. It was further held that "the view that where the amount is advanced from a mixed account or share capital or sale proceeds or profits, it would not be deemed diversion of borrowed capital or that the Revenue had not been able to establish nexus of the funds advanced to the sister concerns with the borrowed funds, is not correct. Once it is borne out from the record that the assessee had borrowed certain funds on which liability to pay interest 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 u/s 36(1) (iii) of the Act."

In view of the aforesaid observations, learned Counsel for the Revenue submitted that in all these four cases it has been established from the record that the assessee had borrowed certain funds from the financial institutions on which they were incurring liability of interest and on the other hand, they have made advances to their sister concerns or their directors, without carrying any interest. The assessees have failed to establish that those advances were made to the sister concerns or their directors for any business purpose, therefore, the interest to the extent of advances without carrying any interest made to the sister concerns or to their directors is to be disallowed.

On the other hand, Mr. Anurag Bansal and Ms. Radhika Suri, advocates, counsel for the assessees, submitted that the assessees have advanced loans to their sister concerns or their directors not from the amount borrowed by the assessees from the bank, but from the share working liability, cash credit and the debit balance account, therefore, it was argued that there was no direct nexus between the amount borrowed by the assessees from the bank and the loan advanced to their sister concerns or the directors, as no amount was so advanced by raising an interest bearing loan. Learned Counsel for the assessees, while referring to the recent decision of the Supreme Court in S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another, , submitted that the real test to determine the question of allowability of interest on borrowed funds is whether this was done as a measure of commercial expediency. Learned Counsel submitted that before making addition in this regard, the Assessing Officer is required to record a finding as to whether the interest free loan was given to the sister concern as a measure of commercial expediency or not. If it is found that the said loan was not given to the sister concern as a measure of commercial expediency, then the said deduction cannot be allowed, but if a finding is recorded that the said advance was made as a measure of commercial expediency, then it should have been allowed.

We have considered the arguments of learned Counsel for the parties.

Section 36(1)(iii) of the Act provides that "the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession" has to be allowed as a deduction in computing the income u/s 28 of the Act. The expression "for the purpose of business" has been held to be wider in scope than the expression "for the purpose of earning income, profits or gains". It has been held in S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another, that when the assessee borrowed the fund from the bank and lent some of it to its sister concern as an interest free loan, then the real test to allow the interest as deduction u/s 36(1) (iii) of the Act is whether this was done as a measure of commercial expediency. It has been held that in order to claim a deduction, it is enough to show that the money is expended, not on necessity and with a view to direct and immediate benefit, but voluntarily and on account of commercial expediency and in order to indirectly to facilitate the carrying on the business. The expression "commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency. In S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another, , it was held that in order to decide whether it was for commercial expediency, the authorities and the courts should have examined the purpose for which the assessee advanced money to its sister concern and what the sister concern did with the money. It was further held that it is not relevant whether the assessee has utilized the borrowed amount in its own business or has advanced the same as interest free loan to its sister concern. What is relevant is whether the amount so advanced was as a measure of commercial expediency or not. It is not necessary that the amount so advanced is earning profit or not but there must be some nexus between expenses and the purpose of business.

In the light of the aforesaid judgment, we have gone through the impugned orders. In our view, the Income Tax Appellate Tribunal has not examined, considered and decided the matter in accordance with the aforesaid principle of law. In none of these cases, a finding has been recorded as to whether the interest free loan was given by the assessee to their sister concerns or their directors not as a measure of commercial expediency. Before disallowing the question of deduction of interest amount pertaining to the interest free loan advanced to the sister concerns or its directors, it is incumbent on the authorities to record such a finding. Therefore, we are of the opinion that the impugned orders, passed by the Income Tax Appellate Tribunal, are not sustainable and the same are, hereby, set aside. The matter is remitted to the Income Tax Appellate Tribunal to reconsider the matter in the light of the principle laid down by the Supreme Court in S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another, and then decide the matter accordingly. It is made clear that it will be open for the Income Tax Appellate Tribunal to seek the report of the Assessing Officer regarding any fact, which is relevant for the decision of the controversy, if the Income Tax Appellate Tribunal feels it just and necessary.

All the appeals are allowed to the extent indicated above.