MAYURESH PROTENZ PRIVATE LIMITED,MUMBAI vs. ASST. CIT 4(2)(2), MUMBAI

Aggrieved, the assessee preferred an appeal before the Tribunal.

The Ld. AR appearing for the assessee submitted that the Revenue authorities erred in constructing an artificial nexus between the two transactions merely on account of the coincidence of dates. The Ld. AR contended that during the entire financial year 2015-16, the assessee had given only one short-term advance of Rs. 2.00 crores to M/s Vicky Fashion Ltd. in furtherance of a probable future project, which was fully repaid within four months (by February 2016) along with interest at 12.75% p.a. The Ld. AR further pointed out that on 16th September, 2015, the assessee had also received Rs. 1,05,00,000/- from another unit and had sufficient independent bank balances to advance the said short-term loan without relying on the borrowed funds received from Gopal Barasia. The Ld. AR emphasized that the assessee's own surplus interest-free funds (share capital and reserves) stood at approximately Rs. 6.07 crores (average), which far exceeded the advance of Rs. 2.00 crores.

The Ld. AR further submitted that all borrowings were utilized exclusively for business purposes, resulting in an increase in turnover from Rs. 190.51 crores to Rs. 342.65 crores and in profit before tax from Rs. 34.03 lakhs to Rs. 6.05 crores. Without prejudice, the Ld. AR also submitted that there was no tax evasion or loss to the exchequer so as to attract the provisions of Section 40A(2)(b) of the Act. The lender, i.e. Shri Gopal Barasia, had already offered the interest income of Rs. 1,70,52,838/- in his return of income and paid tax thereon at the rate of 34.608%, which was higher than the assessee's applicable tax rate of 33.063%.

On the other hand, the Ld. Departmental Representative (DR) strongly relied upon the orders of the lower authorities and argued that borrowing at a higher rate and advancing funds at a lower rate on the very same day clearly established diversion of borrowed funds, thereby justifying the disallowance under Section 36(1)(iii) read with Section 40A(2)(b).

We have heard the counsels for both the parties, perused the material placed on record, the judgments cited before us, and the order passed by the Revenue Authorities.

From the records we noticed that, the core issue for consideration is whether the disallowance of interest expenditure amounting to Rs. 1,78,05,674/- made by the Assessing Officer under Section 36(1)(iii) read with Section 40A(2)(b) is sustainable in law. Therefore, we will examine as to whether there is, absence of Nexus and Sufficiency of Own Interest-Free Funds.

In this regard, we find that the Assessing Officer's disallowance rests entirely on the presumption of a nexus between the loan taken from Shri Gopal Barasia at 18% p.a. and the advance given to M/s Vicky Fashion Ltd. at 12.75% p.a., merely because both transactions took place on 16th September, 2015. However, the record establishes that the assessee had mixed funds and possessed sufficient interest-free reserves. The assessee's own interest-free funds (share capital and reserves) averaged around Rs. 6.07 crores (Rs. 3.76 crores as on 31.03.2015 and Rs. 8.39 crores as on 31.03.2016), which significantly exceeded the temporary advance of Rs. 2.00 crores given to M/s Vicky Fashion Ltd.

It is a well-settled proposition of law that the Hon'ble Supreme Court, in CIT v. Reliance Industries Ltd. [2019] 102 taxmann.com 52 (SC) and South Indian Bank Ltd. v. CIT [2021] 130 taxmann.com 178 (SC), has held that where an assessee possesses mixed funds or where its own interest- free funds exceed the investments or advances made, a legal presumption arises that such advances or investments were made out of its own interest- free funds and not out of interest-bearing borrowed capital. The same principle has been reiterated by the Hon'ble Jurisdictional Bombay High Court in PCIT v. Champaklal Bhupendra Dalal (160 taxmann.com 560) and PCIT v. Shapoorji Pallonji and Co. Ltd. (164 taxmann.com 707). Applying the ratio of the aforesaid decisions, since the assessee had adequate own interest-free funds to cover the advance of Rs. 2.00 crores, thus no disallowance under Section 36(1)(iii) is warranted.

Now as far as applicability of Section 40A(2)(b) and Revenue Neutrality is concerned we are of the view that under the circumstances the invocation of Section 40A(2)(b) by the AO is equally misplaced. The object of Section 40A(2)(b) is to prevent tax avoidance through excessive or unreasonable payments to related parties. As clarified in CBDT Circular No. 6-P dated 06.07.1968, the provision is intended to curb tax evasion and should not be applied so as to cause hardship in bona fide business transactions.

In the instant case, the lender/director, Gopal Barasia, is assessed at the highest tax bracket and has paid tax on the interest income received at the rate of 34.608%, whereas the Assessee Company's applicable tax rate is 33.063%. Thus, the transaction has resulted in a higher tax incidence in the hands of the recipient, and there is no loss of revenue or tax evasion whatsoever.

The Hon'ble Jurisdictional Bombay High Court in CIT v. Indo Saudi Services (Travel) (P.) Ltd. (310 ITR 306) held that where the Revenue is unable to demonstrate any tax evasion because the payee is paying tax at a higher rate, disallowance under Section 40A(2) on account of alleged excessive payment is unjustified. A similar view has been taken by the Hon'ble Gujarat High Court in PCIT v. Gujarat Gas Financial Services Ltd. (233 Taxman 532). Therefore, the allegation of unreasonable or excessive payment under Section 40A(2)(b) fails on the ground of revenue neutrality and absence of any intent to evade taxes.

Furthermore, the record reveals that the borrowings were utilized in a commercially prudent manner for business operations, as evidenced by the substantial increase in turnover and profitability.

In view of the facts and circumstances of the case and the judicial precedents discussed above, we hold that the disallowance of interest expenditure amounting to Rs. 1,78,05,674/- made under Section 36(1)(iii) read with Section 40A(2)(b) is wholly unjustified and unsustainable. Accordingly, the impugned addition is directed to be deleted, and the grounds raised by the assessee are allowed.

In the result, the appeal filed by the assessee stands allowed.