THE COMMISSIONER OF INCOME TAX, COCHIN vs. O E N INDIA LTD.,

The issue stands covered in favour of the assessee and against the Revenue by the decisions of the Hon'ble Supreme Court in CIT v. Lakshmi Machine Works, [2007] 290 ITR 667 and CIT v. Catapharma (India) Pvt. Ltd., Appeal (Civil) No.3204/2007 dated 23.07.2007. The question stands answered in favour of the assessee and against the revenue.

There is a further question urged by the Revenue, which is re-framed as follows:- Whether the First Appellate Authority and the Tribunal were correct in following its earlier decisions to find the disallowance of interest income on loans given to subsidiary companies to be bad for reason only of the assessee having own funds; especially when there is no examination of the quantum of funds available with the assessee ?

We see that the First Appellate Authority had merely referred to the earlier order of the Tribunal and reversed the disallowance of interest. The assessee admittedly had advanced certain amounts, interest free to subsidiary companies. The assessee at the same time had borrowed funds, towards which the assessee had interest liability and was paying it; which was claimed for deduction. The Assessing Officer found that the assessee had borrowed funds from other institutions on which interest was paid, claimed as expenditure. Hence, the deduction towards interest paid on advances, were disallowed proportionately, on the ratio of the borrowed funds and own funds.

The learned Senior Counsel, Government of India (Taxes) would rely on the decision in C.I.T. v. V.I.Baby & Co., [2002] 254 ITR 248, wherein a Division Bench of this Court upheld the principle of such proportionate disallowance.There the assesee had availed advances which carried interest, which was claimed as an allowance. At the same time the assessee had debit balances in the accounts of its partners, their relatives and sister concerns; which did not - 4 - carry any interest. The assessee claimed that it had sufficient cash balance to make the interest free advances. It was also argued that the partners have utilised the money for making investments in the nature of construction of shop building etc, which were for business purposes. The Division Bench found that the investments made by the partners, only benifitted them and not the firm. As far as the assessee firm is concerned the debit balances were only interest free advances made by it to its partners. As for having sufficient cash balance, it was held, then there was no requirement to take advances with interest liability. The principle of propotionate reduction of interest claimed as allowance, as against interest free advances, was upheld.

S.A. Builders v.CIT (Appeals),[2007] 288 ITR 1 was a case in which the assessee was found to have made huge interest free advances to its sister concern; while claiming allowance for the interest paid on its advances from Banks. The assessing officer disallowed the interest, in proportion to the interest relating to the (interest free) advances made by the assessee to - 5 - its sister concern. The assessee claimed that they had own funds received from their own clients, which was utilised to make the interest free advances to the sister concern. Essentially it was argued that the advances to sister concern had no nexus with the interest bearing advances of the assessee. The Hon'ble Supreme Court found the allowance enabled by Section 36(1)(iii) to be for the amount of interest paid in respect of capital borrowed for the "purposes of business or profession"; which has a wider scope than for the "purpose of earning income, profits or gains". The test to be applied in such a case of interest free loans having been granted; was to examine whether this was done as a measure of commercial expediency. It was held so:

The expression

The High Court and the other authorities should have examined the purpose for which the assessee advanced the money to - 6 - its sister concern, and what the sister concern did with this money, in order to decide whether it was for commercial expediency, but that has not been done.

It is true that the borrowed amount in question was not utilised by the assessee in its own business, but had been advanced as interest-free loan to its sister concern. However, in our opinion, that fact is not really relevant. What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency. xxx xxx xxx

We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (B) Ltd., [2002] 254 ITR 377 that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure

We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the - 7 - assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the Directors of the sister concern utilise the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans."

In view of the binding declaration by the Hon'ble Supreme Court V.I.Baby & Co. looses its precedential sheen insofar as a mechanical disallowance of interest in proportion to that amounts advanced free of interest. We notice that the quantum of borrowed funds and own funds have not been gone into by any of the authorities nor has the aspect of business or commercial expediency engaged the attention of either the assessee or the A.O. In such circumstances, we direct the Assessing Officer to look into the matter afresh based on the principles laid down by the Supreme - 8 - Court. The appeal is partly allowed. No order as to costs. K.VINOD CHANDRAN JUDGE ASHOK MENON dkr JUDGE - 9 -