ROSHNI BEGUM,JAIPUR vs. DY. CIT, JHUNJHUNU(RAJASTHAN), JHUNJHUNU

This appeal by the Assessee is directed against the order of the learned Additional/Joint Commissioner of Income Tax (Appeals)-4, Kolkata [hereinafter referred to as “the learned CIT(A)”] dated 13.01.2026 arising out of the assessment order dated 11.09.2018 passed by the Deputy Commissioner of Income Tax, Circle Jhunjhunu (hereinafter referred to as “the AO”) under section 143(3) read with section 254 of the Income Tax Act, 1961 (hereinafter referred to as “the Act”) for the assessment year 2012-13.

Briefly stated, the facts of the case are that the assessee, an individual, runs a hotel, bar and restaurant at Taranagar. She filed her return for the year under consideration on 19.09.2012 declaring total income of Rs 30,77,340. In the original assessment completed under section 143(3) of the Act on 13.01.2015, the AO disallowed interest of Rs 32,77,827 under section 36(1)(iii) of the Act, holding that interest bearing funds had been diverted to interest free advances and non business investments. This is the second round of litigation on that issue. Its journey so far is summarised below:

On the assessee’s appeal, the Tribunal, in paragraph 4.1 of its order dated 06.04.2017, observed and directed as under:

In the set aside proceedings, the AO treated the loans from three persons, aggregating to Rs 66,22,436 and carrying interest at 9%, as interest bearing. The AO worked out the interest free funds (capital plus the remaining unsecured loans) at Rs 3,99,87,239 as on 31.03.2012. Against this, the AO placed the advances to Metro Colonizers India Ltd. (Rs 4,29,44,975), Kohinoor Bar & Restaurant (Rs 13,06,039) and Shri Manoj Khan (Rs 22,16,118), the investment in agricultural land (Rs 16,30,000) and the investment in shares of Metro Colonizers India Ltd. (Rs 75,99,600), totalling Rs 5,56,96,132. The shortfall of Rs 1,57,08,893 was treated as interest bearing funds diverted to sister concerns. As no data for the year of the original investment (financial year 2005-06) was furnished, the AO presumed that the position of that year was similar to that of assessment year 2008-09. Relying on S.A. Builders Ltd. v. CIT [2007] 288 ITR 1 (SC), the AO held that commercial expediency was not proved,

Before the learned CIT(A), the assessee contended that the advances were made in earlier years out of interest free funds, that the assessments for assessment years 2007-08, 2008-09 and 2010-11 were completed under section 143(3) of the Act without any such disallowance, and that the AO had travelled beyond the remand. The learned CIT(A) issued a notice dated 23.12.2025 setting out a fund position as on 31.03.2011 and 31.03.2012 and calling upon the assessee to show cause why a proportionate disallowance under section 36(1)(iii) of the Act should not be made. The learned CIT(A) then held that (i) the issue had never been examined in earlier years and res judicata does not apply to income tax proceedings; (ii) once an enquiry is made, the onus lies on the assessee to prove that the advances were not made out of interest bearing funds; and (iii) the Tribunal had restored the issue for decision afresh, and even if the advances were made earlier out of interest free funds, what mattered was that they were financed out of interest bearing funds as on date. The learned CIT(A) also treated personal assets such as property and jewellery of Rs 50,16,877 as utilisation of interest free funds, computed the funds diverted at Rs 2,07,26,371, enhanced the disallowance to Rs 26,75,774 and dismissed the appeal.

The learned Authorised Representative (hereinafter referred to as “the learned AR”) relied on the written submissions and the paper book. It was submitted that the Tribunal had restored the issue for the limited purpose of verifying whether the advances were made in earlier years out of interest free funds; that the advance of Rs 4,29,44,975 to Metro Colonizers India Ltd. has remained unchanged over the years; that no fresh interest free advance was made during the year; and that the scrutiny assessments of

The learned Departmental Representative (hereinafter referred to as “the learned DR”) relied on the orders of the authorities below. It was urged that the assessee failed to prove that the advances and investments were made out of interest free funds, and that commercial expediency was not established before either authority.

We have heard both sides and perused the material on record. The scope of the second round is set by the Tribunal’s direction quoted in paragraph 4 above. The Tribunal did not leave the issue open at large. It restored it to the AO to verify a specific claim, namely, whether the advances had been made in earlier years out of the interest free funds then available. That direction binds the AO and the learned CIT(A) alike. Judicial discipline requires a lower authority to carry out a remand direction as it stands, and not to substitute a different test of its own. The learned CIT(A) observed that even if the advances had been made in earlier years out of interest free funds, that would not help the assessee. That observation sets aside the very test that the Tribunal laid down, and it cannot be sustained.

The relevant figures, as they appear in the AO’s order, the learned CIT(A)’s order and the paper book, are tabulated below. The interest free funds are as computed by the AO himself in Table B of the show cause notice dated

Three facts emerge from the record. First, the advance to Metro Colonizers India Ltd., which accounts for about 92% of the interest free advances, stood at the same figure of Rs 4,29,44,975 from assessment year 2008-09 onwards. The balance sheet of that company as at 31.03.2011 and 31.03.2012 (paper book pages 22 and 23) confirms the same unchanged figure. No part of it was advanced during the year under consideration. Second, on the AO’s own figures for assessment year 2008-09, the interest free funds of Rs 4,41,18,953 exceeded the advances to Metro Colonizers India Ltd. and Kohinoor Bar & Restaurant of Rs 4,37,45,740 taken in the AO’s Table C. The AO arrived at a shortfall in that year only by adding the investment in shares and the agricultural land, and in doing so presumed that the position in financial year 2005-06 mirrored that of assessment year 2008-09. Third, during the year under consideration the aggregate interest free advances fell by Rs 17,58,341, while the capital of the assessee rose by Rs 18,52,632. The increase of Rs 5,25,274 in the balance of Kohinoor Bar & Restaurant was far outweighed by the repayment of Rs 22,83,615 by Shri Manoj Khan. The loans from the three lenders were, by 6

Section 36(1)(iii) of the Act allows the interest paid on capital borrowed for the purposes of the business. The disallowance therefore has to rest on a finding that borrowed capital was in fact used for a non business purpose. A comparison of closing balances alone does not supply that finding where the advances are old balances carried forward and no fresh outflow has taken place. A balance sheet is a photograph of a date; it does not by itself tell the story of where the money went. Where interest free funds were available when the advances were made, the presumption is that the advances came out of those funds. In Hero Cycles (P.) Ltd. v. CIT [2015] 379 ITR 347 (SC), the Hon’ble Supreme Court held as under in paragraph 16:

We agree with the learned CIT(A) that res judicata does not apply to income tax proceedings, and we do not rest our decision on that doctrine. However, the scrutiny assessments for assessment years 2007-08, 2008- 09 and 2010-11 are relevant for a different reason. They show that the advances and the investments existed and were before the AO in those years, which supports the assessee’s claim that these were made in earlier years. The Tribunal had asked precisely that question. The AO answered it not by verifying the source of funds in the year of the investment but by a presumption. The learned CIT(A) went further, and added personal assets and jewellery of Rs 50,16,877 to the uses of funds, an item that was never part of the disallowance in either round. A disallowance built on presumption, and widened in the second round beyond what the Tribunal restored, cannot be sustained.

In view of the above, we hold that the advances and investments in question were made in earlier years out of interest free funds, that no borrowed capital of the year has been shown to have been diverted to them, and that the conditions for a disallowance under section 36(1)(iii) of the Act are not satisfied. The disallowance of Rs 20,28,018 made by the AO, as enhanced to Rs 26,75,774 by the learned CIT(A), is deleted. Ground No. 1 is allowed.

Ground No. 2, raised without prejudice, challenges the enhancement on the ground of non compliance with section 251(2) of the Act. As the entire 8