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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI GEORGE GEORGE K. & Ms. PADMAVATHY S
Per Padmavathy S., Accountant Member This appeal is against the order of the Commissioner of Income Tax (Appeals) – 3, Bangalore dated 10.01.2020 for the assessment year 2016-17.
The assessee is into the demerged business of leasing buildings and prior to demerger the business of leasing was carried on along with the business of manufacturing high reliability electromagnetic components and providing integrated engineering services under the name of M/s Hical Technologies Private Limited. In a composite scheme of arrangement and its sanction by the High Court of Karnataka vide order dated 18.9.2015, the
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manufacturing, design and engineering business of Hical Technologies Private Limited was demerged into Hical Aerospace Private Limited and the leasing business was retained by the assessee. The scheme also approved change of name of Hical Technologies Ltd renamed as Hical Infra Pvt. Ltd (demerged company and the assessee herein) and Hical Aerospace Pvt. Ltd (resulting company) renamed as Hical Technologies Ltd. [para 7.7 of the scheme – page 118 of the paper book].
The assessee filed the return of income for the year under consideration declaring an income Rs.1,13,60,920. Subsequently the assessee filed a revised return on 15/03/2018 with a revised income of Rs.86,62,050. The case was selected for scrutiny and notice u/s.143(2) was issued and served.
The AO passed the assessment order u/s 143(3) dated 28/12/2018 by making disallowance under section 36(1)(iii) of the Income-tax Act, 1961 [the Act] in respect of interest paid amounting to Rs. 78,11,581. The AO also held that out of interest expenditure of Rs. 78,11,581, TDS has not been paid in respect of interest expense of Rs. 67,04,528 and hence 30% of the said expenditure amounting to Rs. 20,11,358 is to be disallowed under section 40(a)(ia). As the entire interest expenditure of Rs. 78,11,581 was disallowed under section 36(1)(iii), it was stated that the disallowance of Rs. 20,11,358 will be enforced based on the findings in favour of the Assessee (if any) by the appellate authorities at a later stage. Aggrieved by the assessment order, the assessee filed the appeal to CIT(A).
The learned CIT(A) vide order dated 10.1.2020 dismissed the appeal and upheld the addition made by the AO under section 36(1)(iii) and 40(a)(ia) of the Act.
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Aggrieved by the CIT(A) order, the assessee has filed this appeal. The grounds of appeal are as under :-
General Ground 1.1 The learned Deputy Commissioner of Income Tax (OSD), Range 3(1), Bangalore [ ‘AO’] erred in passing the order under section 143(3) of the Income-tax Act, 1961 [‘the Act’] in the manner passed by him and the Commissioner of Income Tax (Appeals)-3, Bangalore [‘CIT(A)’] erred in upholding the said order of the learned AO. The order of the CIT(A) being bad in law is liable to be quashed in its entirety. 2.0 Grounds relating to disallowance under section 36(1)(iii): 2.1 The learned CIT(A) has erred in concurring with the learned AO in disallowing interest expenditure of Rs. 78,11,581 under section 36(1)(iii). 2.2 The learned AO has erred in disallowing interest expenditure amounting to Rs. 78,11,581 under section 36(1)(iii) without appreciating that (a) the loan was utilized for the purpose of business of the assessee; (b) at the time of availing the loan, the assessee was engaged in the business of manufacturing as well as the business of the leasing, which activities constituted one business due to interlacing of funds, unity of control and common administration; (c) the interest on impugned loan was allowed as an expenditure in the earlier assessment years; and (d) the loan liability devolved upon the assessee by demerger which was duly approved by the High Court of Karnataka; and (e) the assessee i.e. Hical Infra Private Limited (formerly known as Hical Technologies Private Limited) was a party to the composite scheme of arrangement.
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2.3 The learned CIT(A) has erred in concluding that (a) the assessee has not brought anything on record to support the argument that the loan was taken for the leasing business of the assessee; and (b) the assessee had not mentioned any amount in row 6(d) of ITR-6 under the heading ‘any amount of interest paid in respect of borrowed capital’; 2.4 On facts and in the circumstances of the case and law applicable, the entire interest expenditure amounting to Rs. 78,11,581 should be allowed as a deduction under section 36(1)(iii). 2.5 Assuming without admitting that the interest expenditure of Rs. 78,11,581 was not allowable under section 36(1)(iii), the same should be allowed as a business loss under section 28. 3.0 Grounds relating to disallowance under section 40(a)(ia)
3.1 The learned CIT(A) has erred in concurring with the learned AO in making protective disallowance of interest expenditure under section 40(a)(ia) amounting to Rs. 20,11,358. 3.2 The learned CIT(A) has erred in disallowance of interest expenditure under section 40(a)(ia) without appreciating that (a) the Form 26A was furnished before the learned AO indicating that Tata Capital Financial Services Limited had paid the taxes due on the impugned interest amount and thus the assessee cannot be treated as an assessee in default as per the provisions of section 201(1); (b) the payment of interest under section 201(1A) prior to filing of Form 26A is not mandatory. (c) assuming without admitting that the impugned interest expenditure is disallowed under section 40(a)(ia) in AY 2016-17, the same should be allowed as a deduction in AY 2017-18.
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3.3 On facts and in circumstance of the case and law applicable, the disallowance under section 40(a)(ia) should be deleted in its entirety. 4.0 Grounds relating to levy of interest under section 234B and section 234C
4.1 The learned AO erred in levying interest under section 234B and 234C amounting to Rs. 6,62,929 and Rs. 60,252 respectively. On facts and circumstances of the case and law applicable, interest under section 234B and 234C is not leviable. The assessee denies its liability to pay interest.” 7. Ground No.1 is general and Ground No.4 is consequential. These grounds do not warrant a separate adjudication. Ground No. 3 and 4 are adjudicated in the following paragraphs.
Disallowance of interest under section 36(1)(iii)
The assessee borrowed a sum of Rs. 8 crores from M/s TATA Capital Financial Services Ltd vide its sanction letter dated 13.1.2013. This sum was obtained by discounting the future rentals (LRD). The said loan was credited to SBI cash credit account on 22.1.2013. When the loan was taken during the FY 2012-13, the assessee was engaged in the business of manufacturing high reliability electromagnetic components, providing integrated engineering services and had lease of the immovable property. Post demerger all liabilities pertaining to / arising out of the activities or operations of the manufacturing, design and engineering business was transferred to the resulting Company. The remaining assets and liabilities consisted of the immovable property deriving rental income and the outstanding loan taken from M/s TATA Capital Financial Services Ltd which relates to the leasing business was retained by the assessee. During the course of assessment the AO noticed that the assessee has debited a sum of Rs.78,11,581towards interest on the outstanding balance of the loan.
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The AO raised query with regard to the loan for which the assessee filed a reply dated 18/12/2018 initially stating that the loan was borrowed for manufacturing business Later vide letter 20/12/2018 submitted that the loan was utilized for making additions / repairs to the lease rental building and to this effect there was an inadvertent error in its letter dated 18/12/2018. The AO called on the assessee to produce the evidences supporting the claim that the loan was utilized towards building improvement for which the assessee submitted that the loan was utilized for the building improvement during the FY 2015-16 and 2017-18 and in support of the claim the assessee provided copies of the bank statements and utilization statements of the loan. The AO noting the discrepancies in the letters files and the details of utilization filed by the assessee when compared to the financial statement of the assessee, concluded the assessment disallowing the entire interest claimed u/s.36(1)(iii).
Aggrieved the assessee filed an appeal before the CIT(A). Before the CIT(A), the assessee submitted that the conditions of section 36(1)(iii) namely Capital had been borrowed, interest is paid on the said borrowing, and the borrowing is for the purpose of business is complied with by the assessee. The assessee filed the copies of loan sanction letter and the copy of escrow account and submitted that the loan was borrowed on the basis of the discounted value of the lease rentals. The assessee also submitted that at the time of borrowing of the loan in 2013, the assessee was engaged in the business of manufacturing as well as leasing business and the loan was used for the purpose of the business of the assessee which fact was not disputed by the revenue till now.
The CIT(A) upheld the order of the AO on the following grounds:-
(i) The end use of the agreement was mentioning the purpose for which the loan is borrowed i.e. whether for manufacturing
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business or lease business is not substantiated considering the discrepancies in the submissions before the AO. (ii) The assessee’s name is not appearing in the composite scheme of arrangements approved by the High Court. (iii) In the return of income filed, the assessee has not mentioned the interest amount claimed against the right clause i.e. Row 6(d). 11. The assessee is in appeal before the Tribunal against the order of the CIT(A). The ld. AR during the course of hearing provided a detailed written submission in support of the arguments, the extract of which is given below:-
(i) Section 36(1)(iii) deals with allowability of interest expenditure. The proviso to section 36(1)(iii) states that interest paid, in respect of capital borrowed for acquisition of an asset shall not be allowed as deduction. Thus, disallowance under section 36(1)(iii) is only mandated if the proviso to section 36(1)(iii) is attracted. In the present case, it is undisputed that proviso to section 36(1)(iii) is not attracted.
(ii) There is no provision in section 36(1)(iii) governing the allowability of interest expenditure in case of an amalgamation or demerger. The Legislature has specifically provided for the allowability of tax benefits and concessions in case of an amalgamation / demerger wherever it intended to. For example: section 35A(6), section 35AB(3), section 35ABB(7)deal with the transfer of tax benefits and concession on amalgamation / demerger. It states that the tax benefits and concessions available to an undertaking of a company shall continue to be available to the undertaking on transfer of the same while concessions and benefits that are available to the transferor company as an entity and not to the undertaking of the
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company proposed to be transferred, should remain with the transferor company. Similar provision is absent for deduction under section 36(1)(iii). Therefore, it is evident that there interest expenditure under section 36(1)(iii) cannot be disallowed for the reason that the undertaking where the loan was utilised was not transferred to a resulting company vide the demerger.
(iii) The fact that the manufacturing business was transferred in the demerger cannot result in disallowance of interest paid on borrowings. This would be so even if it assumed that the said borrowings are used for the purpose of manufacturing business. Reliance in this regard is placed in the case of Veecumsees v CIT [1996] 220 ITR 185.
(iv) Even otherwise, deduction under section 36(1)(iii) is allowable if the capital borrowed is for the purposes of ‘business’. It is trite to state that ‘business’ of an assessee may comprise of one or more undertakings. The common management, unity of control and inter lacing of funds between the various undertakings of the assessee clearly demonstrates that both undertakings constituted the same business of the assessee. Therefore, the fact that particular part of the business or undertaking for which the loans had been obtained had been transferred does not alter the fact that loans had, when obtained, been for the purpose of Assessee’s business.
(v) The Calcutta High Court in CIT v Kanoria Investments P Ltd [1998] 232 ITR 7 held that once the capital has been borrowed for the purpose of business, it is immaterial as to how the borrowed money was applied, the interest payment would be deductible under section 36(1)(iii) of the Act. It is not in dispute in the present case that the loan was used for the
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purpose of business. Thus, notwithstanding the fact that the manufacturing business was transferred in a demerger, the assessee company is entitled for the deduction under section 36(1)(iii).
With regard to the observations of the CIT(A) that the assessee company was not in the picture in the entire composite scheme of arrangement as presented before and approved by the Hon’ble High Court of Karnataka the ld. AR submitted that this is factually incorrect. He drew our attention to the para 7.7 of the scheme of arrangement, where it is mentioned that Hical Technologies Ltd was renamed as Hical Infra Pvt. Ltd (demerged company and the assessee herein) and Hical Aerospace Pvt. Ltd (resulting company) was renamed as Hical Technologies Ltd. Therefore the ld. AR submitted that the assessee was very much part of the demerger process sanctioned by the High Court of Karnataka.
At para 3.6 of the CIT(A) order, it is stated that the assessee has not made a claim for interest expenditure at row 6(d) of the IT return. In this connection, the ld. AR submitted that row 6 of ITR 6 [page 54 of the paper book] deals with ‘Amounts debited to the profit and loss account, to the extent disallowable under section 36 due to non-fulfilment of condition specified in relevant clauses’. Row 6(e) of the ITR 6 thus require disclosure of interest paid in respect of borrowed capital [36(1)(iii)] which is disallowable under section 36. It does not require disclosure of interest paid allowable as deduction under section 36(1)(iii). The interest expenditure of Rs. 78,11,581 was shown at row 43(ii) of Profit and loss account in ITR 6. [page 53 of paper book]. Thus, the claim of deduction for interest expenditure was made in the return of income.
The learned DR supported the orders of the lower authorities. The ld. DR submitted that the loan is borrowed for the purpose of manufacturing
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business and post demerger the interest was paid out of lease rental business thereby not satisfying the conditions us/.36(1)(iii). The ld. DR also argued that as per the loan sanction letter, the assessee was required to file a declaration regarding the end use of the borrowings.
In the present case, the assessee carried on the business of manufacturing and had leased the immovable property when the loan was taken during the FY 2012-13. The loan was taken against the future lease rentals of the property. The loan was credited to SBI cash credit account which was used for meeting the expenses of both manufacturing and leasing business. No separate books of account was maintained for manufacturing and leasing business. The business of manufacturing and leasing according to the ld. AR was a composite one with interlacing or mixed funds. It is also contended that the interest paid on said loan was allowed in the earlier years and that subsequent to demerger also, interest paid on said loan was allowed as deduction while passing the assessment order under section 143(3) for the AY 2015-16. Post demerger the leased asset and the loan are retained with the assessee as per the court order approved scheme.
We will look at the provisions of section 36(1)(iii) which reads as follows:-
“36(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Section 28 – (i) ****** (ii) ****** (iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :- Provided that any amount of the interest paid, in respect of capital
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borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. Explanation. – Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfill such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause.” 17. Subsection (iii) has three important words or phrases that are core to understanding of this Section i.e. (i) Interest, (ii) Borrowed and, (iii) For the purpose of business or profession.
In assessee’s case the contention is with respect to ‘for the purpose of business’ i.e., whether the interest paid on the loan borrowed for the purpose of the manufacturing business which was part of assessee’s business is allowable as a deduction u/s.36(1)(iii) post demerger of the said business to a resultant entity. The Hon’ble Supreme Court in the case of CIT v Malayalam Plantations Ltd (1964) 53ITR 140 (SC) with regard to the term ‘for the purpose of business’ held that :-
“The expression "for the purpose of the business" is wider in scope than the expression "for the purpose of earning profits". Its range is wide : it may take in not only the day to day running of a business but also the rationalization of its administration and modernization of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title ; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business
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and the assessee shall incur it in his capacity as a person carrying on the business.” 19. The Hon’ble Supreme Court in the case of Veecumsees vs CIT (1996) 220 ITR 185 (SC) while considering the issue of continuing the same business for allowability of interest u/s.36(1)(iii) held that :-
“The fact that the revenue had during the years when the assessee carried on the business of cinematographic films permitted as a deduction under section 36(1)(iii) the interest on loans obtained by the assessee for the purpose of constructing the said theatre shows that at the time when the loans were obtained the said theatre was a part of the business of the assessee. It was interest on these loans, borrowed for the purpose of the business of the assessee, which was being paid in the years in question and the Tribunal was, in our view, right in concluding that such interest had to be treated as a deduction under section 36(1)( iii). The loans had been obtained for the purposes of the assessee's business. The fact that the particular part of the business for which the loans had been obtained had been transferred or closed down did not alter the fact that the loans had, when obtained, been for the purpose of the assessee's business. The test of 'same business' appropriate for set-off of carry forward losses is not appropriate here.” 20. In assessee’s case the demerger as approved by the court was an economic reason and the transfer of a line of business on demerger should not put the assessee in disadvantage. If the assessee is not allowed the interest as a deduction, the resultant company in any case cannot claim it as deduction as the resultant company is not the one that has borrowed the loan and the liability has not been assigned as part of the court approved demerger. In that case, neither the assessee nor the resultant company can claim the interest as a deduction which in our view is not interest of justice. In the facts of the case the loan was borrowed against the future lease rentals and the loan amount is deposited in a bank account to be used in the day-today operations of the business for both manufacturing as
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well as leasing business. Further at the time when the capital was borrowed it was for the purpose of business and this factor is not altered due to demerger of a line of business. Therefore merely because the manufacturing business was transferred in the demerger, it is not reasonable to hold that the interest paid cannot be allowed under section 36(1)(iii).
In view of the above discussion and considering the ratios laid by the Hon’ble Supreme Court, we hold that entire interest expenditure of Rs. 78,11,581 is allowable as deduction under section 36(1)(iii) and disallowance made in this regard is deleted.
Disallowance under section 40(a)(ia)
The AO noticed during the assessment proceeding that out of total interest expenditure of Rs. 78,11,581, the assessee has deducted tax in respect of Rs. 11,07,053 and the balance interest expenditure of Rs. 67,04,528 was paid without deduction of tax at source. The AO asked the assessee to submit Form No 26A to verify whether the payee i.e. M/s Tata Capital Financial Services Limited has taken into account the interest paid by the assessee in computing its total income and whether it has filed the return of income or not. The assessee submitted the Form No 26A [page 178 to 180 of the paper book] as per which M/s Tata Capital Financial Services Limited had taken into account the interest paid by the assessee in computing the total income for AY 2016-17 and had filed the return of income on 30.11.2016. The AO did not accept the explanations of the assessee and held that 30% of the interest expenditure of Rs. 67,04,528 i.e., Rs. 20,11,358 is to be disallowed under section 40(a)(ia). As the entire interest expenditure of Rs. 78,11,581 was disallowed under section 36(1)(iii), it was stated by the AO that the disallowance of Rs. 20,11,358 will
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be enforced based on the adverse findings (if any) by the appellate authorities at a later stage.
On further appeal by the assessee the learned CIT(A) held that mere furnishing the certificate in Annexure A without the declaration in Form 26A by the assessee cannot be said to be compliance of the provision. The CIT(A) further held that as per rule 31ACB, the said form should have been furnished to the DGIT (Systems) and therefore upheld the decision of the AO in disallowing 30% of interest expenditure amounting to Rs. 20,11,358 under section 40(a)(ia).
Aggrieved the assessee is in appeal before the Tribunal. The ld. AR reiterated the submissions made before the lower authorities. The ld. AR submitted that in the present case, it is not in dispute that Form No 26A was submitted to the AO during the assessment proceedings which consisted of both the declaration by the assessee and the certificate of the CA certifying that the payee had taken into account the interest paid by the assessee and that the payee filed the return of income on 30.11.2016 for the AY 2016-17. Thus, the ld. AR argued that there is no merit in the contention of the CIT(A) that the declaration of the assessee has not been submitted. As regards non filing of Form No 26A in electronic form to DGIT (Systems), it was the contention of the ld. AR that the same is only a procedural irregularity and that once the condition of filing of Form No 26A is complied in substance the same should be accepted and not rejected only for the reason that the said form is not electronically filed.
The ld. DR supported the order of the lower authorities. A proviso was inserted Section 201 by Finance Act 2012 with effect from 01/07/2012 which reads as under :-
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“Provided that any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a payee or on the sum credited to the account of a payee shall not be deemed to be an assessee in default in respect of such tax if such payee— (i) has furnished his return of income under section 139; (ii) has taken into account such sum for computing income in such return of income; and (iii) has paid the tax due on the income declared by him in such return of income,
The corresponding rule i.e. Rule 31ACB contains the procedure as given below :–
“31ACB. (1) The certificate from an accountant under the first proviso to sub-section (1) of section 201 shall be furnished in Form 26A to the Director General of Income-tax (Systems) or the person authorised by the Director General of Income-tax (Systems) in accordance with the procedures, formats and standards specified under sub-rule (2), and verified in accordance with the procedures, formats and standards specified under sub- rule (2). (2) The Director General of Income-tax (Systems) shall specify the procedures, formats and standards for the purposes of furnishing and verification of the Form 26A and be responsible for the day-to-day administration in relation to furnishing and verification of the Form 26A in the manner so specified.”
Section 40(a)(ia) contains a proviso whereby an assessee is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purposes section 40(a)(ia) it shall be deemed that the assessee has deducted and paid the tax on such sum on
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the date of furnishing of return of income by the payee referred to in the said proviso.
A combined reading of the above provisions of the Act and the rule, makes it clear that an assessee who is required to deduct tax in accordance with Chapter XVII-B, fails to do so would not be treated as an assessee in default provided the payee has paid tax on the said sum and the assessee has filed the required form in 26A along with a CA certificate. When the assessee is not treated as an assessee in default then no disallowance can be done as per the proviso to section 40(a)(ia) as it is deemed that the assessee has deducted and paid the tax.
In the present case, the assessee has submitted Form No 26A to the AO during the assessment proceedings which fact is admitted by the AO in para 5.3 of his order. However the AO and the CIT(A) have disallowed 30% of the interest on the ground that the assessee has not furnished Form 26A to the DGIT(systems) and that the same should have been done before filing the return of income. This in our view is a procedurals lapse on the part of the assessee and the same cannot be the reason for disallowance. In the case of Sardar Amarjit Singh Kalra v. Pramod Gupta, (2003) 3 SCC 272 where it was held that Procedure has always been viewed as the handmaid of justice and not meant to hamper the cause of justice or sanctify miscarriage of justice. In the given case the assessee has substantiated the fact that the payee M/s.Tata Capital has included the interest as income and has paid taxes on the same and the condition of filing of Form No 26A is complied in substance. Therefore in our view the assessee cannot be denied the substantial benefit of claiming the interest expense as a deduction on the ground off a procedural lapse. We therefore delete the disallowance made u/s.40(a)(ia) of Rs. 20,11,358.
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In the result, the appeal by the assessee is allowed.
Pronounced in the open court on this 10th day of July, 2022..
Sd/- Sd/- ( GEORGE GEORGE K. ) ( PADMAVATHY S. ) JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore, Dated, the 10th July, 2022.
/Desai S Murthy /
Copy to:
Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.
By order
Assistant Registrar ITAT, Bangalore.