JAYA HOSPITALAS, WARANGAL,HYDERABAD vs. ADDL. CIT, WARANGAL RANGE, WARANGAL, WARANGAL

This is an appeal by the assessee against the order of CIT (A)-3, Hyderabad dated 20.11.2015. The issue in this appeal is with reference to disallowance of interest to an extent of Rs. 41,34,493/- invoking the provisions of section 37(1)/36(1)(iii).

Facts in brief are that the assessee is a firm and runs a hospital. In the course of assessment proceedings, the A.O. noted (para 10 of the assessment order) that assessee has claimed interest to partners capital account at Rs. 70,85,488/-. Assessee also paid interest of Rs. 5,90,785/- on the loans taken. On perusal of the balance sheet, A.O. noticed an amount of Rs. 4.63 Crs was given on loan to Dr. T. Narasimha Reddy, HUF. A.O. asked why proportionate interest on loan

Before the CIT (A), assessee raised contentions that there are no borrowed funds and further the amount claimed by the partners is under the provisions of section 40(b) of the Act which has to be separately allowed and therefore, the action of the A.O. is not correct in law. Learned CIT(A) while appreciating that the payment of interest by partners is covered by the provisions of section 40(b), however did not allow the contentions of the assessee stating as under:-

In the course of arguments, Learned Counsel has reiterated that the provisions of section 40(b) stand separately and the allowance of interest on the partner’s capital is separately governed and assessee has accordingly claimed, which cannot be disallowed u/s 36(1)(iii)/37 of the Act. It was further submitted that there was a merger of another firm viz., Jaya Diagnostic and Research Centre and the capital balances have increased during the year and the assessee claimed interest as per the provisions of section 40(b)(iv) within 12% as allowed by the provisions. Apart from that, it was also contended that the interest paid and noted down by the A.O. of Rs. 5,90,785/- was interest paid to the banks and that there are no borrowed funds on which assessee has paid interest. Referring to the profit during the year and the balances available with the firm, it was submitted that the advances given to the HUF are out of own funds and there is no nexus with the borrowed funds. It was further submitted that assessee had adequate funds to advance and relied on the following case law:- (i) Sri Ganesh Bottles Pvt Ltd vs. DCIT (ITA Nos. 616 to 619/Hyd/2015, dated 30.08.2017) and (ii) Third Member decision in the case of S.P. Jaiswal Estates (P.) Ltd vs. ACIT (29 Taxmann.com 221). 5. Learned Departmental Representative however submitted that the assessee had advanced various funds to the HUF and the argument that assessee has own funds and has not diverted any borrowed funds was not contended either before the A.O. or before the CIT(A), hence that contention cannot be accepted. Learned Departmental Representative relied on the decision of the Hon’ble High Court of Allahabad in the case of Marolia & Sons vs. CIT (129 ITR 475) and decision of the Hon’ble High

We have considered the rival contentions and perused the documents placed on record and the case law. As seen from the order of the Assessing Officer, there is no finding that borrowed funds are diverted for non-business purposes. It is the contention that the assessee got funds in earlier years without interest and there was also balances of the HUF to their credit to an extent of Rs. 1.85 Crs. Without establishing that borrowed funds are diverted for the purpose of business, Assessing Officer disallowed an amount of Rs. 41, 34,493/- invoking the provisions of section 37 of the Act. First of all, we are unable to understand how provisions of section 37 will apply, when interest on borrowed funds are to be considered u/s 36(1)(iii) of the Act. Be that as it may, the claim of Interest was only Rs 5,90,785/- on the loans taken, as stated by the A.O. in para 10.0 in the Assessment Order where as the claim of Rs. 70,85,488/- is interest on partner’s capital account governed by provisions of section 40(b).

As seen from the provisions of section 40 with the heading “amounts not deductible” it starts with the words “notwithstanding anything to the contrary in section 30 to 38”. Thus, the provisions of section 36(1)(iii) as well as section 37 are not to be considered, when the amounts are governed by section 40. Section 40(b) is with reference to payments of salary, remuneration, interest and other amounts to the partners in the case of any firm. There is no dispute with reference to applicability of section 40(b)(iv) as payment of interest to the partners is

That leaves us with the claim of interest at Rs. 5,90,785/- which is the only interest claimed on loans taken. It is not clear whether the above amount is paid on any borrowed amounts from any parties or the amount paid to banks for the day-to-day over draft facility. The contention that assessee had sufficient funds, including the profits of the year has not been examined by the A.O. and further there is no finding that borrowed funds are diverted for non-business purposes. Since there is no clarity or finding on this issue, in the interest of justice we direct the A.O. to examine whether the interest paid at Rs. 5,90,785/- requires to be disallowed under the provisions of section 36(1)(iii) or not? In case, assessee has sufficiently enough funds to advance the HUF, Assessing Officer cannot disallow any amount out of the interest paid and used for the business. The principles laid down by the Hon’ble Bombay High Court in the case of Reliance Utilities and Power Ltd., (313 ITR 340) (Bom.) will apply. Assessing Officer is directed to examine whether any of the borrowed funds are diverted for non-