FAIRCHEM ORGANICS LTD.,,AHMEDABAD vs. ACIT, CIR-15(1)(1), MUMBAI

The assessee submitted that the capital advances were made towards purchase of fixed assets and were in the nature of business advances made in the ordinary course of business. It was contended that such advances were made out of internal accruals and not from borrowed funds. The assessee submitted that during the relevant financial year it had net cash generation of about Rs. 43.01 crores. The assessee further submitted that current borrowings were utilized for working capital requirements such as inventory and receivables, non-current borrowings were utilised for acquisition of fixed assets and no specific borrowing was made for giving capital advances. It was also submitted that advances for capital goods are a normal business practice and are generally interest-free in nature and adjusted against final purchase consideration.

The Assessing Officer did not accept the contentions of the assessee and held that the assessee failed to establish that the interest-bearing funds were not utilised for granting interest-free advances. The Assessing Officer observed that despite claiming Fairchem Organics Limited sufficient internal accruals, the assessee continued to have substantial borrowings and, therefore, the explanation of the assessee was not satisfactory. The Assessing Officer further held that the assessee failed to demonstrate commercial expediency in granting such advances and also failed to establish nexus between own funds and advances. Relying upon the provisions of section 36(1)(iii) and the decision of the Hon’ble Supreme Court in the case of S.A. Builders vs. CIT (Appeals) [2007] 288 ITR 1 (SC), the Assessing Officer held that interest on borrowed funds is allowable only when such funds are used for the purposes of business. Accordingly, the Assessing Officer computed proportionate disallowance of interest at Rs. 68,14,949/- and added the same to the total income of the assessee.

Aggrieved by the order of CIT(A), the assessee is in appeal before us raising following grounds of appeal:

Levy of interest u/s 234B/ 234C & 234D of the Act is unjustified.

During the course of hearing before us the learned Authorised Representative (AR) for the assessee reiterated the submissions made before the lower authorities and assailed the findings of the Assessing Officer as well as the learned CIT(A).The learned AR invited our attention to the audited financial statements placed on record and submitted that the assessee had sufficient own funds and internal accruals far in excess of the capital advances. Referring to the balance sheet as on 31.03.2020 (paper book page No. 43), the learned AR submitted that the capital advances were only to the extent of Rs. 6,53,87,800/-, whereas the assessee had substantial interest-free funds in the form of equity and reserves amounting to Rs. 12,856.52 lacs. It was thus contended that the advances could not be said to have been made out of borrowed funds. The learned AR further drew our attention to the statement of profit and loss (paper book page Fairchem Organics Limited No. 44) and submitted that the profit after tax itself was Rs. 3,654.86 lacs (rounded Rs. 3,645.21 lacs as per comprehensive income), which clearly demonstrated availability of substantial internal accruals. The learned AR also referred to the cash flow statement and submitted that operating profit before working capital changes was Rs. 5,124.78 lacs, and net cash generated from operating activities was Rs. 3,117.60 lacs. It was contended that these figures clearly establish that the assessee had sufficient internally generated funds during the year.

Based on the above financial data, the learned AR submitted that: i. There was no nexus between borrowed funds and capital advances; ii. No specific borrowings were utilized for granting such advances; iii. The presumption in law, in case of mixed funds, is that advances are made out of interest-free funds.

The learned AR further contended that the learned CIT(A) has failed to deal with the judicial precedents relied upon by the assessee and has merely confirmed the addition without any independent reasoning. It was also submitted that the advances were admittedly given for business purposes, namely for purchase of capital goods required for upgradation and replacement of plant and machinery, which fact has not been disputed by the lower authorities. The learned AR thus submitted that in view of the availability of sufficient own funds and the Fairchem Organics Limited business purpose of the advances, no disallowance under section 36(1)(iii) is warranted and the addition deserves to be deleted.

The learned Departmental Representative (DR), on the other hand, strongly relied upon the orders of the Assessing Officer and the learned CIT(A).

We have heard the rival submissions and perused the material available on record including the assessment order, the impugned order of the learned CIT(A), and the financial statements placed before us. The sole issue for adjudication is whether the disallowance of Rs. 68,14,949/- made under section 36(1)(iii) of the Act on account of alleged diversion of interest- bearing funds towards capital advances is sustainable in law.

The settled legal position governing disallowance under section 36(1)(iii) is that interest on borrowed capital is allowable if the same is used for the purposes of business. Disallowance can arise only when it is established that borrowed funds have been diverted for non-business purposes or for interest-free advances without commercial expediency. It is equally well settled that where an assessee possesses sufficient interest-free funds, a presumption arises that the investments or advances have been made out of such interest-free funds. In this regard, the Hon’ble Supreme Court in the case of CIT vs. Reliance Industries Ltd. (410 ITR 466) has decided the issue. The question before the Hon’ble Apex Court was – Fairchem Organics Limited 1. Whether the High Court is correct in holding that interest amount being interest referable to funds given to subsidiaries is allowable as deduction under Section 36(1)(iii) of the Income Tax Act, 1961(for short 'the Act') when the interest would not have been payable to banks, if funds were not provided to subsidiaries; And it was held as –

Insofar as the first question is concerned, the issue raises a pure question of fact. The High Court has noted the finding of the Tribunal that the interest free funds available to the assessee were sufficient to meet its investment. Hence, it could be presumed that the investments were made from the interest free funds available with the assessee. The Tribunal has also followed its own order for Assessment Year 2002-03.

In view of the above findings, we find no reason to interfere with the judgment of the High Court in regard to the first question. Accordingly, the appeals are dismissed in regard to the first question. 16. Further, in S.A. Builders vs. CIT (Appeals) (288 ITR 1), the Hon’ble Supreme Court has held that allowability of interest depends upon commercial expediency and not on whether the assessee earns profit from such advances.

In the present case, it is an undisputed fact that the assessee had capital advances of Rs. 6,53,87,800/-.However, from the audited financial statements placed on record, the following position emerges: i. Interest-free funds (equity and reserves): Rs. 12,856.52 lacs ii. Capital advances: Rs. 653.88 lacs Thus, the interest-free funds available with the assessee are substantially higher than the advances made.

In view of the above, the contention of the assessee that advances were made out of internal accruals and interest-free funds merits acceptance. The Revenue has not brought any material on record to establish direct nexus between borrowed funds and the impugned advances.

The Assessing Officer has proceeded on a presumption that since the assessee has borrowings, the advances must have been made out of borrowed funds. Such presumption is contrary to the settled law. The learned CIT(A), instead of examining the availability of interest-free funds and the financial position of the assessee, has merely upheld the disallowance on the ground that the assessee failed to furnish supporting documents. In our considered view, once the financial statements clearly demonstrate sufficiency of interest-free funds, the onus shifts on the Revenue to establish nexus between borrowed funds and Fairchem Organics Limited advances, which has not been discharged in the present case. Further, the learned CIT(A) has not dealt with the judicial precedents relied upon by the assessee and has not recorded any independent finding rebutting the presumption recognised by the Hon’ble Supreme Court.

The assessee has consistently submitted that the advances were given for purchase of capital goods for upgradation and replacement of plant and machinery. This factual assertion has not been controverted by the Assessing Officer by bringing any material on record to show that the advances were for non- business purposes. In such circumstances, the advances being in the nature of business advances, the question of disallowance on the ground of lack of commercial expediency does not arise.

Applying the ratio laid down by the Hon’ble Supreme Court in Reliance Industries Ltd. (supra), we hold that where interest- free funds are more than the advances, a presumption arises that the advances are made out of such funds. In the present case, since the interest-free funds of Rs. 12,856.52 lacs are far in excess of the advances of Rs. 653.88 lacs, the said presumption squarely applies. The Revenue has failed to rebut this presumption by establishing any direct nexus between borrowed funds and advances.

In view of the above discussion, we hold that the assessee had sufficient interest-free funds and internal accruals; no nexus has been established between borrowed funds and advances; the advances were made for business purposes; and the disallowance Fairchem Organics Limited has been made merely on presumptions without bringing cogent evidence on record. Accordingly, the disallowance of Rs. 68,14,949/- made under section 36(1)(iii) and confirmed by the learned CIT(A) is unsustainable and is hereby deleted.

The grounds raised by the assessee on the issue of disallowance under section 36(1)(iii) are allowed. The grounds relating to levy of interest under sections 234B, 234C and 234D are consequential in nature. The ground relating to initiation of penalty under section 270A is premature and does not call for adjudication at this stage.

In the result, the appeal of the assessee is allowed.