M/S. SOWBHAGYA HOMES & VENTURES,RAVULAPALEM vs. ACIT, CIRCLE -2(1), RAJAHMUNDRY

In this case, the Assessing Officer(AO) passed an order u/s 143(3) on 27.12.2011 determining total income of Rs.43,66,360/- against the returned income of Rs.41,66,360/-. The Ld.CIT has taken up the case for revision and passed an order u/s 263 on 05.03.2014. The AO given effect to the order of the Ld.CIT vide order u/s 143(3) r.w.s.263 dated 24.03.2015. The assessee went on appeal before the Ld.CIT(A) and the Ld.CIT(A) has allowed the appeal of the assessee partly. Against the order of the Ld.CIT(A) the assessee preferred appeal before the Tribunal.

Ground No.1 and 4 are general in nature which does not require specific adjudication.

Ground No. 2 is related to the addition of Rs.40.46 lakhs made by the AO towards interest on advances to partners. The Ld.CIT in his order u/s 263 in para No.5 found that the assessee has made the investments with ShriCh.NVS Reddy of Rs.2,67,94,681/- and Ch.Chandra Reddy of Rs.3,84,35,845/- and both are partners of the firm. The assessee did not admit any interest / profit from these investments but paid the interest on partners capital accounts promptly. The AO found that the assessee had paid the interest of Rs.1,23,51,423/- to the unsecured loan creditors. Further, it was also observed that the assessee had also advanced the loans and advances of Rs.63,10,000/- to 5 other persons without any interest . From the Balance Sheet it is evidenced that that the capital of all other partners put together was Rs.4,05,82,527/-, and sundry debtors was Rs.1,00,07,461/- to 2 entities / persons (Nigama Developers, Rs. One crore and Shir K.Satyanarayana, Rs.7,461/-). From the above information the Ld.CIT found that interest bearing business funds were diverted for non business purposes. Accordingly set aside the order of the AO, and directed the to disallow proportionate interest on the amounts diverted to non business purposes. Consequent to the order of the Ld.CIT, the AO has given effect to the order of the CIT and made the disallowances of Rs.40,46,123/- on the amounts given to the partners Mr.NVS Reddy and Ch.Chandra Reddy.

Aggrieved by the order of the AO, the assessee went on appeal before the Ld.CIT(A).The assessee submitted before the CIT(A) that the assessee is following cash system of accounting and the interest would be charged as and when the same is received from the debtors. The Ld.CIT(A) observed that the partners are interested persons in the business and they may not pay interest at all on the advances received by them and on the other hand the assessee has paid the interest on partner’s capital accounts at the end of the each year and the system of accounting followed by the assessee does not reflect the true and correct picture of business affairs. The Ld.CIT(A) viewed that when partners receive interest on their capital contribution, and do not pay the interest on advances taken by them, it leads to lopsided and unnatural results. Therefore, the Ld.CIT(A) confirmed the addition made by the AO and directed the AO to disallow the interest from the interest paid to the partners.

Aggrieved by the order of the Ld.CIT(A), the assessee is in appeal before this Tribunal.

We have heard both the parties and perused the material placed on record. The assessee is a partnership firm in which Ch.Chandra Reddy and Mr.Ch.N.V.S. Reddy are partners. They have contributed capital to the partnership firm and also taken advances from the partnership firm. The advances taken by the partners from the partnership firm were more than the capital contribution made by the partners. The assessee firm had paid the interest on contribution to the partners capital, whereas, the firm has not collected the interest for the advances given to the partners even though the same can be collected at source. Therefore, the AO has disallowed the interest proportionately. The Ld.AR argued before the Tribunal that the assessee is following cash system of accounting and would account for the interest as and when the same is received. We have carefully considered the argument of the assessee and not convinced with the argument of the assessee. Though the assessee is following cash system of accounting, when the assessee is paying interest to the partners on their capital accounts, the assessee firm also required to collect the interest from the partners from the source itself. Payment of interest to the partners as at the end of the year and not collecting the interest from the partners on the amounts advanced to them for diversion of funds for non business purposes would distort the profits of the firm and as rightly observed the Ld.CIT(A) it is lopsided and does not reflect the true and correct picture of the profits of the firm. For a query from the bench, the Ld.AR submitted that the firm has not collected the interest from the partners till date and no action was taken against partners for recovery of the interest on the loans. This attitude shows that the assessee is systematically making efforts to reduce profits of the firm and thereby evading the tax. The assessee firm has paid the interest of Rs.1,23,51423/- during the year under consideration on borrowed funds. Similarly, the assessee has paid interest of Rs.60,28,175/- on the partners capital accounts and as per the balance sheet no interest free funds are available to the assessee. The assessee could not establish the business interest or availability of interest free funds to give advances to the partners in the guise of investment. Therefore, we consider it is fair and just to disallow the proportionate interest on the amounts advanced to the partners. Accordingly, we sustain the order of the Ld.CIT(A) and dismiss the appeal of the assessee on this ground.

Ground No.3 is related to the disallowance of interest for diversion of funds on a sum of Rs.1,00,00,000/- given as advance to Nigam Developers. In the order u/s 263, the Ld CIT has found that the assessee has given a loan of Rs.1.00 crore to Nigam Developers for non business purposes. Therefore, the Ld.CIT has directed the AO to disallow the proportionate interest on the loans diverted for the purposes other than the assessee’s own business. The AO has given effect to the order of the Ld.CIT and accordingly made the addition of Rs.12,00,000/- charging interest @12% for non business purposes.

Aggrieved by the order of the AO, the assessee went on appeal before the CIT(A) and the Ld.CIT(A) found that the said amount of Rs. 1.00crore was diverted for non business purposes from interest bearing funds and also observed that the assessee is paying interest @18% on funds on borrowings from the loan creditors. The Ld.CIT(A) discussed with the assessee’s AR and the Ld.AR agreed for enhancing the rate of interest to 18% and accordingly the Ld.CIT(A) enhanced the addition.

Aggrieved by the order of the CIT(A), the assessee filed appeal before this Tribunal. During the appeal hearing, the Ld.AR argued that the assessee has given advance of Rs.1.00crore to Nigam Developers for development of the property and hence the advances were given for business purposes and no interest is chargeable. The assessee’s AR further submitted that he has not agreed for charging the interest for diversion of funds non business purposes but accepted that the payment of interest was @18% on borrowings. The Ld.AR further argued that the assessee is following cash system of accounting and if the interest isrequired to be offered, the same would be offered as and when it is received. Therefore argued that the addition made by the AO to be deleted and the order of the Ld.CIT(A) be set aside.

On the other hand, the Ld.DR relied on the orders of the lower authorities.

We have heard both the parties and perused the material placed on record. As per the balance sheet, capital balances have shown the balance of Rs.4,47,48,884/- and the loans and advances given to the partners in the form of investments were at the order of Rs.6,52,30,526/- and the remaining liabilities are unsecured loans and there are no interest free funds available to the assessee to advance the sums out of the interest free funds. Though the assessee stated that the assessee is following cash system of accounting, the assessee has not established that the expenditure claims was also claimed on cash basis. Further, the assessee has given Rs.1.00 crore to Nigama Developers stated to be for the purpose of business purpose for the development of property, but no evidence in the form of agreement or any other evidence to show that the funds were advanced for business purpose were furnished before the AO or Ld.CIT(A) or the Tribunal during the course of hearing. Therefore, it is established that the interest bearing funds were given for non-business purpose without charging the interest. Though the assessee stated that the assessee is following the cash system of accounting and would admit the income as and when it is received, the assessee has not proved with any evidence that the assessee has made any efforts to collect the advances along with interest till date. No attempt has been made by the assessee to collect the interest on advances given to debtor till date. This attitude clearly shows that the assessee has intentionally diverted interest bearing funds for non business purposes and has no intention to collect the interest to suppress the profits. Therefore, we are unable to accept the contention of the assessee and hold that the Ld.CIT(A) has rightly confirmed the disallowance of interest for non-business purposes and enhanced the interest from 12% to 18%, since the assessee has borrowed loans for interest rate of 18%. Therefore, we uphold the order of the Ld.CIT(A) and dismiss the appeal of the assessee on this ground.

In the result, appeal of the assessee is dismissed.

The Pr.CIT, Rajahmundry

The Commissioner of Income Tax (Appeals)-2, Guntur 5. धिभागीयप्रधिधिधि, आयकरअपीलीयअधिकरण, धिशाखापटणम /DR, ITAT, Visakhapatnam 6.गाडाफ़ाईल / Guard file आदेशािुसार / BY ORDER ////