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Income Tax Appellate Tribunal, “C” BENCH, AHMEDABAD
Before: SHRI P.M. JAGTAP, VICE- & SHRI T.R. SENTHIL KUMAR
O R D E R
PER P.M. JAGTAP, VICE-PRESIDENT :
These two appeals filed by the assessee are directed against two separate orders passed by the learned Commissioner of Income-Tax (Appeals)-1, Vadodara, both dated 06.08.2018; and since the issues involved therein are common, the same have been heard together and are being disposed of by a single consolidated order for the sake of convenience.
First, we shall take up the appeal of the assessee for Assessment Year 2013-14 being the Ground No.1 of which is general in nature which does not call for any specific adjudication.
The issue involved in Ground No.2 relates to disallowance of Rs.3,04,193/- made by the Assessing Officer and confirmed by the learned CIT(A) on account of proportionate interest attributable to capital work-in- progress. & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 2
The assessee, in the present case, is a company which is engaged in the business of manufacturing of various specialty chemicals like pharmaceuticals, agro chemicals, dyes and pigments, etc. It is also engaged in the generation of wind power. The return of income for the year under consideration, i.e. AY 2013-14, was filed by the assessee on 28.09.2013 declaring total income of Rs.40,43,110/-. The said return was selected for scrutiny and a notice under Section 143(2) of the Act was issued by the Assessing Officer to the assessee on 03.09.2014. During the course of assessment proceedings, it was noticed by the Assessing Officer that the assessee has shown an amount of Rs.41,52,223/- as capital work-in- progress. Since the interest paid on the capital borrowed for acquisition of asset in the form of capital work-in-progress was not an allowable deduction as per the proviso to Section 36(1)(iii) of the Act, the assessee was called upon by the Assessing Officer to explain as to why the proportionate interest attributable to the capital borrowed for capital work-in-progress should not be disallowed being capital expenditure. In reply, the following explanation was offered by the assessee in writing: -
"At the outset, the Assessee would like to submit that it has not obtained any fresh loan/ borrowing during the year under reference. The same can be corroborated with the financial statements of the Assessee (available on your goodselfs records). Regarding the term loans availed in earlier years it is submitted that the assets financed by said term loans have been put to use before FY 2022- 13 (relevant to AY 2013-14). Thus, for the financial year under reference no interest was required to be capitalized as per proviso to section 36(1)(iii) of the Act since the assets acquired had already been put to use. The Assessee had availed certain short-term borrowings during the year under reference which were used to meet the working capital requirements of the Assessee and were not used to finance the acquisition of any assets. In view of the above, the Assessee submits that no borrowings were utilized by the company in connection with acquisition of capital assets during the relevant year and requests your goodself to not make any disallowance of proportionate interest expenses under section 36(1)(iii) of the Act.”
& 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 3
The explanation offered by the assessee as above was not found acceptable by the Assessing Officer. He found, on perusal of the relevant ledger account, that the payments towards capital work-in-progress were made by the assessee from Cash Credit Account and there was no evidence furnished by the assessee to prove that the interest free funds were utilized for making the said payments. He, therefore, worked out the interest attributable to the borrowed funds utilized for capital work-in-progress by applying the rate of 12% per annum at Rs.3,04,193/- and disallowance to that extent was made by him by treating the same as capital expenditure.
The disallowance made by the Assessing Officer on account of interest expenditure attributable to the borrowed funds allegedly utilized for capital work-in-progress was challenged by the assessee in appeal before the learned CIT(A) and the submissions made before the Assessing Officer were reiterated on behalf of the assessee before the learned CIT(A) in support of its case on this issue. The learned CIT(A), however, did not find merit in the submissions made on behalf of the assessee and proceeded to confirm the disallowance made by the Assessing Officer on account of proportionate interest for the following reasons given in paragraph No. 4.3 of his impugned order:-
“4.3. Ground No.4 and 4.1 are pertaining to capitalization of interest at Rs.3,04,193/- with the cost of capital work-in-progress. The AO noticed that the assessee had shown capital work-in-progress at Rs.41,52,223/- and hence, interest pertaining to the same should be capitalized. On perusal of the balance sheet, I also find that there was huge capital work-in-progress to the extent of Rs.2,43,35,790/- out of which the amount of Rs.2,01,83,567/- has been transferred to assets. The Volume of capital work-in-progress clearly indicates expansion of business and hence, in view of provisions of Proviso to Section 36(1)(iii), interest expenditure pertaining to acquisition of asset has to be capitalized till the asset is put to use. During the course of the appellant proceedings, it was noticed that the investment was made out of cash credit account bearing cost of interest. However, the Ld AR has claimed in his written submission that negative balance in cash credit account has been & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 4 reduced from Rs.12,34,85,362/- as on 01.04.2012 to Rs.7,31,13,430/- as on 31.03.2013. On perusal of the balance sheet, I find that liability under this head as on 31.03.2013 is Rs.14,13,95,794/- (Note 7 to Balance Sheet). Presuming that there was reduction in the cash credit liability, yet, the fact remains that the borrowed funds have been utilized in investing in the capital work-in-progress. Since, there was direct nexus between the borrowed funds and the investment in capital work-in-progress, the decisions relied upon by the Ld. AR become distinguishable on facts. In view of the Proviso to section 36(1)(iii), interest expenditure deserves to be capitalized with the cost of the capital asset and accordingly, disallowance made by the AO on this account is confirmed. Thus, appellant fails on this account.”
We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. The learned Counsel for the assessee has submitted that since the relevant payments against the capital work-in-progress were found to be made by the assessee-company from the Cash Credit Account, the Assessing Officer as well as the learned CIT(A) held that there was a direct nexus between the borrowed funds and the investment made in capital work-in-progress. He invited our attention to the cash flow statement of the assessee-company for the year under consideration as well as the relevant balance-sheet placed at page Nos.21 to 23 of the paper-book to point out that interest free funds in the form of share capital, reserve & surplus as well as internal accruals were available with the assessee-company at the relevant time and the same being more than sufficient to make investment in capital work-in-progress, it was a clear case of utilization of interest free funds by the assessee-company in capital work- in-progress. He has contended that whenever there is a case of mixed funds maintained by the assessee as in the present case, the nexus theory cannot be applied and what is to be seen is the overall financial position of the assessee to ascertain whether the investment in capital work-in-progress was made out of interest free funds or the interest-bearing borrowed funds. The learned DR has not raised any material contention to dispute this position. He, however, has contended that neither the Assessing Officer nor & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 5 the learned CIT(A) has given any specific finding on this aspect of the matter on the basis of overall financial position of the assessee-company and the matter may, therefore, be sent back to the Assessing Officer for such verification. We are inclined to accept this contention of the learned DR. The impugned order of the learned CIT(A) on this issue is accordingly set aside and the matter is restored to the file of the Assessing Officer to decide the same afresh after verifying overall financial position of the assessee- company in order to ascertain whether the investment in capital work-in- progress was made by the assessee-company out of its own interest free funds or interest-bearing borrowed funds. The Assessing Officer is accordingly directed to decide this issue afresh after such verification and after giving the assessee proper and sufficient opportunity of being heard.
The next issue involved in Ground No.3 relates to the disallowance of Rs.35,70,587/- made by the Assessing Officer on account of proportionate interest attributable to the borrowed funds allegedly utilized by the assessee for giving interest free advances to its subsidiary company.
In the Profit and Loss account filed along with the return of income, a sum of Rs.3,05,28,877/- was debited by the assessee on account of interest expenses. As noticed by the Assessing Officer from the perusal of assessee’s balance-sheet, the interest free advance of Rs.4,34,34,1459/- was given by the assessee to one of its subsidiary company M/s. Diamines Speciality Chemicals Private Limited. In this regard, it was explained by the assessee before the Assessing Officer that the interest free advance to its sister concern was made out of its internal accruals and since the same was made to 100% subsidiary company, no interest had been charged. This explanation of the assessee was not found acceptable by the Assessing Officer. According to him, the assessee did not furnish any evidence to establish that the amount in question was advanced by it to the subsidiary & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 6 company out of its internal accruals and there was no nexus between the interest-bearing borrowed funds and interest free advances given to the subsidiary. He, therefore, worked out the interest attributable to the borrowed funds allegedly utilized for giving interest free advance to its subsidiary company at Rs.35,70,587/- and disallowance to that extent was made by him in the assessment completed under Section 143(3) of the Act vide order dated 16.03.2016.
The disallowance of Rs.35,70,587/- made by the Assessing Officer on account of interest attributable to the interest bearing borrowed funds allegedly utilized for giving interest free advances to the subsidiary company was challenged by the assessee in appeal before the learned CIT(A) and since the submissions made on behalf of the assessee-company in support of its case on this issue were not found acceptable by the learned CIT(A), he proceeded to confirm the disallowance made by the Assessing Officer on this issue for the following the reasons given in paragraph No. 4.4 of his impugned order.
“4.4. Ground No. 5 to 5.2 are pertaining to disallowance of interest at Rs.35,70,587/- in respect of interest free advances given to sister concern i.e. Diamines Speciality Chemicals Pvt. Ltd. Undisputedly, the appellant has invested in share capital of this concern in the year under consideration at Rs.4,00,000/- and also given interest free advances of Rs.4,34,34,159/-. The appellant has failed to furnish documentary evidences in order to establish business exigency and business purpose of such interest free advances. The Ld. AR has heavily relied upon the decision of the Hon'ble Supreme Court in the case of SA Builders (2007) 288 ITR 1 (SC). Since, the appellant has failed to establish business exigency and business purpose of such advances, the decision of the Hon'ble Supreme Court relied upon is of no help. 4.4.1. Alternatively, it has been argued that the interest free advances to the subsidiary company were given out of own funds having no interest burden. However, I find that the advances to the subsidiary company were given out of cash credit account bearing interest burden. Keeping in view this position, the Ld. AR vide order sheet entry dated 09.05.2018 was specifically asked to furnish copy of cash credit account, but instead of furnishing copy of cash credit account, he has submitted a reply stating that the utilization of cash credit has been reduced from Rs.12,34,85,362 as on 01.04.2012 to & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 7
Rs.7,31,13,430/-. However, on perusal of the balance sheet (Note No.7), I find that utilization of cash credit facility as on 31.03,2013 is Rs.14,13,95,794/-. Presuming that there was reduction in the utilization of cash credit facility, yet there was utilization of borrowed funds for advancing interest free funds to the sister concern. Since, there was direct nexus between the interest free advances given to the subsidiary company and borrowed funds, the decisions relied upon by the Ld. AR are distinguishable on facts. In the case of Munjal Sales Corporation 298 ITR 298 (SC) strongly relied upon by the Ld. AR, disallowance of interest was deleted since, the advances to the sister concern were given out of own funds of the firm. Infact, the ratio laid down in the following cases support the cases of revenue:- a) CIT vs Harrisons Malayalam Ltd. (2012) 25 taxmann.com 546 (Ker): After referring to the decision of the Hon'ble Bombay High Court in the case of Reliance Utilities & Power Ltd. (2009) 313 ITR 340/178 taxrnann.com 135 (Born), it has been held that when there is nexus between interest bearing loans & interest free advances to subsidiaries, even if, own funds are available in common pool, disallowance of interest relating to interest free advances u/s 36(1)(iii) has to be made. b) Punjab Stainless Steel Industries v. CIT (2010) 324 ITR 396 (Del.) In this case, after considering the decision of the Hon'ble SC in the case of SA Builders Ltd. (2007) 288 ITR 1 and Munjal Sales Corporation (2008) 298 ITR 298, the Hon'ble High Court has confirmed the disallowance pertaining to interest free advances given to sister concerns. Disallowance u/s 36(1)(iii) was confirmed on the ground that the advances were extended out of borrowed funds and not from any credit balances available with the assessee firm. Further, there was no finding that interest free advances were given for business purposes. Therefore, in view of the above factual and legal position, disallowance of interest made u/s.36(1)(iii) for non-business purposes is justified and hence, grounds raised by the appellant on this account are dismissed.”
We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. It is observed that this issue involved in Ground No.3 of the assessee’s appeal as well as the facts relevant thereto are materially similar to the issue involved in Ground No.2 inasmuch as the disallowance on account of proportionate interest on the & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 8 borrowed funds allegedly utilized for giving interest free advance to the subsidiary company was made by the authorities below by applying the direct nexus theory since the assessee was found to have given the said advance directly from the Cash Credit Account. The case of the assessee as made out before the authorities below and specifically before the Tribunal is that sufficient interest free funds in the form of share capital, reserve & surplus and internal accruals were available at the relevant time to give interest free advance to the subsidiary company and there being the case of mixed funds maintained by the assessee-company, this issue is required to be considered having regard to the overall financial position of the assessee- company and not by applying the direct nexus theory. Following our conclusion drawn on the issue raised in Ground No.2, we restore this issue also to the file of the Assessing Officer for deciding the same afresh after verifying the overall financial position of the assessee-company in order to ascertain as to whether the interest free advance was given by the assessee- company out of interest free funds available at the relevant time or from the interest-bearing borrowed funds. The Assessing Officer is accordingly directed to decide this issue afresh on such verification after giving the assessee proper and sufficient opportunity of being heard. Ground No.3 of assessee’s appeal is thus treated as allowed for statistical purposes.
Now we take up the appeal of the assessee for Assessment Year 2014- 15 being Rs.90,85,891/- made by the Assessing Officer and confirmed by the learned CIT(A) on account of proportionate interest attributable to the interest-bearing borrowed funds allegedly utilized by the assessee-company for giving interest free advance to its subsidiary company. & 2275/Ahd/2018 Diamines and Chemicals Ltd Vs. ITO AY : 2013-14 & 2014-15 9
As the solitary issue involved in this appeal of the assessee for Assessment Year 2014-15 as well as the material facts relevant thereto are similar to the issue involved in Ground No.3 of the assessee’s appeal for Assessment Year 2013-14 which has already been decided by us in the foregoing portion of the order, we follow our conclusion drawn in Assessment Year 2013-14 and restore this issue also to the file of the Assessing Officer on similar terms.
In the result, both the appeals of the assessee are treated as allowed for statistical purposes.
Order pronounced in the Court on 25th March, 2022 at Ahmedabad.