M/S. CHHAGANLAL KISHANLAL & CO.,BURHANPUR vs. THE DCIT, KHANDWA

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ITA 817/IND/2014Status: DisposedITAT Indore28 February 2017AY 2011-1222 pages

In favour of the assessee: the assessee's appeal was allowed. From the AI summary of this appeal.

AI SummaryAllowed

What did the Tribunal hold?

The Tribunal held that the disallowance of interest was not justified. It relied on the principle that if interest-free funds are available, it is presumed that interest-bearing funds were used for interest-free advances, and the assessee had also offered interest income in the previous year and faced difficulties in recovery.

What were the facts?

The assessee firm advanced funds to certain parties without charging interest. The Assessing Officer (AO) disallowed interest expenses of Rs. 35,02,536/- on the grounds that the assessee had diverted its interest-bearing funds for these interest-free advances. The CIT(A) upheld the AO's disallowance.

What were the issues?

Whether disallowance of interest expenses is warranted when interest-bearing funds are advanced without charging interest, especially when recovery is doubtful and interest was offered in a prior year.

Which sections of the Income-tax Act were involved?

Section 36(1)(iii)

AI-generated summary — verify with the full judgment below

Income Tax Appellate Tribunal, INDORE BENCH, INDORE

Before: SHRI C.M. GARG & SHRI O.P. MEENA

For Appellant: Shri S. N. Agarwal, CA, Shri Mohd. Javed, D.R
For Respondent: Shri Mohd. Javed, D.R

आदेश / आदेश / आदेश /

PER O.P. MEENA, ACCOUTANT MEMEBR. This appeal by the assessee is directed against the order of learned Commissioner of Income tax (Appeals)-II, Indore [in short CIT (A)] dated 31.10.2014 for the Assessment Year 2011-12 on following grounds: 1. 1. That on the facts and in the circumstances of the case, the Ld. CIT (A) has erred in confirming the disallowance as made by the AO of Rs. 35,02,536/-out of interest paid by holding that assessee has diverted its interest bearing funds without interest, without properly appreciating the facts of the case and submission made before him.

1.2.

That on the facts and in the circumstances of the case, the Ld. CIT (A) erred in maintaining the addition, made on account of interest paid by holding that the assessee has not offered interest income even when interest was credited in the account of the assessee by the parties to whom advances were given by it without properly appreciating the facts of the case and submission made before him.

1.0.

The sole ground of appeal relates to confirmation of disallowance of interest of Rs. 35,20,536/-

1.1.

Succinctly, facts as culled out from the orders of lower authorities are that the assessee is a partnership

firm and derives income from trading of F.P Bales,

purchase and sale of Cotton seeds and all type of grains.

The return of income was filed on 28.09.2011 declaring

total income of Rs.9,77,070/-. On verification of AIR

information, it was noticed that M/s. Shubham Kela

Agency, Raver, M/s. Shri Ram Kela Agency, Raver and M/s. Saibaba Cotton Industries have paid the interest of Rs. 1,31,735/-, Rs. 93,289/- and Rs. 27,00,000/- respectively to the assessee and deducted due tax at source. Even then the assessee has failed to disclose the above interest income, therefore, it is a clear-cut case of diverting of interest bearing funds for advancing the same

without interest. The AO also noted the assessee has not charged interest on some other parties also asper given

table below:

Name of the Period Interest Interest Less concern in @12% @9% interest days charged 1.Shubham 254 3,66,692 4,34,630 3,66,692 Kela Agency 2.Sri Ram Kela 254 2,60,737 3,38,160 2,60,737 Agency 3.Sudha Garg 254 51,578 Not 51,578 charged

4.

Pramesh 254 16,701 Not 16,701 Shah (HUF) charged 5.Sweta 254 41,753 Not 41,753 enterprise charged 6.Ankit Goyal 254 2,59,870 Not 2,59,870 &Co. charged

7.

Shri Saibaba 254 25,05,205 Not 25,05,205 Cotton charged Industries Total interest 35,02,538 disallowed

1.1.

1. Accordingly, the AO disallowed the interest of Rs. 35,02,536/- by observing that the assessee has diverted interest bearing funds for advancing the same

without interest. 1. 2. Being, aggrieved the assessee filed an appeal before

the ld. CIT (A) wherein detailed submission were filed

which has been reproduced by the ld. CIT (A) in his order.

However, the ld. CIT (A) confirmed the action of the AO by observing that the claim of the appellant that it had substantial own funds has not been substantiated, with corroborating evidences. The facts that three parties have provided interest in their books of accounts and TDS was also done, which has not been controverted by the Appellant. It is also fact that the assessee has shown

interest from these parties in A.Y. 2010-11 and while

following mercantile system of accounting the assessee

has not shown this interest on the ground that interest

was not received from these parties. The contention of the assessee that it had partners capital of Rs. 1.20 crores

beside unsecured loans of Rs. 8.91 crores totaling to interest-free funds of Rs. 10.11 as against interest bearing

funds of Rs. 8.16 crores was not found acceptable by the ld. CIT (A). Accordingly, the Ld. CIT (A) echoed the findings

of the AO. 1. 3. Being, aggrieved the assessee filed this appeal before

the Tribunal. The Ld. A.R. submitted that the AO has disallowed interest in respect of deposits given to following

parties:-

Name of the Amount Amount Interest Concern outstanding outstanding disallowed as on as on @12% 31.03.2010 09.12.2010 1.Shubham Kela 43,91,167 43,91,1667 3,66,692 Agency 2.Sri Ram Kela 31,22,346 31,22,346 2,60,737 Agency 3.Smt. Sudha 6,17,654 6,17,654 51,578 Garg

4.

Pramesh Shah 2,00,000 2,00,000 16,701 (HUF) 5.Sweta 5,00,000 5,00,000 41,753 enterprise 6.Ankit Goyal 41,11,952 31,11,952 2,59,870 &Co. 7.Shri Saibaba 3,00,00,000 Nil(however, 25,05,205 Cotton cheque given Industries by the said party had been returned back as un- cleared and said amount of Rs. 3 crore again reflected in erstwhile company Total interest 35,02,538 disallowed 1.3. 1. The Ld. A.R. submitted that the assessee has advanced funds to the above mentioned parties in the previous year relevant to assessment year 2010-11 and in the previous year relevant to assessment year 2011-12. However, due to dispute with the said parties, the assessee

was not able to even receive the funds back which were advanced earlier. The Ld. A.R. filed copy of accounts of above parties appearing at page No 60,65, and 87 of the Paper Book which were also filed before the Ld.AO. It was submitted that the perusal of copy of account would show

that the assessee has debited interest amount in the account of these parties but the assessee has failed to realize the principal and interest from these parties. The assessee has offered interest from these parties as its income in A.Y. 2010-11 and also paid legitimate tax due

thereon. However, in spite of paying the tax on the amount

of interest in A.Y. 2010-11 , the assessee was not able

collect the amount of Interest and Principal. Hence, in the year under appeal for the assessment year 2011-12, the assessee had not offered the interest income as shown by these parties by merely deducting TDS on the amount of interest credited but not paid to the assessee. It was submitted that the even the principal amount of advance

given to above parties was doubtful of recovery, it was for this reason, the assessee has not offered any interest

recoverable from these parties. Therefore, it was argued

that disallowance of interest out of interest paid is not justified when the assessee has not received that interest

during the year. In support of his contention, the Ld. A.R.

relied in the case of M/s. Maruti Securities Ltd. vs. Addl

CIT in I.T.A. No. 468/Hyd/2009nnd 1939/Hyd/2011 for the assessment year 2005-06 of ITAT Hyderabad, wherein

it was held that the interest income has been recognized in the books of accounts only to the extent of actual

collection, which is the recommended/recognized method

as per Accounting Standard 9 of ICAI. The ld. A.R. also quoted the relevant para of the order which is as under:

“21. We have considered the rival submissions and perused the impugned orders of the Revenue authorities and other material on record. We have also gone through the written submissions filed and the decisions relied upon by the parties before us. We are of the opinion that to arrive at a real income, accrual basis cannot be a justifying factor and the commercial and business realties of the assessee, should be considered. The interest income has been recognized in the books of accounts only to the extent of actual collection, which is the recommended/ recognized method as per Accounting Standard 9 of ICAI which lays down that when uncertainties exist regarding the determination of the amount or its collectability, the revenue shall not be treated as accrued and hence shall not be recognized until collection. The recognition of revenue on accrual basis presupposes the satisfaction of two conditions- (a) The revenue is measurable (b) The revenue is collectable with certainty. The interest income has been admittedly recognised only on receipt basis. The contention of the revenue that the loan agreements have interest clause permitting the assessee to charge interest at the rate of 14% is not tenable. The terms of the agreements, which enabled the assessee company to demand interest were only enabling provisions and those enabling provisions did not guarantee the collection of overdue interest. They only gave a cause of action to the applicant.

22.

The method of accounting, as followed by the assessee, does not create any income; but the method of accounting only recognizes income. There is some merit in the submission of the assessee that when the principal itself is overdue and not collected, there is no basis for making out a case that interest income would be collectable with certainty. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to ascertain the nature of business and character of the transaction and the realities and peculiarities of the situations. The decision very heavily relied upon by the first appellate authority in the case of State Bank of Travancore Vs CIT (1986) 158 ITR 102 was subsequently overruled in its land mark decision in the case of UCO Bank Vs CIT 237 b) Andhra bank(225 ITR 447)(SC): It was held, that there cannot be a tax if no income resulted, despite the entry in the book keeping. The case deals with s. 148. Assessee changed method of accounting from AY 1960 onwards. But during AY 1963- 64, the AO objected the change and reopened assessments for AY 1960 onwards. Apex court held that this amounts to change of opinion and re-assessment is not valid.

23.

Further, the learned counsel for the assessee relied on the decision of the Hon’ble Supreme Court CIT vs. Excel Industries Ltd. & Ors. (358 ITR 295) and submitted that going by the accounting standard though the revenue is collectible by certainty, the assessee in the present case, in fact, had not received any interest and hence, interest in question remained only notional interest. As canvassed by the learned counsel for the assessee, some of the parties did not repay even the principal amount and some of the parties settled the accounts by paying some interest and hence, we agree that computation of notional interest at 14% on all the advances and making additions on that basis to the income of the assessee, is not justified.””

1.3.

2. The Ld. A.R. further placed reliance on the decision of Hon`ble Delhi High Court in the case of CIT vs.

M/s. Vasisth ChayVyapar Ltd. in I.T.A. No. 552 of 2005

dtd. 29.11.2010, wherein it was held that where the assessee company being NBFC is governed by the provisions of RBI Act, in such case interest income cannot

be said to have accrued having regards to the entity

provision of section 45Q of RBI and Prudential Norms

issued by the RBI and where interest was not received and possibility of recovery was almost nil, it could not be treated to have been accrued in favour of the assessee.

1.3.

3. The Ld. A.R. further submitted that the AO

himself has not taxed the said amount of interest of Rs.

29,25,024/- to the income of the assessee but he has disallowed an amount of Rs. 35,02,536/- out of interest

paid.

1.3.

4. The Ld. A.R. submitted that on the facts of the case as the assessee has substantial interest-free funds of Rs. 10,11,43,069/-, (consisting of capital of partners of Rs. 1,20,00,000 and unsecured loan of Rs. 8,91,43,069/- from partners) as on 09.12.2010 as against total interest

bearing funds of Rs. 8,16,45,023/- mainly borrowed from bank. The interest bearing funds were utilized towards the objects for which the said loan was taken by the firm for business purposes. Accordingly, the Ld. A.R. contended

that the assessee has not diverted its interest bearing

funds for non business purposes. The Ld. A.R. further

submitted that above facts of the case shows that advances

to all the seven parties as mentioned in assessment order

from whom interest was not charged or charged at the lesser rate was given out of interest-free funds available

with it.

1.3.

5. The Ld. A.R. relying on the decision of Hon`ble further relied on the decision of Hon`ble Supreme Court in judgement of Hon`ble Bombay High Court in the case of CIT vs. Reliance Utilities & Power Ltd. (2009) 313 ITR 340

(Bom) wherein it was held that if there are fund available

both interest free and interest bearing, then a presumption

would arise that investment were out of interest free funds

generated or available with the assessee. If the interest-free

funds were sufficient to meet the investment no disallowance of interest paid on borrowed funds would be necessary. Once such presumption is established claim of interest was allowable.

1.3.

7. The Ld. A.R. also placed reliance on the judgement of Hon`ble Supreme Court in the case of S. A. judgement : CIT vs. Hero Cycles Ltd. (2010) 323 ITR 518 (P&H) wherein it was held that no disallowance out of interest payment is permissible if AO does not establish

nexus between the expenditure incurred and income

generated. The Ld. A.R. submitted that in the present case

the AO has failed to establish that the assessee had diverted interest bearing funds for non business purposes

or advanced the same without interest. When the assessee

has utilized the interest bearing funds for business

purpose and justified the same , then no disallowance of interest can be made.

1.3.

9. The Ld. A.R. further cited following judicial

pronouncements in support of his contention as follows: Gwalior Pvt. Ltd. vs. CIT 44 ITR 847(MP), D & H Secheron 409(Indore-Trib), and others as per his written

submissions.

1.4.

On the other hand, the Ld. D.R. relying on the orders

of lower authorities submitted that the assessee is not able

to substantiate that interest free advances were given out of interest-free funds available with the assessee, hence,

finding of the AO/ld. CIT (A) may be upheld.

1.5.

We have heard the rival submissions of both the parties and have perused the material available on record.

We find that the ld. A.O. has failed to establish that the assessee has received any interest from the above seven

parties during the year under consideration and the interest free advances to above stated seven parties were out of interest bearing funds. It is the contention of the assessee that it had sufficient non-interest bearing funds

to the tune of Rs. 10.11 crores as on 09.12.2010, which inter-alia included partners capital of Rs.1.20 crores, and unsecured loan from partners of Rs. Rs. 8.91 crores as against interest bearing funds of Rs. 8.16 crores. The ld. A.

R. contended that the assessee had utilised these funds for giving interest-free advances to aforesaid parties on which no interest was shown by the assessee even though M/s.

Shubham Kela Agency, M/s. Ram Kela Agency and M/s.

Saibaba Cotton Industries have shown to have paid

interest of Rs. Rs. 1,31,735/- , Rs. 93,289/- and Rs.

27,00,000/- respectively to the assessee as per AIR information on which TDS was also deducted. We find that as per books of accounts of the assessee , the assessee has not received any interest during the year under consideration even though interest received in preceding

year was duly shown by the assessee as its income for assessment year 2010-11. It is the contention of the 468/Hyd/2009 and 1939/Hyd/2011 for the assessment

year 2005-06 dtd. 05.09.2014 wherein para 22 is reproduced as under:

“22. The method of accounting, as followed by the assessee, does not create any income; but the method of accounting only recognizes income. There is some merit in the submission of the assessee that when the principal itself is overdue and not collected, there is no basis for making out a case that interest income would be collectable with certainty. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to ascertain the nature of business and character of the transaction and the realities and peculiarities of the situations. The decision very heavily relied upon by the first appellate authority in the case of State Bank of Travancore Vs CIT (1986) 158 ITR 102 was subsequently overruled in its land mark decision in the case of UCO Bank Vs CIT 237 b) Andhra bank(225 ITR 447)(SC): It was held, that there cannot be a tax if no income resulted, despite the entry in the book keeping. The case deals with s. 148. Assessee changed method of accounting from AY 1960 onwards. But during AY 1963- 64, the AO objected the change and reopened assessments for AY 1960 onwards. Apex court held that this amounts to change of opinion and re-assessment is not valid.” 1.5. 1. Therefore, in the light of finding of coordinated

bench mentioned as above, we are of the view that when no interest is received same cannot be taxed on notional

basis.

1.5.

2. We further find that the Hon`ble Supreme Court “that going by the accounting standard though the revenue is collectible by certainty, the assessee in the present case, in fact, had not received any interest and hence, interest in question remained only notional interest. As canvassed by the learned counsel for the assessee, some of the parties did not repay even the principal amount and some of the parties settled the accounts by paying some interest and hence, we agree that computation of notional interest at 14% on all the advances and making additions on that basis to the income of the assessee, is not justified.”” 1.5. 3. In view of above, relying on decision of Apex

Court as referred to above, we are of the view the when

interest income is not realized or collected , same cannot

be taxed on notional basis. We further find to the AO has also not taxed the interest income credited by the above

mentioned parties in their books of accounts , but disallowance of interest has been made on the basis of diversion of interest bearing funds to non-business

purposes. However, we find that the Ld. A.R. has fully demonstrated that the interest-free advance were given out

of interest-free funds available with the assessee during

the assessment year 2010-11 and during A.Y. under consideration for which interest-free funds of Rs.10.11

crores [ Rs. 1.20 crore + Rs. 8.91 crore] as mentioned in above paras of this order, as against interest bearing funds

of Rs. 8.19 crores. The Ld. A.R. also placed reliance on the judgement of Hon`ble Supreme Court in the case of S. A. purpose as held in above quoted decision of Hon`ble

Supreme Court. The ld. A. R. has placed reliance in the case of CIT vs. Reliance Utilities & Power Ltd. (2009)313

ITR 340(Bom)/ 178 Taxman 135 (Bom) wherein it was held

that if there was funds available both, interest-free and overdraft and or/loans taken, then a presumption would

arise that investments would be out of the interest-free funds generated or available with the company, if the Cycles Ltd. (2015) 379 ITR 347(SC)/63 taxmann.com 308

(SC)/ (2016) 236 Taxman 447 (SC)wherein it was held as under:

11.

We are of the opinion that such an approach is clearly faulty in law and cannot be countenanced.

12.

Insofar as loans to the sister concern/subsidiary company are concerned, law in this behalf is recapitulated by this Court in the case of S.A. Builders Ltd. v. CIT (Appeals) [2007 (288) ITR 1/158 Taxman 74]. After taking note of and discussing on the scope of commercial expediency, the Court summed up the legal position in the following manner:— '

26.

The expression "commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.

27.

No doubt, as held in Madhav Prasad Jatia v. CIT [1979 (118) ITR 200 (SC)], if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under section 36(1)(iii) of the Act. In Madhav Prasad's case [1979 (118) ITR 200 (SC)], the borrowed amount was donated to a college with a view to commemorate the memory of the assessee's deceased husband after whom the college was to be named, it was held by this court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.

28.

Thus, the ratio of Madhav Prasad Jatia's case [1979 (118) ITR 200 (SC)] is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed under section 36(1)(iii) of the Act.

29.

In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.

30.

It has been repeatedly held by this court that the expression "for the purpose of business" is wider in scope than the expression "for the purpose of earning profits" vide CIT v. Malayalam Plantations Ltd. [1964 53 ITR 140 (SC), CIT v. Birla Cotton Spinning and Weaving Mills Ltd. [1971 82 ITR 166 (SC)], etc.'

13.

In the process, the Court also agreed that the view taken by the Delhi High Court in CIT v. Dalmia Cement (P) Ltd. [2002] 254 ITR 377/121 Taxman 706 wherein the High Court had held that once it is established that there is nexus between the expenditure and the purpose of business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman.

14.

Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s. Hero Fibres Limited became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to M/s. Hero Fibres Limited to meet the working capital for meeting any cash loses.

15.

It would also be significant to mention at this stage that, subsequently, the assessee company had off- loaded its share holding in the said M/s. Hero Fibres Limited to various companies of Oswal Group and at that time, the assessee company not only refunded back the entire loan given to M/s. Hero Fibres Limited by the assessee but this was refunded with interest. In the year in which the aforesaid interest was received, same was shown as income and offered for tax.

16.

Insofar as the loans to Directors are concerned, it could not be disputed by the Revenue that the assessee had a credit balance in the Bank account when the said advance of Rs. 34 lakhs was given. Remarkably, as observed by the CIT (Appeal) in his order, the company had reserve/surplus to the tune of almost 15 crores and, therefore, the assessee company could in any case, utilise those funds for giving advance to its Directors.

17.

On the basis of aforesaid discussion, the present appeal is allowed, thereby setting aside the order of the High Court and restoring that of the Income Tax Appellate Tribunal. 1.5. 4. Therefore, presumption would go in favour of the assessee that the interest free funds were given out of interest free funds available at the disposal of the assessee

as per balance sheet of the assessee, by applying the ratio

as laid down by the Hon’ble Bombay High Court in in the case of CIT vs. Reliance Utilities & Power Ltd. (2009) 178 Taxman 135 (Bom) and the decision of Hon`ble Punjab & Haryana High Court in the case of Hero Cycles Ltd. (2010) 323 ITR 518 (P&H) and other decision as relied by the ld. A.R., we are of the considered opinion that no disallowance of interest is warranted in the case. Accordingly, disallowance of interest of Rs.35,02,536/- is deleted. The above grounds of appeal is therefore, allowed.

1.6.

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

1.7.

The order pronounced in the open Court on 28.02.2017. (ओ.पी.मीना) (सी.एम.गग") लेखा सद"य "याियक सद"य "दनांक /Dated : 28th February, 2017/opm

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