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Facts
The assessee claimed interest expenditure of Rs. 69,53,573/- on borrowed funds, alleging it was for business purposes. The Assessing Officer (AO) disallowed this, stating the funds were used for interest-free investments in partnership firms from which no income was earned. The CIT(A) upheld the AO's decision.
Held
The Tribunal held that the disallowance of interest expenditure under section 36(1)(iii) was not sustainable. The absence of earning interest income on capital invested in a firm is not a bar to claiming interest paid on borrowings for such investment as a deductible expenditure.
Key Issues
Whether the interest expenditure incurred on borrowed funds, used for investment in partnership firms from which no income is earned, is allowable as a deduction under Section 36(1)(iii) of the Income Tax Act, 1961.
Sections Cited
36(1)(iii), 37(1), 28, 14A, 67(3)
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, “G” BENCH, MUMBAI
Before: SHRI SANDEEP GOSAIN, JM &
(Assessment Year: 2019-20) Sachin Chandru Mirani ACIT, Central Circle-1, 2nd Floor, Satyam Apartment, A Wing, 6th Floor, Ashar IT Park, M.G. Road, Opp. Telecom Exchange, Vs. Road No. 16Z, Wagle Ind. Estate, Thane, Mumbai-400602. Thane-400604. PAN : ADWPM3912E Appellant) : Respondent) Appellant /Assessee by : Shri Subodh Ratnaparkhi, CA Revenue / Respondent by : Shri Nagesh Bhimrao Pasale, Sr.DR : 13.11.2024 Date of Hearing : 21.11.2024 Date of Pronouncement O R D E R
Per Padmavathy S, AM:
This appeal by the assessee is against the order of Commissioner of Income Tax (Appeals), Pune-11 [in short 'the CIT(A)'] dated 02.08.2024 for Assessment Year (AY) 2019-20. The assessee raised the following ground of appeal –
1. The Hon CIT(A) erred in upholding addition of Rs. 69,53,573/- made by ld. AO by disallowing interest expenditure claimed as deduction against interest income from partnership firm, for the alleged reason that interest free investments were made out of interest-bearing borrowed funds, without appreciating the provisions of section 36(1)(iii) of the IT Act, 1961 and ignoring the fact that the concerned investments were for the business Sachin Chandru Mirani purposes only and accordingly the interest expenditure was allowable as revenue expenditure as per section 36(1)(iii) of the IT Act, 1961 and should be so allowed in computing total income.
2. The Hon CIT(A) erred in also upholding the alternative argument of the Ld. AO to support the addition of Rs. 69,53,573/-, by relying upon the provisions of section 37(1) of the IT Act, 1961, disallowing interest expenditure incurred on borrowed loans, without appreciating the fact that entire interest expenditure was revenue in nature and incurred wholly and exclusively for the purposes of business and therefore fully allowable as revenue expenditure and hence the disallowance was not justified and bears to be deleted.”
2. The assessee is an individual deriving income from House Property, Business, Capital Gains and Interest Income. The assessee filed a return of income for AY 2019-20 on 30.10.2019 declaring total income at Rs.58,02,470/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. The AO during the assessment proceedings noticed that the assessee has earned interest on capital of Rs. 83,78,564/- from M/s Shri Neminath Buildpro and that the assessee has claimed interest under section 36(1)(iii) of the Income Tax Act, 1961 (the Act) to the tune of Rs. 69,53,573/-. The AO further noticed from on the financial statements filed by the assessee that there is significant increase in the loans and advances given by the assessee and accordingly called on the assessee to explain whether the interest bearing funds have been utilized for interest free loans. The assessee submitted before the AO that the balance in capital account of the assessee is much more than the amount of loans and advances given by the assessee and therefore no disallowance can be made towards interest claimed as a deduction by the assessee. The AO, however, did not accept the submissions of the assessee and held that the interest claimed as deduction by the assessee cannot be allowed as deduction. The reason for making the disallowance is that the borrowed funds are being utilized for investment in capital account of various partnership Sachin Chandru Mirani firms from where the assessee is not earning any income. Further the assessee has extended loans and advances which are not yielding any interest.
3. Aggrieved the assessee filed appeal before the CIT(A). The CIT(A) confirmed the disallowance made by the AO stating that “7. From the balance sheet as on 31.03.2018 suggest that the total unsecured loans raised by the appellant were Rs. 12,91,15,807/-, Against this amount, the total unsecured loans raised as on 31.03.2019 is Rs.18,21,71,423/-. Thus, the appellant has raised substantial amount of fresh unsecured loans during the year under consideration on which he has paid interest during the year. On the other hand, from the cash flow filed by the appellant, it is seen that the investment in capital account of M/s. Shree Neminath Buildpro is only Rs.51,50,000/-. Thus, the appellant has used fresh unsecured loans in making non-interest yielding investments. 8. Thus, it is very clear from the above discussion that the appellant has raised fresh unsecured loans during the year under consideration on which interest has been paid. On the other hand, as discussed above, the appellant has made only small investment in the partnership firm namely M/s. Shree Neminath Buildpro. As discussed above, the appellant has claimed that the expenditure of Rs.69,53,573/- was incurred for earning the interest on capital invested in the said firm. Thus, the claim of the appellant that interest bearing funds were used for making investment in the said partnership firm appears to be incorrect. 9. The appellant's argument is that it had sufficient capital which could fund non- interest yielding investments. From the balance sheet as on. 31.03.2019, it is seen that the appellant had his own capital amounting to Rs 24,16,96,089/ On the other hand, a total of assets are Rs.42,99,21,439/- out of which the investment in M/s. Shree Neminath Buildpro is Rs. 14,32,07,359/-. This means that the assets were amounting to Rs.28,67,14,080/- are non-interest yielding and these assets are more than the total capital of the appellant. Thus, the appellant's own capital of Rs.11,60,97,108/- is not sufficient to fund the investments on which no interest income is being earned by the appellant. Thus, it is very clear that interest bearing funds were utilized for making non- interest earning investments. 10. The appellant has claimed that all unsecured loans were raised for the purposes of business, however no documentary evidence for this claim has been filed. It may be correct to say that the appellant has substantial amount of investment in various partnership firms but it is not earning any interest on most Sachin Chandru Mirani of these partnership firms and reason of same has not been explained by the appellant. Normally, there is a clause in a partnership deed regarding the payment of interest on capital balance of partners but the appellant has not filed the copies of partnership deeds of all the partnership firms in order to explain the reasons for not earning any interest income on the investment made in these partnership firms. In other words, it can be said that the appellant has failed to substantiate that all unsecured loans were raised solely for the purposes of business and were utilized only for the purpose of business.
The ld. AR submitted that the assessee is a partner in 17 Firms and that the assessee is earning interest income towards capital invested only from M/s Shri Neminath Buildpro. The ld. AR further submitted that the assessee has invested borrowed funds in various partnership firms and that the investments made in partnership firm are business investments of the assessee. The ld. AR also submitted that the interest income from partnership firm is taxable under section 28 of the Act and therefore the interest claimed by the assessee under section 36(1)(iii) of the Act is an allowable expenses. The ld. AR drew our attention to the balance-sheet of the assessee to submit that the loans and advances given by the assessee is out of own funds and that the assessee has invested the borrowed funds towards investment in partnership firms. Therefore, the ld. AR argued that the AO is not correct in making disallowance under section 36(1)(iii) for the reason that the assessee is earning income from only one partnership firm and the loans borrowed are invested in firms which are not earning any income. The ld. AR in this regard placed reliance on the decision of the Hon'ble Supreme Court in the case of CIT Vs. Reliance Industries Ltd. (2019) 410 ITR 466 (SC) and the decision of the Bangalore Bench of the Tribunal in the case of Suresh Shriram Vs. ITO 127 taxmann.com 249.
The ld. DR on the other hand submitted that the AO has made the addition based on the movement in the borrowed funds and the investments made in M/s Sachin Chandru Mirani Shri Neminath Buildpro and loans and advances. The ld. DR further submitted that the movement during the year substantiates that the assessee has utilized the borrowed funds towards loans and advances and accordingly the AO has correctly made the disallowance under section 36(1)(iii) of the Act. The ld. DR also submitted that the assessee has not discharged the onus of proving that the interest free investments are made out of own funds and not out of borrowed funds.
We heard the parties and perused the material on record. The assessee is a partner in various partnership firms in which the assessee has made an investment to the tune of Rs.38,21,95,742.11 as of 31.03.2019. Out of this capital with various partnership firms, the assessee is earning interest income only from one firm M/s.Shri Neminath Buildpro and the assessee is also earning remuneration as partner from M/s.Shri Sumatinath Enterprises LLP. The assessee has claimed interest expenditure of Rs.69,53,573 against these two incomes which have been offered to tax under the head profits and gains from business or profession. The contention of the revenue is that the investment in the partnership from where assessee is earning interest income is very low compared to the borrowed funds. The revenue is also contending that the assessee has utilized the interest bearing funds to make investment in partnership firms from where no income is derived, and that the borrowed funds are also used for giving interest free loans and advances. The assessee's argument is that the investment in the capital of the partnership firms are business investments and therefore irrespective of whether any income is earned or not the deduction under section 36(1)(iii) cannot be denied. The assessee has submitted the statement of major contributors for sources and application of funds for the year under consideration before the AO as tabulated below Particulars of Source Amount – Rs. Particulars of Amount – Rs. of Funds Application of funds Loans taken from 8,76,33,070 Loans (Liability) 4,15,36,027 friends and Relatives Capital withdrawn 11,14,21,015 Investment in Firms 14,84,37,308 from various firms Receipts of advances 1,55,12,000 Loans and advances 2,60,12,650 given Total 21,45,66,085 Total 21,45,66,085
From the perusal of above table we notice that the assessee has sourced funds from both interest bearing loans and non-interest bearing funds and that the same is majorly invested in the capital of the partnership firms. There is no dispute that the investment made by the assessee in partnership firms is for the purpose of business. The AO in assessment order has observed that the investment in partnership firms is not earning any income to the assessee except one firm, and therefore the claim of interest paid under section 36(1)(iii) is not allowable. In this regard it is relevant to consider the following observations of the Bangalore Tribunal in the case of Suresh Sreeram vs ITO [2021] 127taxmann.com249 (Bangalore - Trib.) –
Interest, salary, bonus, commission or remuneration received or receivable from the firm by the partners shall be assessable in the hands of the partners as income from business or profession under section 28 of the Act. The partner shall be entitled to all expenditure which is incurred to earn such income or for purposes of the said business. Other deductions as admissible in law can also be claimed by the partner against such income. Under the old provisions, section 67(3) entitled a partner to claim deduction in respect of any interest paid by a partner on capital borrowed by him for the purposes of investment in the firm from the share income. The Supreme Court in CIT v. Ramniklal Kothari [1969] 74 ITR 57 held the share of the partner as business income in his hands and being business income expenditure necessary for the purpose of earning that income and appropriate allowances are deductible there from in determining the taxable income of the partner. The Court held that the amount Sachin Chandru Mirani paid as salary and bonus to staff, expenditure for maintenance and depreciation of motor cars and travelling expenses expended by him in earning the income from firm are deductible from the income. The Delhi High Court in CIT v. Sohan Lal Nyyar [1974] 95 ITR 90 held that section 67(3) is not exhaustive and any deduction otherwise allowable under section 37(1) will have to be allowed even if it does not fall within the ambit of section 67(3) of the Act. Salary paid to a manager by a partner for looking after his interest in the firm stands allowed by the Madras High Court in CIT v. S. Meyyappan [1969] 73 ITR 20. Therefore absence of earning any interest income on capital from the firm is no bar to claim the interest paid on borrowings for the purpose of contributing capital to the firm by the assessee as deductible expenditure. In such an event there would be loss under the head"PGBP" subhead "interest, salary from the partnership firm" and the assessee is entitled to set off the said loss against other income under the same head "PGBP". We are also of the view that the reasoning of the CIT(A) that the interest expense would be expenditure incurred for the purpose of earning income from the partnership firm in the form of share income and therefore the expenditure would be not allowable in terms of sec.14A of the Act. This reasoning of the CIT(A) is incorrect because admittedly the firm incurred loss and the assessee did not receive any exempt income in the form of share of profits from the firm. (emphasis supplied) 8. Section 36(1)(iii) provides that the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession shall be allowed as a deduction. Accordingly the conditions for allowing deduction under this section is that the money, that is capital, must have been borrowed by the assessee, for the purpose of business, and the assessee must have paid interest on the borrowed amount. For the purpose of allowability of interest under section 36(1)(iii), the commercial expediency has to be looked into as has been held in various judicial pronouncements. In assessee's case, there is no contention in this regard is raised by the revenue and the reason for disallowance is that the assessee is not earning any interest income from the investment made in the partnership firms. This in our considered view is not correct reason for making the disallowance under section 36(1)(iii) in assessee's case. Further from the perusal of the above funds flow Sachin Chandru Mirani statement, it is noticed that the loans and advances given during the year is coming out of the pool of funds which includes capital withdrawn from partnership firms, and without a one-to-one match being established by the revenue, it cannot be said that the borrowed funds are used for giving interest free loans and advances. It was also submitted during the course of hearing that some of the loans extended are earning interest and not the entire loans and advances are interest free. In view of these discussions and considering the facts peculiar to assessee's case, we are of the view that the disallowance made under section 36(1)(iii) is not sustainable. Accordingly the AO is directed to deleted the disallowance made in this regard.
In the result, the appeal of the assessee is allowed. Order pronounced in the open court on 21-11-2024. Sd/- Sd/- (SANDEEP GOSAIN) (PADMAVATHY S) Judicial Member Accountant Member *SK, Sr. PS Copy of the Order forwarded to : 1. The Appellant 2. The Respondent 3. DR, ITAT, Mumbai 4. Guard File 5. CIT BY ORDER,
(Dy./Asstt. Registrar) ITAT, Mumbai