ACIT 11(1), MUMBAI vs. CREST ANIMATION STUDIOS LTD, MUMBAI

Assessee by: None Revenue by : Shri. Rajat Mittal सुनवाई की तारीख /Date of Hearing : 04-10-2017 घोषणा की तारीख /Date of Pronouncement : 29.11.2017 आदेश / O R D E R PER RAMIT KOCHAR, Accountant Member These cross appeals, filed by the Revenue and Assessee, being Revenue and being filed by the assessee respectively for assessment year 2006-07, are directed against the appellate order dated 19-05-2010 passed by learned Commissioner of Income Tax (Appeals)-3, Mumbai (hereinafter called “the CIT(A)”), for the assessment year 2006-07, the appellate proceedings had arisen before learned CIT(A) from the assessment order dated 26.12.2008 passed by learned Assessing Officer (hereinafter called “the AO”) u/s 143(3) of the Income-tax Act, 1961 (hereinafter called “the Act”).

“1. "On the facts and in the circumstances of the case and in law, the Ld. CIT(A) Mumbai has erred in deleting addition of Rs. 1,59,66,007/- made on account of section 36(1)(iii} of the I.T. Act, 1961.

2. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) Mumbai failed to appreciate the fact that the cost of advancing moneys have been very low i.e. 1.40% whereas the percentage of interest paid out is as high as 22.75%.

3. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) Mumbai erred in deleting the addition of Rs. 28,61,468/- made on account of section 41(1) of the I.T. Act, 1961.

raised by the assessee in the memo of appeal filed with the Income-Tax Appellate Tribunal, Mumbai (hereinafter called “the tribunal”) read as under:- “ Ground No. 1 : On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in holding that interest bearing funds had been diverted in respect of the inter corporate deposit given by the appellant to M/s Classic Credit Ltd. amounting to Rs. 5,68,50,000/- and notional interest at the rate of 12.25% had to be disallowed on the said amount.”

4. These are very old appeals for the assessment year 2006-07 filed by the 2 assessee as well revenue in the year 2010. In these instant appeals several opportunities were granted to the assessee as per order sheet entries in the file but the assessee is not appearing when the appeals were called for hearing before the tribunal. On 21-08-2017, when the appeal were called for hearing again none appeared on behalf of the assessee. On 21-08-2017, the Bench directed issue of notice by RPAD as well directions were issued by the Bench to serve notice through learned DR. The learned DR has filed acknowledged copy of receipted service of notice which was received by the assessee on 27-09-2017 intimating about hearing fixed on 04-10-2017 , but still none appeared on 04-10-2017 when the appeal was called for hearing. Thus, keeping in view wilful default of the assessee wherein appearances are not entered deliberately by the assessee and no adjournment application is filed, we are proceedings to decide these two appeals after hearing learned DR and perusing material placed on record.

5. The assessee is engaged in the business of animation production services. The A.O observed that assessee has obtained secured loans to the tune of Rs. 7.11 crores from the Banks and Finance Companies. The AO observed that the assessee has incurred interest and other finance charges to the tune of Rs. 1.61 crores . It was also observed by the AO that assessee has advanced Rs. 6.52 crores as loans and advances , out of which the AO observed that loans and advances were given to subsidiaries as well as inter- corporate deposits(ICD) to various companies. The A.O observed that effective rate of interest paid on the borrowing works out to 22.75% . It was also observed by the AO that assessee has advanced Rs. 5,68,50,000 as ICD to Classic Credit Limited in the year 2003 which was marked as doubtful . The AO concluded that there is violation of provisions of Section 36(1)(iii) as on the one hand the assessee has borrowed funds by way of loans on which heavy interest is paid and on the other hand , the amounts are advanced to subsidiaries and as well grant of ICD , majority of which have become doubtful. The AO observed that loans were incurred by the assessee not for the purposes of business but for the benefit of someone else and hence interest on such loans cannot be claimed u/s 36(1)(iii). It was observed that loan contracted by the assessee are colourable device to reduce tax liability. It was also observed by the AO that out of loans and advances of Rs. 6.51 3 crores , the assessee has advanced Rs. 1.60 crores to subsidiary on which interest of only Rs. 9.18 lacs has been recovered which is approx. @ 5.7% . It was also observed that various ICD’s are not providing any benefit to the assessee. The A.O observed that before allowability of interest expenses u/s. 36(1)(iii), the assessee has to prove that money was borrowed by the assessee for the purposes of its own business on which interest has been paid. The A.O relied upon the decision of Hon’ble Supreme Court in the case of CIT v. Calcutta Agency Ltd. (1951) 19 ITR 191(SC) and that the onus is on the assessee to prove that expenses have been incurred for the purposes of business of the assessee . Thus, the AO observed that effective rate of interest paid by the assessee was 22.75% , while the effective rate of interest recovered comes to merely 1.4% , which led to be additions to the tune of Rs. 1,59,66,007/- which was held to be in contravention of Section 36(1)(iii), vide assessment order dated 26-12-2008 passed by the AO u/s 143(3). Further, it was observed by the A.O that creditors to the tune of Rs.28,61,468/- are outstanding for the last more than two years as per list placed by the AO at page 9 and 10 of the assessment order . The AO observed that since the said amounts were outstanding for more than 3 to 4 years as on 31.03.2008 . The AO observed that the burden is on the assessee to prove that the liability subsists as the facts are especially in the knowledge of the assessee. The A.O added the said amount of Rs. 28,61,468/- to the income of the assessee as unclaimed liabilities and on account of cessation/remission of liability u/s. 41(1) of the Act, vide assessment order dated 26-12-2008 passed by the AO u/s 143(3).

6. Aggrieved by the assessment order dated 26-12-2008 passed by the AO u/s 143(3), the assessee filed first appeal before the learned CIT(A). The assessee contended before the learned CIT(A) that the finance charges amounting to Rs.46,60,216/- were also considered while calculating the interest rate at 22.75%. It was also submitted that the sum of Rs.9,48,822/- had been paid towards lease assets and Rs.6,78,002/- was paid towards interest on car acquired on instalments. It was submitted that the amount were borrowed at the rates which varied from 6 to 12.25% and not 22.75% as calculated by the AO. It was also submitted that advances were given for assesses business. It was also submitted that the assessee has also charged interest on loans to its subsidiaries at the rate of 8% on reducing balance as against 5.7% calculated by the A.O and had recovered Rs.9,18,000/- from its subsidiaries .It was also submitted that loans and advances were for business purposes based on commercial expediency and interest should be allowed keeping in view provisions of Section 36(1)(iii). It was submitted that the AO has erroneously calculated interest recovered from subsidiaries @1.4% . The break up was submitted which reflected Rs. 1,60,89,336/- as loans to subsidiaries while ICD including interest accrued thereon were to the tune of Rs. 5,68,50,000/- and balance amount was towards trade advances, deposits, taxes paid , accrued interest on fixed deposits . It was submitted that on the amount advanced/loaned to subsidiaries , the assessee has recovered interest @8% per annum on reducing balance. It was submitted that only the amount of loan and advances to subsidiaries to have been considered by the AO as the others are trade advances, deposits, taxes accrued etc. . Without prejudice , it was submitted that out of total fund , USD 550000 had been advanced to Crest Communication , Singapore out of assessee own funds during F.Y. 2000-01 , out of which USD 394161 was converted to equity during F.Y. 2001-02 . It was submitted that these monies were from assessee’s own funds and therefore no disallowance of interest can be made to this extent. It was also claimed that the amount of disallowance be restricted based on difference of interest between actual maximum rate of interest on borrowed funds i.e. 12.25% and the interest charged at 8% from the subsidiaries. The learned CIT(A) after considering submissions of the assessee held as under:- “2.1.4 Facts and material on record are considered. It is seen that the entire basis of calculation of disallowance of interest by AO is on the basis of figures of balance sheet as on 31.3.06. As per normal banking or financing practice, interests are calculated on daily outstanding balances or on reducing balances depending on the terms of each loan or advance. Interests are, however, not calculated on year end outstanding balances or even on average of opening and closing balances. Moreover, though observing that Appellant had paid interest on fixed loans and others as well as incurred finance charges on leases etc., AO has taken the entire sum of Rs. 1,61,92,705/- to work out-the cost of borrowing at 22.75% disregarding the fact that the term loan, cash credit loan, packing credit loan etc. were at different rates and for different purposes and could not be considered in entirety as directed against the loans and advanced by Appellant to others. Moreover, though the entire loans advances given by Appellant have been 5 considered, AO has only considered the interest received from subsidiaries while working out the percentage of interest received at 1.40%. Additionally, there has been no attempt to identify whether Appellant had utilised interest-bearing loans to make loans and advances to different parties or whether these were out of appellants own funds. 2.1.5 The assessment order also does not contradict nor controvert Appellant's claim that the loans and advances to its subsidiaries were mainly for their working' capital requirements as the subsidiaries provided marketing and technical support to Appellant and helped Appellant to get overseas business. In so far as Appellant's case related to loans and advances to its subsidiaries is concerned, the issue has been discussed in detail in the appellate order of even date in Appellant's case for AY 2005-2006, where AO had disallowed interest observing that interest received from subsidiaries was only at 8%. As in the impugned appeal, in A.Y. 05-06 also it was seen that Appellant had advanced monies to its three foreign subsidiary. Additionally in that year, the Transfer Pricing Officer had held that transaction to be at arm's length. For reasons discussed therein and as held therein, the loans and advances given by Appellant to its subsidiaries are held to be for purpose of business and commercial expediency. It is further held that amounts pertaining to advances recoverable in cash or in kind, sundry deposits, taxes paid, interest accrued on fixed deposits with banks cannot be considered for disallowance of interest as this disallowance had not been discussed by AO, neither substantiated nor established to be based on facts.” And so far as Inter Corporate deposit of Rs.56,850,000/- is concerned , the learned CIT(A) observed that the assessee has not established this advances as being for purpose of business or commercial expediency . It was also not established by the assessee that this ICD was out of its own funds or non interest bearing funds. Thus it was held by learned CIT(A) that interest bearing funds of assessee have been diverted towards this inter corporate deposit from which no interest was received or accrued during the impugned period. The learned CIT(A) upheld the disallowance @ 12.25% w.r.t. borrowings on OD account . With respect to the invocation of provisions of Section 41(1) for cessation of liabilities of the creditors , the assessee had submitted that no opportunity was provided to the assessee by the AO to furnish confirmations from the sundry creditors . It was submitted that merely because the liability is outstanding for more than two years, it cannot be said that the liability has ceased to exist. It was submitted that all the amounts except Shaft Broadcast Private Limited and Sh. Sushant G. Mohite were written back as income u/s 41(1) in AY 2007-08. With respect to Sh. Sushant G Mohite it was submitted that the amount of Rs. 6,168/- was paid on 12-4-2006 and remaining Rs. 1200/- was written back as income u/s 41(1) on AY 2007-08. With respect to Shaft Broadcast Private Limited, it was submitted that the dispute is pending before the Court and though disputed liability is continuing in books of accounts. The copy of summary suit filed with Hon’ble Bombay High Court was filed. Thus, it was submitted that no additions can be made for the amounts which were already written back in AY 2007-08. The learned CIT(A) observed that no disallowance can be made by the A.O. , by holding as under: “ 2.2.3 Facts and material on record are considered. There is a details discussion in the assessment order on this disallowance. However, it does not seem that the A.O queried the appellant for satisfaction. regarding the creditors/liabilities except for asking Appellant to produce details with regard to creditors lying outstanding for past two years. As stated in the assessment order, this compliance was made by the Appellant by their letter dated 26.12.2008. The assessment order does not indicate an opportunity provided to Appellant for establishing that the said liabilities were not ceased or remitted or to file any confirmations from the said creditors. Appellant has also submitted that certain liabilities were written back and offered for taxation in AY. 2007-2008, for which the due date of filing return would have been 31.10.2007 i.e. prior to the passing of the impugned order. It, therefore, follows that had Appellant been queried in this respect, the fact of amounts written back and offered for tax would have been available to AO. Further, in so far as liability of Shaft Broadcast is concerned, there is no cessation or remission as evidenced by the court case. In the facts and circumstances of the case, it is held that the amounts written back and offered for tax in AY. 2007-2008 by Appellant cannot be added to the total income for the impugned in assessment year. Further in view of the pending litigation with Shaft Broadcast, there is no evidence of this liability having been ceased or remitted. The addition u/s. 41(1) by tile AO is, therefore, deleted in entirety.”

7. Aggrieved by the appellate orders dated 19-05-2010 passed by learned CIT(A), both the Assessee and Revenue have come in appeal before the tribunal . None appeared on behalf of the assessee despite several notices issued to the assessee. . Ld. DR has vehemently argued for upholding orders of the A.O. . With respect to the relief given by the Ld. CIT(A), it was submitted that interest bearing funds were raised to the tune of Rs. 7.11 crore at the cost of the 22.75% , while with respect to the advances given interest received was only Rs. 9.18 lacs which were given in the form of loans to subsidiaries and ICD’s . It was also submitted that with respect to the subsidiaries , the learned CIT(A) has given relief w.r.t. advances so made to subsidiaries while learned CIT(A) upheld the disallowance of interest in connection with ICD of Rs. 5.68 crore given to Classic Credit Limited . With respect to the additions made u/s. 41(1) in connection with cessation of liability , it was submitted amounts were outstanding from more than two years and learned CIT(A) has given relief and the issue may be set aside to the file of the A.O for further scrutiny of the claim of the assessee . It was submitted that in this business in which the assessee is engaged, the liability does not exist outstanding for payment beyond one year. It is submitted that the matter can be restored to the file of the A.O. for necessary verifications .

8. We have considered the contentions of Ld. DR and have perused the material on record including orders of the authorities below. The assessee is engaged in the business of animation production services. The A.O observed that assessee has obtained secured loans to the tune of Rs. 7.11 crores from the Banks and Finance Companies. The AO observed that the assessee has incurred interest and other finance charges to the tune of Rs. 1.61 crores . It was also observed by the AO that assessee has advanced Rs. 6.52 crores as loans and advances , out of which the AO observed that loans and advances were given to subsidiaries as well as Inter-corporate Deposits(ICD) to various companies. It was also observed by the AO that assessee has advanced Rs. 5,68,50,000 as ICD to Classic Credit Limited in the year 2003 which was marked as doubtful . The AO concluded that there is violation of provisions of Section 36(1)(iii) as on the one hand the assessee has borrowed funds by way of loans on which heavy interest is paid and on the other hand , the amounts are advanced to subsidiaries and as well grant of ICD , majority of which have become doubtful. The AO observed that loans were incurred by the assessee not for the purposes of business but for the benefit of someone else and hence interest on such loans cannot be claimed u/s 36(1)(iii). It was observed by the AO that loan contracted by the assessee are colourable device to reduce tax liability. It was also observed by the AO that out of loans and advances of Rs. 6.51 crores , the assessee has advanced Rs. 1.60 crores to subsidiary on which interest of only Rs. 9.18 lacs has been recovered which is approx. at 5.7% . It was also observed that various ICD’s are not providing any benefit to the assessee. the A.O observed that before allowability of interest expenses u/s. 36(1)(iii), the assessee has to prove that money was borrowed by the assessee for the purposes of its own business on which interest has been paid. The A.O relied upon the decision of Hon’ble Supreme Court in the case of CIT v. Calcutta Agency Ltd. (1951) 19 ITR 191(SC) and that the onus is on the assessee to prove that expenses have been incurred for the purposes of business of the assessee . Thus, the AO observed that effective rate of interest paid by the assessee was 22.75% , while the effective rate of interest recovered comes to merely 1.4% , which led to be additions to the tune of Rs. 1,59,66,007/- which was held to be in contravention of Section 36(1)(iii), vide assessment order passed by the AO. The learned CIT(A) has granted partial relief w.r.t. loans to subsidiaries on which rate of interest recovered was @8% wherein additions stood deleted by learned CIT(A), while w.r.t. ICD granted by the assessee wherein no interest was recovered and business nexus was not proved, the additions stood sustained by learned CIT(A). We have observed that the assessee has raised loans to the tune of Rs. 7.11 crore on which interest of 1.61 crore have been paid . The loans raised are mainly term loans, vehicle loans, cash credit limits/packing credit limits from the banks. It is also seen that the assessee has made loans and advances to the tune of 6.51 crores . The details of the loan and advances raised by the assessee are enclosed here under:-

SCHEDULE ANNEXED TO AND FORMING PART OF THE BALANCE SHEET AS AT 31ST MARCH, 2006 (RUPEES) SCHEDULE-C SECURED LOANS

, (1) Term loan from State Bank of India 15,000,000 (2) Term loan from State Bank of India 13,172,898 (3) Vehicle loans from ICICI Bank Limited 8,160,685 - (4) Equipment loan from Ceejay Finance Limited , (5) Cash credit from State Bank of India 21,213,640 13,007,923 (6) Packing credit from State Bank of India 71,155,146 We have also observed from the financial statements which are part of the assessment order of the AO at page 2 , that the total owned funds of the assessee ( share capital + reserves and surplus-debit balance in P&L A/c) as at 31-03-2006 were to the tune of Rs. 94.36 crores , while investments are to the tune of Rs. 41.88 crores and loans and advances including ICD are to the tune of Rs. 6.51 crores. Further , on perusal of the loans availed by the assessee, it clearly appears that these loans raised by the assessee are tied up loans for specific purposes such as vehicle loan, cash credits, packing credit etc. . There is no specific adverse finding on diversion of funds by the assessee w.r.t. loans raised by the assessee by both the authorities below. Under such circumstances, presumption will apply that the assessee has utilised its own interest free funds available with it for granting loans and advances to subsidiaries /ICD’s and also making investments, wherein we have seen that net owned funds are much higher than combined value of investments as well loans and advances granted by the assessee. The ratio of decision of Hon’ble Bombay High Court in the case of Reliance Utilities and Power Limited (2009) 313 ITR 340(Bom. HC) will apply. The additions as sustained by learned CIT(A) stood deleted and relief granted by learned CIT(A) stood confirmed. We order accordingly. With respect to the second issue for disallowance u/s. 41(1) on account of cessation of liabilities which additions were deleted by learned CIT(A) , we have observed that learned CIT(A) has granted relief to the assessee as the assessee has written back these liabilities in AY 2007-08 except two liabilities firstly payable to Shaft Broadcast Private Limited on the ground that this liability was disputed/contested by the assessee before Hon’ble Bombay High Court and secondly liability payable to Mr. Sushant G Mohite wherein part payments was made by the assessee subsequently and partly the same was written back in AY 2007-08. The afore-said claims were made before learned CIT(A) for the first time wherein relief was granted by learned CIT(A) without verification . The AO is directed to make verification of the aforesaid claims so made by the assessee for the first time before learned CIT(A) and if the contentions of the assessee are found to be correct, we find no reason to withhold relief to the assessee. We order accordingly.