P.SUNDARARAJAN,AVANASHI vs. DCIT, TIRUPPUR

आदेश / O R D E R

PER CHANDRA POOJARI, ACCOUNTANT MEMBER

I.T.A.No.1666/Mds/2013. :- 2 -:

According to the Assessing Officer there was reason to believe that income has escaped assessment u/s.147 of the Act and the case was reopened by issuing notice u/s.148 dated 22.04.2010. The assessee in his letter requested to treat the return originally filed as the return in I.T.A.No.1666/Mds/2013. :- 4 -: compliance to the notice u/s.148. The assessee was asked to reply why the interest expenses paid to the tune of �26,52,520/- after conversion of firm to private limited company should not be disallowed u/s.36(ii) of the Act. During the course of assessment proceedings, the assessee submitted his reply which was perused by Assessing Officer and was found not acceptable because for the interest free loan with the private limited company, the assessee had paid interest which was not allowable as per the sec 36(ii) of the Act �26,52,520/- and accordingly interest expenses towards interest free loan is disallowed and brought to tax and the total income is computed as under:-

Income as per order u/s.143(3), dated 22.04.2008 1,04,62,716/- Add: Disallowance of interest expenses Towards interest free loan 26,52,500/- ----------------- Assessed Income 1,31,15,216/- ------------------

However, the Commissioner of Income Tax (Appeals) rejected the plea of the assessee and observed that as per the proviso to section 147, reassessment proceedings can be initiated after expiry of four years I.T.A.No.1666/Mds/2013. :- 5 -: only if there is a failure on the part of the assessee. But in this present case, the re-assessment was done within four years from the end of the relevant assessment year. Accordingly, he upheld the reopening of assessment. Against this, the assessee is in appeal before us.

Being so, there is no question to disallow the interest payment. The ld. Authorised Representative for assessee submitted that after considering the assessee’s letter, the Assessing Officer opted not to disallow any I.T.A.No.1666/Mds/2013. :- 6 -: payment of interest at the time of original assessment. He further relied on the judgment of jurisdictional High Court in the case of CIT vs. Ashley Services Ltd 369 ITR 209 (Mad) wherein it was held that a reading of the reasons given for reopening of the assessment showed that it was nothing but a review of the orders passed under section 143(3) relating to the assessment years 1996-97 and 1997-98.

Consequently, even though the assessment was reopened within the limitation period of four years, there being no fresh material to disturb the reasoning arrived at for the assessment year, the reassessment proceedings were not valid.

“3. After the enactment of the Direct Tax Laws (Amendment) Act, 1987 i.e., prior to April 1, 1989, section 147 of the Act reads as under:

'147. Income escaping assessment.—If the Assessing Officer, for reasons to be recorded by him in writing, is of the opinion that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allow ance, as the case may be, for the assessment year concerned (here after in this section and in sections 148 to 153 referred to as the relevant assessment year) :' (emphasis supplied) 4. After the Amending Act, 1989, section 147 reads as under : '147. Income escaping assessment.—If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject I.T.A.No.1666/Mds/2013. :- 8 -: to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the pro ceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year) : ' (emphasis supplied) 5. On going through the changes, quoted above, made to section 147 of the Act, we find that, prior to the Direct Tax Laws (Amend ment) Act, 1987, reopening could be done under the above two conditions and fulfilment of the said conditions alone conferred juris diction on the Assessing Officer to make a back assessment, but in section 147 of the Act (with effect from April 1, 1989), they are given a go-by and only one condition has remained viz. that where the Assessing Officer has reason to believe that income has escaped assessment, confers jurisdiction to reopen the assessment. Therefore, post- April 1, 1989, power to reopen is much wider. However, one needs to give a schematic interpretation to the words 'reason to believe' failing which, we are afraid, section 147 would give arbitrarypowers to the Assessing Officer to reopen assessments on the basis of 'mere change of opinion', which cannot be per se reason to reopen. We must also keep in mind the conceptual difference between power to review and power to reassess. The Assessing Officer has no power to review ; he has the power to reassess. But reassessment has to be based on fulfilment of certain precondition and if the concept of 'change of opinion' is removed, as contended on behalf of the Department, then, in the garb of reopening the assessment, review would take place. One must treat the concept of 'change of opinion' as an in-built test to check abuse of power by the Assessing Officer. Hence, after April 1, 1989, the Assessing Officer has power to reopen, provided there is 'tangible material' to come to the conclusion that there is escapement of income from assessment. Reasons must have a live link with the formation of the belief. Our view gets support from the changes made to section 147 of the Act, as quoted hereinabove. Under the Direct Tax Laws (Amendment) Act, 1987, Parliament not only deleted the words 'reason to believe' but also inserted the word 'opinion' in section 147 of the Act. However, on receipt of representations from the companies against omission of the words 'reason to believe', Parliament reintroduced the said expression and deleted the word 'opinion' on the ground that it would vest arbitrary powers in the Assessing Officer. We quote hereinbelow the relevant portion of Circular No. 549 dated I.T.A.No.1666/Mds/2013. :- 9 -:

October 31, 1989, which reads as follows ([1980] 182 ITR (St.) 1, 29) : '7.2. Amendment made by the Amending Act, 1989, to reintroduce the expression "reason to believe" in section 147.—A number of representations were received against the omission of the words "reason to believe" from section 147 and their substitution by the "opinion" of the Assessing Officer. It was pointed out that the mean ing of the expression, 'reason to believe' had been explained in a number of court rulings in the past and was well settled and its omission from section 147 would give arbitrary powers to the Assess ing Officer to reopen past assessments on mere change of opinion. To allay these fears, the Amending Act, 1989, has again amended section 147 to reintroduce the expression "has reason to believe" in the place of the words 'for reasons to be recorded by him in writing, is of the opinion'. Other provisions of the new section 147, however, remain the same.' (emphasis supplied)".

Applying the said decision to the facts of this case, the proceeding initiated for re-assessment cannot be quashed at the threshold. In the present case the reason reflect the ground that the income as escaped in view of the fact that assessee claimed interest payment of �56,61,461/- which is not allowable. There is no details available on record to indicate what fund was lent to M/s. S.P. Apparels as the assessee advanced a sum of �24,52,61,029/- to M/s. S.P. Apparels Limited Ltd. Further, there was investment of �12 crores in shares. The assessee has not admitted any dividend income from such shares. The claim of the interest paid is not reflected as investment in any business activities or in any income generating assets. Thus, there was excessive relief claimed by the assessee in the form of interest payments. In the I.T.A.No.1666/Mds/2013. :- 10 -: circumstances, in so far as assessment order passed u/s.143(3) is concerned, it does not reflect any application of mind by the Assessing Officer to the claim of interest payment. However, according to the ld. Authorised Representative for assessee in the light of enquiry made by the Assessing Officer and the reply filed by the assessee to the relevant facts filed by him at the time of original assessment, which lead to the conclusion that the Assessing Officer has applied his mind to the same.

In this regard, he has relied on the judgment of jurisdictional High Court in the case of Ashley Services Ltd (cited supra). In our opinion production before the Assessing Officer of accounts books or other evidence from which material facts could with due diligence have been discovered by the Assessing Officer will not necessarily amount to disclosure within the meaning of this section. Had the assessee disclosed the interest payment bifurcation to the Assessing Officer at the time of original assessment, then it would have been said that assessee had done his duty and it is for the Assessing Officer to draw any interference on the fact placed before him. On the failure of the assessee to disclose the fact that assessee made investment in firms/companies and it was not derived any benefit though assessee incurred heavy interest expenditure. In our opinion, a failure on assessee’s part to disclose full and true material facts necessary for the I.T.A.No.1666/Mds/2013. :- 11 -: assessment is a reason to reopen the assessment though original assessment has been completed u/s.143(3) of the Act. In the present case, since reopening is within the period of four years from the end of the relevant assessment year, requirement of the proviso in sec 147 of the Act namely failure on the part of the assessee to disclose full and all materials facts for his assessment is not required to be fulfilled.

However, it is apparent that the omission of the assessee to bring it to the Assessing Officer’s notice those particulars of investment made by the assessee, will amount to omission to disclose fully and truly all materials facts necessary for his assessment. In the case of Indo-Aden Salt Mfg. and Trading Co. P. Ltd. vs CIT 159 ITR 624(SC) held that mere production of evidence before the Assessing Officer is not enough.

There may be a failure to make a true and full disclosure, if some material for the assessment lay embedded in the evidence which the Revenue could have uncovered but did not, then, it is the duty of the assessee to bring it to the notice of the Assessing Officer. The assessee knows all the material and relevant facts - The Assessing Authority might not. Testing the facts of the present case in the light of the aforesaid principles, as noted hereinabove, the Assessing Officer in the assessment order has not discussed the issue of interest from investment to M/s. S.P. Apparels Limited Ltd. The Assessing Officer I.T.A.No.1666/Mds/2013. :- 12 -: while recording the reasons has formed an opinion that excess interest claim was allowed to the assessee and on that reason assessment was re-opened. Further a perusal of the material on record does not indicate that the assessee had drawn the attention of the Assessing Officer to the fact that the reasons mentioned for re-assessment at the time of completion of original assessment. According to the ld. Authorised Representative for assessee it is not necessary for the assessee to point out the above set of facts to the Assessing Officer and that the assessee is entitled to the claim of interest. Merely because the Assessing Officer mentioned in the original assessment order that �2,46,065/- is under the head other expenses to be disallowed, it does not mean the Assessing Officer is examining the interest allowability also. Thus, the Assessing Officer while framing the original assessment u/s.143(3) of the Act does not appear to have formed an opinion with regard to allowability of interest and he has accepted the claim of the assessee, as the assessee wanted to be accepted by the Assessing Officer. The assessee having failed to draw the attention of the Assessing Officer regarding interest payment, it cannot be said that there is no violation of provisions of the Act. Further, when no opinion has been expressed in the assessment order and no details or explanation in relation to the claim of interest has been called for by the I.T.A.No.1666/Mds/2013. :- 13 -:

Assessing Officer, it is not possible to accept the contention of the assessee that the Assessing Officer has applied his mind to the said aspect of interest payment. In the light of the aforesaid discussion, we are of the view that in the light of the reasons recorded by the Assessing Officer, there was sufficient material for Assessing Officer to form the requisite belief that income has escaped assessment for the assessment year under consideration. The assumption of jurisdiction under section 147 by issuance of notice under section 148 of the Act is valid and legal and as such no case is made out for intervention by this Tribunal. Therefore, the assessee fails in this ground. This ground is rejected.

Apparels Limited. Further he relied on the judgment of the Supreme Court in the case of S.A. Builders Ltd vs. CIT (A) and another 288 ITR 1(SC) wherein held that In order to decide whether interest on funds borrowed by the assessee to give an interest free loan to a sister concern(eg., a subsidiary of the assessee) should be allowed as a deduction under section 36(1)(iii) of the Income-tax Act, 1961, one has to enquire whether the loan was given by the assessee as measure of commercial expediency. The expression ‘’commercial expediency’’ is one of wide import and includes such expenditure may not have been incurred under any legal obligation, but yet it is allowable as business expenditure if it was incurred on grounds of commercial expediency. Decisions relating to sec.37 will also be applicable to section 36(1)(iii) because in section 37 also the expression used is ‘’ for the purpose of the business’’. ‘’For the purpose of business’’ includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if a third party also benefits thereby. To consider whether one should allow deduction under section 36(1)(iii) of interest paid by the assessee on amounts borrowed by it for advancing to a sister concern, the authorizes and the courts should examine the purpose for which the assessee advanced the money and what the sister concern did with the money. That the borrowed amount is not utilized by the assess in its own business but had been advanced as interest free loans to its sister concern is not relevant. What is relevant is whether the amount was advanced as a measure of commercial expediency and not from the point of view whether the amount was advanced for earning profits. Once it is established that there was nexus between the expenditure and purpose of the 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 I.T.A.No.1666/Mds/2013. :- 15 -: circumstances of the case. No businessman can be completed to maximize his profits.’’

Further, he submitted that the assessee at the same time, paid interest of �56,61,461/- and the Assessing Officer is justified in disallowing the interest of �26,52,500/- out of the interest expenditure incurred by the assessee of �56,61,461/-. He relied on the judgment of Punjab and Haryana High Court in the case of CIT vs. Abhishek Industries Ltd 286 ITR 1, wherein held that the share capital is meant to be used for productive use in the business. If the share capital, according to the assessee, was surplus and it could part with the same to its sister concern for non-business purpose without any interest, there was no need to raise the loans to that extent and the amount of such share capital should have been utilized for the project itself. In case the assessee has not advanced loans to its sister concern on interest fee basis, even if the alleged surplus amount could not be repaid to the financial institution before the scheduled date as far as the term loan I.T.A.No.1666/Mds/2013. :- 16 -: was concerned, the interest being paid by the assessee on the working capital could have certainly been saved to that extent. The borrowing of the funds by the company to that extent was not for the purpose of business and there was nothing on record to suggest that amounts were advanced to the sister concerns to advance some business object.

Accordingly, the assessee was not entitled to claim deduction of the interest on the borrowings to the extent those were diverted to sister concerns or other persons without interest.

The monies received as share capital, as term loan, as working capital loan, as sale proceeds etc. do not have any different colour. Whatever are the receipts in the business, that have the colour of business receipts and have no separate identification. Sources has no concern whatsoever. The only thing sufficient to disallow the interest paid on the borrowing to the extent the amount is lent to sister concern without carrying any interest for non-business purposes would be that the assessee has some loans or other interest bearing debts to be repaid. In case the assessee had some surplus amount which, according to it, could not be repaid prematurely to any financial institution, still the same is either required to be circulated and utilised for the purpose of business or to be invested in a manner in which it generates income and not that it is diverted towards sister concern free of interest. This would result in not presenting true and correct picture of the accounts of the assessee as at the cost being incurred by the assessee, the sister concern would be enjoying the benefits thereof. It cannot possibly be I.T.A.No.1666/Mds/2013. :- 19 -: held that the funds to the extent diverted to sister concerns or other persons free of interest were required by the assessee for the purpose of its business and loans to that extent were required to be raised. We do not subscribe to the theory of direct nexus of the funds between borrowings of the funds and diversion thereof for nonbusiness purposes. Rather, there should be nexus of use of borrowed funds for the purpose of business to claim deduction under Section 36(1)(iii) of the Act. That being the position, there is no escape from the finding that interest being paid by the assessee to the extent the amounts are diverted to sister concern on interest free basis are to be disallowed.

This would depend on facts of each case.

The amount so lent, according to the assessee, came out of the contract earnings. The amount borrowed, according to the assessee was invested in the execution of the contracts. It is clear, therefore, that the assessee had invested the borrowed funds in the execution of the contracts, had recouped the money so invested presumably with profits as well on executing the contract. The amount realised on the execution thus, included the amount which the assessee had borrowed and invested. When the assessee decided to lend a substantial part of those funds interest-free to the relatives of the partners, it was clearly not a business purpose. The assessee clearly diverted the funds which had been borrowed, had been invested in the contract I.T.A.No.1666/Mds/2013. :- 21 -: work, after the investment was recovered and was available either for the purposes of the business or by way of repayment of the loan. The assessee did neither, but chose to divert the money for non-business purposes. After such diversion, the interest paid on the capital borrowing to the extent of the amounts diverted can no longer be an item of expenditure which can be claimed for deduction as an item of business expenditure. If the amounts diverted was subsequently brought back into the business and utilised in the business, the assessee could thereafter claim the interest paid as a deduction. But so long as the diversion continues the assessee would be disentitled.

14.1 In the case of Commissioner of Income-Tax v. M.S.

Venkateswaran 222 ITR 163, the Madras High Court accepting the plea of the Revenue held as under (Page 168):

The facts on record would clearly go to show that the father of the assessee had definitely diverted a portion of the borrowed capital for his own purposes and not for business purposes. In such a case, it cannot be said that there can be a presumption that a part of the capital would have been diverted for non-business purposes not from the borrowed capital but from the capital contributed by the assessee. In the absence of such an element in the facts arising in the present case, we are unable to subscribe to the view of the Tribunal that the assessee is entitled to deduction under Section 36(1)(iii) with regard to the interest paid on borrowed capital, which was utilised by the assessee's father for non-business purposes.

14.2 In the case of Commissioner of Income-tax v. P. Ganu Rao and Sons, 185 ITR 324 (Mad), interest on borrowed capital to the extent the same was utilised for non- business purposes was disallowed under Section 36(1)(viii) of the Act.

I.T.A.No.1666/Mds/2013. :- 22 -:

14.3 In the case of Commissioner of Income-Tax v. V.I. Baby and Co., 254 ITR 248, the Kerala High Court, while reversing the order of the Tribunal, held as under (Page 250):

‘’We are inclined to accept the argument raised by counsel for the Revenue, because the advances to the partners, their relatives and the sister concerns are not for business purposes and the assessee has not derived any benefit out of the same. Admittedly, no interest was charged on these advances. The Tribunal appears to have placed reliance on the fact that the partners and their relatives have utilised the amounts for business purposes, such as construction of a shop building etc. So long as the assessee- firm is not the beneficiary of such investments, the nature of investment or the utilisation of such advances has no relevance. So far as the assessee is concerned, it is only an interest free advance. The claim of the assessee's counsel that cash balances were available with the firm for advances to the partners, their relatives and the sister concerns does not advance the assessee's case. If cash balances are available, the borrowing itself is not for the purpose of the business. An assessee with liquidity cannot claim that it can give interest free advances to the partners and others and then borrow funds from the bank on interest for business purposes. Such borrowings will not be for business purposes, but for supplementing the cash diverted by the assessee without any benefit to it. Therefore, so long as the assessee is not the beneficiary of the investments made by the partners, their relatives and the sister concerns, and so long as the advances are interest free, the Assessing Officer is perfectly justified in disallowing the interest in proportion to the advances made.’’ 14.4 We may notice that in the case of CIT v. Motor General Finance Ltd. 254 ITR 449, Delhi High Court held as under (page 460):

‘’From the conspectus of the decisions as noticed hereinbefore, there cannot be any doubt whatsoever I.T.A.No.1666/Mds/2013. :- 23 -: that the nexus between the amount paid by way of advance to a sister concern and the fund available at the relevant time in the assessee's hands must be found out from the advances taken by the assessee. The onus to prove that it is entitled to (deduction) in this regard was on the assessee. It was to be proved that a bona fide loan had been granted in favour of a sister concern. It was, therefore, its duty to place requisite materials on record’’.

14.5 This aspect of the matter has also been considered in the case of CIT v. H.R. Sugar Factory Pvt. Ltd., 187 ITR 363, wherein the Allahabad High Court held (page 370):

‘’The court cannot shut its eyes to realities. What has actually happened is visible to the naked eye. The assessee, a private limited company closely held by three family groups, is made to lend huge amounts (up to 23 lakhs of rupees as per the compromise arrived at between the assessee and the directors/ shareholders in the civil suits referred to above) at a very low rate of interest and the entire difference of interest is being charged to the assessee. The assessee is not a finance company. It is engaged in the manufacture of sugar. No business purpose of the assessee-company is served by such lendings to its directors/ shareholders. It cannot be said that it is expedient in the interest of business or is laid out for the purpose of the business of the assessee.... May be that the company borrows large amounts for the purpose of its business every year, but that does not explain the huge advances to the directors/shareholders. Had this money been not advanced to the directors, it would have been available to the assessee for its business purposes and to that extent it may not have been necessary to borrow from the banks. We are, therefore, of the opinion that the Income-tax Officer wasright in disallowing the difference of interest under Section 36(1)(iii) of the Income-tax Act and that the Tribunal's approach is not only superficial but too naïve’’.

I.T.A.No.1666/Mds/2013. :- 24 -:

14.6 In the case of Indian Metals and Ferro Alloys Ltd. v. CIT (1992) 193 ITR 344, the Orissa High Court held as under (page 349):

‘’... it may be pointed out that, in a hypothetical case, an assessee can earn profits only after the date of investment and advance. It cannot be said that because, in the concerned assessment year, the profit was more than the investment and advance, those came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee.

14.7 Yet again in CIT v. H.R. Sugar Factory Pvt. Ltd. 190 ITR 643 (All.), B.P. Jeevan Reddy C.J. (as his Lordship then was) relying upon his earlier decision in H.R. Sugar Factory Pvt. Ltd.'s case that the assessee-company was not entitled to the allowance of interest.

14.8 In Veecumsees v. CIT, 220 ITR 185 (SC) ; The Hon'ble the Supreme Court held that deduction for payment of interest on the loans raised for building a cinema theatre, which was ultimately closed, was allowable deduction as the assessee was engaged in a composite business of jewellery and cinema. The facts of the case are distinguishable with the facts of the case in hand.

I.T.A.No.1666/Mds/2013. :- 25 -:

14.9 In the case Commissioner of Income-Tax v. Saraya Sugar Mills (P) Ltd. , 201 ITR 181, the Allahabad High Court held that where part of the overdraft diverted to Directors and concerns in which they were substantially interested, interest in such amount to that extent was held disallowable. Similar views were expressed by Bombay High Court in Phaltan Sugar Works Ltd. v. Commissioner of Wealth Tax, and Phaltan Sugar Works Ltd. v. Commissioner of Income-Tax 215 ITR 582 (Bom).

14.10 In the case of Elmer Havell Electrics and Ors. v.

Commissioner of Income-Tax and Anr. 277 ITR 549, the Delhi High Court, while rejecting the appeal of the assessee on the issue of disallowance of interest on interest free advances made to sister concern, observed that the assessee itself had taken loan with interest and had advanced funds by diversion or otherwise to its sister concern free of interest. Taking this and other findings by the Tribunal into consideration, the appeal was dismissed.

14.11 In Commissioner of Income Tax v. Sujanni Textiles (P)

Ltd. , 225 ITR 560, the Madras High Court disallowed the interest on I.T.A.No.1666/Mds/2013. :- 26 -: the borrowed capital to the extent the same was advanced to the Directors without interest.

14.12 In Indian Metals & Ferro Alloys Ltd. v. Commissioner of Income Tax (1992) 193 ITR 344, Orissa High Court held as under (page 348):

‘’The determinative question in a case of this nature is the source from which the assessee makes investments or advances. Where an assessee seeks to deduct certain items from his business profits, the onus of proving the same falls on him. The burden of proving a claim to an allowance or deduction is on an assessee. If the assessee makes a claim to deduction in terms of Section 36 for the purpose of computation of income referred to in Section 28, he has to place materials in support of his claim of entitlement to the deduction. Therefore, the assessee was required to show that the amounts invested in or advanced to the subsidiary company came out of the assessee's own funds. The Tribunal, with reference to the factual aspects, came to hold that the money utilised was from the borrowed funds. This essentially is an inference from factual aspects. Illustratively, it may be pointed out that, in a hypothetical case, an assessee can earn profits only after the date of investment and advance. It cannot be said that because, in the concerned assessment year, the profit was more than the investmentand advance, those came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee’’.

I.T.A.No.1666/Mds/2013. :- 27 -:

14.13 In Regal Theatre v. Commissioner of Income Tax, 225 ITR 205, the Delhi High Court held that consideration of the issue regarding allowability of deduction under Section 36(1)(iii) of the Act is purely a question of law as it is an inference to be drawn from the facts.

Order pronounced on Thursday, the 25th of June , 2015, at Chennai.