INTERVO TECHNOLOGIES P.LTD,NEW DELHI vs. ADDL.CIT, SPECIAL RANGE-4, NEW DELHI

PER GIRISH AGRAWAL, Accountant Member: ITA Nos. 5267/Del.2018 and 5509/Del/2018 are cross appeals filed by the assessee and revenue and ITA No. 5268/Del/2018 filed by the assessee are against the order of Ld. CIT(A)-35, New Delhi dated 18.05.2018 and 28.05.2018 against the assessment order passed by Addl. CIT, Special Range-4, New Delhi u/s.143(3) of the Income-tax Act, 1961 (hereinafter referred to as the “Act”) for AY 2014-15 & 2015-16 dated 09.09.2016 and 09.10.2017, respectively. 2. First we take up the appeals filed by the assessee wherein a common issue is involved in respect of disallowance of interest expenses claimed u/s. 36(1)(iii) of Rs.1,05,93,760/-. The amount is common in both the appeals relating to the two assessment years i.e. AYs 2014-15 and 2015-16. We will draw the facts from AY 2014-15 and our observations and findings will apply mutatis mutandis to the other appeal also. 3. Brief facts of the case are that assessee is engaged in the business of call centre operation, maintenance and repairs service, non-technology software services. Assessee filed its return of income on 29.11.2014 reporting a loss of Rs.8,49,36,865/-. During the assessment proceedings, Ld. AO required the assessee to substantiate the claim of interest expenses. Ld. AO had observed that assessee has advanced loans to its subsidiary companies, details of which are tabulated as under:

ITA No.5267, 5509 & 5368/Del/2018 Intervo Technologies P. ltd.., AYs: 2014-15 & 2015-16

ITA No.5267, 5509 & 5368/Del/2018 Intervo Technologies P. ltd.., AYs: 2014-15 & 2015-16

calculated @ 12% on the opening balance of the loans/advances outstanding. 5.1. Before the Ld. CIT(A), assessee submitted that it had advanced loans to its wholly owned subsidiaries. Assessee had borrowed long term loans from banks to meet its funds requirement. According to it, in the past few years, assessee and its wholly owned subsidiaries had incurred huge losses. Owing to these losses, there were financial crunch and, therefore, in order to help its wholly owned subsidiaries to meet their fund requirements and help them to pay off their expenses, assessee advanced interest free loans to them. It was submitted that funds infused by the assessee into its wholly owned subsidiaries were utilized to meet their business needs. These funds were advanced to them out of commercial expediency so as to bring them out from their loss scenario. Ld. CIT(A) after considering the submissions made by the assessee sustained the disallowance made by the Ld. AO though, he dealt with the aspect of commercial expediency in respect of advancement of loan to the subsidiaries by the assessee. 6. Before us, Ld. Counsel for the assessee reiterated the submissions discussed above. On a specific query by the Bench in respect of nature of business conducted by the assessee and its four wholly owned subsidiaries to whom assessee had given loans/advances, Ld. Counsel referred to a chart placed at page 8 of the paper book to demonstrate that both, assessee and its four subsidiaries were engaged in the I T sector business. The said chart is reproduced for ease of reference:

ITA No.5267, 5509 & 5368/Del/2018 Intervo Technologies P. ltd.., AYs: 2014-15 & 2015-16

ITA No.5267, 5509 & 5368/Del/2018 Intervo Technologies P. ltd.., AYs: 2014-15 & 2015-16

6.1. From the above chart, Ld. Counsel pointed out that the key managerial person, Mr. Pravin Jain is common to all the four subsidiaries including the assessee. He also submitted that all of them have negative reserve and surplus because of huge losses suffered by them. Ld. Counsel submitted extracts of Balance sheet of assessee and its subsidiaries as at 31.03.2014 to demonstrate the financial position of all at a glance to portray as the scenario. The extract is reproduced as under:

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6.2. From the above extracts, Ld. Counsel submitted that assessee had borrowed the funds from the banks which were then advanced to its wholly owned subsidiaries so as to enable them to bring them out of the loss scenario and, therefore, no interest was charged by the assessee from its wholly owned subsidiaries. Based on the above facts, ld. Counsel strongly asserted that assessee has advanced loans to its subsidiaries out of commercial expediency. Funds advanced by the assessee have been used for the purpose of business by the wholly owned subsidiaries which is not in dispute and not doubted by the Ld. AO.

6.3. According to Ld. Counsel, expression ‘commercial expediency’ is an expression of wider import and include such expenditure as a prudent businessman incurs for the purpose of business. The expenditure must not have been incurred under any legal obligation yet it is allowable as a business expenditure if it was incurred on ground of commercial expediency. To buttress his contentions, he placed reliance on the decision of Hon’ble Supreme Court in the case of S A Builders Ltd. Vs. CIT (2007) 288 ITR 1 (SC). The observations and findings of the Hon’ble Apex Court in the said decision are extracted as under:

“In Madhav Prasad Jatia v. CIT AIR 1979 SC 1291, the Supreme Court held that the expression 'for the purpose of business' occurring under the provision of section 36(1)(iii) is wider in scope than the expression 'for the purpose of earning income, profits or gains', and this has been the consistent view of the Supreme Court. [Para 20] The High Court in the impugned judgment as well as the Tribunal and the income-tax authorities had approached the matter from an erroneous angle. In the instant case, the assessee borrowed the fund from the bank and lent part of it to its sister concern (a subsidiary) as interest-free loan. The test in such a case was really whether this was done as a measure of commercial expediency. [Para 21] The decisions relating to section 37 will also be applicable to section 36(1)(iii) because in section 37 also the expression used is 'for the purpose of business'. It has been consistently held in decisions relating to section 37 that the expression 7

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'for the purpose of business' includes expenditure voluntarily incurred jar commercial expediency, and it is immaterial if a third party also benefits thereby. [Para 22] In Atherton v. British Insulated & Helsby Cables Ltd. [1925] 10 TC 155, it was held by the House of Lords that in order to claim a deduction, it is enough to show that the money is expended, not of necessity and with a view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly facilitate the carrying on of the business. [Para 23] The High Court as well as the Tribunal and other income-tax authorities should have approached the question of allowability of interest on the borrowed funds from the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest-free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed. [Para 24] 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, yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency. [Para 25] No doubt as held in Madhav Prasad Jatia's case (supra), 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). [Para 26] Thus, the ratio ofMadhav Prasad Jatia (supra), 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). [Para 27] In the instant case, neither the High Court nor the Tribunal and other authorities had examined whether the amount advanced to the sister concern was by way of commercial expediency. [Para 28] The High Court and other authorities should have examined the purpose for which the assessee advanced the money to its sister concern, and what the sister concern did with the money, in order to decide whether it was for commercial expediency, but that had not been done. [Para 30] It is not in every case that interest on borrowed loan has to be allowed if the assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the directors of the sister concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances. Where holding company, has a deep interest in its subsidiary, and the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the holding company would ordinarily be entitled to deduction of interest on its borrowed loans. [Para 35]

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In view of the above, the appeals were to be allowed and the impugned judgments of the High Court, the Tribunals and other authorities were to be set aside and the matter was to be remanded to the Tribunal for afresh decision, in accordance with law and in the light of the observations made above.” 7. We have heard the rival contentions and perused the material available on record. It is undisputed fact that assessee had advanced its borrowed funds to the wholly owned subsidiaries. Further, both assessee and its subsidiaries are engaged in the business relating to I T sector, all of which are under huge losses. Facts relating to advancement of funds to the subsidiaries and incurring of interest expenses by the assessee on the funds borrowed by it from the banks is not in dispute. The only contention of the Ld. AO for making the disallowance/addition is that assessee has advanced its interest bearing funds to its subsidiaries/related parties without charging any interest for which he has calculated a notional interest @ 12% on the opening balances of advance outstanding. We also take note of the fact that key person is common to both the assessee and the four subsidiaries. 7.1. Ld. Counsel has also pointed out before us that out of the total long term borrowings of the assessee of Rs.29.32 Cr., total advance given to its subsidiaries are closed to Rs. 8 Cr. Further, there is a current liability of Rs.49.16 Cr. in the case of the assessee as extracted above. From the financial statement placed on record, we note that assessee had borrowed the funds from banks and lent part of it to its subsidiaries as interest free loans. 7.2. Addition made is on the issue whether this is done by the assessee as a measure of commercial expediency or otherwise. In order to substantiate the claim of commercial expediency, Ld. Counsel has already submitted that it has been done by the assessee being a holding company as a measure to bring its subsidiaries out of the loss scenario 9

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by enabling them to meet their business expenses by the funds it has extended to them as advance. We note that it is not a case where the amount advanced by the assessee are for any personal benefit of the directors of the subsidiaries. It is prudent that a holding company has all the interest in its subsidiaries and it would take all the steps to protect its own interest as well as the interest of its subsidiaries. There is nothing on record brought before us to demonstrate that there have been any personal benefits enjoyed out of the funds advanced by the assessee to the subsidiaries. We thus find that assessee has advanced its interest bearing funds to its subsidiaries out of commercial expediency and, therefore, the addition made by the Ld. AO towards interest expenses is to be deleted. For our observations and finding, we draw force from the decision of Hon’ble Supreme Court in the case of S A Builders Ltd. (supra) findings of which are already extracted above. Thus ground taken by the assessee in both the appeals is allowed.

“I. (a) Whether, on the facts and in the circumstances of the case, the Ld CIT(A) has erred in deleting the addition of Rs.2,25,00,000/- made by the Assessing Officer on account of disallowance of Management Consultancy Fee, not appreciating the fact that the said payment was made in contravention of the provisions of the section 297(1) of the Companies Act, 1956 governing the related party transactions, and therefore, hit by the bar placed in terms of Explanation 1 to 37 of the Income Tax Act, 1961 ("the Act") which prohibits deduction of unlawful expenditure. (b) Whether on the facts and in the circumstances of the case, the Ld CIT(A) has erred in holding that non-compliance with the provisions of the companies Act governing related party transactions is a mere procedural defect which does not render the payment as unlawful so as to bring it under the scope of Explanation 1 to Section 37 of the Act. 10

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“The Ld. CIT(A) has granted relief to the assessee holding on page 9 (bottom para) that provision of section 297(1) of the companies Act was not applicable for the year under consideration. This is not the right interpretation of the fact. The Ld.CIT(A) on page 8 (12th line) has given that section 297(1) was withdrawn w.e.f. 01.04.2014. We are discussing facts of F.Y. 2013-14. So the said section 297 was very much applicable to the contract for F.Y. 2013-14. The Ld. CIT(A) on page 9 (bottom para) also held that non compliance to the provisions of section 297(1) of the companies Act 1956 is a mere procedural defect which does not render any contract unlawful so as to bring the same under the scope of explanation 1 of section 37(1) of the Act. This is nor the right interpretation of the provisions. Any act in infringement of a statute be it procedural act or substantive act, makes the act unlawful. In the present case, a contract with holding company without the statutory obligation (section 297(1) of the companies Act) of approval from the Central Government makes the contract void & liable to penalty u/s 629 A or the companies Act, 1956. In view of above, it is prayed to sustain the addition made by the Assessing Officer. On the issue of Disallowance of Advances to suppliers/Deposits written off: Addition on this account is made by the AO not satisfied with the assessee is general and vague explanation that these pertain to same advances given to suppliers in past years. An addition on this account had been made in earlier A.Y. also. The AO noticed that no reason has been given by the assessee regarding the allowability of this expenditure. The assessee has not shown that these amounts were given wholly & exclusively for the purpose of business and it was also not demonstrated by the assessee that these had become irrecoverable, except mere statements. Operative part of the Ld.ClT{A)'s order holding/giving any satisfaction as to whether the advances were for business purpose as also the CIT(A) did not give any finding of fact that the advances had become irrecoverable. It is clear that the Ld. CIT{A) has simply accepted the assessee's statement/claim for admissibility of the advances to suppliers/Deposits written off without any evidence to the effect having been given/placed on records.

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In view of above, it is prayed to sustain the addition made by the Assessing Officer.” 11. Per contra, Ld. Counsel for the assessee submitted that detailed explanations were furnished in the course of assessment proceeding which included copy of agreement dated 04.09.2009 entered into with Somana Management Partners Pvt. Ltd. in relation to management consultancy fee, it being holding company of the assessee. Approval obtained from the Central Government u/s. 297(1) of the Companies Act, 1956 vide approval letter dated 31.05.2010 issued by the Regional Director (NR), Ministry of Corporate Affairs, Govt. of India granting approval for availing management service from the holding company was also furnished. According to the Ld. Counsel, assessee had entered into a valid contract with its holding company for availing management service and has paid the management consultancy fees under the normal course of its business. According to him, though the approval granted was valid upto 31.03.2012, the said requirement of obtaining approval from the Central Government had been done away with after Companies Act, 2013 which is brought on statute book wherein section 188(1) has been substituted corresponding to the erstwhile section 297(1) w.e.f. 01.04.2014. Under the said section 188(1), expenditure incurred by the assessee with the related parties can be undertaken with the approval obtained by way of Board Resolution. Ld. Counsel pointed that the sole basis of making the disallowance by the Ld. AO is that assessee has not obtained approval u/s. 297(1) which is not relevant for the year under consideration vis-à-vis section 188(1) made effective from 01.04.2014 under the Companies Act, 2013. 11.1. According to him, incurring of expenses are not doubted or have been disputed to be held as bogus or sham. Claim of these expenses is a

ITA No.5267, 5509 & 5368/Del/2018 Intervo Technologies P. ltd.., AYs: 2014-15 & 2015-16

legitimate business expenditure incurred by the assessee in the conduct of its business vide a valid contract entered into with its holding company. He referred to the well reasoned findings given by the Ld. CIT(A) to this effect wherein provisions of section 37(1) have been dealt with in detail vis-à-vis approval requirement u/s. 297(1) of the Companies Act, 1956 which are mere procedural requirement and cannot lead to holding incurring of such business expenditure by the assessee as “prohibited under the law” to make a disallowance.

11.2. The observations and findings given by the Ld. CIT(A) are reproduced as under:

“4.2.3. The appellant has in the written submission dated 28.05.2018 contested that the AO was not justified in disallowing the management consultancy fee amounting to Rs. 2,25,00,000/-. The AO in his order stated that the appellant company has made payment of Rs.2,25,00,000/- to its holding company named Sonama Management Partners Pvt Ltd as management consultancy fee. The payment has been made in pursuance to an agreement dated 04.09.2009 entered into between the appellant company and its parent company M/s Sonama management partners Pvt Ltd. The AO stated that the said agreement dated 04.09.2009 was valid for the period of 3 years. The appellant company was granted approval by the Ministry of Corporate Affairs under section 297(1) of the Companies Act 1956 which was also valid up to 31 March 2012. Since, the appellant could not file the copy of approval letter of central government under section 297(1) of the Companies Act 1956 for renewal of the contract for the year under consideration, the AO took the adverse view for allowing this expenditure. The AO referred to explanation 1 of section 37(1) of the Income Tax Act which provides that any expenditure incurred by the appellant which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and therefore the said amount was disallowed and added to the income. The appellant company has submitted that the said expenditure has been incurred by the appellant company in the past years as well which is duly supported by an agreement. The validity of the agreement was extended by the board of directors by approving the extension of the aforesaid agreement. The copy of letter supported by copy of board resolution was placed before the AO in the assessment proceedings. The AR contended that the appellant company has corporate structure and all management executions take place at the level of holding company to avoid duplication in the cost. The holding company is being paid for the services for the management of the company consistently under the agreement and the decision of the board, the copy of which is also placed before me. The AR further pointed out that the Ld/- AO while adjudicating the matter, relied-upon the first proviso to 13

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section 297(1) of the Companies Act 1956, ignoring the fact that the same was withdrawn with effect from 01.04.2014 and in substitution to this section 188(1) of the Companies Act 2013 was brought into effect. Henceforth, the requirement for taking the approval from the central government was dispensed. Therefore the expenditure can now be incurred simply where board resolution to this effect. The counsel has further stated that the AO has not interpreted the explanation 1 of section 37(1) of the Income Tax Act in its correct perspective. It states that any expenditure incurred by an appellant for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business and profession and no deduction for allowance shall be made in respect of such expenditure. The AR has relied upon the decision of Hon'ble Jurisdictional ITAT in the case of Jai Surgicals Ltd. v. ACIT. [2014] 46 taxmann.com 246 (Delhi - Trib.). The facts of the case are similar to the present case in this judgment Hon'ble ITAT has stated that explanation being a deemed provision, is required to be strictly followed as per its express language and not beyond. If the purpose of expenditure which is sought to be disallowed is not an offence or not prohibited by law. The same cannot be brought within the scope of explanation to section 37(1) of the Income Tax Act. If on the other hand the purpose of expenditure is an offence or is prohibited by law, the same cannot escape the clutches of the explanation. The natural corollary which thus follows is that if the 'purpose' of expenditure is not to commit an offence or is otherwise not prohibited by law, then any breach of some procedural statutory provision necessary to be complied with before incurring such expenditure, would not per se convert the otherwise lawful purpose into an offence or prohibition under law so as to attract the wrath of the Explanation. The crux of the matter is that the 'purpose' of the expenditure incurred should be viewed in isolation unbothered by anything else for determining whether or not the Explanation is attracted." In addition to above, the AR further relied on various judgments to substantiate its view that for determining whether the expenditure can be disallowed under Explanation 1 of section 37(1) of the Act or not, the purpose of the expenditure is vital. In the instant case, although the appellant had not obtained approval from the Central Government, however, this does not ipso facto render any expense unlawful. The management and Administrative Services taken by the appellant is in relation to the appellant's business. Merely because the appellant has not followed the procedures laid down by Companies Act, 1956 prior undertaking the transaction, it had not altered the intent of appellant while undertaking such transactions. The judgments relied upon are as under: Hon'ble High Court of Madhya Pradesh in the case of CIT v. Khemchand Motilal Jain Tobacco Products Pvt Ltd. [2011) 13 taxmann.com 27 (Madhya Pradesh) Hon'ble Jurisdictional ITAT in the case of ACIT v. Sanjay Enterprises [2008) 23 SOT 498 (Delhi) In view to the above submission made by the AR it can be clearly observe that the AO made the addition in accordance to the provision of section 297(1) of the Companies Act 1956 ignoring the fact that the same was not applicable for the year under consideration. Therefore, the approval of Central Government is not 14

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required for undertaking any such expenditure. Without prejudice to above, it is of no doubt that the non-compliance to the provisions of section 297(1) of the Companies Act 1956 is a mere procedural defect which do not render any contract unlawful, so as to bring the same under the scope of explanation 1 of section 37(1) of the Act. It has also been pointed out that the appellant Company has deducted the TDS on the said payment under section 194J as per Income Tax Act. And as such the interest revenue is not prejudiced. The submissions filed by the appellant company has been considered and the appeal on Ground no. 2 is allowed.” 12. He also referred to the decision of the Coordinate Bench of ITAT, Delhi in the case of Jai Surgicals Ltd. Vs. ACIT in ITA No. 844/Del/2013 dated 26.06.2014 wherein similar issue has been dealt with and held in favour of the assessee, allowing the expenses. The relevant findings of the Coordinate Bench in this respect are reproduced as under:

“12. As against that and adverting to the facts of the instant case, we find that the expenditure which has been instantly disallowed is a sum of Rs.41.24 lac on account of job work charges paid by the assessee to Mis Razormed Inc. It is not the case of the Revenue and naturally cannot be that the payment of job work charges is an offence or is prohibited by law. What the authorities below have taken into consideration while making the disallowance is that since there was no prior approval from the Central Government, the expenditure of job work charges became disallowable. We fail to understand as to how the payment of job work charges can by any stretch of imagination be construed as offence or prohibited by law simply because the necessary permission from the Central Government was obtained belatedly. It has been noticed above that the inquiry should stop on determining the immediate purpose of expenditure, which in the present case is job work done for the assessee. The first question to be asked is whether such payment of job charges is an offence? The answer is obviously in negative. The second question is whether such payment of job charges is prohibited by law? Again the answer is in negative because no law prohibits the payment of job work charges in a manufacturing unit. When the language of the Explanation is crystal clear and does not encompass the incurring of expenses for a lawful purpose, such as the job charges, within its ambit, it is wholly impermissible to import a further requirement in the language of the Explanation to make the otherwise lawful purpose as unlawful for lack of the prior approval of the Central Government. As the 'purpose' of incurring the expenditure of job charges is neither an offence nor is prohibited by law, we fail to comprehend as to how the otherwise lawful purpose would become contingent upon obtaining or not obtaining the prior approval of the Central Government. Since such expenditure in itself is neither an offence nor prohibited by any law and there is a valid and lawful quid pro quo for the same, we are disinclined to uphold the view canvassed in the impugned order.

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13.1. The only reason for disallowance by the Ld. AO is absence of approval by the Central Government u/s. 297(1) of the Companies Act, 1956. It is important to note that Companies Act, 1956 was substituted by the Companies Act, 2013. The corresponding section which dealt with section 297(1) referred by the Ld. AO is section 188 which is made effective from 01.04.2014. Ld. Counsel has pointed out that requirement of obtaining approval from the Central Government has been done away with. Even otherwise, we note that similar issue has been dealt with extensively by the Coordinate Bench in the decision of Jai Surgicals Ltd. (supra) wherein it has been held that otherwise lawful purpose cannot be deemed to be an office or prohibited by law, contingent upon obtaining or not obtaining the prior approval of Central Government. The Coordinate Bench noted that such expenditure in itself is neither an offence nor prohibited by any law and there is a valid and lawful quid pro quo for the same. We find ourselves in agreement with the decision of the Coordinate Bench. 16

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13.2. Considering the facts on record and the substitution of section 188(1) of the Companies Act, 2013 as well as judicial precedent in the case of Jai Surgicals Ltd. (supra), we do not find any reason to interfere with the well reasoned findings given by the Ld. CIT(A) on this issue. Accordingly, ground no. 1 taken by the revenue is dismissed. 14. On the second issue relating to claim of Rs.22,30,113/- towards advance to suppliers/deposits written off, assessee has claimed that it had given advances to parties during the normal course of business which subsequently became irrecoverable and hence, were written off. According to the assessee, since the funds were advanced for business purpose, any loss incurred by it on account of non-recoverability is a business loss and is allowable u/s. 37 of the Act. From the submissions made by the Ld. CIT, DR, we note that assessee has not been able to demonstrate as to how these were given wholly and exclusively for the purpose of business of the assessee. The submission of the assessee is general and vague by stating that this pertained to the advances to suppliers in earlier years. In this respect a specific query was raised by the Bench to the Ld. Counsel of the assessee to demonstrate as to how and in which year these advances written off and claimed by the assessee, have been booked as revenue in the past. However, nothing came up in this respect except for general submission. Ld. Counsel also could not establish that these are trade advances and the purpose of giving the same. In absence of correct factual data brought on record, we are inclined to uphold the addition made by the Ld. AO in this respect by setting aside the relief granted by the Ld. CIT(A). Accordingly, ground taken by the revenue on this issue is allowed. 15. In the result, appeal of the revenue is partly allowed.

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Order pronounced in the open court on 19.10.2023.

Sd/- Sd/- (Chandra Mohan Garg) (Girish Agrawal) Judicial Member Accountant Member Dated: 19th October, 2023. JD. Sr. P.S