INCOME TAX ACT, 1961

--Business deduction under section 36(1)(iii)--Interest on borrowed capital Interest-free trade advances--In the course of assessment proceedings, assessing officer on verification of final accounts noticed that assessee had taken secured, and unsecured loans estimating to Rs. 44 crores on which interest expenditure has incurred by assessee. Assessing officer noticed that assessee had advanced huge amount to one M/s, A a proprietory concern of one 'L' who happens to be a promoter of assessee company. He also noticed that no interest was charged by assessee on huge advances/outstanding balance. Assessing officer held that on account of diversion of borrowed fund there was no commercial expediency in advancing amount to 'A' and disallowed proportionate interest on outstanding balance. Commissioner (Appeals) allowed assessee's appeal. Held: Rightly so. Since there was business consideration in allowing trade advances between parties and advances were made towards purchases assessing officer cannot question reasonableness of advances and made disallowance of proportionate interest payable on overdraft/borrowing.

When the assessing officer is proceeding to make a disallowance under section 36(1)(iii), he must bring sufficient material on record to prove that the money advanced by the assessee has no nexus with the business activity of the assessee. The assessee has brought material on record to discharge the onus cast upon it for proving that the advance made by it is purely a trade advance, having been made against purchases and is purely for the purposes of business. The copy of the ledger account clearly demonstrates that the assessee has regular business transactions with M/s. A. and the advance made by it has been adjusted in due course, and at the end of the year, there is a closing credit balance of Rs.2.68 lakhs. The contention of the Authorised Representative for the assessee that what expenditure is required to be met has to be looked into from the perspective of a businessman, has substantial force. A person carrying on business is the best person to judge what expenditure is to be incurred in the best interests of business, keeping in view the commercial expediency. The assessing officer certainly can raise questions regarding the genuineness and reasonableness of the expenditure incurred. However, as long as there is nexus between the expenditure incurred and the business of the assessee, the assessing officer cannot step into the shoes of a businessman to say that the expenditure incurred is not required in the interests of the business. The Hon'ble Supreme Court in the case of S.A. Builders Ltd.'s case have observed in no uncertain terms that what is relevant is whether the amount advanced by an assessee is as a measure of commercial expediency and not from the point of view whether the amount was advanced for earning profit. Once the assessee establishes that there is nexus between the expenditure and the purpose of business, the Department will not be empowered to sit in judgment over the decision taken by the businessman to decide whether the expenditure incurred is correct or not. Merely on the ground that the profit declared by the assessee is low, one cannot draw an inference that the expenditure incurred towards interest is not allowable. From the material on record, it is evident that the money advanced by the assessee to M/s. Agarwal Steel is not an interest free loan, but a trade advance. Therefore, the conclusion reached by the assessing officer without any cogent material brought on record, is unsustainable in law. The decisions relied upon by the Departmental Representative are not applicable to the facts of the present case since in the appeal, the advance is in the nature of trade advance and not interest free loan. [Para 12] Further, the stand of the assessing officer is also contradictory in view of the fact that the assessing officer himself has finally come to a conclusion that an amount of Rs.1 crore can be treated as a trade advance. By drawing such an inference, the assessing officer admits the fact that there is a nexus between the advancing of money and the business of the assessee. The assessing officer has also not given any reason, why he considers Rs. 1 crore to be the amount which can be treated as trade advance to M/s. A, and why the balance should not also be treated as trade advance. Since the assessing officer has made the disallowance based on mere presumptions and surmises without bringing sufficient material on record, to prove that the advance is not for the purpose of business, the Commissioner (Appeals) was correct in deleting the addition made. [Para 13]