INCOME TAX ACT, 1961

Business deduction under section 36(1)(iii)- Interest on borrowed capital-Assessee utilised its own surplus funds to give interest free loans to sister concerns

Assessee-company paid interest on the borrowings made by it during the relevant assessment years. It claimed deductions of interst under section 36(1)(iii) along with other business deductions. It also gave interest-free advances to one of its sister concerns, out of its surplus funds, during the first assessment year. The audited statement of accounts as well as cash flow statement supported the factum that in addition to its own capital and reserves and surplus, cash profits were generated by it during that year and the entire profit was deposited in its sole cash credit (overdraft) account with a bank. It made no fresh advances during the second assessment year and only brought forward the interest-free advances earlier made during the first assessment year to the same concern along with another of its sister concerns and to the third party during the second assessment year. AO disallowed certain sum out of interest expenditure claimed by assessee under section 36(1)(iii) on the ground that those advances were given out of its borrowed funds for non-business purposes and the nexus between the funds borrowed on interest and interest-free advances given to those three parties was clearly established. CIT (A) upheld the view of AO. By placing reliance on Woolcombers of India Ltd. v. CIT [1982] 134 ITR 129/[1981] 7 Taxman 188 (Cal.), assessee reiterated its submission that it was similarly maintaining one Cash Credit (CC) account and all trading receipts were deposited in the said account and the said advances were made out of that account only, no disallowance out of interest expenditure was made in the earlier assessment years. Held:Assessee gave interest-free advances to the sister-concerns out of CC account with the bank, but it was also an uncontroverted fact that the entire profits of the current year were also deposited by it in the same CC account, with the same bank as it had only one bank account. That showed that the entire cash profits earned during the relevant assessment year were also deposited in the same bank account which adequately covered the amount of interest-free loans given to the sister concerns. Assessee had submitted before AO as well as before CIT (A) that the entire profits of the current years had also been deposited in the same CC account with the bank, out of which interest-free loan was advanced to the sister-concern. Therefore, the entire cash profits had been pumped into the same CC account (overdraft account with the bank) was a well established fact in the present case. Further the loan given to other sister concerns were old loans which were outstanding since the financial year 1990-91. The department had brought no material or evidence to show that any fresh advances were given to those two parties. Also no disallowance out of interest expenditure was made in the assessment years 1991-92 and 1992-93. The advance to the third party was given in the assessment year 1992-93. Disallowance made out of interest expenditure in the assessment year 1992-93 in relation to advance given to the aforesaid sister concern had rightly been deleted by the Vice-President. Thus, assessees own capital and current years profits were substantially more than the advances given to those three sister-concerns, which proved the absence of any nexus between the funds borrowed on interest and interest-free advances given to those three parties. Disallowance out of interest expenditure could not be sustained in relation to interest-free advances given in earlier years in cases where, no such disallowance out of interest expenditure was made in those earlier years. Hence, the Vice-President was justified in directing AO to delete the disallowance in the assessment year 1993-94 also.