If interest free loan given in business expediency to Sister concern, no disallowance can be made towards interest paid to banks.
AO has to establish the nexus between the interest bearing borrowings and interest free loan to prove that interest expenditure was for non-business purposes.
IN THE SUPREME COURT OF INDIA
HERO CYCLES (P) LTD. Vs COMMISSIONER OF INCOME TAX (CENTRAL), LUDHIANA
CIVIL APPELLATE JURISDICTION; CIVIL APPEAL NO. 514 OF 2008
Facts of case
1. The assessee claimed deduction of interest paid on borrowed sums from Bank under the provisions of Section 36(1)(iii) of the Income Tax Act (hereinafter referred to as ‘Act’).
2. The assessee had interest free loan /advanced a sum of Rs.1,16,26,128/- to its subsidiary company known as M/s. Hero Fibers Limited
3. According to the Assessing Officer, substantial money out of the loans taken from the Bank was diverted by giving advance to M/s. Hero Fibres Limited on which no interest was charged by the assessee. Therefore, he concluded that money borrowed on which interest was paid was not for business purposes and no deduction could be allowed.
4. In addition, the assessee had also given advances to its own directors in the sum of Rs. 34 lakhs on which the assessee charged from those directors interest at the rate of 10 per cent, whereas interest payable on the money taken by way of loans by the assessee from the Banks carried interest at the rate of 18 per cent.
5. On that basis, the Assessing Officer held that charging of interest at the rate of 10 per cent from directors and paying interest at much more rate, i.e., at the rate of 18 per cent on the money borrowed from bank cannot be treated for the purposes of business of the assessee.
The CIT (Appeals) set aside the order of the Assessing Officer holding that the interest paid by the assessee of which deduction was claimed, on the facts of this case, was for business purposes and, therefore, the entire interest paid by the assessee should have been allowed as business expenditure.
It would be pertinent to mention that insofar as the advance given to M/s. Hero Fibres Limited is concerned, the case put up by the assessee even before the Assessing Officer was that it had given an undertaking to the financial institutions to provide M/s. Hero Fibres Limited the additional margin to meet the working capital for meeting any cash loses. It was further explained that the assessee company was promotor of M/s. Hero Fibres Limited and since it had the controlling share in the said company that necessitated giving of such an undertaking to the financial institutions. The amount was, thus, advanced in compliance of the stipulation laid down by the three financial institutions under a loan agreement which was entered into between M/s. Hero Fibres Limited and the said financial institutions and it became possible for the financial institutions to advance that loan to M/s. Hero Fibres Limited because of the aforesaid undertaking given by the assessee. It was also mentioned that no interest was to be paid on this loan unless dividend is paid by that company.
On that basis, it was argued that the amount was advanced by way of business expediency. CIT (Appeals) accepted the aforesaid plea of the assessee.
Insofar as the loan given to its own Directors is concerned at the rate of 10 per cent is concerned, the explanation of the assessee was that this loan was never given out of any borrowed funds. The assessee had demonstrated that on the date when the loan was given that is on 25.03.1987 to these directors, there was a credit balance in the account of the assessee from where the loan was given. It was demonstrated that even after the encashment of the cheques of Rs. 34 lakhs in favour of those directors by way of loan, there was a credit balance of Rs.4,95,670/- in the said bank account.
The aforesaid explanation was also accepted by the CIT (Appeal) arriving at a finding of fact that the loan given to the Directors was not from the borrowed funds. Therefore, interest liability of the assessee towards the Bank on the borrowing which was taken by the assessee had no bearings because otherwise, the assessee had sufficient funds of its own which the assessee could have advanced and it was for the Assessing Officer to establish the nexus between the borrowings and advancing to prove that expenditure was for non-business purposes which the Assessing Officer failed to do.
Insofar as loans to the sister concern / subsidiary company are concerned, law in this behalf is recapitulated by this Court in the case of ‘S.A. Builders Ltd. v. Commissioner of Income Tax (Appeals) and Another’ [2007 (288) ITR 1 (SC)]. After taking note of and discussing on the scope of commercial expediency, the Court summed up the legal position in the following manner: –
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, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.
No doubt, as held in Madhav Prasad Jatia v. CIT [1979 (118) ITR 200 (SC)], 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) of the Act.
In Madhav Prasad’s case [1979 (118) ITR 200 (SC)], the borrowed amount was donated to a college with a view to commemorate the memory of the assessee’s deceased husband after whom the college was to be named, it was held by this court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.
Thus, the ratio of Madhav Prasad Jatia’s case [1979 (118) ITR 200 (SC)] 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) of the Act.
It has been repeatedly held by this court that the expression “for the purpose of business” is wider in scope than the expression “for the purpose of earning profits” vide CIT v. Malayalam Plantations Ltd. [1964 53 ITR 140 (SC), CIT v. Birla Cotton Spinning and Weaving Mills Ltd. [1971 82 ITR 166 (SC)], etc.”
In the process, the Court also agreed that the view taken by the Delhi High Court in ‘CIT v. Dalmia Cement (B.) Ltd.‘ [2002 (254) ITR 377] wherein the High Court had held that once it is established that there is nexus between the expenditure and the purpose of 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 circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman.
Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s. Hero Fibres Limited became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to M/s. Hero Fibres Limited to meet the working capital for meeting any cash loses.
Insofar as the loans to Directors are concerned, it could not be disputed by the Revenue that the assessee had a credit balance in the Bank account when the said advance of Rs. 34 lakhs was given. Remarkably, as observed by the CIT (Appeal) in his order, the company had reserve/surplus to the tune of almost 15 crores and, therefore, the assessee company could in any case, utilise those funds for giving advance to its Directors.
On the basis of aforesaid discussion, the present appeal is allowed in favour of assessee.
November 05, 2015.