P.Sundararajan, Avanashi vs Assessee

ी चं पज ू ार , लेखा सद य एवं ी वी. दग ु ा" राव, या#यक सद य के सम% BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER & SHRI V. DURGA RAO, JUDICIAL MEMBER आयकर अपील सं./ I.T.A. No.1666/Mds/2013 ( नधा रण वष / Assessment Year : 2006-2007)

R. Sundararajan, The Deputy Commissioner of No.39-A, Extension Street, Vs Income Tax, Kaikattipudur, Company Circle, Avinashi 641 654 Tirupur

[PAN: AGQPS 1345A] (अपीलाथ'/Appellant) (()यथ'/Respondent)

अपीलाथ क ओर से / Appellant by : Shri. G. Baskar, Advocate यथ क ओर से / Respondent by : Shri. N. Madhavan, IRS, JCIT.

सन ु वाई क तार ख/Date of hearing : 11.06.2015. घोषणा क तार ख /Date of Pronouncement : 25.06.2015.

आदे श / O R D E R

PER CHANDRA POOJARI, ACCOUNTANT MEMBER

This appeal by assessee is directed against the order of the

Commissioner of Income Tax (Appeals)-II, Coimbatore, dated

25.06.2013, for the assessment year 2006-2007.

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

2. The first ground raised by the assessee challenges the reopening

of assessment as original assessment was completed u/s.143(3) of the

Act disallowing a part of other expenses, and the re-assessment was

made only on change of opinion on the very same set of already

considered facts without any fresh tangible information and there is no

valid reason to reopen the assessment.

3. The facts of the case are that the assessee is an individual

director in S P Apparel Ltd derives income from salary, rent filed the

original return of income for the assessment year 2006-07 on

13.03.2007 admitting total income of E1,02,16,651/-. The case was

selected for scrutiny and the original assessment was completed on

22.04.2008 with an addition of E2,46,065/- under the head other

expenses. During the financial year 2005-06 pertaining to A.Y. 2006-07

the assessee had paid interest totaling to E56,61,461/- and interest

income from firm was received upto 30.11.12006, up on Part IX

conversion the capital account of the assessee after allotment of share

had become unsecured loan. For this unsecured loan assessee has not

received any interest. So, it has become interest free loan to the

company. But, assessee was found to have debited interest expenses

to the tune of E26,52,520/- in the profit and loss account. As there was

reasons to believe that income has escaped assessment within the :- 3 -: I.T.A.No.1666/Mds/2013.

meaning of sec.147, the case was reopened and notice u/s.148 dated

22.04.2010 was issued. Accordingly, the Assessing Officer recorded the

reason for re-opening of assessment as follows:-

''The assessee had shown sundry debtors of ₹34.70 crores. He admitted interest received from M/s. S.P. Apparels of ₹1,61,93,186/- vide his letter dated nil filed in this office on 22.04.2008, the assessee explained that he was deriving income as interest on capital from M/s. S.P. Apparels and interest from bank only. Further, vide letter dated 22.04.2008 the assessee explained that his sundry debtors include ₹24,52,61,029/- from M/s. S.P. Apparels Ltd which is a closely held company.

In the balance sheet furnished as on 31.03.2006, the assessee has not mentioned anything about his assets or liabilities with the firm in which he is a partner. As already mentioned sundry debtors mainly consist of the investment with M/s. S.P. Apparels Ltd.

Assessee's admitted income includes only interest from bank and M/s. S.P. Apparels apart from the share of profit from the said firm. He has claimed interest paid of ₹56,61,461/-. There is no detail available on record to indicate that the loans borrowed were utilized to make investment with M/s. S.P. Apparels (firm). On the contrary, all the assets shown are not related to the purpose of any business activity. It is true that the assessee has made investments to the tune of ₹12 crores in shares. But, he had not admitted any dividend income from such shares. Hence, the claim of interest paid is not related to investments in any business activity or in any income generating assets or activity. Thus, in the return furnished and as per the enclosures, the assessee has claimed an item of expenditure which is not allowable under law and thus the assessee's income has been made the subject of excessive relief under the Act as provided in sub-clause (c) of Explanation 2 to Sec.147. Hence, I have reason to believe that income chargeable to tax has escaped assessment.

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

compliance to the notice u/s.148. The assessee was asked to reply why

the interest expenses paid to the tune of E26,52,520/- 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 E26,52,520/- 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/- ------------------

4. Aggrieved, the assessee carried the matter in appeal before the

Commissioner of Income Tax (Appeals) stating that there was no fresh

material as to reopen the concluded assessment and according to ld.

Authorised Representative for assessee it is only a change of opinion.

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

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.

5. The ld. Authorised Representative for assessee submitted

that in the course of original assessment, the Assessing Officer applied

his mind regarding the issue of allowability of interest and after

considering the facts and the circumstances, he disallowed a sum of

E2,46,065/- claimed as other expenses other than interest payment. So

the reason recorded for reopening the assessment is nothing but review

of original assessment order which was completed u/s.143(3) of the

Act. He also drew our attention to the letter filed before the Assessing

Officer on 22.04.2008 which is placed on record at page no.7 of the

paper book to suggest that the assessee is having sufficient own funds

to advance to the sundry debtors viz M/s. S.P. Apparels Limited wherein

the assessee is one of the major shareholder. The assessee has not

advanced any interest bearing funds to M/s. S.P. Apparels Limited.

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

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.

6. On the other hand, the ld. Departmental Representative

submitted that the Commissioner of Income Tax (Appeals) in this case

assessment was reopened within 04 years from the end of the relevant

assessment year. The reassessment notice u/s.148 was issued on the

reason that there was escapement of income on account of wrong claim

of expenditure which is not allowable under law and excessive relief has

been granted to the assessee.

7. We have heard both the parties and perused the material

available on record. In this case reassessment notice has been issued

to the assessee on 22.04.2010 for reopening of assessment for :- 7 -: I.T.A.No.1666/Mds/2013.

assessment year 2006-2007 by recording reason that the assessee has

claimed excessive expenditure towards interest which is evident from

the reason recorded by the Assessing Officer which was reproduced in

earlier para of this order. The main contention of the assessee counsel

is that this was only change of opinion and all materials available for

assessment has already been available with the Assessing Officer in

assessment record. We cannot appreciate this argument of the of the

ld. Authorised Representative for assessee. The requirement for the

Assessing Officer to initiate reassessment u/s.147 of the Act is explained

by Supreme Court in its decision in the case of CIT vs. Kelvinator of

India Limited 320 ITR 561, wherein it is held as under:-

"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 :- 8 -: I.T.A.No.1666/Mds/2013.

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

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

E56,61,461/- 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 E24,52,61,029/- to M/s. S.P. Apparels

Limited Ltd. Further, there was investment of E12 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 :- 10 -: I.T.A.No.1666/Mds/2013.

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

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

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

E2,46,065/- 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 :- 13 -: I.T.A.No.1666/Mds/2013.

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.

8. Regarding disallowance of interest the ld. Authorised

Representative for assessee submitted that the sundry creditors as on

31.03.2006 was at E34,70,32,605/-. Out of this, an amount of

E24,52,61,029/- due from M/s. S.P. Apparels Limited which is a closely

held company and according to the ld. Authorised Representative for

assessee capital of the assessee as on 31.03.2006 was around

E39,73,08,548/-. In addition to this, the assessee borrowed interest

free loans from his family members. As such, the amount advanced to

M/s. S.P. Apparels Limited is out of interest free own funds and interest :- 14 -: I.T.A.No.1666/Mds/2013.

bearing funds was not at all used for the purpose of loan to M/s. S.P.

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

circumstances of the case. No businessman can be completed to maximize his profits.''

9. On the contrary, the ld. Departmental Representative

submitted that the assessee advanced an amount of E24,52,61,029/- to

M/s. S.P. Apparels Limited without any interest. Further, there was

investment of E12 crores in shares and the loan and investment are

made without bringing any business advantage to the assessee.

Further, he submitted that the assessee at the same time, paid interest

of E56,61,461/- and the Assessing Officer is justified in disallowing the

interest of E26,52,500/- out of the interest expenditure incurred by the

assessee of E56,61,461/-. 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 :- 16 -: I.T.A.No.1666/Mds/2013.

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.

10. We have heard both the parties and perused the material on

record. In the present case, admittedly the assessee has advanced a

sum of E24,52,61,029/- to M/s. S.P. Apparels Limited and also made

investment of E12 crores in shares from which the assessee has not

derived any interest/dividend from these loans or from shares. At the

same time, the assessee claimed an expenditure towards interest of

E56,61,461/-. Due to this reasoning, the Assessing Officer disallowed

proportionate interest of E26,52,520/-. The claim of the assessee

before us is that there was enough interest free funds available with the

assessee to make advance to M/s. S.P. Apparels Limited and also to

make investment in shares. Further, the facts shows that the assessee

has incurred interest expenditure of E56,61,461/-. In our opinion, if the :- 17 -: I.T.A.No.1666/Mds/2013.

interest free funds are available with the assessee, it is the duty of the

assessee to establish the nexus of the interest free funds to the non-

income generating investment and also to show that only interest free

funds were invested in non-income bearing investments and the

assessee cannot expect that the Revenue has to prove that interest

free funds available with the assessee was diverted in investment which

yielded no returns. Section 36(1) (iii) of the Act provides for deductions

of interest on the loans raised for business purposes. Once the assessee

claims any such deduction in the books of accounts, the onus will be on

the assessee to satisfy the Assessing Officer that whatever loans were

raised by the assessee, the same were used for business purposes. If in

the process of examination of genuineness of such a deduction, it

transpires that the assessee had advanced certain funds to sister

concerns or any other person without any interest, there would be very

heavy onus on the assessee to be discharged before the Assessing

Officer to the effect that inspite of pending term loans and working

capital loans on which the assessee is incurring liability to pay interest,

still there was justification to advance loans to sister concerns for non-

business purposes without any interest and accordingly, the assessee

should be allowed deduction of interest being paid on the loans raised

by it to that extent. In our view, even the plea of nexus of loans raised :- 18 -: I.T.A.No.1666/Mds/2013.

by the assessee with the funds advanced to the sister concerns on

interest free basis, may be it is pleaded to be out of sale proceeds or

share capital or different account cannot be accepted.

11. The Entire money in a business entity comes in a common kitty.

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

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.

12. If the plea of the assessee is accepted that the interest free

advances made to the sister concerns for non-business purposes was

out of its own funds in the form of capital introduced in business, that

again will show a camouflage by the assessee as at the time of raising

of loan, the assessee will show the figures of capital introduced by it as

a margin for loans being raised and after the loans are raised, when

substantial amount is diverted to sister concerns for non-business

purposes without interest, a plea is sought to be raised that the amount

advanced was out of its capital, which in fact stood exhausted in setting

up of the unit. Such a plea may be acceptable at a stage when no loans :- 20 -: I.T.A.No.1666/Mds/2013.

had been raised by the assessee at the time of disbursement of funds.

This would depend on facts of each case.

13. Section 106 of the Indian Evidence Act or the principles

analogous thereto places the burden in respect thereof upon the

assessee, as the facts are within its special knowledge. However, a

presumption may be raised in a given case as to why an assessee who

for the purpose of running its business is required to borrow money

from banks and other financial institutions would be giving loan to its

subsidiary companies and that too when it pays a heavy interest to its

lenders, it would claim no or little interest from its subsidiaries.

14. In the case of K. Somasundaram and Brothers v. Commissioner

of Income-Tax 238 ITR 939, while dealing with a similar proposition,

Madras High Court held as under (page 944):

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

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.

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

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

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''.

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

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.

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

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

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''.

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

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.

15. In our opinion, if the amount is advanced from a mixed

account or share capital or sale proceeds or profits etc., the same would

be termed as diversion of borrowed capital and that the revenue need

not require to establish nexus of the funds advanced to the sister

concerns with the borrowed funds. Once it is borne out from the record

that the assessee had borrowed certain funds on which liability to pay

tax is being incurred and on the other hand, certain amounts had been

advanced to sister concerns or others without carrying any interest and

without any business purpose, the interest to the extent the advance

had been made without carrying any interest is to be disallowed under

Section 36(1)(iii) of the Act. Such borrowings to that extent cannot

possibly be held for the purpose of business but for supplementing the

cash diverted without deriving any benefit out of it. Accordingly, the

assessee will not be entitled to claim deduction of the interest on the :- 28 -: I.T.A.No.1666/Mds/2013.

borrowings to the extent those are diverted to sister concerns or other

persons without interest.

16. In the result, the appeal of the assessee in ITA No.1666/Mds/2013

is dismissed.

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

Sd/- Sd/- (वी. दग ु ा" राव) (चं पज ू ार ) V. DURGA RAO (CHANDRA POOJARI) या#यक सद य / JUDICIAL MEMBER लेखा सद य/ ACCOUNTANT MEMBER

चे$नई/Chennai. %दनांक/Dated:25.06.2015. KV

आदे श क त(ल)प अ*े)षत/Copy to: 1. अपीलाथ /Appellant 2. यथ / Respondent 3.

आयकर आय, ु त (अपील)/CIT(A) 4. आयकर आय, ु त/CIT 5. )वभागीय त न/ध/DR 6. गाड फाईल/GF.