Solar International , Mumbai vs Assessee

ी जो ग दर संह, या यक सद य एवं ी संजय अरोड़ा, लेखा सद य के सम । BEFORE SHRI JOGINDER SINGH, JM AND SHRI SANJAY ARORA, AM

आयकर अपील सं./I.T.A. No. 3798/Mum/2012 ( नधारण वष / Assessment Year: 2007-08) ITO-19(3)(4), Solar International rd 3 Floor, Piramal Chamber, 264, Geeta Niketan, Room No. 304, Lalbaug, बनाम/ Linking Road, Bandra (W), Mumbai-400 012 Vs. Mumbai-400 050

थायी ले खा सं . /जीआइआर सं . /PAN/GIR No. AAJFS 6213 N (अपीलाथ /Appellant) : ( यथ / Respondent)

या ेप सं./Cross Objection No. 292/Mum/2013 (Arising out of ITA No. 3798/Mum/2012) ( नधारण वष / Assessment Year: 2007-08) Solar International ITO-19(3)(4), 264, Geeta Niketan, 3rd Floor, Piramal Chamber, बनाम/ Linking Road, Bandra (W), Room No. 304, Lalbaug, Mumbai-400 050 Vs. Mumbai-400 012

थायी ले खा सं . /जीआइआर सं . /PAN/GIR No. AAJFS 6213 N ( या ेपक/ Cross objector) : ( यथ / Respondent)

राज व क ओर से / Revenue by : Shri Pavan Kumar Beerla

नधा रती क ओर से/Assessee by : Shri Umesh Kolapkar

सनु वाई क तार ख / : 06.01.2015 Date of Hearing घोषणा क तार ख / : 08.01.2015 Date of Pronouncement 2 ITA No. 3798/M/12 & CO No. 292/M/13(A.Y. 2007-08) Solar International

आदे श / O R D E R Per Sanjay Arora, A. M.:

These are cross appeals, i.e., by the Revenue and the Assessee, directed against the Order by the Commissioner of Income Tax (Appeals)-30, Mumbai ('CIT(A)' for short) dated 27.03.2012, partly allowing the Assessee's appeal contesting its assessment u/s.143(3) of the Income Tax Act, 1961 ('the Act' hereinafter) for the assessment year (A.Y.) 2009-10 vide order dated 16.12.2009.

Revenue's Appeal (in ITA No. 3798/Mum/2012)

2. Both the Revenue's appeal and the assessee's cross objection (C.O.) raise common grounds, i.e., qua the disallowance of the assessee's claim of interest on borrowed capital u/s.36(1)(iii) in the computation of its' business income for the year. It will be relevant to recount the background facts of the case, which are though largely undisputed. The assessee, a partnership firm in the business of trading in footwear and readymade garments, was observed to have claimed a sum of Rs.48,90,096/- by way of interest, which stood also receipted by it at Rs.18,95,014/- for the year. The interest was paid on unsecured loans, which were availed at an average of Rs.380.19 lacs for the year, yielding an average borrowing rate of 12.86% p.a. The entire funding as at the close of the year was, as per the assessee's balance-sheet thereat, vide borrowed funds, at Rs.331.46 lacs. The same, therefore, to the extent applied toward non-business purposes, would merit disallowance of interest. The assets or the utilization of the funds were categorized by the Assessing Officer (A.O.) into three broad groups for the purpose, as under:

(Amt. in Rs.) Remarks A Sources of funds

1. Borrowed funds (unsecured loans) 3,31,46,257 B Application of funds

1. Business assets 26,43,301

2. Interest bearing loans 1,30,70,541

3. Interest free advances 1,15,89,410

4. Partner's overdraft 58,43,004 without interest 3 ITA No. 3798/M/12 & CO No. 292/M/13(A.Y. 2007-08) Solar International The interest bearing advances were found to be at an average rate of 9.86% p.a. As the assessee could not advance any business purpose of the said loans, the A.O. disallowed the claim of interest thereon, working out the same with reference to the average of such funds, at Rs.192.23 lacs for the year, so that the disallowance in its respect worked to Rs.5,77,035/- (Rs.1,92,22,777/- @ 3%). As regards the balance funds, i.e., given by way of interest free deposits and that withdrawn by the partners, and which would therefore also warrant disallowance of proportionate interest, were worked out by him at Rs.1,54,24,942/-, i.e., after reducing the amounts which were or could be said to be applied or toward business purposes. Interest was proportionately disallowed at Rs.19,83,647/- (i.e., Rs.154.25 lacs @ 12.86%). In appeal, the assessee explained that the negative balance in the partner's capital accounts was occasioned on account of losses.

The same, therefore, cannot be considered as utilization for or toward non-business purposes, so as to warrant disallowance of interest. In fact, Rs.60.86 lacs was paid to the retiring partners during the year, which also depleted the firms' resources considerably, i.e., apart from business losses. The interest free advances also included Rs.20,500/- paid to the employees and Rs.34.76 lacs to three sister concerns, which had though become unrecoverable as the said concerns had become inoperational. The ld. CIT(A), accepting the assessee's claim in principle, directed for restriction of disallowance only qua the sum referable to the amount advanced to the three concerns (i.e., Rs.34.76 lacs), resulting in a partial relief to the assessee at Rs.15,36,697/-, i.e., out of the total disallowance of Rs.19.84 lacs. The disallowance of Rs.5.77 lacs was, however, confirmed in the absence of any business purpose of the relevant advances. Aggrieved, both the Revenue and the assessee are in appeal.

3. We have heard the parties, and perused the material on record. We shall take up both the disallowances in seriatim:

a) Disallowance for Rs.5,77,035/- :

There is no finding by either authority of the relevant advances as being for business purposes. In fact, we find no material on record to justify such a finding, only on the basis of which could the assessee state of the non charge of 4 ITA No. 3798/M/12 & CO No. 292/M/13(A.Y. 2007-08) Solar International the interest (in case of one advance) or at a lower charge of interest, i.e., with reference to the borrowing rate (on the others), as inconsequential. We, accordingly, find no infirmity in the confirmation of the disallowance by the first appellate authority, and confirm the same.

b) Disallowance for Rs.19,83,647/- :

Our first observation in the matter is that while the A.O. bases, and only rightly so, the disallowance of interest on the funds utilized for non-business purposes, the same stands computed by him not with reference to the funds so utilized or availed of on average basis, but on the balance outstanding as at the end of the year. Interest is charged on the basis of the balance outstanding from day to day, i.e., on the basis of the average funds availed, computed, albeit grossly, by simply averaging the opening and the closing balances for the year. The disallowance of interest, where the interest bearing funds are applied for non-business purposes, would therefore have necessarily to be on the basis of such utilization, on an average. One could, for example, recover deposit from such a non-business asset/avenue at the end of the year, either repaying the interest bearing loan or even parking the said recovered funds in bank. Would that, then, operate to circumvent the disallowance of interest, which is only on the basis of the funds borrowed or the borrowings during the year, even as the same does not or may not outstand as at the year-end.

Surely not. This would also obviate the need to exclude the disallowance of interest corresponding to the withdrawal of capital by the retiring partners, as appears to have been considered by the ld. CIT(A) as an application for business purposes. The withdrawal of capital by the outgoing partners does not form part of the fund utilization of Rs.154.25 lacs as at the year-end, with reference to which the impugned disallowance has been worked out by the A.O., so that the said withdrawal, which could only be of positive capital, is largely irrelevant for the disallowance of interest. Considered holistically, it is only the partner's capital, on an average for the year, positive or negative, which is relevant figure. The same is to be worked out preferably on a day to day basis or at least by taking 5 ITA No. 3798/M/12 & CO No. 292/M/13(A.Y. 2007-08) Solar International the average of the monthly balance, again, taken at an average of the opening and the closing balance to ease computation. Of-course, to the extent of the debit balance in the partner's accounts arises on account of losses falling to their share, no disallowance of interest could follow or ensue on such losses, representing an excess of expenditure, incurred for business purposes, over the revenue generated.

The same, therefore, ought to be excluded. So, however, this would have to be preceded by a finding to that effect by the A.O., based on the materials and evidences led by the assessee, which were not before him, leading to the Revenue's principal grievance of contravention of the provision of rule 46A of the Income Tax Rules, 1962. The matter would, accordingly, require being restored back to the file of the A.O. for enabling the assessee to establish its case, including its contention of the average borrowing rate of 12.86% p.a. being on a higher side (as made before the ld. CIT(A)), as also the A.O. removing the discrepancy/s, as noted above, in his working. The onus, we may clarify, to prove its' claims and case shall be strictly on the assessee. Where, however, the assessee is able to show the average borrowing rate, as applied, being higher than that actually obtaining, the A.O. shall, after issuing a finding to that effect, also cause a consequential relief qua the disallowance of Rs.5.77 lacs, since confirmed by us in-as-much as, having been worked out with reference to the said borrowing rate (of 12.86% p.a.), the same becomes only consequential.

We decide accordingly.

4. In the result, the Revenue's appeal is allowed and the assessee's C.O. is partly allowed for statistical purposes.

प रणामतः राज व क अपील वीकृत और नधा रती क या पे सां यक य उ े य के लए आं शक वीकृत क जाती है ।

Order pronounced in the open court on January 08, 2015

Sd/- Sd/-

(Joginder Singh) (Sanjay Arora) या यक सद य / Judicial Member लेखा सद य / Accountant Member मंब ु ई Mumbai; दनांक Dated :08.01.2015 6 ITA No. 3798/M/12 & CO No. 292/M/13(A.Y. 2007-08) Solar International

व. न.स./Roshani, Sr. PS

आदे श क त ल प अ े षत/Copy of the Order forwarded to : 1. अपीलाथ / The Appellant 2. यथ / The Respondent 3. आयकर आयु त(अपील) / The CIT(A) 4. आयकर आयु त / CIT - concerned 5. वभागीय त न ध, आयकर अपील य अ धकरण, मब ंु ई / DR, ITAT, Mumbai 6. गाड फाईल / Guard File आदे शानस ु ार/ BY ORDER,

उप/सहायक पंजीकार (Dy./Asstt. Registrar) आयकर अपील य अ धकरण, मुंबई / ITAT, Mumbai