No addition on account of notional interest on interest free advance permissible if Assessee’s have sufficient surplus in capital account

When assessee had produced books of account and audited statements, which proved that the assessee had sufficient surplus in his capital account to give interest free loan, then, no addition on account of notional interest on interest free advance was made by AO.

Assessee claimed interest expenditure. AO made a disallowance of interest of a sum being a notional interest of interest free advance. Assessee’s contention was that he had sufficient surplus in his capital account to give interest free loan and the advances were not out of borrowed funds, but the CIT(A) confirmed the addition. Held:Assessee had produced books of account and audited statements, which proved that the assessee had sufficient surplus in his capital account to give interest free loan. Further that, the AO as well as CIT(A) had not brought anything on record to show that money so advanced was out of the borrowed funds. Hence, the direction was given to the AO to delete the disallowance of interest.

Decision: In assessee’s favour.

Referred: Hero Cycles (P.) Ltd. v. CIT (2015) 379 ITR 347 (SC); CIT v. Reliance Utilities & Power Limited, (2009) 178 Taxman 135 (Bom); Elmer Havell Electrics (2005) 277 ITR 549 (Del) and R. D. Joshi & Co. v. CIT (2001) 251 ITR 332 (MP).

IN THE ITAT, INDORE BENCH

KUL BHARAT, J.M. & MANISH BORAD, A.M.

John Jacob v. Jt. CIT

ITA No. 1328/Ind/2016

28 February, 2018

Appellant by: M.K.Sharma, C.A.

Respondent by: Rajeev Jain, Sr. DR

Kul Bharat, J.M.

Appeal by the assessee is directed against the order of Commissioner (Appeals) – 31, New Delhi, Camp at Bhopal dated 29-8-2016, pertaining to assessment year 2010-11. The assessee has raised the following grounds of appeal :–

1. That the learned Commissioner (Appeals) has erred in law and on facts in confirming the addition of Rs. 6,39,274 to the total income of the appellant.

2. That the learned Commissioner (Appeals) has erred in law and on facts in confirming the addition, ignoring the fact that the ld. assessing officer failed to prove a one to one correlation between the amount of interest free advances given by the appellant and the amount of borrowed funds.

3. That the learned Commissioner (Appeals) has erred in law and on facts in confirming the addition on account of notional interest ignoring the fact that the appellant had sufficient surplus in his Capital Account to give interest free loan and the advances were not out of borrowed funds.

4. That the learned Commissioner (Appeals) has erred in law in not following the ratio of the judgement by the High Court of Madhya Pradesh in the case of R. D. Joshi & Co. v. CIT (2001) 251 ITR 332 (MP).

2. Briefly stated, the facts of the case are that the case of the assessee was picked up for scrutiny assessment and the assessment under section 143(3) of the Income Tax Act, 1961 ( hereinafter referred to as the “Act”) vide order dated 1-3-2013, was framed. While framing the assessment, the assessing officer made the additions on account of disallowance of interest on TDS, disallowance out of commission expenses at Rs. 6,23,807, disallowance out of commission expenses on account of non-deduction of tax of Rs. 28,700, disallowance out of interest of Rs. 6,39,274 and other small disallowances being personal in nature. Against this, the assessee preferred the appeal before the learned Commissioner (Appeals), who after considering the submissions confirmed the addition of Rs. 6,39,274 made on account of disallowance of interest expenses. Aggrieved by this, the assessee is in present appeal.

3. The learned Counsel for the assessee vehemently argued that the authorities below were not justified in making the addition on the ground that the assessee has reiterated the submissions as made in the written submissions :–

“The facts of the case are that the learned assessing officer has made a disallowance of interest of Rs. 6,39,274 being a notional interest on the interest free advance of Rs. 61,20,000.

The learned assessing officer has ignored the fact that the appellant had proprietary capital of Rs. 1,63,98,930 against the advance given to Aliamma Jacob for a sum of Rs. 61,20,000, details of which are as follows :–

It is not in dispute that appellant had a capital balance in books of account and audited statements, more than the interest free advances given by him. The learned assessing officer in his order and also the Commissioner (Appeals) in his order has not brought anything in record to show that money so advanced was out of the borrowed funds.

In case of R.D. Joshi & Co. v. CIT (2001) 251 ITR 332 (MP) has held that “where no such nexus or link was established or had been shown to have existed between borrowings made by assessee firm. Interest on entire debit balance is allowable.” This judgment is of the Jurisdictional High Court. Therefore, it is binding on the lower authorities.

Your further attention is drawn to the judgment of Hon’ble Bomb assessment year High Court in case of CIT v. Reliance Utilities & Power Limited, (2009) 178 Taxman 135 (Bom) where it was held that “If there are funds available both interest free & over draft and/or loan taken, then a presumption would arise that investment should be out of interest free funds generated or available with company, provided said sum are sufficient to meet expenses.”

The Hon’ble Supreme Court in case of Hero Cycles (P.) Ltd. v. CIT (2015) 379 ITR 347 (SC) vide appeal no.514 of 2008 held that “the company has Reserve and surplus to the tune of almost 15 crores and therefore assessee company could in any case utilize those funds for granting it to directors.

Therefore, in view of judgment of Hon’ble Jurisdictional High Court and also judgment of Hon’ble S.C. disallowance of Rs. 6,39,274 under section 36(1)(iii) of Income Tax Act, 1961, should be deleted for the reasons given below :-

1. Learned assessing officer and learned Commissioner (Appeals) both failed to prove nexus between borrowing and interest free advance given.

2. learned assessing officer and learned Commissioner (Appeals) has failed to appreciate the fact that the capital available with the appellant was much higher than the interest free advance.

3. In view of judgments of High Courts including Jurisdictional High Court and Hon’ble Supreme court, such disallowances are unsustainable and Your Honour is kindly requested to delete the disallowance of interest and appeal of appellant may please be allowed in full.”

4. On the contrary, the learned Departmental Representative opposed the submissions.

5. We have considered the facts, rival submissions and perused the material available on record. The learned Commissioner (Appeals) has confirmed this addition by observing as under :–

“4.4 I have considered the findings recorded by the learned assessing officer as per the assessment order, the submissions made by the learned AR and the facts of the case on record. The learned assessing officer made a disallowance of Rs. 6,39,274 out of interest expenses, as the appellant had not charged interest on certain advances whereas he had paid interest on loans taken. The appellant contended that such loans on which no interest has been charged have been given out of own funds interest free funds available with him. However, the appellant has not substantiated the above contention with any documentary evidence. It has not been established that such loans on which no interest has been charged have actually flown out of the interest free funds, as claimed. In the absence of the appellant’s establishing the aforesaid contention, the same becomes untenable. It is trite that once interest free and interest bearing funds reach the coffers of an assessee, they lose their identity and become one. Therefore, unless a direct nexus between the interest free funds and advancement of the non interest bearing loans is established, for which the onus is entirely on the assessee, the argument put forth by the appellant Cannot be accepted, Similarly, the argument that only a small amount was advanced during the year is of no avail as it is the amount outstanding during the year that matters rather than whether any loan was given during the year or not. Under these circumstances, I am of the considered view that an addition was called for as on one hand the appellant has claimed payment of interest on loans taken and on the other hand had advanced interest free funds for which no nexus with the business has been established. Hence, proportionate disallowance out of the interest expenses is required to be made, Reliance in this regard is placed on the decision of Hon’ble Delhi High Court in the case of Elmer Havell Electrics (2005) 277 ITR 549 (Del) and in the case of V.1. Baby & Co. (2002) 254 ITR 248 (Ker). The decisions cited by the appellant are distinguishable both on ‘ facts and law as in all those cases the assessee were able to show nexus between the business and the advances given, which has not been done in this case. Hence the decisions relied upto by the learned assessing officer are not applicable to this case. Thus, the addition of Rs. 6,39,274 made by the learned assessing officer is confirmed. Accordingly, the ground no, 4 is partly allowed.”

6. The learned Counsel for the assessee during the course of hearing relied upon the judgment of Hon’ble Supreme Court as rendered in the case of Hero Cycles (P) Ltd. v. CIT (Central) (2015) 379 ITR 347 (SC), wherein the Hon’ble Supreme Court has held as under :–

“In sofar 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 Commissioner (Appeals) in his order, the company had reserve/surplus to the tune of almost 15 crores and, therefore, the assessee company could in any case, utilize those funds for giving advance to its Directors.”

7. The assessee has stated that it was having sufficient amount to give advance free loans to Mrs. Preeti Sharma and Mr. Rijwan Khan. In support of this, the assessee has drawn our attention to the paper book page no.11, where the balance sheet as on 31-3-2009 is enclosed. On the said balance sheet, it is evident that the assessee was having sufficient balances to make such advances. Therefore, we direct the assessing officer to delete these disallowances. Grounds raised in this appeal are allowed.

8. In the result, the appeal filed by the assessee is allowed.

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