Shri. Akhilesh Kumar Sah, Advocate, has provided valuable perspective on the controversial issue relating to the deduction of interest on loan diverted to sister/ subsidiary concerns without interest. The entire law on the subject as encapsulated in the recent verdict of the Supreme Court in Hero Cycles (P) Ltd vs. CIT is considered
Introduction:
Many a times dispute arises about the deduction of interest on loan while computing income from business where the assessee parts loan to its sister/ subsidiary concern without interest. Also, a lot of cases have arisen since the introduction of income tax law about the nexus of an expenditure in relation to the income from deduction point of view.
Recently, in Hero Cycles (P) Ltd vs. CIT (Central), Ludhiana [Civil Appeal No. 514 Of 2008, November 5, 2015], as per facts & circumstances of the case, the Apex Court has put an end to the controversy.
Facts & Decision In Brief Of Hero Cycles Case(supra):
In the above mentioned case, basically there were two following issues:-
(1) The assessee had advanced a sum of Rs.1,16,26,128/- to its subsidiary company known as M/s. Hero Fibers Limited and this advance did not carry any interest. According to the AO, the assessee had borrowed the money from the banks and paid interest thereupon. Deduction was claimed as business expenditure but substantial money out of the loans taken from the Bank was diverted by giving advance to 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.
(2) 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%. On that basis, the AO held that charging of interest at the rate of 10% from the above mentioned persons and paying interest at much more rate, i.e., at the rate of 18% on the money borrowed by the assessee cannot be treated for the purposes of business of the assessee.
Hon’ble Supreme Court observed that insofar as loans to the sister concern / subsidiary company are concerned, law in this behalf is recapitulated by Supreme Court in the case of ‘S.A. Builders Ltd. vs. CIT(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:
“26. 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.
27. No doubt, as held in Madhav Prasad Jatia vs. 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.
28. 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.
29. In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.
30. 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 vs. Malayalam Plantations Ltd. [1964 53 ITR 140 (SC), CIT vs. 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 vs. 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.
The Hon’ble judges of the Supreme Court, applying the aforesaid ratio to the facts of this case, observed that it is manifest that the advance to 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 Hero Fibres Limited to meet the working capital for meeting any cash loses.
It would also be significant to mention at this stage that, subsequently, the assessee company had off-loaded its share holding in the said Hero Fibres Limited to various companies of Oswal Group and at that time, the assessee company not only refunded back the entire loan given to Hero Fibres Limited by the assessee but this was refunded with interest. In the year in which the aforesaid interest was received, same was shown as income and offered for tax.
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 (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, utilise those funds for giving advance to its Directors.
The Supreme Court allowed appeal, thereby setting aside the order of the High Court and restoring that of the ITAT.
Bottomline:
Section 36(1)(iii), subject to its Proviso and Explanation, of the Income Tax Act, 1961 allows deduction of the amount of interest paid in respect of capital borrowed for the purposes of business or profession while computing income of it. Controversy about deduction of interest has arisen of many types in many cases. Some cases have been decided in the favour of assessees and some have been decided against the assessees. Also, reasonability of an expenditure has also been questioned by the Revenue in many cases.
The Supreme Court in Swadeshi Cotton Mills Co. Ltd. vs. CIT [1967] 63ITR 57 has held that the question whether an amount claimed as an expenditure has been laid out or expended wholly and exclusively for the purpose of the assessee’s business or profession or vocation has to be decided on the facts and in the light of the circumstances of each case. But the final conclusion on the admissibility of an allowance is one of law. The latest decision of the Apex Court in Hero Cycles case(supra) shall become a guiding factor in respect of the above issue.
I recall that about a year back in one of the decisions, the hon SC had thought that the decision in the case is SA Builders was not correct and had referred the matter to a superior bench. I am not aware of the decision of the Hon SC in that case.