SUPER METER MFG. CO. v. JOINT COMMISSIONER OF INCOME TAX
[Citation -2006-LL-1031-13]

Citation 2006-LL-1031-13
Appellant Name SUPER METER MFG. CO.
Respondent Name JOINT COMMISSIONER OF INCOME TAX
Court ITAT
Relevant Act Income-tax
Date of Order 31/10/2006
Assessment Year 1998-99
Judgment View Judgment
Keyword Tags disallowance of interest • interest-bearing funds • assessment proceeding • interest-free advance • non-business purpose • personal expenditure • business expenditure • business transaction • proportionate basis • business connection • capital expenditure • overdraft account • capital borrowed • credit facility • current account • capital account • life membership • working capital • credit balance • share capital • interest paid • bank balance • cash credit • term loan • borewell
Bot Summary: The CIT(A) has noted that almost the entire funds available with the assessee were interest-bearing on which the assessee paid as much as Rs. 20,60,149 as interest and therefore the interest pertaining to non-business loans/advances had to be disallowed on proportionate basis and we are in agreement with the conclusions reached by the CIT(A). There is no doubt that a current/overdraft account is always for availing of a credit facility for the requirements of the assessee s business and that the assessee pays interest in respect thereof. 13.2 The Supreme Court, affirming the decision of High Court held, that the borrowing of Rs. 5.5 lakhs was made by the assessee to meet her personal obligation and not the obligation of her business and as such the expenditure incurred by the assessee by way of interest thereon was not for carrying on the business or in her capacity as a person carrying on that business. The AO had taken a view that if the assessee had collected the outstandings which were due to it from others, it would have been able to reduce its indebtedness and save a part of the interest which it had to pay on its own borrowings, that the assessee was not justified in allowing its outstandings to remain without charging any interest thereon, while it was paying interest on the amounts borrowed by it, and that to the extent to which it would have been in a position to collect interest on the outstandings due to it from others, it could not be permitted to claim interest paid by it to outsiders. Once, the assessee claims any deduction under s. 36(1)(iii) of the Act 1961 in the books of account, the onus will be on the assessee to satisfy the AO, that whatever loans were raised by the assessee were used for business purposes. If in the process of examination of the genuineness of such a claim it transpires that the assessee had advanced certain funds to its sister-concerns or to any other person without any interest, there would be a very heavy onus on the assessee to discharge before the AO to the effect that in spite of pending term loans and working capital loans on which the assessee was incurring liability to pay interest, still there was justification to advance interest-free loans to sister-concerns for non-business purposes and accordingly the assessee should be allowed deduction of interest being paid on the loans raised by it to that extent. The amount borrowed must continue to be used for the purposes of the business and the fact that it was used for some point of time, but later diverted would not entitle the assessee to claim the interest paid on the borrowing as a deduction even after such diversion, that any view to the contrary would not in the least sub serve the object of the provision, but it would only open the gates for the assessees to borrow merrily and after ostensibly using it in the business for a short period at a subsequent point of time divert the funds in whole or part, for non-business purposes and continue to claim the interest on the borrowing as a deductible item of expenditure.


AHMAD FAREED, A.M. ORDER This appeal by assessee is directed against order of CIT(A), dt. 15th Jan., 2002 for asst. yr. 1998-99. Ground No. 1 : "The learned Hon ble CIT(A)-I, Pune, has erred in confirming addition of Rs. 2,00,000 to its total income as disallowance of Rs. 2,00,000 for payment made to Royal Western India Turf Club Ltd., as life membership fees on ground that said life membership fees is not business expenditure and is in nature of personal expenditure and alternatively also treated as capital expenditure." 2. assessee firm had taken membership of Royal Western India Turf Club Ltd. (RWITC) in name of two partners Shri. Rajesh R. Chinta and Shri Vijay R. Chinta. AO treated it as capital expenditure and his action was upheld by CIT(A). 3. Shri S.P. Joshi, learned Authorised Representative, pointed out that this issue was covered in favour of assessee by decision of Tribunal Pune, in case of Chindhy s Interiors in ITA No. 619/Pune/2002 for asst. yr. 1998-99, dt. 3rd March, 2006. In para 3.3 of his order Tribunal held as under : "3.3 We have considered facts of case and rival submissions. There are number of Tribunal decisions including decisions discussed by t h e learned CIT(A) that membership fees of clubs for executives and directors constitute admissible expenditure as such membership gives chance to employees to interact with existing and future customers. Western Royal Turf Club did not permit membership of firm and, therefore, assessee decided to take up life membership in name of partner. benefit accruing to firm will be same as accruing to companies when membership is taken for employees or directors. Therefore, we find that there is no distinction in facts of this case and facts of cases relied upon by assessee. Accordingly, it is held that assessee was entitled to deduct aforesaid amount of Rs. 1 lakh in computing its income. Thus, this ground of appeal is also allowed." 4. We find that facts of case in present appeal are identical and therefore, we follow precedent and allow ground No. 1. Ground No. 2 : "The learned Hon ble CIT(A), Pune, has erred in making addition of Rs. 16,800 on ground that digging and installation of borewell is capital expenditure." 5 . Shri S.P. Joshi, learned Authorised Representative, did not press this ground and therefore, it is rejected. Ground No. 3 : "The learned Hon ble CIT(A), Pune, has erred in restricting disallowance of interest paid on borrowed funds paid to sister-concerns. apportionment of interest on ground that not charging of interest on loans given to sister-concerns, relatives and others without having any business connection or business transaction is nothing but diversion of benefits in favour of others." 6 . During assessment proceeding, it was noticed by AO that assessee had given interest-free loans/advances to three parties which were not connected with its business. position of these loans/advances as on 31st March, 1998 was as under : (Rs.) 1. M/s Shivshakti Chambers 3,45,389 2. M/s Surya Automobiles 6,26,469 3. Shri Shankar R. Chinta 1,45,200 Total 11,17,058 7. It was also noticed by AO that interest aggregating to Rs. 20,65,149 was debited to P&L a/c as under : (Rs.) Interest on unsecured loans 1,54,187 Bank interest 6,30,648 Interest on partner s capital 12,80,314 Total 20,65,149 8 . AO made disallowance in respect of claim for interest calculated at 18 per cent and made addition of Rs. 2,01,070. CIT(A) confirmed AO s action and his order has been challenged in present appeal. 9 . Shri S.P. Joshi, learned Authorised Representative, reiterated arguments which were put forward on behalf of assessee before AO and CIT(A). He submitted that there was no direct nexus between interest- bearing funds and interest-free loans/advances given by assessee, that there was no increase in cash credit limit sanctioned by bank during last two years, that these loans/advances were given out of profits of assessee firm, that assessee had substantial bank balance and Rs. 36,74,565 were converted into fixed deposit, that assessee had received interest-free loans amounting to Rs. 6,00,000, that assessee had its own capital aggregating to Rs. 65,58,709. Shri Joshi placed reliance on decisions in following cases : (i) CIT vs. Bombay Samachar Ltd. (1969) 74 ITR 723 (Bom); (ii) CIT vs. Radico Khaitan Ltd. (2005) 194 CTR (All) 451 : (2005) 274 ITR 354 (All); (iii) East India Pharmaceutical Works Ltd. vs. CIT (1997) 139 CTR (SC) 372 : (1997) 224 ITR 627 (SC). 1 0 . Shri V.S. Kumar, learned Departmental Representative, placed reliance on orders of authorities below. He vehemently argued saying that order of CIT(A) needed to be upheld. 11. We have considered rival submissions in light of material on record and precedent cited. s. 36(1)(iii) of IT Act deals with deduction of amount of interest paid in respect of capital borrowed for purposes of business or profession. It would be found from cl. (iii) of sub-s. (1) of s. 36 of Act that three conditions must be established by assessee for getting benefit under aforesaid clause : (1) interest should have been payable, (2) there should be borrowing, and (3) capital must have been borrowed or taken for business purposes. 12. It is not case of assessee that impugned loans/advances were given by assessee for purposes of its business. assessee paid interest aggregating to Rs. 12,80,314 to partners on their capital, Rs. 6,30,648 to bank and Rs. 1,54,187 on other unsecured loans. CIT(A) has noted that almost entire funds available with assessee were interest-bearing on which assessee paid as much as Rs. 20,60,149 as interest and therefore interest pertaining to non-business loans/advances had to be disallowed on proportionate basis and we are in agreement with conclusions reached by CIT(A). 12.1 In business, current account or overdraft account is used by assessee as channel or conduit for two-way flow of funds and when cash credit/overdraft limit is attached to such account, it only ensures uninterrupted flow of funds subject to sanctioned limit. cash credit/overdraft limits are taken by assessees from banks for their working capital requirements. amount of interest paid in respect of such cash credit/overdraft accounts depends upon extent to which sanctioned credit limits are utilized. debit or credit balance in overdraft account keeps limits are utilized. debit or credit balance in overdraft account keeps changing with successive transactions routed through such account. payment from buyer is deposited and there is credit balance and then payment made therefrom to supplier may result in debit balance. Further, there is always time lag between issue of cheque from current/overdraft account and entry in this account in respect of encashment of cheque deposited. 12.2 When cheque is issued from current/overdraft account for interest-free advance for non-business purpose, it becomes immaterial whether there was debit balance or credit balance at time when cheque was issued or at time when amount represented by that cheque was posted in account. There is no doubt that current/overdraft account is always for availing of credit facility for requirements of assessee s business and that assessee pays interest in respect thereof. Therefore, nexus between interest-bearing funds and interest-free advance can be said to exist whenever cheque is issued in respect of interest-free advance for non business purpose from current/overdraft account and in such situation claim in respect of interest cannot be said to fulfil conditions of s . 36(1)(iii) of Act. This view of ours is fortified by decisions in following cases : (i) Madhav Prasad Jatia vs. CIT (1979) 10 CTR (SC) 375 : (1979) 118 ITR 200 (SC); (ii) CIT vs. Abhishek Industries Ltd. (2006) 205 CTR (P&H) 304 : (2006) 286 ITR 1 (P&H); (iii) K. Somasundaram & Bros. vs. CIT (1999) 153 CTR (Mad) 153 : (1999) 238 ITR 939 (Mad). 13. In case of Madhav Prasad Jatia vs. CIT (supra), assessee derived income from various sources such as shares, properties and businesses. On 21st Oct., 1955, assessee promised to donate Rs. 10 lakhs for setting up of engineering college and further sum for hospital. Initially, on 21st Nov., 1955, sum of Rs. 10 lakhs was debited to her capital account (which had ample credit balance) and corresponding credit was given to account of college. Thereafter, on 7th Jan., 1956, assessee drew sum of Rs. 5.5 lakhs from overdraft account maintained with bank for her business and paid it to college. 13.1 question was whether interest paid by assessee to bank on sum of Rs. 5.5 lakhs for asst. yrs. 1957-58 to 1959-60 was allowable expenditure in computing her business profits. Tribunal held that sum of Rs. 5.5 lakhs overdrawn from bank was not borrowed for business purposes and that interest was not allowable as deduction under s. 10(2) of IT Act, 1922. High Court affirmed decision of Tribunal. 13.2 Supreme Court, affirming decision of High Court held, that borrowing of Rs. 5.5 lakhs was made by assessee to meet her personal obligation and not obligation of her business and as such expenditure incurred by assessee by way of interest thereon was not for carrying on business or in her capacity as person carrying on that business. making of initial entries on 21st Nov., 1955 debiting assessee s capital account and crediting account of college did not alter character of borrowing. interest paid to bank on borrowing of Rs. 5.5 lakhs was not deductible either under s. 10(2)(iii) or under s. 10(2)(xv) of IT Act, 1922. apex Court discussed and distinguished decision of Bombay High Court in case of Bombay Samachar (supra). 14. In case of Bombay Samachar (supra), it was not disputed that capital borrowed by assessee from outsiders was used by assessee for purposes of its business. AO had taken view that if assessee had collected outstandings which were due to it from others, it would have been able to reduce its indebtedness and save part of interest which it had to pay on its own borrowings, that assessee was not justified in allowing its outstandings to remain without charging any interest thereon, while it was paying interest on amounts borrowed by it, and that to extent to which it would have been in position to collect interest on outstandings due to it from others, it could not be permitted to claim interest paid by it to outsiders. High Court held that such view was clearly unsustainable and that in deciding whether claim of interest on borrowing can be allowed, fact that assessee had ample resources at its disposal and need not have borrowed was not relevant matter for consideration. 1 5 . Supreme Court in later judgment in case of East India Pharmaceutical Works Ltd. vs. CIT (supra), referred to its decision in case of Madhav Prasad (supra) and observed that payment made by assessee by drawing cheque on overdraft account was borrowing within meaning of s. 10(2)(iii) of IT Act, 1922. 16. In case of CIT vs. Abhishek Industries Ltd. (supra), secured loans standing against assessee company as on 31st March, 1993 were to tune of Rs. 25,40,04,090 and interest liability which arose during year thereon was Rs. 2,26,64,994 out of which Rs. 1,48,51,396 were debited to P&L a/c and balance of Rs. 81,81,508 was capitalized. assessee company filed its return for asst. yr. 1993-94 showing income as nil. Subsequently, revised return was filed declaring loss of Rs. 4,53,07,410. During assessment proceeding, it was noticed by AO that assessee had advanced large sums of money to its sister-concern. In assessment order, loss was assessed at Rs. 96,81,213 after inter alia disallowing interest under s. 36(1)(iii) of Act on ground of interest-free advances made by assessee to its sister-concern for non-business purposes. Tribunal held in favour of assessee. Punjab & Haryana High Court reversed order of Tribunal and held in favour of Department and against assessee. 16.1 Court held as not correct stand of assessee that onus of proving nexus of borrowed funds and interest-free advances made to sister-concern was on Revenue. Once, assessee claims any deduction under s. 36(1)(iii) of Act 1961 in books of account, onus will be on assessee to satisfy AO, that whatever loans were raised by assessee were used for business purposes. If in process of examination of genuineness of such claim it transpires that assessee had advanced certain funds to its sister-concerns or to any other person without any interest, there would be very heavy onus on assessee to discharge before AO to effect that in spite of pending term loans and working capital loans on which assessee was incurring liability to pay interest, still there was justification to advance interest-free loans to sister-concerns for non-business purposes and accordingly assessee should be allowed deduction of interest being paid on loans raised by it to that extent. 16.2 entire money in business entity comes in common kitty. monies received as share capital, as term loan, as working capital loan, as sale proceeds, do not have any different colour and have no separate identification. disallowance of interest paid on borrowing to extent amount is lent to sister-concern, interest-free, and for non-business purposes would be justified if assessee had some loans or other interest-bearing debts to be repaid. Because in such situation, cost of funds being incurred by assessee, sister-concern would be enjoying benefits thereof. Once it is borne out from record that assessee had borrowed certain funds on which liability to pay interest was being incurred and at same time certain interest-free advances had been made to sister-concerns for non-business purposes, interest paid on borrowing to extent of interest-free advances is to be disallowed under s. 36(1)(iii) of Act. This decision of Punjab & Haryana High Court supports view taken by us in this case in para 12.2 above. Court also referred to decision of Madras High Court in case of K. Somasundaram & Brothers vs. CIT (supra). 1 7 . In case of K. Somasundaram (supra), it was claimed by assessee that amounts lent as interest-free advances came out of contract earnings and that amount borrowed was invested in execution of contracts. It was observed by their Lordships of Madras High Court that assessee had recouped with profits borrowed funds invested in execution of contracts and amount realized on execution of contracts included amount which assessee had borrowed and invested. When assessee decided to lend substantial part of those funds interest- free to relatives of partners, assessee was clearly diverting funds which had been borrowed after it was recovered/recouped and was available either for purposes of business or for repayment of loans, assessee did neither, but chose to divert funds for non-business purposes. After such diversion, interest paid on capital borrowing to extent of amount diverted cannot be claimed for deduction as business expenditure. amount diverted cannot be claimed for deduction as business expenditure. observations made by their Lordships are that words used in statutory provision are borrowed for purpose of business . amount borrowed must continue to be used for purposes of business and fact that it was used for some point of time, but later diverted would not entitle assessee to claim interest paid on borrowing as deduction even after such diversion, that any view to contrary would not in least sub serve object of provision, but it would only open gates for assessees to borrow merrily and after ostensibly using it in business for short period at subsequent point of time divert funds in whole or part, for non-business purposes and continue to claim interest on borrowing as deductible item of expenditure. This judgment of Madras High Court also supports view that we have taken in para 12.2 above. 18. ground No. 3 is accordingly rejected for reasons discussed in paras 12, 12.1 and 12.2 above. 19. In result, appeal filed by assessee is partly allowed. *** SUPER METER MFG. CO. v. JOINT COMMISSIONER OF INCOME TAX
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