O/TAXAP/851/2014 ORDER IN HIGH COURT OF GUJARAT AT AHMEDABAD TAX APPEAL NO. 851 of 2014 to TAX APPEAL NO. 856 of 2014 COMMISSIONER OF INCOME TAX -V Appellant(s) Versus LAXMI BIDI TRADING CO. Opponent(s) Appearance: MR MR BHATT, SR. ADVOCATE with MRS MAUNA M BHATT, ADVOCATE for Appellant MR SN SOPARKAR, SR. ADVOCATE with MR B S SOPARKAR, ADVOCATE for Respondent CORAM: HONOURABLE MS.JUSTICE HARSHA DEVANI and HONOURABLE MS JUSTICE SONIA GOKANI Date : 01/09/2014 ORAL COMMON ORDER (PER : HONOURABLE MS.JUSTICE HARSHA DEVANI) Page 1 of 13 O/TAXAP/851/2014 ORDER 1. All these appeals under section 260A of Income Tax Act, 1961 are directed against common order dated 29 th November, 2013 passed by Income Tax Appellate Tribunal, Ahmedabad B Bench (hereinafter referred to as Tribunal ) and hence same were taken up for hearing together and are disposed of by this common judgment. 2. assessment years are 2001-02, 2003-04, 2004-05, 2005-06, 2006-07 and 2007-08 respectively. While framing assessment in case of respondent-assessee, Assessing Officer observed that assessee had paid interest to relatives of partners at rates varying from 12% to 18% per annum. assessee had made investment in Fixed Deposits in various banks and had earned interest thereon at rate of 5 to 8% per annum. Assessing Officer observed that assessee had invested huge amounts in bank in Fixed Deposits at lower rates of interest and was paying much higher interest on unsecured loans. He, accordingly, held that interest paid on borrowed funds and interest paid to others to extent interest paid is more than interest received on fixed deposits, cannot be considered as interest paid for business purposes, as well as for earning of interest income. Assessing Officer, accordingly, invoked provisions of section 40A(2)(b) read with section 36(iii) of Act and made disallowance of difference between interest paid and interest earned. assessee carried matter in appeal before Commissioner (Appeals), who held Page 2 of 13 O/TAXAP/851/2014 ORDER that placing of borrowed funds in fixed deposit was part of business expediency of assessee and interest thereon is allowable in terms of decision of Supreme Court in case of S.A. Builders. He, however, observed that assessee had admitted receipt of borrowed funds from transporters at rate of 15% and from Goods Deposits at rate of 13% to 15% as against 18% from family members. Commissioner (Appeals) observed that for assessment years 2001-02 and 2003-04, market rate of borrowing was 15% and rate of interest payable to family members was 18% and for assessment years 2004-05 and 2005-06 rate of interest in respect of loans from goods deposits was only 13% and rate of interest to transporters was 15% and therefore market rate for purpose of disallowance under section 40A(2)(b) of Act as average of 13% and 15% would be 14%, He, accordingly, held that excess payment at rate of 3% and 4% respectively is disallowable under section 40A(2)(b) of Act in respect of said assessment years. Both, assessee as well as revenue went in appeal before Tribunal which allowed assessee s appeals and dismissed revenue s appeals on this ground. 3. Vehemently assailing impugned order, Mr. M.R. Bhatt, Senior Advocate, learned counsel for appellant submitted that chart analyzing assets and liabilities of assessee from assessment year 2001-02 to 2008-09 had been submitted Page 3 of 13 O/TAXAP/851/2014 ORDER during proceedings which brought out following interesting facts: (i) Sundry debtors of assessee firm for all assessment years is shown at NIL, which proves that assessee is doing cash sales. (ii) quantum of advance against goods and security for deposit of goods received by assessee firm proves that it is selling premium product for which advance payment is received from customers. (iii) assessee firm had enough cash and bank balance for all assessment years which is enough to service approximately one or more than one month purchase. (iv) There is no co-relation between increase in sales and purchase of assessee firm over seven years and huge increase in unsecured loan raised and fixed deposits made by firm during these years. (v) increase in different heads was also analysed as detailed in paragraph 5 of impugned order. 3.1 It was argued that there is no analysis of facts and chart in impugned order and above submissions of revenue has been completely missed out. Moreover, while allowing appeal of assessee Tribunal has also not Page 4 of 13 O/TAXAP/851/2014 ORDER recorded any finding with regard to tax slab or tax returns of beneficiaries nor has it recorded any finding as regards revenue neutrality of transactions. It was urged that Tribunal has failed to appreciate that assessee had itself admitted receipt of borrowed funds from transporters at rate of 15% and from goods deposits at rate of 13% to 15% as against payment of interest at rate of 18% to relatives of partners. Moreover, assessee had failed to substantiate that market rate of interest was 18%. According to learned counsel, both, Commissioner (Appeals) as well as Tribunal failed to appreciate that by borrowing money at higher rate from family members of partners and depositing such money in Bank FDRs, assessee helped them to earn more income by way of interest than what they would have earned otherwise. Thus, assessee having failed to discharge initial onus, disallowance was correctly made. Under circumstances, appeals require to be admitted on question proposed or as may be formulated by court. 4. Opposing appeals, Mr. S. N. Soparkar, Senior Advocate, learned counsel appearing on behalf of respondent assessee on caveat, drew attention of court to order passed by Commissioner (Appeals) to point out that assessee had made detailed submissions demonstrating that it obtains funds for business from partners and their relatives. turnover of firm is around Page 5 of 13 O/TAXAP/851/2014 ORDER Rs.170 crores and purchase is around Rs.161 crores. magnitude of business requires huge funds at disposal of assessee who pays to bidi suppliers, advance for obtaining goods. statement given by assessee explaining in detail utilization of unsecured loans obtained during year and its use in business clearly shows that borrowed funds (deposit) have been utilised for payments to suppliers of goods. It was submitted that for smooth running of business assessee always keeps money ready at its disposal. firm had disclosed huge profit which could be possible only with help of huge funds obtained from unsecured loans. Thus, unsecured loans have been utilised by firm for business purpose. It was further pointed out that Commissioner (Appeals) has also believed that unsecured loans are utilised for business purpose but has disallowed excess interest of 3% and 4% on borrowings from family members. Referring to impugned order it was pointed out that Tribunal has given cogent and sufficient reasons while allowing appeals of assessee and has found that rate of interest paid by assessee is quite reasonable having regard to fair market rate. It was accordingly urged that impugned order being just, legal and proper does not warrant interference. 5. This court has considered rival submissions advanced by learned counsel for respective parties and has perused orders of assessment, orders passed by Page 6 of 13 O/TAXAP/851/2014 ORDER Commissioner (Appeals) as well as impugned order passed by Tribunal. 6. facts as emerging from record are that assessee had made borrowings for its business purpose and paid interest at 18% on these borrowings. assessee was required to make funds available as and when necessary and hence, same were parked in fixed deposits which were used for business purposes. assessee s turnover for assessment years 2001-02, 2003-04, 2004-05, 2005-06 , 2006- 07 and 2007-08 was Rs.168 crores, Rs.170 crores, Rs.167 crores, Rs.175 crores, Rs.186 crores and Rs.170 crores, respectively. assessee required huge funds for purchase of bidis and for availing such funds from banks it was required to undergo various formalities and certain documents were required to be executed over and above personal collateral securities of partners. Further, periodical statements such as, stock statement and huge data for securing loans were required by banks and number of forms were also required to be submitted. Since such procedures are cumbersome, many times partners were not willing to give personal guarantees. In such cases, even after formalities were completed, assessee was not in position to avail finance from bank. Moreover, banks were charging interest at rate of 16% to 17%. In these circumstances, assessee opted for unsecured loans from specified persons and paid interest at rate of 18% to them. It was case of assessee, that specified persons were in maximum Page 7 of 13 O/TAXAP/851/2014 ORDER marginal rate of tax and therefore, there was no revenue loss to Department while allowing interest at rate of 18%. 7. Commissioner (Appeals) was of considered view that funds in fixed deposits were part and parcel of business expediency of assessee. He placed reliance upon decision of Supreme Court in case of S.A. Builders, 288 ITR 1 for proposition that if it is found that particular expenditure or payment is made towards business expediency (that is, what prudent businessman would have done) then same is allowable expenditure. He, however, was of view that rate of interest paid to family members was in excess by 3% and 4% as discussed hereinabove and disallowed interest to that extent. Thus, to extent of use of funds for business expediency is concerned, both, Tribunal as well as Commissioner (Appeals) have recorded concurrent findings of fact to effect that same were used for business purposes. Insofar as disallowance of interest to extent of 3% and 4% is concerned, Tribunal has held thus: 9. We have heard rival contentions and perused material on record. assessee has huge turn over during years. It is true that there is marginal increase in borrowing from specified persons either by way of fresh loan or credit of interest. assessee had deducted TDS and paid to Government Exchequer. rate of interest paid Page 8 of 13 O/TAXAP/851/2014 ORDER was 18% and interest received on TDS was at lower rates, but money was not advanced to outsider. Therefore, this is not case of diversion of income. If rate of interest paid to specified persons in compared with rate on unsecured loan are more or less are same. Besides this, various formalities are required to avail finance from bank. It is also settled law that how business should be carried on is prerogative of assessee and Assessing Officer cannot dictate terms as to how business should be carried on. While considering claim u/s 36(1)(iii) what is to be required to judge is whether amount is borrowed for purpose of business or not. Since amount has been borrowed in earlier years as well as during year at stipulated rate of interest and which has been still utilized for purpose of business, interest rate could not have been re- negotiated for earlier year. Therefore, rate of interest, paid by assessee is quite reasonable having regard to fair market value of such services. Therefore, CIT (A) was incorrect in restricting interest payable to extent of 15% or 14% which is supported by various decisions mentioned in order in preceding paras. Since interest rate paid by assessee is reasonable, order of CIT(A) is reversed and addition is deleted. Thus, assessee s appeals are allowed and Revenue s appeals are dismissed on this ground. 8. In aforesaid backdrop, sole question that arises for consideration is about allowability of interest on borrowed funds. 9. Before adverting to merits of case it may be apposite to refer to decision of Supreme Court in S. A. Page 9 of 13 O/TAXAP/851/2014 ORDER Builders Ltd. v. Commissioner of Income Tax (Appeals) Chandigarh, (2007) 1 SCC 781, wherein it has been held thus: 15. In our opinion, decisions relating to Section 37 of Act will also be applicable to Section 36(1)(iii) because in Section 37 also expression used is for purpose of business . It has been consistently held in decisions relating to Section 37 that expression for purpose of business includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if third party also benefits thereby. Thus in Atherton v. British Insulated & Helsby Cables Ltd. (1925) 10 TC 155, it was held by House of Lords that in order to claim deduction, it is enough to show that money is expended, not of necessity and with view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly facilitate carrying on business. above test in Atherton case (supra) has been approved by this Court in several decisions e.g. Eastern Investments Ltd. v. CIT, (1951) 20 ITR 1, CIT v. Chandulal Keshavlal & Co. (1960) 38 ITR 601, etc. 16. In our opinion, High Court as well as Tribunal and other Income Tax Authorities should have approached question of allowability of interest on borrowed funds from above angle. In other words, High Court and other authorities should have enquired as to whether interest-free loan was given to sister company (which is subsidiary of assessee) as measure of commercial expediency, and if it was, it should have been allowed. expression commercial expediency is expression of wide import and includes such expenditure as prudent businessman incurs for purpose of business. 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. Page 10 of 13 O/TAXAP/851/2014 ORDER 10. Examining facts of present case in light of above decision, Commissioner (Appeals) in his order has observed that there is no dispute that assessee requires huge funds for purpose of its business. For making purchases of bidi, assessee has to make advance payments. volume of purchases is Rs.160 crores or more in one year. For this purpose assessee has to borrow money from different persons. Since it is not certain as to exactly when such payment will be required to be made, and it may not be possible to secure such loans immediately when payment is required to be made, for smooth running of business, assessee has to borrow such funds in advance and keep same ready at its disposal. Under circumstances, instead of keeping such funds idle, assessee parked same in short term fixed deposits which in turn were used for making payment against purchase of bidis. Moreover, as noticed hereinabove, obtaining loans from banks is cumbersome process and interest rate is also high, hence, assessee has obtained unsecured loans from relatives of partners at rate of 18%. Commissioner (Appeals) has held that to keep funds in fixed deposits is part and parcel of business expediency of assessee. He has also held that interest payment to relatives of partners is allowable expenditure but has disallowed same to extent same exceeded interest paid to transporters and against Goods deposits . Tribunal has noted that amount has been borrowed in earlier years as well as during Page 11 of 13 O/TAXAP/851/2014 ORDER years under consideration at stipulated rate of interest and which has been utilised for purpose of business; interest rate could not have been renegotiated from earlier year. Therefore, rate of interest paid by assessee is quite reasonable. Considering facts of case in their totality, it is apparent that assessee has borrowed funds and used same for its business purposes. Both, Commissioner (Appeals) as well as Tribunal have concurrently found that borrowed funds have been used for business purposes and have held that interest on such borrowed funds is allowable expenditure. only difference in opinion is to extent of interest allowable on such borrowed funds. Commissioner (Appeals) has restricted such allowance to interest paid to transporters and towards goods deposits whereas Tribunal has held interest paid at rate of 18% to be reasonable. Having regard to findings recorded by Tribunal for holding rate of interest at 18% to be reasonable, it is not possible to state that there is any legal infirmity in conclusion arrived at by Tribunal so as to give rise to question of law, much less, substantial question of law, warranting interference. 11. In absence of any question of law, appeals fail and are accordingly, dismissed. (HARSHA DEVANI, J.) Page 12 of 13 O/TAXAP/851/2014 ORDER (MS SONIA GOKANI, J.) parmar* Page 13 of 13 Commissioner of Income-tax-V v. Laxmi Bidi Trading Co