I have my own funds and borrowings. Can the AO assume the interest-free advance came out of the loan?
Where an assessee has interest-free funds of its own that are sufficient to meet the investment, and has also borrowed, it can be presumed the investment came out of the interest-free funds. The sufficiency of the own funds is the condition of the presumption, and here it rested on concurrent findings of fact by the Commissioner (Appeals) and the Tribunal.
Decided by the High Court (Bombay High Court - F.I. Rebello and R.S. Mohite, JJ. (judgment by Rebello, J.), IT Appeal No. 1398 of 2008) on 2009-01-09, reported as [2009] 313 ITR 340 / 178 Taxman 135 / 221 CTR 435 (Bom.)(HC); IT Appeal No. 1398 of 2008. It bears on section 36(1)(iii) of the Income Tax Act 1961, in Deductions & Disallowances matters.
This shifts the burden in the most frequent form of interest disallowance, where the officer infers diversion from nothing more than the coexistence of interest-free advances and interest-bearing borrowings. On this reasoning that coexistence is not by itself enough. It is a High Court decision and the presumption is rebuttable, so it holds only until the officer produces something tying the specific borrowing to the specific advance.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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The assessee generated power. Between January and March 2000 it invested Rs. 389.60 crores in Reliance Gas Limited and Rs. 1.01 crores in Reliance Strategic Investments Limited, both in the energy sector. The Assessing Officer found that Rs. 213 crores of that came from the assessee's own funds and Rs. 147 crores from borrowed funds, and disallowed interest of Rs. 4.40 crores, worked out at 12 per cent for the three months. Before the Commissioner (Appeals) the assessee showed that on the balance sheet as at 31 March 2000 its interest-free funds were Rs. 398.19 crores - share capital Rs. 180 crores, reserves and surplus Rs. 120.80 crores and depreciation reserves Rs. 95.39 crores - and that its Rs. 43.62 crores of debenture borrowing had gone into capital expenditure and an inter-corporate deposit. The Commissioner (Appeals) accepted that there were enough interest-free funds, deleted the disallowance and directed the interest to be allowed under s.36(1)(iii). The Tribunal recorded a finding that the assessee had sufficient funds of its own to make the investment without using interest-bearing funds and upheld that order. On the department's appeal the only argument pressed was that the balance sheet as at 31 March 1999 showed shareholders' funds of Rs. 172.10 crores applied to fixed assets, so there were no own funds left.
The department's appeal was dismissed. Where an assessee has interest-free funds available that are sufficient to meet its investments, and has also raised a loan, it can be presumed that the investments came out of the interest-free funds. The sufficiency of the interest-free funds is part of the rule, not an aside: the presumption arises only if the interest-free funds are enough to meet the investments. Here the Commissioner (Appeals) and the Tribunal had both recorded that the assessee had interest-free funds of its own generated in the year beginning 1 April 1999, and Rs. 398.19 crores were available on the balance sheet, so the presumption was established and the finding of fact could not be faulted. The Court also rejected the department's only pressed argument on its own terms: the relevant balance sheet was the one as at 31 March 2000, not 31 March 1999, and in any event nothing in the profit and loss account or balance sheet showed that shareholders' funds had been applied to fixed assets. The separate question whether advances to sister concerns were for business purposes was raised in the appeal memo but not pressed in view of S.A. Builders Ltd. v. CIT, and was not admitted, so nothing was decided about it.
The Court took the presumption from authority rather than stating it at large. It read the Supreme Court's decision in East India Pharmaceutical Works, where it had been argued that advance tax paid should be presumed to have come out of the year's profits rather than out of an overdraft. The Supreme Court had said the argument had considerable force but did not answer it because it had not been taken earlier; it then noted that in Woolcombers of India the Calcutta High Court had held that where profits were sufficient to meet the advance tax liability and had been deposited in the overdraft account, the taxes should be presumed to have been paid out of the profits and not out of the overdraft, there being sufficient material to raise the presumption and the contention having been urged below. From those two decisions the Bombay High Court drew the principle for the case before it: where funds are available both interest-free and by way of overdraft or loan, a presumption arises that the investment came out of the interest-free funds generated or available with the company, provided those interest-free funds were sufficient to meet the investment. It then found the presumption established on the concurrent findings of the Commissioner (Appeals) and the Tribunal about the availability of interest-free funds, and separately held the department's balance-sheet argument to be based on the wrong year and unsupported by the accounts.
The principle therefore would be that if there are funds available both interest free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest free fund generated or available with the company, if the interest free funds were sufficient to meet the investments.
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Handle my notice → Ask a CA on WhatsAppWhere an assessee has interest-free funds of its own that are sufficient to meet the investment, and has also borrowed, it can be presumed the investment came out of the interest-free funds. The sufficiency of the own funds is the condition of the presumption, and here it rested on concurrent findings of fact by the Commissioner (Appeals) and the Tribunal. This was decided by the High Court (Bombay High Court - F.I. Rebello and R.S. Mohite, JJ. (judgment by Rebello, J.), IT Appeal No. 1398 of 2008) and bears on section 36(1)(iii) of the Income Tax Act 1961. It is reported as [2009] 313 ITR 340 / 178 Taxman 135 / 221 CTR 435 (Bom.)(HC); IT Appeal No. 1398 of 2008. This shifts the burden in the most frequent form of interest disallowance, where the officer infers diversion from nothing more than the coexistence of interest-free advances and interest-bearing borrowings. On this reasoning that coexistence is not by itself enough. It is a High Court decision and the presumption is rebuttable, so it holds only until the officer produces something tying the specific borrowing to the specific advance. If it applies to you, the first step is this: Set out own funds — capital, reserves, free cash — as at the date of each advance, so the presumption has figures to attach to.
The assessee generated power. Between January and March 2000 it invested Rs. 389.60 crores in Reliance Gas Limited and Rs. 1.01 crores in Reliance Strategic Investments Limited, both in the energy sector. The Assessing Officer found that Rs. 213 crores of that came from the assessee's own funds and Rs. 147 crores from borrowed funds, and disallowed interest of Rs. 4.40 crores, worked out at 12 per cent for the three months. Before the Commissioner (Appeals) the assessee showed that on the balance sheet as at 31 March 2000 its interest-free funds were Rs. 398.19 crores - share capital Rs. 180 crores, reserves and surplus Rs. 120.80 crores and depreciation reserves Rs. 95.39 crores - and that its Rs. 43.62 crores of debenture borrowing had gone into capital expenditure and an inter-corporate deposit. The Commissioner (Appeals) accepted that there were enough interest-free funds, deleted the disallowance and directed the interest to be allowed under s.36(1)(iii). The Tribunal recorded a finding that the assessee had sufficient funds of its own to make the investment without using interest-bearing funds and upheld that order. On the department's appeal the only argument pressed was that the balance sheet as at 31 March 1999 showed shareholders' funds of Rs. 172.10 crores applied to fixed assets, so there were no own funds left. The matter was decided on 2009-01-09 by the High Court (Bombay High Court - F.I. Rebello and R.S. Mohite, JJ. (judgment by Rebello, J.), IT Appeal No. 1398 of 2008). On those facts the High Court held as follows. The department's appeal was dismissed. Where an assessee has interest-free funds available that are sufficient to meet its investments, and has also raised a loan, it can be presumed that the investments came out of the interest-free funds. The sufficiency of the interest-free funds is part of the rule, not an aside: the presumption arises only if the interest-free funds are enough to meet the investments. Here the Commissioner (Appeals) and the Tribunal had both recorded that the assessee had interest-free funds of its own generated in the year beginning 1 April 1999, and Rs. 398.19 crores were available on the balance sheet, so the presumption was established and the finding of fact could not be faulted. The Court also rejected the department's only pressed argument on its own terms: the relevant balance sheet was the one as at 31 March 2000, not 31 March 1999, and in any event nothing in the profit and loss account or balance sheet showed that shareholders' funds had been applied to fixed assets. The separate question whether advances to sister concerns were for business purposes was raised in the appeal memo but not pressed in view of S.A. Builders Ltd. v. CIT, and was not admitted, so nothing was decided about it.
The Court took the presumption from authority rather than stating it at large. It read the Supreme Court's decision in East India Pharmaceutical Works, where it had been argued that advance tax paid should be presumed to have come out of the year's profits rather than out of an overdraft. The Supreme Court had said the argument had considerable force but did not answer it because it had not been taken earlier; it then noted that in Woolcombers of India the Calcutta High Court had held that where profits were sufficient to meet the advance tax liability and had been deposited in the overdraft account, the taxes should be presumed to have been paid out of the profits and not out of the overdraft, there being sufficient material to raise the presumption and the contention having been urged below. From those two decisions the Bombay High Court drew the principle for the case before it: where funds are available both interest-free and by way of overdraft or loan, a presumption arises that the investment came out of the interest-free funds generated or available with the company, provided those interest-free funds were sufficient to meet the investment. It then found the presumption established on the concurrent findings of the Commissioner (Appeals) and the Tribunal about the availability of interest-free funds, and separately held the department's balance-sheet argument to be based on the wrong year and unsupported by the accounts. In the words reproduced by the source cited on this page: "The principle therefore would be that if there are funds available both interest free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest free fund generated or available with the company, if the interest free funds were sufficient to meet the investments." The decision followed or applied East India Pharmaceutical Works Ltd. v. CIT [1997] 224 ITR 627 / 91 Taxman 185 (SC) (para 10); Woolcombers of India Ltd. v. CIT [1982] 134 ITR 219 / [1981] 7 Taxman 188 (Cal.) (paras 7, 10).
It was decided by the High Court on 2009-01-09 and is reported as [2009] 313 ITR 340 / 178 Taxman 135 / 221 CTR 435 (Bom.)(HC); IT Appeal No. 1398 of 2008. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 36(1)(iii), the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The department's appeal was dismissed. Where an assessee has interest-free funds available that are sufficient to meet its investments, and has also raised a loan, it can be presumed that the investments came out of the interest-free funds. The sufficiency of the interest-free funds is part of the rule, not an aside: the presumption arises only if the interest-free funds are enough to meet the investments. Here the Commissioner (Appeals) and the Tribunal had both recorded that the assessee had interest-free funds of its own generated in the year beginning 1 April 1999, and Rs. 398.19 crores were available on the balance sheet, so the presumption was established and the finding of fact could not be faulted. The Court also rejected the department's only pressed argument on its own terms: the relevant balance sheet was the one as at 31 March 2000, not 31 March 1999, and in any event nothing in the profit and loss account or balance sheet showed that shareholders' funds had been applied to fixed assets. The separate question whether advances to sister concerns were for business purposes was raised in the appeal memo but not pressed in view of S.A. Builders Ltd. v. CIT, and was not admitted, so nothing was decided about it. It arises in Deductions & Disallowances matters, on section 36(1)(iii) of the Income Tax Act 1961, and was decided by Bombay High Court - F.I. Rebello and R.S. Mohite, JJ. (judgment by Rebello, J.), IT Appeal No. 1398 of 2008. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Ask the officer in writing to identify the specific borrowing he says funded the advance, since the presumption stands until it is displaced. Check whether any borrowing is tied by its own terms to a stated end use, because that is the material the department needs to rebut you. Confirm the current standing of this decision before you file it, since no later history for it has been traced.
Still good law. Applied at High Court level in CIT v. HDFC Bank Ltd. [2014] 49 taxmann.com 335 (Bombay), 23 July 2014, and in CIT v. UTI Bank Ltd. [2013] 32 taxmann.com 370 (Gujarat), 22 March 2013, and it continues to be cited in later High Court and Tribunal decisions. The judgment itself carries no later-treatment banner and no adverse treatment was found. On the provision: the main clause of s.36(1)(iii) is unchanged; the proviso substituted by the Finance Act 2015 with effect from AY 2016-17 governs interest on capital borrowed to acquire an asset before it is put to use and does not touch the presumption about the source of funds. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The judgment has now been read in full in a law report. The Bench is F.I. Rebello and R.S. Mohite, JJ., the appeal is IT Appeal No. 1398 of 2008 and the date is 9 January 2009; the citation 313 ITR 340, previously unconfirmed, is correct and the decision is also at 178 Taxman 135 and 221 CTR 435. Two things the entry said need correcting. The sentence that stood as the key quote is not the Court's and it stopped short of the condition the Court attached - the presumption arises only where the interest-free funds are sufficient to meet the investment. And this is not a case about interest-free advances to sister concerns for non-business purposes: that question was raised in the appeal memo, not pressed in view of S.A. Builders Ltd. v. CIT [2007] 288 ITR 1 (SC), and not admitted, so the Court decided nothing on it. What it decided was that on the concurrent findings of the Commissioner (Appeals) and the Tribunal there were sufficient interest-free funds, and that the department's argument from the balance sheet as at 31 March 1999 was directed at the wrong year. The Court did not say what happens where the interest-free funds are not sufficient to meet the whole investment, whether the presumption then applies pro tanto or not at all. It did not say what evidence would rebut the presumption, since it treated the concurrent findings as establishing it. It says nothing about advances for non-business purposes, that question having been left undecided. And it is a decision on s.36(1)(iii); its use in s.14A disallowance arguments comes from later cases applying the same presumption, not from this judgment. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The department's appeal was dismissed. Where an assessee has interest-free funds available that are sufficient to meet its investments, and has also raised a loan, it can be presumed that the investments came out of the interest-free funds. The sufficiency of the interest-free funds is part of the rule, not an aside: the presumption arises only if the interest-free funds are enough to meet the investments. Here the Commissioner (Appeals) and the Tribunal had both recorded that the assessee had interest-free funds of its own generated in the year beginning 1 April 1999, and Rs. 398.19 crores were available on the balance sheet, so the presumption was established and the finding of fact could not be faulted. The Court also rejected the department's only pressed argument on its own terms: the relevant balance sheet was the one as at 31 March 2000, not 31 March 1999, and in any event nothing in the profit and loss account or balance sheet showed that shareholders' funds had been applied to fixed assets. The separate question whether advances to sister concerns were for business purposes was raised in the appeal memo but not pressed in view of S.A. Builders Ltd. v. CIT, and was not admitted, so nothing was decided about it.
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