The AO says my borrowings funded advances to a sister concern and my directors. Can he disallow the interest?
No, not once a nexus between the expenditure and the purpose of the business is shown. The advance to the sister concern was imperative as a business expediency because of undertakings given to financial institutions about its working capital margin, and the advances to directors were covered by the company's own reserves, so nothing was left for the disallowance to bite on.
Decided by the Supreme Court (A.K. Sikri and Rohinton Fali Nariman, JJ. (judgment delivered by A.K. Sikri, J.)) on 2015-11-05, reported as [2015] 379 ITR 347 (SC); [2015] 281 CTR 481 (SC); [2016] 236 Taxman 447 (SC); [2015] 63 taxmann.com 308 (SC). It bears on section 36(1)(iii) of the Income Tax Act 1961, in Deductions & Disallowances matters.
This applies S.A. Builders and is the more recent Supreme Court authority for the same proposition, which matters when the department argues that S.A. Builders is doubtful. It also supplies two distinct answers on one set of facts: a commercial reason for the group advance, and sufficiency of own funds for the director advances. Where reserves cover the advance, the argument never has to reach commercial expediency at all.
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For assessment year 1988-89 the company claimed a deduction of Rs.20,53,120 as interest on money borrowed from banks. The Assessing Officer disallowed Rs.16,39,010 of it, by an order of 26 March 1991, on two grounds. First, the company had advanced Rs.1,16,26,128 interest-free to Hero Fibres Limited, its subsidiary, of which it was the promoter and in which it held the controlling share, while itself paying interest on bank borrowings. Second, it had advanced Rs.34 lakhs to its own directors on 25 March 1987 charging 10 per cent, while paying 18 per cent on its bank loans. The company's answer was that the advance to Hero Fibres was made under an undertaking it had given to three financial institutions, as a condition of their lending to Hero Fibres, that it would provide the additional margin needed to meet that company's working capital and any cash losses; and that the advance to the directors came from its own funds, there having been a credit balance of Rs.4,95,670 in the account even after the cheques were encashed. The Commissioner (Appeals) accepted both explanations and the Tribunal upheld him. On the Revenue's appeal under s.260A the Punjab and Haryana High Court, by judgment of 6 December 2006, restored the Assessing Officer's order.
The appeal was allowed, the High Court's judgment set aside and the Tribunal's order restored (para 17). The High Court's approach was held to be clearly faulty in law and not to be countenanced: it had not discussed the facts established on the record at all, and had simply quoted its own earlier judgment in CIT v. Abhishek Industries Ltd. to hold that interest on bank borrowings could not be claimed where money had been advanced interest-free (paras 9 to 11). Once a nexus is established between the expenditure and the purpose of the business - which need not be the assessee's own business - the Revenue cannot put itself in the businessman's arm-chair and decide how much expenditure is reasonable (para 13). On the facts, the advance to Hero Fibres was imperative as a business expediency, given the undertaking to the financial institutions (para 14), and the advance to the directors was covered by the company's own reserves and surplus of almost Rs.15 crores (para 16).
On loans to a subsidiary the Court recapitulated S.A. Builders Ltd. v. CIT (Appeals), setting out its paragraphs 26 to 30: commercial expediency is an expression of wide import and covers expenditure a prudent businessman incurs for the purpose of business even without legal obligation; Madhav Prasad Jatia holds only that a borrowed sum advanced to a third party for sentimental or personal reasons is not so covered; and 'for the purpose of business' is wider than 'for the purpose of earning profits' (para 12). The Court then agreed with the Delhi High Court's formulation in CIT v. Dalmia Cement (P.) Ltd., that once a nexus between the expenditure and the purpose of business is established the Revenue cannot decide for the businessman what expenditure is reasonable, no businessman can be compelled to maximise his profit, and the authorities must look at the matter from the standpoint of a prudent businessman rather than their own (para 13). Applying that, the undertaking to the financial institutions made the advance to Hero Fibres imperative as a business expediency (para 14); and the Court noted that the company later off-loaded its shareholding in Hero Fibres, that the whole loan was repaid with interest, and that the interest was offered to tax in the year of receipt (para 15). On the advance to the directors the Court proceeded on the finding, undisputed by the Revenue, that there was a credit balance in the bank account at the time and reserves and surplus of almost Rs.15 crores, so the company could in any case have used its own funds (para 16).
The authorities must not look at the matter from their own view point but that of a prudent businessman.
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Handle my notice → Ask a CA on WhatsAppNo, not once a nexus between the expenditure and the purpose of the business is shown. The advance to the sister concern was imperative as a business expediency because of undertakings given to financial institutions about its working capital margin, and the advances to directors were covered by the company's own reserves, so nothing was left for the disallowance to bite on. This was decided by the Supreme Court (A.K. Sikri and Rohinton Fali Nariman, JJ. (judgment delivered by A.K. Sikri, J.)) and bears on section 36(1)(iii) of the Income Tax Act 1961. It is reported as [2015] 379 ITR 347 (SC); [2015] 281 CTR 481 (SC); [2016] 236 Taxman 447 (SC); [2015] 63 taxmann.com 308 (SC). This applies S.A. Builders and is the more recent Supreme Court authority for the same proposition, which matters when the department argues that S.A. Builders is doubtful. It also supplies two distinct answers on one set of facts: a commercial reason for the group advance, and sufficiency of own funds for the director advances. Where reserves cover the advance, the argument never has to reach commercial expediency at all. If it applies to you, the first step is this: Show the reserves and own funds available on the relevant dates and match them against the advances, so the director or shareholder loans are answered on funding alone.
For assessment year 1988-89 the company claimed a deduction of Rs.20,53,120 as interest on money borrowed from banks. The Assessing Officer disallowed Rs.16,39,010 of it, by an order of 26 March 1991, on two grounds. First, the company had advanced Rs.1,16,26,128 interest-free to Hero Fibres Limited, its subsidiary, of which it was the promoter and in which it held the controlling share, while itself paying interest on bank borrowings. Second, it had advanced Rs.34 lakhs to its own directors on 25 March 1987 charging 10 per cent, while paying 18 per cent on its bank loans. The company's answer was that the advance to Hero Fibres was made under an undertaking it had given to three financial institutions, as a condition of their lending to Hero Fibres, that it would provide the additional margin needed to meet that company's working capital and any cash losses; and that the advance to the directors came from its own funds, there having been a credit balance of Rs.4,95,670 in the account even after the cheques were encashed. The Commissioner (Appeals) accepted both explanations and the Tribunal upheld him. On the Revenue's appeal under s.260A the Punjab and Haryana High Court, by judgment of 6 December 2006, restored the Assessing Officer's order. The matter was decided on 2015-11-05 by the Supreme Court (A.K. Sikri and Rohinton Fali Nariman, JJ. (judgment delivered by A.K. Sikri, J.)). On those facts the Supreme Court held as follows. The appeal was allowed, the High Court's judgment set aside and the Tribunal's order restored (para 17). The High Court's approach was held to be clearly faulty in law and not to be countenanced: it had not discussed the facts established on the record at all, and had simply quoted its own earlier judgment in CIT v. Abhishek Industries Ltd. to hold that interest on bank borrowings could not be claimed where money had been advanced interest-free (paras 9 to 11). Once a nexus is established between the expenditure and the purpose of the business - which need not be the assessee's own business - the Revenue cannot put itself in the businessman's arm-chair and decide how much expenditure is reasonable (para 13). On the facts, the advance to Hero Fibres was imperative as a business expediency, given the undertaking to the financial institutions (para 14), and the advance to the directors was covered by the company's own reserves and surplus of almost Rs.15 crores (para 16).
On loans to a subsidiary the Court recapitulated S.A. Builders Ltd. v. CIT (Appeals), setting out its paragraphs 26 to 30: commercial expediency is an expression of wide import and covers expenditure a prudent businessman incurs for the purpose of business even without legal obligation; Madhav Prasad Jatia holds only that a borrowed sum advanced to a third party for sentimental or personal reasons is not so covered; and 'for the purpose of business' is wider than 'for the purpose of earning profits' (para 12). The Court then agreed with the Delhi High Court's formulation in CIT v. Dalmia Cement (P.) Ltd., that once a nexus between the expenditure and the purpose of business is established the Revenue cannot decide for the businessman what expenditure is reasonable, no businessman can be compelled to maximise his profit, and the authorities must look at the matter from the standpoint of a prudent businessman rather than their own (para 13). Applying that, the undertaking to the financial institutions made the advance to Hero Fibres imperative as a business expediency (para 14); and the Court noted that the company later off-loaded its shareholding in Hero Fibres, that the whole loan was repaid with interest, and that the interest was offered to tax in the year of receipt (para 15). On the advance to the directors the Court proceeded on the finding, undisputed by the Revenue, that there was a credit balance in the bank account at the time and reserves and surplus of almost Rs.15 crores, so the company could in any case have used its own funds (para 16). In the words reproduced by the source cited on this page: "The authorities must not look at the matter from their own view point but that of a prudent businessman." The decision followed or applied S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 / 158 Taxman 74 (SC) (recapitulated and applied, para 12); CIT v. Dalmia Cement (P.) Ltd. [2002] 254 ITR 377 / 121 Taxman 706 (Delhi) (agreed with, para 13).
It was decided by the Supreme Court on 2015-11-05 and is reported as [2015] 379 ITR 347 (SC); [2015] 281 CTR 481 (SC); [2016] 236 Taxman 447 (SC); [2015] 63 taxmann.com 308 (SC). Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. 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 appeal was allowed, the High Court's judgment set aside and the Tribunal's order restored (para 17). The High Court's approach was held to be clearly faulty in law and not to be countenanced: it had not discussed the facts established on the record at all, and had simply quoted its own earlier judgment in CIT v. Abhishek Industries Ltd. to hold that interest on bank borrowings could not be claimed where money had been advanced interest-free (paras 9 to 11). Once a nexus is established between the expenditure and the purpose of the business - which need not be the assessee's own business - the Revenue cannot put itself in the businessman's arm-chair and decide how much expenditure is reasonable (para 13). On the facts, the advance to Hero Fibres was imperative as a business expediency, given the undertaking to the financial institutions (para 14), and the advance to the directors was covered by the company's own reserves and surplus of almost Rs.15 crores (para 16). It arises in Deductions & Disallowances matters, on section 36(1)(iii) of the Income Tax Act 1961, and was decided by A.K. Sikri and Rohinton Fali Nariman, JJ. (judgment delivered by A.K. Sikri, J.). 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. Put on record the commitments that forced the group advance — undertakings to lenders, working capital support obligations — as the source page describes them here. Tell the officer that once nexus with the business is established he cannot sit in the arm-chair of the businessman and reject the claim as he thinks fit. Do not concede that borrowed funds were used merely because borrowings and advances coexist in the same year.
Still good law. Followed by the Punjab and Haryana High Court in Beekons Industries Ltd. v. CIT [2023] 149 taxmann.com 383 / [2023] 456 ITR 431 (P&H), decided 16 February 2023, which set aside a Tribunal order disallowing interest and restored the Commissioner (Appeals) - its CASE REVIEW records this decision as followed. That court also records the same High Court having followed it earlier in Pr. CIT v. Holy Faith International (P.) Ltd., IT Appeal No. 87 of 2017, decided 24 July 2017. 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.
Two points of precision. The Court did not in terms overrule CIT v. Abhishek Industries Ltd. [2006] 286 ITR 1 (P&H); what it said was that the High Court's approach, resting on that judgment and taken without discussing the facts on record, was clearly faulty in law and could not be countenanced (paras 10 and 11). The Punjab and Haryana High Court has since read this decision as overruling Abhishek Industries - it says so in Beekons Industries Ltd. v. CIT [2023] 456 ITR 431 - so the practical position in that jurisdiction is settled, but a written submission should quote what this Court actually said. Second, the arm-chair and prudent-businessman formulation the case is usually cited for is at para 13, where the Supreme Court adopted the Delhi High Court's statement of it in CIT v. Dalmia Cement (P.) Ltd. [2002] 254 ITR 377. 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 appeal was allowed, the High Court's judgment set aside and the Tribunal's order restored (para 17). The High Court's approach was held to be clearly faulty in law and not to be countenanced: it had not discussed the facts established on the record at all, and had simply quoted its own earlier judgment in CIT v. Abhishek Industries Ltd. to hold that interest on bank borrowings could not be claimed where money had been advanced interest-free (paras 9 to 11). Once a nexus is established between the expenditure and the purpose of the business - which need not be the assessee's own business - the Revenue cannot put itself in the businessman's arm-chair and decide how much expenditure is reasonable (para 13). On the facts, the advance to Hero Fibres was imperative as a business expediency, given the undertaking to the financial institutions (para 14), and the advance to the directors was covered by the company's own reserves and surplus of almost Rs.15 crores (para 16).
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