The officer has disallowed my interest because the money went to a group company, to a director and into a plant that was not running - how much of that is actually sustainable, and does it matter that my own funds are four times the advances?
The client is a private limited company making corrugated packaging, assessed at a circle in Rajkot. For AY 2023-24 the return filed on 31 October 2023 declared Rs 2,08,00,000 after interest of Rs 2,86,00,000 on a cash credit limit of Rs 9,60,00,000 at 9.25 per cent and two term loans. Paid-up capital and free reserves stood at Rs 24,80,00,000 on 31 March 2023. The order under s.143(3) read with s.144B dated 24 February 2026 disallows Rs 1,42,70,000 across six heads. An interest-free advance of Rs 3,20,00,000 to a group company that supplies kraft paper, given under a supply arrangement recorded in a board minute of 12 May 2022, produced a disallowance of Rs 29,60,000 at the cash credit rate. An interest-free advance of Rs 40,00,000 to a director produced Rs 3,70,000. Interest of Rs 41,00,000 on a term loan of Rs 6,00,00,000 taken for a new corrugation line, erected by March but not commissioned until 4 July 2023, was disallowed under the proviso. Interest of Rs 48,00,000 prepaid in one sum on a five-year loan, claimed in full though amortised over five years in the books, was allowed only to one fifth, disallowing Rs 38,40,000. A capital contribution of Rs 2,40,00,000 to an LLP whose profit share is exempt produced a further Rs 24,60,000 under s.14A against exempt income of Rs 1,80,000. And an unsecured loan of Rs 60,00,000 was added under s.68 with the interest of Rs 5,40,000 on it disallowed.
Prepare a funds-flow statement for the year before touching the grounds: opening own funds, the movement in reserves, every drawing on the cash credit account by date, and the date and source of each advance and investment. The officer's case is that borrowed money went where it should not have gone. Every answer in this file - commercial expediency, the own-funds presumption, the s.14A attribution - is made or lost on whether you can show what left which account on what day. Without it the presumption becomes an assertion, and an assertion has already failed once in this library.
The Supreme Court has held that interest on borrowed funds advanced interest-free to a sister concern is deductible where the advance was made on grounds of commercial expediency, an expression of wide import covering what a prudent businessman spends for the purposes of the business. In another case it held that once a nexus between the expenditure and the purpose of the business is shown the interest cannot be disallowed, where the advance to the sister concern was imperative as a business expediency because of undertakings given to financial institutions about its working capital margin. More recently it set aside a High Court order which had disallowed interest because the borrowed money was ultimately used for the benefit of the assessee's subsidiary rather than for the assessee's own business, and where the money had passed through a group company before the shares were bought. Security of kraft paper supply, on a recorded board minute, is that argument.
A High Court has held that where an assessee has interest-free funds of its own sufficient to meet the investment and has also borrowed, it can be presumed that the investment came out of the interest-free funds, and that the sufficiency of the own funds is the condition of the presumption. The Supreme Court has held the same for tax-free investments: where interest-free own funds exceed the investment, a presumption arises that the investment came from those funds and the officer cannot substitute an estimated proportionate figure. Here own funds of Rs 24,80,00,000 stand against advances and investments totalling Rs 6,00,00,000, so the presumption is available on the face of the audited balance sheet for the sister-concern advance and for the LLP contribution alike, and the ground should set out all three figures.
The proviso to s.36(1)(iii) takes out of the deduction any interest paid in respect of capital borrowed for the acquisition of an asset, for the period from the date of borrowing to the date on which the asset was first put to use. The line was commissioned on 4 July 2023, so the Rs 41,00,000 is out of the revenue claim for AY 2023-24 and the ground is not that it is deductible but that it enters the actual cost of the line and returns as depreciation from AY 2024-25. Say that expressly, and check that the officer's order records the capitalisation rather than simply disallowing, because a disallowance that leaves the cost untouched loses the allowance permanently. The Supreme Court decision holding that user in the year is irrelevant to this clause is confined in this library to years before 1 April 2004 and does not answer a 2023 year.
The Supreme Court has held that interest on money borrowed to meet a personal obligation is not deductible, either as interest on capital borrowed for the purposes of the business or as business expenditure, where the borrowing was completely unrelated to the purpose of the business and was in fact used for a personal purpose. An interest-free advance of Rs 40,00,000 to a director, with no business explanation on the file, sits on that side of the line. It is saveable only if it is in truth part of the terms of appointment or a board-sanctioned advance against remuneration, in which case the document exists and should be produced, or if the funds-flow statement shows it went out of own funds on a day the cash credit account was in credit.
The two provisions ask different questions. The Supreme Court has held that an agreement to pay the unpaid balance of a purchase price does not give rise to a loan - a loan produces a debt but not every debt involves a loan, and capital borrowed in the interest clause means money borrowed - and yet allowed the interest as business expenditure. So a ground that pleads only the interest clause can lose a claim that the general deduction would carry. On this file that matters for any interest on deferred payment terms to suppliers and for the compensatory element in the group arrangement, and it should be pleaded as a distinct alternative with the reason why the item falls outside the interest clause at all.
The Supreme Court has held that where revenue expenditure is incurred and paid in a year the ordinary rule applies and the assessee is entitled to the deduction in that year, and that if he claims it then the Department cannot refuse it; spreading the expenditure is an indulgence available only where the assessee himself wants it, and the treatment in the books does not decide the matter. The whole Rs 48,00,000 is therefore deductible in AY 2023-24 notwithstanding the five-year amortisation in the accounts, and the officer's one fifth is the wrong test. This is one of the two heads in this file that should be won outright.
Three points in order. The formula is not reached until the officer has recorded the satisfaction the section and the rule require, on the accounts, and a High Court has held that where he never explained why the assessee's working was unsatisfactory the recomputation cannot stand. On quantum, a High Court has held that a disallowance amounting to the whole of, or more than, the exempt income cannot stand - here Rs 24,60,000 against Rs 1,80,000. On the average, only investments whose income does not form part of total income go in, and a High Court set aside a computation that took the whole investment schedule. On the interest element, the own-funds presumption applies here on its own statutory footing, and the Supreme Court has held the officer cannot substitute an estimated proportionate figure.
The library's position on this pairing is that the interest disallowance is consequential and not automatic: there is no provision that disallows interest merely because the principal has been added, and the disallowance rests on the separate footing that a borrowing which does not exist cannot carry a deductible interest cost, so in practice the two stand or fall together. The effort therefore belongs on identity, creditworthiness and genuineness of the Rs 60,00,000, not on the Rs 5,40,000. On penalty, a High Court has quashed a penalty and directed immunity where the only addition was a recomputation of a figure the assessee had itself estimated and disclosed, and the Supreme Court has held that a disallowance does not automatically carry penalty because the provision needs concealment or particulars that are factually false.
The prepaid interest head is usually won outright. The group advance is usually won where the supply arrangement is documented and the own funds exceed it, and usually lost where the file has only a board minute and no performance behind it. The director's advance is usually lost and is not worth the cost of winning. The new line's interest is not really in contest once it is reframed as capitalisation, and the argument is only about whether the cost gets credited. The exempt-income head usually comes down to somewhere at or under the exempt income, on the cap and the average together. The cash credit addition is the one that most often survives, and it is the one that costs the most because of the special rate. A full deletion across all six heads is uncommon.
