Abhishek Industries Ltd reversed by Apex Court in Hero Cycles Pvt Ltd

 I am sharing with your goodself an important latest judgement relating to Disallowance of Interest.

 

HERO CYCLES (P) LTD VS CIT ,SUPREME COURT OF INDIA,CIVIL APPEAL NO. 514 OF 2008

       

          ISSUE INVOLVED :-

 

1. Whether interest could be disallowed for interest free advance made to subsidiary company  for purpose of their business needs?
2. Whether interest could be disallowed for advances made to directors out of surplus funds ?

  

          FACTS OF THE CASE:-

  

The assessee advanced certain sum to its subsidiary company without interest for the purpose of business of the subsidiary company. Further certain sum was also advanced to its own directors on which interest was charged at the rate of ten percent. The assessee company itself was paying interest to Bank at the rate of eighteen percent, deduction for which was claimed under Section 36(1)(iii). Assessing Officer disallowed interest on borrowed sum on the ground that such funds were not used for business purposes.

 

The CIT (Appeals) set aside the order of AO. Further, the ITAT also upheld the order of CIT(A). However, the appeal of revenue was allowed by the High court.

 

Being aggrieved, the appellant Company approached the Hon’ble Supreme Court.                           

    

REVENUE’S CONTENTIONS :-

  

1. That assessee had borrowed funds from the banks and paid interest thereon but substantial money out of loans taken from bank was diverted by giving advance to subsidiary company without any interest. Hence interest paid to banks was not for business purposes.
2. That sums advanced to directors were not for business purposes and since interest charged from directors was much less than the interest paid to banks, hence interest ought to be disallowed.

 

3. Reliance was placed on the case of M/s Abhishek Industries Limited for disallowance of interest expenditure.

 

 

ASSESSEE’S CONTENTIONS :-

 

1. That sum advanced  to subsidiary company, M/s Hero Fibres Limited, was by way of business expediency.
2. That assessee held controlling interest in the subsidiary company and sum advanced was in compliance with stipulation laid down by three financial institutions before advancing funds by such FI’s to the subsidiary company.
3. That sum advanced to directors was out of surplus funds and were never given out of borrowed funds.
4. That assessee had sufficient funds of its own and it was for assessing officer to establish the nexus between the borrowings and advancing to prove that expenditure was for non business purposes

 

HELD:-

 

The Hon’ble Supreme Court  discussed the relevant Sections  of the Income Tax Act  and observed & held as under:-

  

1. That  High Court, without discussing established facts on record, simply relied upon its own judgment in the case of CIT v. M/s Abhishek Industries Ltd. That such approach was clearly faulty in law and could not be countenanced.

 b That  once it was established that there was nexus between the expenditure and the purpose of business (which need not necessarily be the business of the assessee itself), the revenue could not justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much was reasonable expenditure having regard to the circumstances of the case. Views taken by the Delhi High Court in case of CIT v. Dalmia Cement (P.) Ltd were upheld by the Hon’ble Supreme Court.

 c. That in so far as loans to the sister concern/subsidiary company were concerned, law in this behalf was recapitulated by this Court in the case of M/s S.A. Builders Ltd and scope of commercial expediency was explained.

 

4. Applying the ratio to the facts of the case, it was manifest that the advance to subsidiary-company became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to subsidiary-company to meet the working capital for meeting the cash losses.

 

5. That as regards loan given to Directors , it could not be disputed by the revenue that assessee had credit balance in the Bank Account when the said advance was given. The advance was made out of surplus and assessee company could in any case, utilize those funds for giving advance to Directors.

 

6. Hence order of High Court to be set aside and that of ITAT to be restored.

 

           COMMENTS:-

 

The case of judgment of M/s Abhishek Industries Limited, routinely quoted by the department in the case of every assessee has been rigthly reversed by the Hon’ble Supreme Court. The apex Court has clearly laid down two propositions in cases relating to interest disallowance on borrowed funds.

 

First, commercial and business expediency has to be seen from the angle that advancing interest free money to sister concern or subsidiary company for the purpose  of their business also falls in the category of commercial expediency. It has been clearly laid down now that commercial or business expediency does not mean for business of assessee itself only.

 

Second, the apex court has clearly laid down that if surplus funds are available with the assessee , interest cannot be disallowed without proving nexus of borrowed funds being used for advancing to directors.

 

This ruling of Hon’ble Supreme Court is going to put a full stop on a lot of litigation arising out of disallowance of interest being made in the routine manner.

 

             Contributed  By:

             CA.Arun Gupta

9814104273

Ex-Chairman Ludhiana Branch of NIRC of ICAI

Ex-Secretary Distt Taxation Bar Association,Ludhiana