Case Law Details

Case Name : M/s. Chhaganlal Kishanlal & Co. Vs DCIT Khandwa (ITAT Indore)
Appeal Number : I.T.A. No.817/Ind/2014
Date of Judgement/Order : 28/02/2017
Related Assessment Year : 2011-12
Courts : All ITAT (2768) ITAT Indore (21)

If there was funds available both, interest-free and overdraft and or/loans taken, then a presumption would arise that investments would be out of the interest-free funds generated or available with the company, if the interest free funds were sufficient to meet the investments. In the present case, there sufficient interest free funds were available at the disposal of the assessee.

ITAT held that that if interest income does not result at all, there cannot be any tax and that if an income has not materialized, then merely an entry made about a hypothetical income by following book keeping methods, the liability to tax cannot be attracted.

Income cannot be taxed on hypothetical basis, and it is only the real income that is to be brought to tax.

1.5. We have heard the rival submissions of both the parties and have perused the material available on record. We find that the ld. A.O. has failed to establish that the assessee has received any interest from the above seven parties during the year under consideration and the interest free advances to above stated seven parties were out of interest bearing funds. It is the contention of the assessee that it had sufficient non-interest bearing funds to the tune of Rs. 10.11 crores as on 09.12.2010, which inter-alia included partners capital of Rs. 1.20 crores, and unsecured loan from partners of Rs. Rs. 8.91 crores as against interest bearing funds of Rs. 8.16 crores. The ld. A. R. contended that the assessee had utilised these funds for giving interest-free advances to aforesaid parties on which no interest was shown by the assessee even though M/s. Shubham Kela Agency, M/s. Ram Kela Agency and M/s. Saibaba Cotton Industries have shown to have paid interest of Rs. Rs. 1,31,735/- , Rs. 93,289/- and Rs. 27,00,000/- respectively to the assessee as per AIR information on which TDS was also deducted. We find that as per books of accounts of the assessee , the assessee has not received any interest during the year under consideration even though interest received in preceding year was duly shown by the assessee as its income for assessment year 2010-11. It is the contention of the assessee that the assessee has debited interest in to account of these parties but failed to realize the said interest from these parties hence, it was not offered to tax. It was noticed that the assessee was not able to even receive principal amount from these parties and cheques issued could not be realized. In view of this matter, we are of the view that interest income has been recognized in the books of accounts only to the extent of actual collection, which is the method recognized as per Accounting Standard 9 of ICAI. The Ld. A.R. also relied in the case of Maruti Securities Ltd. vs. Addl CIT (I.T.A. No. 468/Hyd/2009 and 1939/Hyd/2011 for the assessment year 2005-06 dtd. 05.09.2014 wherein para 22 is reproduced as under:

“22. The method of accounting, as followed by the assessee, does not create any income; but the method of accounting only recognizes income. There is some merit in the submission of the assessee that when the principal itself is overdue and not collected, there is no basis for making out a case that interest income would be collectable with certainty. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to ascertain the nature of business and character of the transaction and the realities and peculiarities of the situations. The decision very heavily relied upon by the first appellate authority in the case of State Bank of Travancore Vs CIT (1986) 158 ITR 102 was subsequently overruled in its land mark decision in the case of UCO Bank Vs CIT 237 ITR 889. In this regard, we place reliance on the ratio laid down by various judicial authorities on the proposition that the income cannot be taxed on hypothetical basis, and it is only the real income that is to be brought to tax. In this behalf, we also rely, giving below summary of the ratio laid down, on the following decisions

a) CIT vs. Godhra Electricity Co. 225 ITR 746 (SC),

The view expressed was that if income does not result at all, there cannot be any tax and that if an income has not materialized, then merely an entry made about a hypothetical income by following book keeping methods, the liability to tax cannot be attracted.

b) Andhra bank(225 ITR 447) (SC):

It was held, that there cannot be a tax if no income resulted, despite the entry in the book keeping. The case deals with s. 148. Assessee changed method of accounting from AY 1960 onwards. But during AY 1963- 64, the AO objected the change and reopened assessments for AY 1960 onwards. Apex court held that this amounts to change of opinion and re-assessment is not valid.”

1.5.1. Therefore, in the light of finding of coordinated bench mentioned as above, we are of the view that when no interest is received same cannot be taxed on notional basis.

1.5.2. We further find that the HonGble Supreme Court in the case of CIT vs. Excel Industries Ltd. 358 ITR 295 (SC had held as under

“that going by the accounting standard though the revenue is collectible by certainty, the assessee in the present case, in fact, had not received any interest and hence, interest in question remained only notional interest. As canvassed by the learned counsel for the assessee, some of the parties did not repay even the principal amount and some of the parties settled the accounts by paying some interest and hence, we agree that computation of notional interest at 14% on all the advances and making additions on that basis to the income of the assessee, is not justified.BB

1.5.3. In view of above, relying on decision of Apex Court as referred to above, we are of the view the when interest income is not realized or collected , same cannot be taxed on notional basis. We further find to the AO has also not taxed the interest income credited by the above mentioned parties in their books of accounts , but disallowance of interest has been made on the basis of diversion of interest bearing funds to non-business purposes. However, we find that the Ld. A.R. has fully demonstrated that the interest-free advance were given out of interest-free funds available with the assessee during the assessment year 2010-11 and during A.Y. under consideration for which interest-free funds of Rs. 10.11 crores [ Rs. 1.20 crore + Rs. 8.91 crore] as mentioned in above paras of this order, as against interest bearing funds of Rs. 8.19 crores. The Ld. A.R. also placed reliance on the judgement of HonGble Supreme Court in the case of S. A. Builders vs. CIT (2007) (288 ITR 1) (SC) wherein it was held that where the assessee has made investment out of mixed funds for the commercial expediency then no disallowance could be made under section 36 (1) (iii) of the Act. We find that the AO has not been able to establish the nexus between interest bearing funds utilized for non business purpose as held in above quoted decision of Honble Supreme Court. The ld. A. R. has placed reliance in the case of CIT vs. Reliance Utilities & Power Ltd. (2009)313 ITR 340(Bom)/ 178 Taxman 135 (Bom) wherein it was held that if there was funds available both, interest-free and overdraft and or/loans taken, then a presumption would arise that investments would be out of the interest-free funds generated or available with the company, if the interest free funds were sufficient to meet the investments. In the present case, there sufficient interest free funds were available at the disposal of the assessee. We further find support from decision in the case of CIT vs. Hero Cycles Ltd. (2015) 379 ITR 347(SC)!63 taxmann.com 308 (SC)! (2016) 236 Taxman 447 (SC)wherein it was held as under:

11. We are of the opinion that such an approach is clearly faulty in law and cannot be countenanced.

12. Insofar as loans to the sister concern/subsidiary company are concerned, law in this behalf is recapitulated by this Court in the case of S.A. Builders v. CIT (Appeals) [2007 (288) ITR 1/158 Taxman 74]. After taking note of and discussing on the scope of commercial expediency, the Court summed up the legal position in the following manner:—

’26. The expression “commercial expediency” is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.

27. No doubt, as held in Madhav Prasad Jatia v. CIT [1979 (118) ITR 200 (SC)/, if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under section 36(1)(iii) of the Act. In Madhav Prasad ‘s case [1979 (118) ITR 200 (SC)/, the borrowed amount was donated to a college with a view to commemorate the memory of the assessee’s deceased husband after whom the college was to be named, it was held by this court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.

28. Thus, the ratio of Madhav Prasad Jatia’s case [1979 (118) ITR 200 (SC)/ is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed under section 36(1)(iii) of the Act.

29. In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.

30. It has been repeatedly held by this court that the expression “for the purpose of business” is wider in scope than the expression “for the purpose of earning profits” vide CIT v. Malayalam Plantations Ltd. 11964 53 ITR 140 (SC), CIT v. Birla Cotton Spinning and Weaving Mills Ltd. [1971 82 ITR 166 (SC)/, etc.’

13. In the process, the Court also agreed that the view taken by the Delhi High Court in CIT v. Dalmia Cement (P) Ltd. 12002] 254 ITR 377/121 Taxman 706 wherein the High Court had held that once it is established that there is nexus between the expenditure and the purpose of business (which need not necessarily be the business of the assessee itself), the Revenue cannot 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 is reasonable expenditure having regard to the circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman.

14. Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to MIs. Hero Fibres Limited 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 MIs. Hero Fibres Limited to meet the working capital for meeting any cash loses.

15. It would also be significant to mention at this stage that, subsequently, the assessee company had off-loaded its share holding in the said MIs. Hero Fibres Limited to various companies of Oswal Group and at that time, the assessee company not only refunded back the entire loan given to MIs. Hero Fibres Limited by the assessee but this was refunded with interest. In the year in which the aforesaid interest was received, same was shown as income and offered for tax.

16. Insofar as the loans to Directors are concerned, it could not be disputed by the Revenue that the assessee had a credit balance in the Bank account when the said advance of Rs. 34 lakhs was given. Remarkably, as observed by the CIT (Appeal) in his order, the company had reserve/surplus to the tune of almost 15 crores and, therefore, the assessee company could in any case, utilise those funds for giving advance to its Directors.

17. On the basis of aforesaid discussion, the present appeal is allowed, thereby setting aside the order of the High Court and restoring that of the Income Tax Appellate Tribunal.

1.5.4. Therefore, presumption would go in favour of the assessee that the interest free funds were given out of interest free funds available at the disposal of the assessee as per balance sheet of the assessee, by applying the ratio as laid down by the Hon’ble Bombay High Court in in the case of CIT vs. Reliance Utilities & Power Ltd. (2009) 178 Taxrnan 135 (Born) and the decision of Hon’ble Punjab & Haryana High Court in the case of Hero Cycles Ltd. (2010) 323 ITR 518 (P&H) and other decision as relied by the ld. A.R., we are of the considered opinion that no disallowance of interest is warranted in the case. Accordingly, disallowance of interest of Rs.35,02,536/- is deleted. The above grounds of appeal is therefore, allowed.

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