Interest on Loans to Sister Concerns Requires Own-Funds Verification: ITAT Chennai

UFX Ventures Pvt. Ltd. Vs ACIT (ITAT Chennai)

Summary: The Income Tax Appellate Tribunal, Chennai ‘A’ Bench, comprising Vice President George George K and Accountant Member S.R. Raghunatha, partly allowed for statistical purposes two appeals filed by UFX Ventures Pvt. Ltd. against orders passed by the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi, both dated 7 April 2025. The appeals concerned assessment years 2013-14 and 2014-15 and the disallowance of interest expenditure on borrowed funds where the assessee had advanced amounts to sister concerns, directors and key managerial personnel. The central controversy concerned the allowability of borrowing costs under Section 36(1)(iii) of the Income-tax Act, 1961, the availability of interest-free funds, the utilisation of term loans for specific capital assets and the existence of commercial expediency in making advances to associated enterprises. The Tribunal did not accept that the entire disputed interest expenditure was automatically disallowable merely because related-party advances had been made, but it also declined to grant unconditional relief without examining the source and purpose of the funds.

For assessment year 2013-14, the assessee was engaged in publishing newspapers, leasing film projectors, trading mobile phones and set-top boxes, and providing business consultancy services. It filed a return declaring a loss of Rs.59,99,532. The assessment under Section 143(3) of the Income-tax Act resulted in additions aggregating to Rs.2,91,00,718, including interest disallowance of Rs.2,74,49,888. The First Appellate Authority reduced this disallowance by Rs.76,575, representing interest on a home loan already disallowed by the assessee, but sustained the balance of Rs.2,73,73,313. The appellate authority considered that sufficient documentary evidence had not been furnished to establish the utilisation of individual borrowings or that interest-free advances were sourced from available interest-free funds. The assessee disputed this approach, contending that borrowings sanctioned for acquisition of specific assets could not automatically be treated as diverted to related parties. It also maintained that the authorities had not adequately appreciated the distinction between term loans and working-capital facilities.

The assessee explained that its total interest expenditure of Rs.2,74,49,888 included Rs.70,20,645 relating to overdraft facilities and loans against fixed deposits and Rs.2,04,29,493 attributable to term loans and other borrowings used for acquiring machinery, vehicles, fixed assets and housing-related purposes. It submitted that funds borrowed for identifiable capital assets should not be treated as diverted merely because the balance sheet disclosed advances to related parties. It further argued that Rs.5,37,011 of interest expenditure had already been disallowed in its return for non-deduction of tax at source and that a further addition of the same amount would cause double disallowance of the same expenditure. The assessee also contended that advances to sister concerns were made for business reasons because its activities depended on support services from those entities and the amounts were periodically adjusted against service costs. In support of commercial expediency, it relied upon S.A. Builders Ltd. v. CIT, (2007) 288 ITR 1 (Supreme Court), Bright Enterprises Pvt. Ltd. v. CIT, (2016) 381 ITR 107 (Punjab and Haryana High Court) and TT Holding & Services Pvt. Ltd. v. ACIT, ITA No.1284/Mds/2012, decided on 27 November 2015 (ITAT Chennai).

Examining the accounts for AY 2013-14, the Tribunal noted that loans and advances to related parties totalled Rs.15,55,15,645, comprising Rs.14,02,29,667 advanced to associated concerns and Rs.1,52,85,978 advanced to directors and key managerial personnel. The assessee claimed that it had its own interest-free funds of Rs.16,10,03,361, exceeding the total related-party advances. The Tribunal held that where an assessee possesses sufficient interest-free funds to finance advances to sister concerns, disallowance of borrowing costs cannot be justified without proper examination of the funding position. This approach is consistent with judicial principles concerning the presumption that investments or advances are made from available interest-free funds, as discussed in decisions applying the own-funds presumption. The Tribunal therefore directed the Assessing Officer to examine the claim that sufficient own funds were available for advancing monies to related parties. However, it separately found that there was no evidence showing that advances made to directors and key managerial personnel were supported by commercial expediency. It accordingly directed proportionate disallowance of interest attributable to such advances and restored the overall issue to the Assessing Officer for fresh examination after granting the assessee a reasonable opportunity of hearing.

For assessment year 2014-15, the assessee filed a return declaring nil income after setting off brought-forward losses of Rs.19,75,030. The Assessing Officer made additions aggregating to Rs.2,15,39,118, including interest disallowance of Rs.1,98,35,123. The assessment recorded interest-free loans to related parties of Rs.14,08,48,095 against interest-bearing bank borrowings of Rs.10,25,81,313. The Assessing Officer concluded that the interest expense debited to the profit and loss account was liable for disallowance under Section 37, but reduced the adjustment by Rs.4,85,594 already disallowed under Section 14A read with Rule 8D(2)(ii). The First Appellate Authority confirmed the remaining disallowance. Before the Tribunal, the assessee submitted that its interest expenditure of Rs.2,03,20,717 consisted of Rs.77,40,578 relating to overdraft and loan-against-deposit facilities used for working capital and Rs.1,25,80,139 relating to term loans, housing loans and associated borrowing expenses. It argued that the authorities had wrongly treated all categories of borrowings alike, without identifying diversion of funds from the particular loans used for acquiring capital assets.

The assessee also contended that it had offered interest income of Rs.46,37,360 on advances to related parties during AY 2014-15 and that the deduction for interest on its own borrowings could not be denied without examining both the interest incurred and the interest recovered. The Tribunal observed that the admission that funds had been advanced to associated concerns and interest had been charged did not automatically establish the allowability of the entire interest expenditure claimed. It held that the relevant computation required examination of interest paid on borrowings vis-à-vis interest charged on loans or advances to related parties. On the facts as recorded, the Tribunal directed that the differential amount representing the cost of diverted funds was liable to disallowance under Section 36(1)(iii). It further found that advances to directors and key managerial personnel had not been supported by any material demonstrating business necessity or commercial expediency. The corresponding interest attributable to such advances was therefore also liable for disallowance. The matter was restored to the Assessing Officer for recomputation in accordance with these directions after providing adequate opportunity to the assessee.

In conclusion, the Tribunal partly allowed both appeals for statistical purposes and directed fresh examination by the Assessing Officer. The decision illustrates that the allowability of interest expenditure involving related-party advances depends on the source and deployment of funds, the availability of the assessee’s own interest-free resources, the purpose of the advances and the relationship between interest costs and interest income. It also draws a distinction between advances to sister concerns and advances to directors or key managerial personnel where no evidence of business purpose has been furnished. The Tribunal did not finally delete the disputed additions but remanded the issues for factual verification and recomputation. The order is particularly relevant to companies facing disallowance under Section 36(1)(iii) where term loans, working-capital borrowings, intra-group advances and directors’ loans coexist in their accounts.

Cases Discussed

1. Bright Enterprises Pvt. Ltd. v. CIT (Punjab and Haryana High Court); (2016) 381 ITR 107; [2015] 11 TMI 342 — Cited by the assessee regarding the availability of interest-free funds and the allowability of interest expenditure on borrowings.
2. TT Holding & Services Pvt. Ltd. v. ACIT (ITAT Chennai); ITA No.1284/Mds/2012; 27/11/2015 — Cited by the assessee concerning the disallowance of interest where advances to associated concerns are claimed to have been made on grounds of commercial expediency. An exact TaxGuru judgment URL was not verified.
3. S.A. Builders Ltd. v. CIT (Supreme Court); (2007) 288 ITR 1 — Relied upon by the assessee for the principle that interest on borrowed capital may be deductible where funds are advanced to sister concerns for genuine business or commercial purposes.

FULL TEXT OF THE ORDER OF ITAT CHENNAI

These appeals filed by the assessee are directed against two orders of Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi, both dated 07.04.2025 passed under section 250 of the Income Tax Act, 1961 (hereinafter called ‘the Act’). The relevant Assessment Years are 2013-14 & 2014-15.

ITA No.2272/CHNY/2025 (AY 2013-14)

2. The grounds raised by the assessee read as follows:-

3. Brief facts of the case are as follows: The assessee is a company engaged in the business of publishing newspapers, leasing of film projectors, trading of mobile phones and set top boxes. It is also rendering business consultancy services. For the assessment year 2013-14, the return of income was filed on 31.03.2015 declaring loss of Rs.59,99,532/-. The assessment was completed under section 143(3) of the Act vide order dated 30.03.2016. In the assessment order, the AO made additions amounting to Rs.2,91,00,718/- under various heads, including disallowance of interest expenditure amounting to Rs.2,74,49,888/-.

4. Aggrieved, assessee filed appeal before the First Appellate Authority (FAA). As regards interest disallowance of Rs.2,74,49,888/-, the FAA partly-allowed the ground. The FAA noticed that interest on home loan of Rs.76,575/- was self-disallowed by assessee and balance of Rs.2,73,73,313/- was sustained (2,74,49,888 – 76,575). The relevant finding of the FAA read as follows:-

5.1.4 The contentions of the appellant and the facts of the case have been taken into consideration. It is the claim of the appellant that apart from interest on OD of Rs. 69,52,985/-, other interest expenditure cannot be disallowed in its hand as the other loans are utilized for the purposes for which they were taken; for example, vehicle loan has been utilized for buying the vehicle, and also majority of the said loans amounting to Rs. 7,67,09,493/- were taken in the year(s) preceding to the concerned F.Y. In this regard, it is pertinent to mention that the appellant has not brought on record any documentary evidence to substantiate its claim as to whether or not the impugned loans have been used for the purposes for which they are disbursed to it. Further, it is also not the claim of the appellant that interest-free loans were given to its related parties out of interest-free funds available with it. In this scenario, it cannot be disputed that its interest bearing funds were utilized by the appellant for extending interest-free funds to its related parties. For the issue under deliberation i.e. whether or not interest expenditure claimed by the appellant is allowable in its hands u/s. 37 of the Act, it is incumbent on the appellant to establish that interest-free loans were given to its related parties out of interest-free funds available with it and not out of interest bearing funds. For this, the fact that some of the loans were received by the appellant in the year(s) preceding to the concerned F.Y. is immaterial and does not come to the to its aid. The AO has clearly established that the interest bearing loans outstanding as on 31.03.2013 in the Balance Sheet of the appellant were less than interest-free loans that were given to its related parties, and nothing has been brought on record by the appellant to demonstrate that sufficient interest-free funds were available with it so as to enable it to grant interest-free loans to its related parties. It has also not been demonstrated by the appellant that funds made available to its related parties were for any business purpose against which any income has accrued to it during the concerned year. Therefore, in this scenario the entire interest expenses debited by the appellant to its Profit and Loss Account are liable for disallowance.

5.1.5 Further, the claim of the appellant that it has self-disallowed interest on home loans of Rs.76,575/- and interest on unsecured loan and term loan of Rs.5,37,011/-, total amounting to Rs.6,13,586/- in its computation of Total Income, is also found to be partially correct. The computation of Total Income filed by the appellant is reproduced hereunder:

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From this computation, it can be clearly seen that only interest on home loans of Rs.76,575/- has been self-disallowed by the appellant. Therefore, addition to the extent of R.76,575/- stands deleted and the balance addition of Rs.2,73,73,313/- on account of interest expense u/s.37 of the Act is confirmed. Accordingly, the ground of appeal raised by the appellant is partly allowed.”

5. Aggrieved, assessee is in appeal before us. The Ld. AR submitted that the assessee had debited interest expenditure of Rs.2,74,49,888/- in the Profit & Loss account in respect of loans obtained from banks in earlier years for business purposes. Out of the total interest expenditure, an amount of Rs.70,20,645/- pertains to interest on overdraft account and loan against fixed deposits availed for working capital purposes, whereas the balance amount of Rs.2,04,29,493/- relates to interest on term loans sanctioned for acquisition of capital assets such as machinery, vehicles and other fixed assets and also housing loan availed in earlier years. It was submitted that even assuming that interest-free advances were given to related parties, the same could only be out of the overdraft facility or loan against fixed deposit and not out of term loans which were specifically sanctioned for acquisition of assets. However, the Assessing Officer without appreciating this distinction disallowed the entire interest expenditure, which was partly- confirmed by the FAA. The Ld. AR further submitted that the assessee had already disallowed interest expenditure of Rs.5,37,011/- in the return of income for non-deduction of TDS. However, the Assessing Officer without considering the said disallowance again disallowed the entire interest expenditure resulting in double disallowance to that extent. It was further contended that the advances given to sister concerns were out of commercial expediency as the business of the assessee was largely dependent on the support services rendered by those concerns. The advances were periodically adjusted against the cost of such services. In support of the contention that interest cannot be disallowed where advances are made to sister concerns on account of commercial expediency, the Ld. AR relied on the judgment of the Hon’ble Supreme Court in the case of S.A. Builders Ltd. vs. CIT (288 ITR 1) and the judgment of the Hon’ble Punjab & Haryana High Court in Bright Enterprises Pvt. Ltd. vs. CIT reported in [2015] (11) TMI 342] as well as other judicial precedents including the decision of the Chennai Tribunal in TT Holding & Services Pvt. Ltd. vs. ACIT in ITA No.1284/Mds/2012 (order dated 27.11.2015)

6. The Ld.DR relied on the orders of the AO and the FAA.

7. We have heard the rival submissions and perused the materials available on record. The issue involved in the present appeal relates to the disallowance of interest expenditure amounting to Rs.2,74,49,888/- made by the AO. The FAA confirmed the addition of Rs.2,73,73,313/-. The contention of the assessee is that the borrowings consist of term loans obtained for acquisition of capital assets and overdraft facilities for working capital requirements and therefore the entire interest expenditure cannot be considered for disallowance on account of advances made to related parties. It is also the claim of the assessee that a portion of the interest expenditure had already been disallowed in the return of income on account of non-deduction of TDS.

8. From the materials placed on record, it is clear that the assessee has given loans and advances to related parties totalling to Rs.15,55,15,645/-, out of which advances to associate concerns amounting to Rs.14,02,29,667/- and the balance amount of Rs.1,52,85,978/- represents advances given to directors and key managerial personnel. The assessee has claimed that it had sufficient own interest free funds amounting to Rs.16,10,03,361/- for making such advances. In this context, the Ld.AR took us through the financials for relevant year. We are of the view if assessee is having own interest free funds then interest free advances to sister concern does not call for disallowance of interest expenditure. Therefore, the AO is directed to examine the claim of the assessee as to whether the assessee had sufficient own funds (interest free funds) for the purpose of making interest-free loans and advances to related parties.

9. However, as regards the diversion of funds for amounts and advances given to directors and key managerial personnel, there is nothing on record to suggest that these advances / loans were made out of commercial expediency for the purpose of assessee’s business. Hence, to the extent of loans advanced to directors and key managerial personnel, proportionate interest shall be disallowed for such diversion.

10. In view of the above facts and circumstances, we deem it appropriate to restore the issue to the file of the Assessing Officer for fresh examination of the claim of the assessee with regard to availability of own funds, advances made to associate concerns and the advances made to directors and key managerial personnel. The Assessing Officer shall recompute the disallowance, if any, in accordance with law after affording reasonable opportunity of being heard to the assessee. The assessee is also directed to co-operate with the proceedings and furnish necessary details as may be called for.

11. Accordingly, the ground raised by the assessee is partly-allowed for statistical purposes.

ITA No.2273/CHNY/2025 (AY 2014-15)

12. The grounds raised read as follows:-

1. The order of the learned Commissioner of Income Tax (Appeal), NFAC is erred in confirming disallowance of interest expenses of Rs. 1,98,35,123/-

2. The learned CIT (A) was unjustified in not considering the submission of the Appellant that interest on term loan sanctioned for acquiring specific assets cannot be disallowed as the term loans were utilised by the Appellant for the purpose of acquiring specific assets.

3. The learned CIT (A) is not justified in confirming the disallowance of interest on term loans without any specific finding that the term loans were diverted and utilised for giving interest free loans.

4. The learned CIT(A) failed to consider the fact that the Appellant had taken interest free unsecured loans amounting to Rs. 8.53 crores from relatives and friends and therefore, the entire loan advanced to related parties cannot be from interest bearing funds and this disallowance of entire interest is unjustified, illegal and arbitrary.

5. The learned CIT(A) did not consider the fact that the loans were advanced to sister concerns in the normal course of business and therefore, disallowance of interest is not justified as per judicial precedence.

13. Brief facts of the case are as follows: For the assessment year 2014–15, the return of income was filed on 30.03.2016 declaring ‘nil’ income after setting off the brought forward loss of Rs.19,75,030/-. The assessment was completed u/s.143(3) of the Act vide order dated 20.12.2016. The AO made additions aggregating to Rs.2,15,39,118/- under various heads, including disallowance of interest expenditure amounting to Rs.1,98,35,123/-. As regards disallowance of interest expenditure amounting to Rs.1,98,35,123/-, the AO held that assessee has extended interest-free loans to its related parties of Rs.14,08,48,095/- which was greater than the interest bearing loans availed by it from banks amounting to Rs.10,25,81,313/-. Accordingly, the AO was of the opinion that the entire interest expenses debited by to its Profit and Loss account of Rs.2,03,20,717/- was liable for disallowance u/s.37 of the Act. However, as interest of Rs.4,85,594/- was already disallowed by the assessee u/s.14A read with Rule 8D(2)(ii), the AO proceeded to disallow the balance sum of Rs.1,98,35,123/- on this count.

14. Aggrieved, assessee filed appeal before the FAA. The FAA confirmed the disallowance made by the AO.

15. Aggrieved, assessee is in appeal before the Tribunal. The Ld. AR submitted that the assessee had debited interest expenditure of Rs.2,03,20,717/- in the Profit & Loss account in respect of various loans availed from banks. Out of the total interest expenditure, an amount of Rs.77,40,578/- pertains to interest on overdraft account and loan against fixed deposits availed for working capital purposes, whereas the balance amount of Rs.1,25,80,139/- relates to interest on term loans sanctioned for acquisition of capital assets such as machinery, vehicles and other fixed assets, housing loans availed in earlier years and loan processing charges. It was contended that even assuming that interest-free advances were given to related parties, the same could only be out of the overdraft facility or loan against fixed deposits and not out of term loans which were specifically sanctioned for acquisition of assets. However, the Assessing Officer without appreciating this distinction disallowed the entire interest expenditure, which was confirmed by the Ld. CIT(A).

16. The Ld. AR further submitted that the assessee had already disallowed an amount of Rs.5,37,011/- towards interest expenditure in the return of income on account of non-deduction of TDS. However, the Assessing Officer without considering the same again disallowed the entire interest expenditure, resulting in double disallowance to that extent. It was further submitted that the advances given to related parties were out of commercial expediency as the business of the assessee was largely dependent on the support services rendered by the sister concerns and such advances were periodically adjusted against the cost of such services.

17. The Ld. AR also submitted that the assessee had charged interest amounting to Rs.46,37,360/- on the advances extended to related parties during the relevant previous year and the same was offered as income in the Profit & Loss account. Therefore, it was contended that when the assessee has charged interest on such advances, the disallowance of interest expenditure claimed by the assessee is not justified.

18. The Ld. AR further placed reliance on the provisions of section 36(1)(iii) of the Act and submitted that interest paid on capital borrowed for the purpose of business is allowable as deduction. Reliance was also placed on various judicial precedents including the decision of the Hon’ble Supreme Court in the case of S.A. Builders Ltd. vs. CIT (288 ITR 1), the decision of the Hon’ble Punjab & Haryana High Court in Bright Enterprises Pvt. Ltd. vs. CIT, the decision of the Chennai Tribunal in TT Holding & Services Pvt. Ltd. vs. ACIT and other decisions of the Hon’ble High Courts wherein it has been held that interest on borrowed funds cannot be disallowed where advances are made to sister concerns on account of commercial expediency. Accordingly, the Ld. AR prayed that the disallowance of interest expenditure confirmed by the FAA may kindly be deleted.

19. The Ld.DR supported the orders of the AO and the FAA.

20. We have heard the rival submissions and perused the materials available on record. The issue involved in the present appeal relates to the disallowance of interest expenditure under section 36(1)(iii) of the Income Tax Act, 1961. The Ld. AR submitted that the assessee had incurred interest expenditure on loans obtained from banks and financial institutions for the purpose of business. It was also contended that certain advances were made to related parties and the assessee has charged interest on such advances amounting to Rs.46,37,360/-, which has been duly offered to tax. According to the Ld. AR, therefore, the disallowance of the entire interest expenditure is not justified.

21. From the submissions made before us, it is evident that the assessee itself admits that certain funds were diverted to associated concerns and interest has been charged on such advances. Therefore, to the extent the assessee admits that the funds were diverted to associated concerns and interest has been charged thereon, the same cannot automatically justify the allowability of the entire interest expenditure claimed by the assessee. In our considered opinion, the allowability of interest expenditure has to be examined with reference to the interest paid by the assessee on its borrowings vis-à-vis the interest charged by the assessee on the advances made to the related parties.

22. Therefore, to the extent of the difference between the interest paid by the assessee on borrowed funds and the interest charged by the assessee on the loans or advances given to the related parties, such differential amount would represent the cost of funds diverted and the same is liable to be disallowed u/s.36(1)(iii) of the Act.

23. Further, with regard to the advances made to directors and key managerial personnel, we find that there is nothing placed on record to demonstrate that such advances were made out of commercial business expediency. The assessee has not produced any material to establish that such advances were in furtherance of the business interests of the assessee. In the absence of any evidence to show commercial expediency, the diversion of borrowed funds to directors and key managerial personnel cannot be considered as having been made for the purposes of business.

24. Accordingly, to the extent of loans or advances diverted to directors and key managerial personnel, the corresponding interest attributable to such diversion of funds shall be disallowed u/s.36(1)(iii) of the Act.

25. In view of the above observations, the issue is restored to the file of the Assessing Officer to recompute the disallowance of interest expenditure in accordance with the directions given above after providing adequate opportunity of being heard to the assessee.

26. Accordingly, the ground raised by the assessee is partly-allowed for statistical purposes.

27. In the result, the appeals filed by the assessee are partly-allowed for statistical purposes.

Order pronounced in the open court on 11th March, 2026 at Chennai.