If assessee advanced to sister concerns or others without interest for no business purpose, interest to that extent to be disallowed

 If assessee advanced to sister concerns or others without interest for no business purpose, interest to that extent to be disallowed

The assessee claimed deduction of Rs. 38,39,250 towards interest paid to bank and other loans. The Assessing Officer noticed that the assessee-company has invested Rs. 53,96,000 in M/s. Green Rayalaseema Industries Ltd. The Assessing Officer was of the opinion that the proposed interest on the amount invested in this company is not for the purpose of business and the same was disallowed proportionately. As per provisions of section 36(1)(iii) of the Act, the interest on loans raised by the assessee for business purposes are available. Once the assessee claims any such interest as deduction in their books of account the onus always will be on the assessee to satisfy the Assessing Officer that whatever loans were raised by the assessee were for the purpose of business. If in the process of examination of genuineness of such deduction, if it transpires that the assessee has advanced certain funds to sister concerns charging no interest, there would be a very heavy onus on the assessee to discharge before the Assessing Officer to the effect that in spite of outstanding loans on which the assessee is incurring liability to pay interest, there would be no justification to advance the loans to sister concerns for non-business purposes without charging any interest.

Entire money in a business entity comes in a common kitty. The monies received as share capital, as term loan, as working capital loan, as sale proceeds etc. do not have any different colour. Whatever are the receipts in the business, which have the colour of business receipts and have no separate identification? The only thing sufficient to disallow the interest paid on the borrowing to the extent the amount is lent to sister concern without carrying any interest for non-business purposes would be that the assessee has some loans or other interest bearing debts to be repaid. In case the assessee had some surplus amount which, according to it, could not be repaid prematurely to any financial institution, still the same is either required to be circulated and utilised for the purpose of business or to be invested in a manner in which it generates income and not that it is diverted towards sister concern free of interest. This would result in not presenting true and correct picture of the accounts of the assessee as at the cost being incurred by the assessee, the sister concern would be enjoying the benefits thereof. It cannot possibly be held that the funds to the extent diverted to sister concerns or other persons free of interest were required by the assessee for the purpose of its business and loans to that extent were required to be raised. We do not subscribe to the theory of direct nexus of the funds between borrowings of the funds and diversion thereof for non-business purposes. Rather, there should be nexus of use of borrowed funds for the purpose of business to claim deduction under Section 36(1)(iii) of the Act. That being the position, there would be no escape from the finding that interest being paid by the assessee to the extent the amounts are diverted to sister concern on interest free basis are to be disallowed.

If the plea of the assessee is accepted that the interest free advances made to the sister concerns for non-business purposes was out of its own funds in the form of capital introduced in business, that again will show a camouflage by the assessee as at the time of raising of loan, the assessee will show the figures of capital introduced by it as a margin for loans being raised and after the loans are raised, when substantial amount is diverted to sister concerns for non-business purposes without interest, a plea would be raised that the amount advanced was out of its capital, which in fact stood exhausted in setting up of the unit. Such a plea may be acceptable at a stage when no loans had been raised by the assessee at the time of disbursement of funds. This would depend on facts of each case.

The view that where the amount is advanced from a mixed account or share capital or sale proceeds or profits, it would not be deemed as diversion of borrowed capital or that the Revenue had not been able to establish nexus of the funds advanced to the sister concerns with the borrowed funds is not correct. Once it is borne out from the record that the assessee had borrowed certain funds on which liability to pay tax is being incurred and on the other hand, certain amounts had been advanced to sister concerns or others without carrying any interest and without any business purpose, the interest to the extent the advance had been made without carrying any interest is to be disallowed under Section 36(1)(iii) of the Act.

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