Interest Disallowance Not Sustainable Where Own Funds Exceed Investments: ITAT Bangalore

Kirloskar Electric Company Ltd. Vs DCIT (ITAT Bangalore)

Material Facts: The assessee, engaged in the business of manufacturing and trading electric motors, alternators, traction equipment, transformers, DG sets, circuit breakers, starters and contractors, filed its return of income for AY 2010-11 declaring Nil income under the normal provisions and book profit of Rs.50,59,46,016 under section 115JB. The return was processed under section 143(1) and subsequently selected for scrutiny. Notices under sections 143(2) and 142(1) were issued, and the assessee furnished the details sought by the Assessing Officer.

The Assessing Officer completed the assessment under section 143(3), making the following additions:

• Disallowance under section 14A – Rs.12,83,690.
• Disallowance of interest – Rs.86,29,243.
• Capitalisation of interest – Rs.9,69,40,630.

Procedural History: The assessee appealed before the Commissioner of Income Tax (Appeals), who partly allowed the appeal. The assessee thereafter appealed before the Tribunal, which remanded the matter to the CIT(A) for fresh examination. After reconsideration, the CIT(A) dismissed the assessee’s appeal. The assessee again appealed before the ITAT. Since identical issues arose for AYs 2010-11, 2011-12 and 2012-13, the Tribunal heard all appeals together and treated AY 2010-11 as the lead case.

Legal Issues: The principal issue before the Tribunal was whether the Assessing Officer was justified in capitalising interest on the ground that borrowed funds had been utilised for making investments in the assessee’s subsidiary company.

Relevant Statutory Provisions

• Section 14A
• Section 115JB
• Sections 143(1), 143(2), 142(1) and 143(3) of the Income-tax Act.

Parties’ Submissions

Assessee’s submissions

The assessee submitted that investments in its subsidiary, Kirsons BV, Netherlands, were made entirely from accumulated interest-free funds. It pointed out that as on 31.03.2010 it had share capital and reserves aggregating to Rs.19,527.61 lakhs, whereas advances to the sister concern amounted to only Rs.9,118.76 lakhs. The assessee also referred to its annual report, profit and loss account and cash flow statement to demonstrate the availability of sufficient own funds and submitted that no additional borrowings had been made for investment in the subsidiary. Reliance was placed on the decisions of the Supreme Court in CIT Vs. Reliance Industries Ltd. and the Bombay High Court in CIT Vs. Reliance Utilities and Power Ltd..

Revenue’s submissions

The Revenue submitted that the assessee had availed loans and maintained no separate divisible pool distinguishing borrowed funds from own funds. Referring to the annual report and the Assessing Officer’s analysis of the cash flow statement, the Revenue contended that sufficient cash balance was not available for making the investments and accordingly supported the orders of the Assessing Officer and the CIT(A).

Tribunal’s Findings and Reasoning

The Tribunal observed that the Assessing Officer proceeded on the basis that the assessee had utilised borrowed funds for investment in subsidiary companies and had proportionately capitalised the related interest expenditure.

After examining the balance sheet as on 31.03.2010, the Tribunal found that the assessee possessed equity capital of Rs.6,599.32 lakhs and reserves and surplus of Rs.12,928.29 lakhs, aggregating to shareholders’ funds of Rs.19,527.61 lakhs. The total investments stood at Rs.8,579.43 lakhs, of which investment in Kirsons BV amounted to Rs.8,429.62 lakhs. On these figures, the Tribunal concluded that the assessee had sufficient non-interest-bearing own funds to make the investments.

The Tribunal referred to the Supreme Court decision in CIT Vs. Reliance Industries Ltd., which recognised the presumption that investments are made from interest-free funds where such funds are sufficient. It also referred to the Bombay High Court decision in CIT Vs. Reliance Utilities and Power Ltd., which held that where both interest-free and borrowed funds are available, investments are presumed to have been made out of interest-free funds if those funds are sufficient to cover the investments.

The Tribunal noted that the Revenue did not dispute the availability of shareholders’ funds and that its objection related only to the absence of a divisible pool between own funds and borrowed funds. Following the judicial precedents relied upon, the Tribunal held that sufficient interest-free funds were available and that it could safely be presumed that the investments were made from those funds.

Final Ruling

The Tribunal directed the Assessing Officer to delete the disallowance of Rs.9,69,40,630 towards capitalisation of interest and allowed the grounds raised by the assessee for AY 2010-11. Since AYs 2011-12 and 2012-13 involved identical issues, the Tribunal applied the same reasoning and allowed those appeals as well. Accordingly, all the assessee’s appeals were allowed.

Cases Discussed

• CIT Vs. Reliance Industries Ltd. (Supreme Court of India), [2019] 102 taxmann.com 52 (SC)
• CIT Vs. Reliance Utilities and Power Ltd. (Bombay High Court), [2009] 178 Taxman 135 (Bombay)

FULL TEXT OF THE ORDER OF ITAT BANGALORE

These appeals are filed by the assessee against the order of learned Commissioner of Income Tax – Appeals (NFAC, Delhi) [in short “CIT(A)”] vide DIN Nos. ITBA / NFAC / S / 250 / 2024-25 / 106486446(1), ITBA / NFAC / S /250/2024-25/1064867864(1) dated 14.05.2024, and ITBA/NFAC/S/250/2024-25/1064935672(1) dated 16.05.2024, for the Assessment Years 2010-11 to 2012-13 respectively, arising out of the order passed under section 143(3) and 270A of the Act dated 22.03.2013, 20.03.2014 and 11.03.2015 respectively. Since the assessee is same, and the issues are common and identical, these appeals are clubbed and heard together and a consolidated order is passed.

2. Firstly, we take up appeal in ITA No.1316/Bang/2024 as a lead appeal and the facts are culled out therefrom.

3. Briefly stated facts of the case are assessee is engaged in the business of manufacturing / trading of Electric Motors, Alternators, Traction equipment, Transformers, DG sets, Circuit Breakers / Starts / Contractors, filed its return of income declaring income as Nil under normal provisions and Rs.50,59,46,016/- under section 115JB of the Act. The return of income was summarily processed under section 143(1) of the Act. The case was subsequently selected for scrutiny. Notice under section 143(2) of the Act dated 27.08.2011 was issued and served on the assessee. Thereafter, notice under section 142(1) of the Act on various dates were issued and served on the assessee calling for details. In response to the notice, the assessee’s Authorized Representative [in short ‘AR’] appeared from time to time and produced the details called for. The learned Assessing Officer [in short ‘AO’], after examining all the details on record, concluded the assessment by making the following additions:

i. 14A disallowance – 12,83,690/-

ii. Disallowance of interest – 86,29,243/-

iii. Capitalization of interest – 9,69,40,630/-

4. On being aggrieved by the Order of the learned AO, assessee carried the matter before the learned CIT(A). The learned CIT(A) partly allowed appeal of the assessee.

5. On being aggrieved by the order of the learned CIT(A), the assessee carried the matter before the Tribunal. The Tribunal remanded the matter back to the CIT(A) for examining the matter afresh. Thereafter, the learned CIT(A), in compliance of the direction of the Tribunal, after examining the submissions made by the assessee, being not satisfied, dismissed the appeal of the assessee.

6. The learned AR submitted that the assessee has made investments in its subsidiary viz., M/s. Kirsons BV, Netherlands, out of the accumulated interest free funds available with the assessee. He further submitted that the learned AO, observing that the assessee has secured and unsecured loans and has claimed interest expenditure of Rs.22,56,74,000/-, concluded that assessee has utilized borrowed funds for the purpose of granting advances and investing in subsidiary companies. He further submitted that the company has accumulated share capital and reserves amounting to Rs.19527.61 lakhs whereas the advances to sister concern is only Rs.9118.76 lakhs. The learned AR drew our attention to Page No.28 of the Annual report for the Financial Year 2009-10 demonstrating the availability of share capital, reserves and surplus and the investments correspondingly made against them. He also drew our attention to Page No.29 wherein the interest and finance charges on the loans taken by the assessee stood at Rs.225 lakhs in the Profit and Loss account for the Financial Year 2009-10. He further submitted that interest on the borrowings has not increased when compared to the previous year and hence no additional borrowings made during the Financial Year for the purpose of making investments in subsidiary companies. He also referred to the cash flow statements in Page No.30 wherein the assessee had net cash from operating activities an amount of Rs.5224 lakhs. He therefore vehemently argued that assessee has utilized own funds for the purpose of investing in subsidiary companies and hence interest need not be capitalized. The learned AR relied on the decision of Hon’ble Supreme Court of India in the case of CIT Vs. Reliance Industries Ltd., reported in [2019] 102 taxmann.com 52 (SC) and decision of Hon’ble High Court of Bombay in the case of CIT Vs. Reliance Utilities and Power Ltd., reported in [2009] 178 Taxman 135 (Bombay). He therefore pleaded that interest disallowed by the AO be deleted.

7. Per contra, the learned Departmental Representative [in short ‘DR’] referred to Page No.28 of the Annual Report and stated that the assessee has availed loans and there is no divisible pool maintained by the assessee between the own funds and the borrowed funds. He vehemently supported the orders of the learned AO wherein the AO has analyzed the cash flow statement filed by the assessee and concluded that the assessee does not have sufficient cash balance for making investments / advances to assessee concern. He, therefore, pleaded that the order of the learned CIT(A) be upheld.

8. We have heard rival contentions and perused the material available on record including the written submissions filed by the assessee. The main contention of learned AO is the assessee has invested huge sums in the subsidiary companies out of the borrowed funds by stating that the percentage of borrowings to net worth stood at 72% for the Financial Year 2009-10. He therefore was of the view that the assessee has partly utilized the loan funds for the purpose of investments and hence interest should be proportionately disallowed and capitalized along with the investments. However, on perusal of the Balance Sheet as on 31.03.2010, it is evident that the assessee has equity capital amounting to Rs.6599.32 lakhs and Rs.12,928.29 lakhs as accumulated reserves and surplus aggregating to Rs.19527.61 lakhs as net worth of the company. The investments stood at Rs.8579.43 lakhs out of which investments in subsidiary viz., Kirsons BV stood at Rs.8429.62 lakhs. On a plain observation of the above shareholder funds, the investments made by the assessee it can be safely concluded that the assessee had sufficient own funds which is non-interest bearing for the purpose of investments in the subsidiary companies.

9. The Hon’ble Supreme Court in the case of CIT Vs. Reliance Industries Ltd., (supra), relied on by the learned AR in paragraphs 7 and 8 observed as follows:

7. Insofar as the first question is concerned, the issue raises a pure question of fact. The High Court has noted the finding of the Tribunal that the interest free funds available to the assessee were sufficient to meet its investment. Hence, it could be presumed that the investments were made from the interest free funds available with the assessee. The Tribunal has also followed its own order for Assessment Year 2002-03.

8. In view of the above findings, we find no reason to interfere with the judgment of the High Court in regard to the first question. Accordingly, the appeals are dismissed in regard to the first question.

10. Similarly, the Hon’ble High Court of Bombay in the case of CIT Vs. Reliance Utilities and Power Ltd., (supra) on identical facts and circumstances in para 10 has held as follows:

10. If there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest-free funds available. In our opinion the Supreme Court in East India Pharmaceutical Works Ltd.’s case (supra) had the occasion to consider the decision of the Calcutta High Court in Woolcombers of India Ltd.’s case (supra) where a similar issue had arisen. Before the Supreme Court it was argued that it should have been presumed that in essence and true character the taxes were paid out of the profits of the relevant year and not out of the overdraft account for the running of the business and in these circumstances the appellant was entitled to claim the deductions. The Supreme Court noted that the argument had considerable force, but considering the fact that the contention had not been advanced earlier it did not require to be answered. It then noted that in Woolcombers of India Ltd.’s case (supra) the Calcutta High Court had come to the conclusion that the profits were sufficient to meet the advance tax liability and the profits were deposited in the overdraft account of the assessee and in such a case it should be presumed that the taxes were paid out of the profits of the year and not out of the overdraft account for the running of the business. It noted that to raise the presumption, there was sufficient material and the assessee had urged the contention before the High Court. The principle therefore would be that if there are 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 fund generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption is established considering the finding of fact both by the CIT (Appeals) and ITAT.

11. In the instant case, Revenue is not disputing the availability of shareholders own funds but Revenue’s objection is with respect to non-availability of divisible pool between own funds and borrowed funds for the purpose of making investments / advances to subsidiary / sister concerns. Various judicial decisions have consistently held and affirmed the view that when funds available, in the form of both interest free and loan funds, the presumption would arise that investments would be out of funds generated from the company provided the said funds are sufficient to making the investments. In the instance case, the share capital and reserves and surplus as at 31^st March 2010, aggregating to Rs.19527.61 lakhs are sufficient enough to making an investment of Rs.8579.43 lakhs. Respectfully following the judicial pronouncements as discussed above, we are of the opinion that since the interest free funds are available, it can be safely presumed that the investments were out of interest free funds of the assessee. Hence the learned AO is directed to delete the disallowance of Rs.9,69,40,630/-. We therefore allow the grounds raised by the assessee. It is ordered accordingly.

12. ITA Nos.1317 & 1318/Bang/2024 (AY: 2011-12 & 2012-13)

In these appeals, the assessee has raised the similar grounds involving the identical issues with that of the assessee’s appeal in ITA No. 1316/Bang/2024 for the AY 2010-11, which is adjudicated in the foregoing paragraphs of this order. Considering the identicalness of the issues involved in all these appeals, our decision rendered while adjudicating the ITA No. 1316/Bang/2024 (supra) mutatis mutandis applies to the assessee’s appeals in ITA No. 1317 & 1318/Bang/2024 also. Accordingly, by applying the same analogy, we allow the grounds raised by the assessee in its appeals for the AY 2011-12 and 2012-13.

13. In the result, all the appeals of the assessee are allowed.

Pronounced in the open court on the date mentioned on the caption page.