Pune ITAT Upholds Deletion of ₹5.02 Crore Interest Disallowance: Presumption Applies When Interest-Free Funds Exceed Advances

ACIT Vs Mehul Construction Company Pvt. Ltd. (ITAT Pune)

Pune ITAT Upholds Deletion of ₹5.02 Crore Interest Disallowance: Presumption Applies When Interest-Free Funds Exceed Advances

The Pune ITAT dismissed the Revenue’s appeals for three assessment years and upheld the deletion of interest disallowance of ₹5.02 crore, holding that where the assessee possesses sufficient interest-free funds exceeding the amount advanced, a presumption arises that the advances were made out of such funds and no disallowance under Section 36(1)(iii) is warranted.

The assessee company had advanced interest-free loans aggregating to ₹33.49 crore to M.M. Patel Public Charitable Trust, a trust engaged in establishing a medical college and hospital. During the assessment, the Assessing Officer observed that the assessee had incurred substantial interest expenditure on borrowings and therefore disallowed ₹5.02 crore as proportionate interest allegedly attributable to diversion of borrowed funds towards interest-free advances.

Before the appellate authorities, the assessee explained that the advances were made to assist the trust in meeting the margin money requirements for bank finance and that the lender banks had treated such advances as quasi-capital. It was further pointed out that the Charity Commissioner had permitted the trust to accept only interest-free loans, and that the assessee had itself secured construction contracts from the trust through a competitive bidding process.

More importantly, the assessee demonstrated that as against the advance of ₹33.49 crore, it possessed own funds in the form of share capital and reserves exceeding ₹42.61 crore, apart from other interest-free funds. The CIT(A) accepted this factual position and deleted the disallowance by relying on the decisions in Reliance Utilities & Power Ltd. (Bom HC) and Reliance Industries Ltd. (SC).

The Tribunal noted that the Revenue had not challenged similar relief granted to the assessee in earlier assessment years on identical facts, thereby lending support to the principle of consistency. It further observed that the assessee had successfully established the availability of interest-free funds substantially in excess of the advances made to the trust.

Rejecting the Revenue’s argument that the presumption laid down in Reliance Utilities applied only to investments and not to interest-free loans, the ITAT held that the principle depends upon the availability of sufficient interest-free funds and not on the nature of the advance. Once such funds are available, it is presumed that the advances have been made out of those funds rather than borrowed funds.

Accordingly, the Tribunal held that the assessee had successfully demonstrated that the interest-free advances to the charitable trust were funded out of reserves, surplus and other interest-free resources, and therefore the disallowance of ₹5.02 crore under Section 36(1)(iii) was unsustainable. The Revenue’s appeals for all three assessment years were dismissed.

FULL TEXT OF THE ORDER OF ITAT PUNE

These appeals filed by the Revenue are directed against the separate orders dated 25.09.2025 passed by Ld. CIT(A), Pune-11 [‘Ld. CIT(A)’] for the assessment years 2016-17, 2017-18 & 2018-19 respectively.

2. Since identical facts and common issues are involved in all the above captioned three appeals of the Revenue, therefore, we proceed to dispose of the same by this common order.

3. First, we shall take up the appeal of the Revenue in ITA No.2918/PUN/2025 for A.Y. 2016-17 for adjudication as the lead case.

ITA No.2918/PUN/2025, A.Y. 2016-17 :

4. The Revenue has raised the following grounds of appeal :-

“1. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in deleting the disallowance of interest expenses of Rs.5,02,48,524/- by holding that the assessee had sufficient interest-free funds, without appreciating the fact that the assessee failed to prove that interest free unsecured loan advanced to M.M. Patel Public Charitable Trust was out of its reserve and surplus/interest free funds, despite the fact that the A.O had asked during the course of assessment proceedings to justify its claim with the supporting documents.

2. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) has justified in deleting the disallowance of interest expenses, without appreciating the fact that assessee failed to substantiate its claim of interest free loan and advance given to M.M. Patel Public Charitable Trust out of its interest free funds, with any nexus or documentary evidence such as cash-flow/fund-flow statements, bank statements, etc. particularly when the assessee had several other liabilities and all bank accounts reflected pooled funds, making it impossible to demonstrate that reserves or surplus alone were used for floating the loan.

3. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) has justified in deleting the disallowance of interest expenses of Rs. 5,02,48,524/-, despite the fact that the assessee was incurring interest expenditure on borrowings from banks, directors, and relatives, while simultaneously advancing interest-free loans to M.M. Patel Public Charitable Trust, thus attracting the legal presumption of diversion of interest-bearing funds for non-business purposes in the absence of demonstrated nexus or commercial expediency.

4. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in accepting the assessee’s plea of commercial expediency when the assessee itself admitted that it obtained the construction contract from the Trust through a lawful competitive bidding process, thereby negating any business necessity or justification for providing interest-free financial assistance to the Trust.

5. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in accepting the assessee’s contention that the advances were linked to stipulations of the Charity Commissioner, without appreciating that such stipulations apply only to the trustees of the Trust and not to the assessee company, which is not a trustee and hence cannot rely on such conditions to justify interest-free advances.

6. Whether, on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in relying on the judgment of the Hon’ble Bombay High Court in CIT v. Reliance Utilities & Power Ltd., without appreciating that the said ruling pertains to investment of surplus funds and was misapplied to a situation involving interest-free loans to a related Trust, especially when the assessee failed to discharge its statutory burden of proving availability of surplus funds/and also the nexus between the interest free loan granted to the trust & the interest free funds available.

7. Whether the learned CIT(A) erred in granting relief by disregarding settled judicial principles that, in the absence of demonstrated commercial expediency and without clear proof that interest-free funds were available and actually utilized, proportionate disallowance of interest is warranted under section 36(1)(iii).

8. The appellant craves leave to add, amend, modify, or delete any of the above grounds of appeal at the time of hearing.”

5. Facts of the case, in brief, are that the assessee is a private limited company and has furnished its original return of income on 30.09.2016 by declaring an income of Rs.6,82,55,180/-. Subsequently, a search and seizure action was carried out in the Mehul Groups and its entities on 25.08.2022. The assessee M/s Mehul Construction Company Pvt. Ltd. being key entity of this group was also covered in the search action. During the course of search and seizure action u/s 132 of the IT Act, it was found that the Directors of Mehul Construction Company Pvt. Ltd. and Trustees of M. M. Patel Public Charitable Trust (‘MMPPCT’) running the Medical College are common. From the financials of M/s Mehul Construction Company Pvt. Ltd. (‘MCCPL’), it was found that the assessee had given interest-free loans to the M. M. Patel Public Charitable Trust. The company MCCPL had taken interest bearing funds from financial institution & during the year booked/claimed interest expenses of Rs.5,15,52,654/- in its books of accounts. Since the assessee company had not charged any interest (estimated at Rs.5,02,48,524/-) on these loans of Rs.33,49,90,162/- given to the trust [out of which Rs.30,18,90,162/- was opening balance & Rs.3,31,00,000/- was advanced during the year under consideration], however paid interest on other loans, a notice u/s 148 of the IT Act was issued to the assessee after following the statutory procedure. The assessee in response to above notice filed its return of income on 18.04.2023 declaring the same income of Rs.6,82,55,180/- as was declared in original return of income. Subsequently, notices u/s 143(2) and 142(1) of the IT Act and show cause notice respectively were issued to the assessee. Being not satisfied with the reply and submission of the assessee wherein it was stated that the loan to M. M. Patel Public Charitable Trust was advanced from reserves and surplus and interest-free unsecured loans available with the assessee company, the Assessing Officer disallowed the proportionate interest expenses of Rs.5,02,48,524/- out of total interest expenses of Rs.5,15,52,654/- claimed by the assessee and added the same to the income of the assessee. Accordingly, the Assessing Officer vide order dated 30.05.2024 passed the assessment order u/s 143(3) r.w.s. 147 of the IT Act by determining income of the assessee at Rs.11,85,03,704/- as against the income of Rs.6,82,55,180/- returned by the assessee. The above assessed income includes addition of Rs.5,02,48,524/- on account of disallowance of proportionate interest expenses claimed by the assessee.

6. Being aggrieved with the above assessment order, the assessee preferred an appeal before Ld. CIT(A). After considering the reply and submissions of the assessee, Ld. CIT(A) allowed the appeal filed by the assessee by accepting the argument of the assessee company that interest-free advances to M. M. Patel Public Charitable Trust have been given from reserves and surplus and interest-free funds available with the assessee company and therefore, deleted the addition of Rs.5,02,48,524/- regarding disallowance of proportionate interest expenditure by observing as under :-

“5.2 During appellate proceedings, the appellant contended that interest free advances given to the Trust is justified on the ground of availability of interest free funds, commercial expediency, and business consideration and hence no interest disallowance is called for. The appellant relied in the decision of the Hon’ble Bombay High court in the case of CIT Vs. Reliance Utilities & Power Ltd. (2009) 313 ITR 0340 (Bom), which had been upheld by Hon’ble Supreme Court in the case of CIT Vs. Reliance Industries Ltd [2019] 102 taxmann.com 52 (SC) and the order of CIT (Appeal) NFAC dated 20.01.2023, in assessee’s own case for AY 2013-2014, AY 2014-2015 and AY 2015-2016. The relevant part of the submission of the appellant on 15.09.2025 which is reproduced as under:

“1) With respect to disallowance of proportionate interest expenditure of Rs 50248524/- on interest free advance/loan given to MM Patel Public Charitable Trust, the assessee would like to submit as under:

The assessee, Mehul Construction Company Private Limited is in the business of construction of roads and buildings. During the year under consideration, the assessee Company has incurred interest expenditure in respect of loans/borrowings availed from banks, financial institutions, directors & their relatives, which were utilized for the purpose of business.

The assessee had advanced the interest free unsecured loans from time to time to M M Patel Public Charitable Trust, (the ‘Trust’), a trust promoted by the directors of the assessee Company, registered under The Bombay Public Trust Act and also u/s. 12AA of the Act. The main object of the Trust is education. The assessee Company has advanced an aggregate of sums of Rs 33,49,90,162/- till 31.03.2017, (entirely consisting of opening balance of Rs 33,49,90,162/-) in the form of interest free unsecured loans to facilitate to meet some portion of margin money to be raised by the Trust against the term loan from banks, for setting up the project of medical college with attached hospital. The office of the Charity Commissioner while granting approval to the Trust for accepting unsecured loan from the assessee Company, stipulated the condition that the said loan should be interest free. The copy of the order of the Charity Commissioner has been placed on record during assessment proceedings. The same is enclosed here with for your honour’s kind perusal as Annexure 1. Moreover, the lender bankers of the Trust also stipulated the condition that the said unsecured loan shall be treated as quasi capital and should not be repaid till the repayment of their entire bank loan.

The assessee Company has been awarded by the said Trust the contract of construction of medical college and hospital building worth Rs. 102.81 Cr. as a lowest bidder, approved by the official of the Charity Commissioner. Accordingly, besides commercial expediency, the said interest free loan advanced to trust is also out of business dealings with the trust.

During the year under consideration the assessee Company has not made any fresh advance to M M Patel Public Charitable Trust. The closing balance of short term/long term advance made by assessee company to M M Patel Public Charitable Trust as on 31/3/2017 is Rs 33,49,90,162/-. As against this the assessee company is having own funds (i.e., Share capital + Reserves) of Rs 46,17,93,720/-. The said fact can be verified from the financial statements of the company. The assessee company is also having unsecured loans of Rs 21,30,823/-on which assessee has not paid any interest.

Thus, as against interest free advance of Rs 33,49,90,162/-, the assessee company is having interest free funds of Rs 46,39,24,543/- (i.e., Rs 46,17,93,720 + Rs 21,30,823) and hence no interest disallowance is called for.

In order to justify that interest bearing funds have been utilized for the business purposes, we would like to draw your honour’s attention to the fact that during preceding seven years, i.e. starting from AY 2011-2012, the assessee company has made additions to the fixed assets worth Rs 1,827.42 lakhs, which ultimately resulted in significant increase in turnover from Rs 2,968.60 lakhs in AY 2011-2012 to Rs 13,327.59 lakhs in AY 2017-2018 i.e. year under consideration Thus, it can be very well said that the interest bearing funds have been fully utilized for the purpose of business of the assessee Company.

We would further like to state that, ours is not the case where the interest-bearing funds were borrowed and given, in turn, as interest free advances to the Trust, since the loan accounts of banks are composite account, i.e. the cheques were issued to the Trust from the business receipts which are credited to these bank accounts. It is, therefore, submitted that the only source available for advancing the interest free funds to the trust was out of share capital; free reserves blended with accumulated profit and accumulated depreciation for the earlier years.

Thus, from the above discussions, it is submitted that the interest-bearing funds have been utilized exclusively to discharge the assessee’s direct business obligations. It is also submitted that the interest free advances given to the Trust is justified on the ground of availability of interest free funds, commercial expediency, and business consideration and hence no interest disallowance is called for.

It is further submitted that Hon’ble Bombay High court in the case of CIT Vis. Reliance Utilities & Power Ltd. (2009) 313 ITR 0340 (Born), wherein Hon’ble Bombay High court in para 10 has observed that:

“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. (supra) had the occasion to consider the decision of the Calcutta High Court in Woolcombers of India Ltd. (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 assessee 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 Woolcomber’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(A) and Tribunal.”

The above ratio has been upheld by Hon’ble Supreme Court in CIT Vs. Reliance Industries Ltd [2019] 102 taxmann.com 52 (SC).

It is humbly submitted that ratio of above judgment applies in full force in assessee’s case.

Going further CIT (Appeal) NFAC, in assessee’s own case for AY 2013-2014, AY 2014-2015, and A Y 2015-2016, has decided matter in favour of the assessee company. The copies of the said orders are enclosed here with as Annexure 2. Till date the department has not contested the decision of CIT (Appeal) NFAC in ITAT and period of sixty days for filling appeal to ITAT has been expired. Thus, in effect the department has accepted the decision of CIT (Appeal) NFAC. Therefore, it is humbly requested that to keep consistency in judicial proceedings no interest disallowance is required for, considering that the facts before CIT (Appeal) NFAC and the AO were identical.

Thus, Considering the facts of the case and relevant judicial pronouncements, it is humbly requested to your honour that addition made on account of proportionate interest disallowance of Rs 50248524/- may please be deleted”

5.3 I have carefully considered the facts of the case, the finding of the AO and submissions of the appellant.

5.4 The relevant part of the finding of the CIT (Appeal) NFAC dated 20.01.2023, in assessee’s own case for AY 2015-16 is as under:

“7. The addition made by the Assessing Officer and the submissions of the appellant have been perused. It is a fact that the appellant company advanced funds of Rs.4,75,75,000/-during the year under consideration and total loan advanced till end of the year is Rs.21,56,49,000/- to M.M. Patel Public Charitable Trust. The AO disallowed proportionate interest expenditure incurred for non-business purpose not being incidental to business activity. However, the appellant claims that it had advanced funds to the Trust towards the part fulfilment of margin money to be raised by the trust for treating it quasi capital by the bank lenders against their loans. The appellant claims that it had advanced funds from the availability of interest free funds and placed reliance on the decision of Hon’ble Supreme Court of India in the case of CIT vs. Reliance Industries Ltd. in Civil Appeal Nos.35,37,38 & 39 of 2019 dated 02.01.2019. On examination of the details submitted by the appellant, it is seen that the appellant is having sufficient interest free funds (about Rs.31,60,46,264) to advance to the trust. Considering the facts and circumstances of the case and following the decision of Hon’ble Supreme Court cited supra, the addition made by the AO is deleted. Hence Ground Nos. 1 & 2 are allowed.”

5.5 It is a fact that the appellant company had advanced loan of Rs.NIL during the year under consideration and total loan advanced till end of the year is Rs. 33,49,90,162/- to M.M. Patel Public Charitable Trust. On examination of the details submitted by the appellant and Balance Sheet as at 31st March 2017, it is seen that the appellant is having sufficient interest free funds in the form of Reserve and Surplus amounting to Rs. 44,13,38,820/- to advance above loans to the Trust. Considering the facts and circumstances of the case and following the decision of the Hon’ble Bombay High court in the case of CIT Vs. Reliance Utilities & Power Ltd. (supra) which had been upheld by Hon’ble Supreme Court in the case of CIT Vs. Reliance Industries Ltd (supra) and the order of CIT (Appeal) NFAC dated 20.01.2023, in assessee’s own case for AY 2013-2014, AY 2014-2015 and AY 2015- 2016, I am of the considered view that the AO was not justified in making disallowance of interest expenses amounting to Rs.5,02,48,524/-. Accordingly, Ground Nos. 1 & 2 are allowed.”

7. It is the above order against which the Revenue is in appeal before this Tribunal.

8. We have heard Ld. counsels from both the sides and perused the material available on record including the paper book furnished by the assessee. In this regard, we find that the Revenue has raised as many as 7 grounds of appeal which are mainly against the deletion of disallowance of proportionate interest expenses of Rs.5,02,48,524/- by Ld. CIT(A). In this regard, we find that the Assessing Officer did not accept the contention of the assessee company that interest-free advances were given from available interest-free funds and out of reserves and surplus available with the assessee company. We also find that for earlier three assessment years under identical facts similar addition was made in the case of the assessee by disallowing the proportionate interest expenditure and Ld. CIT(A) was pleased to delete the addition.

Copy of orders passed by Ld. CIT(A) for immediate preceding 3 years i.e. assessment years 2013-14 to 2015-16 in favour of the assessee are also perused by us. However, we find that the Revenue has not challenged the above first appellate orders passed by Ld. CIT(A) for the immediately 3 preceding years i.e. for assessment years 2013-14 to 2015-16 involving the identical issue of deletion of proportionate interest expenditure, although the tax effect in two of the cases was more than the monetary limits prescribed for filing the second appeal before this Tribunal. This fact of non-filing of second appeal against the orders passed by Ld. CIT(A) itself demonstrates that the Revenue has accepted the orders passed by Ld. CIT(A) for earlier assessment years wherein Ld. CIT(A) deleted the identical addition towards disallowance of proportionate interest expenditure.

9. Apart from this fact of non-filing of second appeal before the Tribunal, we also find that Ld. CIT(A) after considering the detailed written submissions furnished by the assessee has given a categorical finding that the assessee company has advanced loan to MMPPCT out of reserves & surplus & also out of interest-free funds available with the assessee company. In this regard, various relevant details including list of interest-free funds available with the assessee company, and details of unsecured loans availed by the assessee was also produced before the lower authorities. We find that the assessee company in its written submission furnished before Ld. CIT(A) has explained that the closing balance in the name of MMPPCT never exceeded the Reserves & Surplus available with the assessee company & in support of these contentions, the assessee company successfully demonstrated that the closing balance of short term/long term advance made by assessee company to M. M. Patel Public Charitable Trust as on 31/3/2016 is Rs.33,49,90,162/-. As against this, the assessee company is having own funds (i.e., Share capital + Reserves) of Rs.42,61,17,545/-. The said fact was duly verified by Ld. CIT(A) from the financial statements of the assessee company. As per the submissions made before Ld. CIT(A), the assessee company was also having unsecured loans of Rs.21,71,468/- on which assessee has not paid any interest. It was also submitted before Ld. CIT(A) that the interest-free unsecured loan was provided to MMPPCT to facilitate to meet some portion of margin money to be raised by the trust against the term loan from banks for setting up the project of medical college with attached hospital. It was also pointed out before us that the lender banker of the trust also stipulated the condition that the said unsecured loan shall be treated as quasi capital and should not be re-paid till the repayment of their entire bank loan. We also find that the assessee company has produced copy of order passed by Charity Commissioner wherein permission was granted to MMPPCT to obtain interest-free loan from others for the purposes of construction of hospital consisting of 500 beds.

10. The Revenue has also raised a ground that the case law in the case of CIT v. Reliance Utilities & Power Ltd. relied on by the assessee is not applicable to the facts of the case, since the issue involved was investment in sister concern & in the instant case in hand the issue is with regard to interest free loan to related trust. In this regard, it is apposite to quote the relevant operative portion of the above judgment (supra)

“10. ……… 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”.

11. A bare perusal of the aforesaid makes it clear that the presumption as propounded by the Hon’ble High Court of Bombay in the case of CIT v. Reliance Utilities & Power Ltd, also squarely applies in the instant case at hand notwithstanding the fact that the amount in this case was given as interest free loan to the related trust rather than investment in the assessee’s sister concern as in the case of CIT v. Reliance Utilities & Power Ltd. The presumption is dependent upon the availability of surplus funds and not on the nature of advance to the other entity.In this case this presumption is established considering the concurrent finding of fact by Ld CIT(A) that all the interest free advances have been given from reserves & surplus & also out of interest-free funds available with the assessee company which is evident from the closing balance of short term/long term advance made by assessee company to M. M. Patel Public Charitable Trust as on 31/3/2016 is Rs.33,49,90,162/-. As against this, the assessee company is having own funds (i.e., Share capital + Reserves) of Rs.42,61,17,545/-, which is obviously more than the interest-free loan amount. The said fact was duly verified by Ld. CIT(A) from the financial statements of the assessee company.

12. Under the above facts & in the circumstances of the case, we do not find any infirmity in the orders passed by Ld. CIT(A) & accordingly, the same is confirmed wherein Ld. CIT(A) deleted the addition of proportionate expenditure of interest claimed by the assessee by accepting the argument of the assessee company that all the interest-free advances have been given from reserves & surplus & also out of interest-free funds available with the assessee company. Thus, the grounds of appeal raised by the Revenue are dismissed.

13. In the result, the appeal filed by the Revenue in ITA No.2918/PUN/2025 for A.Y. 2016-17 is dismissed.

ITA Nos.2906 & 2943/PUN/2025,
A.Y. 2017-18 & 2018-19 :

14. Since the facts and issues involved in both the above appeals of the Revenue in ITA Nos.2906 & 2943/PUN/2025 for A.Ys. 2017-18 & 2018-19 are identical to the appeal of the Revenue in ITA No.2918/PUN/2025 for A.Y. 2016-17 therefore, our decision in ITA No.2918/PUN/2025 for A.Y. 2016-17 shall apply mutatis mutandis to the appeal of the Revenue in ITA Nos.2906 & 2943/PUN/2025 for A.Ys. 2017-18 & 2018-19. Accordingly, the appeal of the Revenue in ITA Nos.2906 & 2943/PUN/2025 for A.Ys. 2017-18 & 2018-19 are also dismissed.

15. To sum up, all the above captioned three appeals filed by the Revenue are dismissed, as indicated above.

Order pronounced on this 10^th day of June, 2026.