Latest Expert Exchange Queries
sitemapHome | Registration | Job Portal for CA's | Expert Exchange | Currency Converter | Post Matrimonial Ads | Post Property Ads
News shortcuts: From the Courts | News Headlines | VAT (Value Added Tax) | Service Tax | Sales Tax | Placements & Empanelment | Various Acts & Rules | Latest Circulars | New Forms | Forex | Auditing | Direct Tax | Customs and Excise | ICAI | Corporate Law | Markets | Students | General | Indirect Tax | Mergers and Acquisitions | Continuing Prof. Edu. | Budget Extravaganza | Transfer Pricing
Popular Search: TDS :: form 3cd :: articles on VAT and GST in India :: ACCOUNTING STANDARDS :: VAT RATES :: empanelment :: ARTICLES ON INPUT TAX CREDIT IN VAT :: VAT Audit :: TAX RATES - GOODS TAXABLE @ 4% :: list of goods taxed at 4% :: due date for vat payment :: cpt :: Central Excise rule to resale the machines to a new company :: ICAI offer Get Windows 7,Office 2010 in Rs.799 Taxes :: ACCOUNTING STANDARD
News Headlines »
 8 benefits you must know about this tax-saving mutual fund
 10 most important income-tax changes which will apply from April 1
 Delhi: 54 CAs, company secretaries on radar in I-T crackdown against black money
 10 Income Tax Rules That Will Change From April. See Details Herea
 Looking for last-minute tax planning with Section 80C investments? Here's help
 Aadhaar mandatory for filing income tax return
 Will Aadhaar linkage solve India's income tax woes?
 GST roll out from July 1 will make goods cheaper: Jaitley
 Aadhaar To Be Mandatory For Filing Income Tax Return, PAN Application
 7 best tax-saving solutions which can help you save money
  No proposal to replace Income Tax with Banking Cash Transaction Tax

Diversion of borrowed funds
October, 28th 2006


It is for the assessee-company to prove that the borrowals were utilised for its own business and that the diversion to the sister firm was out of its capital.

A company has paid-up capital and reserves. It has borrowed heavily from financial institutions and is paying huge interest on the loans. At the same time, it has advanced loans to sister concerns without charging interest. How is the assessing officer (AO) to deal with the claim for deduction of interest paid on borrowals under Section 36(1)(iii) of the Income-Tax Act, 1961? There are several ways of looking at the matter.

If the company has adequate interest-free funds by way of proprietary capital or deposit from customers, there can be an inference that borrowed funds are not diverted for non-business purposes. This was the view of the Allahabad High Court in CIT vs Prem Heavy Engineering Works (P) Ltd (285 ITR 554). The court had cited a number of precedents in support of its ruling.

Utilisation in business

Where the funds of the company are so mixed-up that it is not possible to identify the extent of borrowing utilised in such loans, the Madras High Court felt, in K. Somasundaram and Brothers vs CIT (238 ITR 939), that a proportionate amount could be disallowed. If the amount diverted was subsequently brought back into the business and utilised, the company could thereafter claim the interest paid as a deduction. But so long as the diversion continues, the company would be disentitled.

Now comes a leading judgment of the Punjab and Haryana High Court in CIT vs Abishek Industries Ltd (286 ITR 1). In this case, the AO disallowed claims made for interest paid under Section 36(1)(iii) of the Act on the ground that the company had made interest-free advances to its sister concerns. As the Tribunal decided the matter against the Revenue, the matter was taken to the court.

Exhaustive ruling

In an exhaustive judgment on the subject, the court dealt with the case from several angles. It pointed out that the entire money in a business entity comes from a common kitty. The money received as share capital, term loans, working capital loan, sale proceeds, etc., do not have different colour. Whatever be the receipts, they have the colour of business receipts with no separate identification. The only reason to disallow the interest paid on the borrowing to the extent the amount is lent to a sister concern without carrying any interest for non-business purposes would be that the company has some loans or other interest-bearing debts to be repaid.

In case the company had some surplus amount, which, according to the company, could not be repaid prematurely to any financial institution, still, the same is required either to be circulated and utilised for business or invested in a manner that generates income and not diverted to sister concerns free of interest. The sister concern would be enjoying the benefits of the assessee-company's borrowings. It cannot possibly be held that the funds to the extent diverted to sister concerns free of interest were required by the assessee-company for its business, and loans to that extent raised.

"We do not," said the High Court, "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 is no escape from the finding that interest being paid by the assessee to the extent the amounts are diverted to sister concerns on interest-free basis are to be disallowed."

A different view

It is for the assessee-company to prove that the borrowals were utilised for its own business and that the diversion to the sister firm was out of its capital. The High Court pointed out that in fact the capital of the company stood exhausted in setting up of the unit.

"A presumption may be raised in a given case as to why an assessee who for the purpose of running its business is required to borrow money from banks and other financial institutions, would be giving loan to its subsidiary companies and that too when it pays heavy interest to its lenders, it would claim no or little interest from its subsidiaries."

The Punjab and Haryana High Court chose to disagree with the Delhi, Allahabad, Calcutta and Madhya Pradesh High Court decisions. It cited the Supreme Courts Ruling in the McDowell case (154 ITR 148) in support of its views. The judgment of the Punjab and Haryana High Court needs to be considered at length, both by the Revenue and financial advisors, whenever matters concerning the interpretations of Section 36(1)(iii) of the Act come up for study.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)

Home | About Us | Terms and Conditions | Contact Us
Copyright 2017 CAinINDIA All Right Reserved.
Designed and Developed by Binarysoft Technologies Pvt. Ltd.
Binarysoft Technologies - We Bring IT. Offshore software outsourcing company. We use Global Delivery Model (GDM) and believe in Follow The Sun principle

Transfer Pricing | International Taxation | Business Consulting | Corporate Compliance and Consulting | Assurance and Risk Advisory | Indirect Taxes | Direct Taxes | Transaction Advisory | Regular Compliance and Reporting | Tax Assessments | International Taxation Advisory | Capital Structuring | Withholding tax advisory | Expatriate Tax Reporting | Litigation | Badges | Club Badges | Seals | Military Insignias | Emblems | Family Crest | Software Development India | Software Development Company | SEO Company | Web Application Development | MLM Software | MLM Solutions