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Tax relief for intra-corporate advances
December, 29th 2006

In a far-reaching judgement on intra-corporate advances, the Supreme Court has held that tax cannot be levied on a corporate if it transfers borrowed money to its subsidiary or any other entity, if the transaction is driven by commercial reasons.

The Supreme Court was deciding on the issue of whether interest on borrowed fund can be deducted in the computation of taxable income, even if the borrowed fund is transferred to a subsidiary company.

The apex court held that the only factor the income tax department should consider, is that if borrowing and advancing to a sister company is driven by commercial expediency. If the transaction is driven by objectives other than commercial, such deals cannot claim exemption from tax.

The Supreme Court added that if the directors of the sister concern utilise the money advanced to it for their personal benefit, it cannot be said such money has been given for commercial purpose.

We wish to make it clear that it is not in our opinion that in every case, interest on borrowed loan has to be allowed if the assessee advances it to a sister concern. It all depends on the facts and circumstances of the case, the court said.

Shri T P Ostwal, a senior chartered accountant, said: It is a decision that reflects the ground realities of doing business.

This courts judgement was related to a case involving SA Builders. This company had transferred Rs 82 lakh to its subsidiary company SAB Credit, out of the cash credit account in which there is a huge debit balance. It was an interest-free loan to the subsidiary.

The I-T department did not take the interest-free loan theory for granted. The departments opinion was that interest should have been claimed from the subsidiary by SA Builders.

It, therefore, disallowed deduction of over Rs 5 lakh as interest that should have been claimed from the subsidiary, while computing the expenditure by way of interest paid to the bank by SA Builders.

The Supreme Court held: It is true that borrowed amount in question was not utilised by the assessee in its own business but had been advanced as interest-free loan to its sister concern. However, in our opinion, that fact is not really relevant. What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency.

The apex court disagreed with contrary views taken by other appellate forums, including a Bombay High Court decision in Phaltan Sugar Works Vs Commissioner of Wealth Tax (1994) in which it was held that deduction under Section 36 (1) (iii) can only be allowed on the interest if the assessee borrows capital for its own business.

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