SECTION 36(1)(iii)/INCOME-TAX ACT

[2007] 158 TAXMAN 74 (SC)

SUPREME COURT OF INDIA

S.A. Builders Ltd.

v.

 Commissioner of Income-tax (Appeals), Chandigarh

S.B. SINHA AND MARKANDEY KATJU, JJ.

CIVIL APPEAL NOS. 5811 AND 5812 OF 2006

DECEMBER 14, 2006

Section 36(1)(iii) of the Income-tax Act, 1961 - Interest on borrowed capital - Assessment years 1990-91 and 1991-92 - Whether borrowed fund advanced to a third party should be for commercial expediency, if it is sought to be allowed under section 36(1)(iii) - Held, yes - Assessee borrowed fund from bank and advanced part of it to its sister concern (a subsidiary) as interest-free loan - Assessing Officer disallowed interest under section 36(1)(iii) on borrowings to extent those were advanced to subsidiary - Tribunal as well as High Court upheld order of Assessing Officer - Whether since neither High Court nor Tribunal and other authorities had examined whether amount advanced to sister concern was by way of commercial expediency, matter was to be remanded to Tribunal for a fresh decision in accordance with law - Held, yes

Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of - Assessment years 1990-91 and 1991-92 - Whether expenditure may not have been incurred under any legal obligation, yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency - Held, yes

FACTS

During the assessment proceedings for the assessment years 1990-91 and 1991-92, the Assessing Officer found that the assessee had advanced huge amounts as interest-free loans out of its cash credit account in which there was a huge debit balance. The Assessing Officer disallowed the proportionate interest relating to said amount out of total interest paid to bank, holding that the assessee had diverted its borrowed funds to its sister concern without charging any interest. On appeal, the Commissioner (Appeals) accepted partial claim of the assessee on ground that out of total amount advanced by the assessee only certain sum had a clear nexus with borrowed funds, as balance amount had been paid out of receipts from other parties to whom no interest had been paid. However, on cross appeals, the Tribunal allowed the revenues appeal. On the assessees appeal, the High Court held that order of the Tribunal did not suffer from any factual or legal infirmity, as the amount in question had been advanced by the assessee to its sister concern out of overdraft account in which there was already a huge debit balance.

On appeal to the Supreme Court :

HELD

In Madhav Prasad Jatia v. CIT AIR 1979 SC 1291, the Supreme Court held that the expression for the purpose of business occurring under the provision of section 36(1)(iii) is wider in scope than the expression for the purpose of earning income, profits or gains, and this has been the consistent view of the Supreme Court. [Para 20]

The High Court in the impugned judgment as well as the Tribunal and the income-tax authorities had approached the matter from an erroneous angle. In the instant case, the assessee borrowed the fund from the bank and lent part of it to its sister concern (a subsidiary) as interest-free loan. The test in such a case was really whether this was done as a measure of commercial expediency. [Para 21]

The decisions relating to section 37 will also be applicable to section 36(1)(iii) because in section 37 also the expression used is for the purpose of business. It has been consistently held in decisions relating to section 37 that the expression for the purpose of business includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if a third party also benefits thereby. [Para 22]

In Atherton v. British Insulated & Helsby Cables Ltd. [1925] 10 TC 155, it was held by the House of Lords that in order to claim a deduction, it is enough to show that the money is expended, not of necessity and with a view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly facilitate the carrying on of the business. [Para 23]

The High Court as well as the Tribunal and other income-tax authorities should have approached the question of allowability of interest on the borrowed funds from the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest-free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed. [Para 24]

The expression commercial expediency is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency. [Para 25]

No doubt as held in Madhav Prasad Jatias case (supra), if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under section 36(l)(iii). [Para 26]

Thus, the ratio of Madhav Prasad Jatia (supra), is that the borrowed fund advanced to a third party should be for commercial expediency, if it is sought to be allowed under section 36(1)(iii). [Para 27]

In the instant case, neither the High Court nor the Tribunal and other authorities had examined whether the amount advanced to the sister concern was by way of commercial expediency. [Para 28]

The High Court and other authorities should have examined the purpose for which the assessee advanced the money to its sister concern, and what the sister concern did with the money, in order to decide whether it was for commercial expediency, but that had not been done. [Para 30]

It is not in every case that 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 respective case. For instance, if the directors of the sister concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances. Where holding company, has a deep interest in its subsidiary, and the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the holding company would ordinarily be entitled to deduction of interest on its borrowed loans. [Para 35]

In view of the above, the appeals were to be allowed and the impugned judgments of the High Court, the Tribunals and other authorities were to be set aside and the matter was to be remanded to the Tribunal for afresh decision, in accordance with law and in the light of the observations made above.

CASE REVIEW

Decision of the Punjab and Haryana High Court in S.A. Builders Ltd. v. CIT [2004] 269 ITR 535/145 Taxman 107 - Reversed.

Decision of the Bombay High Court in Phaltan Sugar Works Ltd. v. CIT [1995] 215 ITR 582/[1994] 73 Taxman 518 and Phaltan Sugar Works Ltd. v.CWT [1994] 208 ITR 989/72 Taxman 325 - Disapproved.

Decision of the Delhi High Court in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377/121 Taxman 706 - Approved.

CASES REFERRED TO

S.A. Builders Ltd. v. CIT [2004] 269 ITR 535/145 Taxman 107 (Punj. & Har.) [Para 2], Madhav Prasad Jatia v. CIT AIR 1979 SC 1291 [Para 20],Atherton v. British Insulated & Helsby Cables Ltd. [1925] 10 TC 155 (HL) [Para 23], Eastern Investment Ltd. v. CIT [1951] 20 ITR 1 (SC) [Para 23], CIT v. Chandulal Keshavlal & Co. [1960] 38 ITR 601 (SC) [Para 23], CIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140 (SC) [Para 29],CIT v. Birla Cotton Spg. & Wvg. Mills Ltd. [1971] 82 ITR 166 (SC) [Para 29], Phaltan Sugar Works Ltd. v. CWT [1994] 208 ITR 989/72 Taxman 325 (Bom.) [Para 32], Phaltan Sugar Works Ltd. v. CIT [1995] 215 ITR 582/[1994] 73 Taxman 518 (Bom.) [Para 33] and CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377/121 Taxman 706 (Delhi) [Para 34].

Nidhesh Gupta, Vinod Shukla, Deepak Goel and Ms. S. Janani for the Appellant. Ravindra Srivastava, Ranvir Chandra, Ms. Shilpa Singh andB.V. Balaram Das for the Respondent.

JUDGMENT

Markandey Katju, J - Leave granted.

2. These two appeals involve common question of law and fact and hence are being disposed of by a common judgment.

Since the leading case is that of S.A. Builders Ltd. v. CIT [SLP(C) 21707-21710/2004] reported in [2004] 269 ITR 535 (Punj. & Har.), we shall be taking note of the facts of this case.

3. These appeals have been filed against the impugned judgment of the Punjab and Haryana High Court dated 13-5-2004 in Income-tax Appeal Nos. 6, 7, 119 and 120 of 2003, and the judgment dated 21-5-2004 in ITA No. 117/118 of 2003.

Heard learned counsel for the parties and perused the record.

4. During the course of the proceeding, for the relevant assessment year(s), the Assessing Officer under the Income-tax Act observed that the assessee had transferred a huge amount of Rs. 82 lakhs to its subsidiary company M/s. SAB Credits Limited out of the cash credit account of the assessee in which there was a huge debit balance. He, therefore, held that since the assessee had diverted its borrowed funds to a sister concern without charging any interest, proportionate interest relating to the said amount out of the total interest paid to the bank deserved to be disallowed. Accordingly, he disallowed a sum of Rs. 5,66,729.

5. The assessee preferred an appeal to the Commissioner of Income-tax (Appeals) Chandigarh [for short hereinafter referred to as the CIT(A)], who videhis order dated 15-4-1993 partially accepted the claim of the assessee. According to the CIT(A), out of the total amount of Rs. 82 lakhs advanced by the assessee in the relevant assessment year to M/s. SAB Credit Limited, only a sum of Rs. 18 lakhs had a clear nexus with the borrowed funds, as the balance amount had been paid out of the receipts from other parties to whom no interest had been paid. Accordingly, the CIT(A) directed the Assessing Officer to calculate disallowance of interest only relating to the sum of Rs. 18 lakhs, and the disallowance was reduced accordingly.

6. Both the assessee as well as the revenue filed appeals before the Income-tax Appellate Tribunal (hereinafter referred to as the Tribunal). The Tribunal by its order dated 20-6-2002 allowed the appeal of the revenue, and held that the entire amount of Rs. 82 lakhs had been advanced by the assessee by utilizing the overdraft account, and hence it was of the view that disallowance made by the Assessing Officer was justified. Accordingly, the appeal filed by the revenue was allowed and the appeal filed by the assessee was dismissed.

7. Against the order of the Tribunal, the assessee filed appeals in the High Court which were dismissed by the impugned judgment.

8. In the assessment year 1991-92, the Assessing Officer noticed that in addition to the sum of Rs. 82 lakhs advanced in the assessment year 1990-91, a further sum of Rs. 37,85,000 had been advanced to M/s. SAB Credits Ltd. which also had a clear nexus with the amounts borrowed by the assessee on payment of interest. Accordingly, the Assessing Officer disallowed proportionate interest relatable to these amounts amounting to Rs. 20,08,836.

9. On appeal by the assessee, the CIT(A) upheld the finding of the Assessing Officer that the sum of Rs. 37,85,000 advanced during assessment year 1990-91, was relatable to the borrowed funds. However, in view of the findings of her predecessor in assessment year 1990-91, that out of Rs. 82 lakhs advanced during that year, advance of Rs. 64 lakhs had no nexus with the borrowed funds, she reduced the disallowance from Rs. 20,08,836 to Rs. 10,03,538 videher order dated 28-7-1994. The assessee was granted further relief of Rs. 1,48,464 by the CIT(A) vide order dated 6-9-1995 under section 154 of the Act. On the cross-appeals filed by the assessee as well as the revenue, the Tribunal following its order for assessment year 1990-91, upheld the disallowance as made by the Assessing Officer. Accordingly, the appeal of the revenue on this issue was allowed and that of the assessee dismissed.

10. Against this decision also, the assessee filed an appeal before the High Court.

11. In the impugned judgment dated 13-5-2004, the High Court held that the Tribunal had recorded a categorical finding of fact that the amount advanced by the assessee to M/s. SAB Credits Limited by utilizing the overdraft account and that on the date on which the amount was advanced there was no credit balance in the bank account of the assessee. The Tribunal further observed that the assessee has not been able to explain the purpose for which the amount had been advanced to its sister concern without charging any interest and there was no material on record to show that the assessee had derived any business benefit by advancing the interest free amounts to its sister concern.

12. The High Court held that since it stands established that the amount of Rs. 82 lakhs and Rs. 37.85 lakhs had been advanced by the assessee to its sister concern from out of the overdraft account with the bank in which there was already a debit balance, the order of the Tribunal does not suffer from any factual or legal infirmity. Accordingly, the High Court dismissed the appeal.

13. Learned counsel for the appellant-assessee submitted that the High Court has erred in failing to consider the fact that the appellant had made the advances to its sister concern by withdrawals from its bank accounts in which there was sufficient credit balance as the appellant had received payments from its clients. It is an admitted fact that the appellant had received these payments from its clients and had deposited these in the account out of which advances were subsequently made to the sister concern. These deposits/payments/advances of Rs. 82 lakhs as and when received and made by the appellant to its sister concern, namely, SAB Credits Ltd. in the assessment year 1990-91 are reproduced hereunder in a tabular form :

14. Learned counsel for the appellant submitted that a perusal of the above tabular statement makes it apparent that such payments as claimed were in fact received and deposited. Thus, there is no direct nexus between the amount borrowed by the appellant-assessee from the bank and the loans advanced by the appellant-assessee to its sister concern, as no amount was so advanced by raising an interest bearing loan.

15. Learned counsel submitted that the High Court has erred in not considering the categorical finding of the CIT(A) in this regard. He further stated that the CIT(A) in its order dated 15-4-1993 had given a clear finding of fact that except a sum of Rs. 18 lacs there was no clear nexus between the amount received on interest and the interest free advance made to M/s. SAB Credits Limited. He further stated that the amount of Rs. 24 laks, 20 lakhs and 20 lakhs respectively, were not paid out of the cash credit account but were paid out of the receipts from other parties to whom no interest had been paid. The amount of Rs. 18 lakhs was paid out of the cash credit account because there was a debit balance of Rs. 18 lakhs on that date and, therefore, a clear nexus is proved in respect of the amount of Rs. 18 lakhs in the interest bearing loans and interest free advances. On this view, the CIT(A) held that the Assessing Officer should have only disallowed interest relatable to Rs. 18 lakhs and not the entire amount of Rs. 82 lakhs.

16. Learned counsel for the appellant submitted that even this disallowance of Rs. 18 lakhs by the CIT(A) was erroneous and the entire sum of Rs. 82 lakhs should have been allowed.

17. In paragraph 35-41 of its order the Tribunal has considered in detail the question of allowability of the interest amount on the borrowed funds. The Tribunal was of the view that the assessee had given an advance of Rs. 82 lakhs to its sister concern without charging any interest. The Tribunal further observed that there was no material on record to show that the assessee derived any business advantage by advancing an interest free amount of Rs. 82 lakhs to its sister concern. It referred to several decisions in support of the view which it took.

18. We have considered the submission of the respective parties. The question involved in this case is only about the allowability of the interest, on borrowed funds and hence we are dealing only with that question. In our opinion, the approach of the High Court as well as the authorities below on the aforesaid question was not correct.

19. In this connection we may refer to section 36(1)(iii) of the Income-tax Act, 1961 (hereinafter referred to as the Act) which states that the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession has to be allowed as a deduction in computing the Income-tax under section 28 of the Act.

20. In Madhav Prasad Jatia v. CIT AIR 1979 SC 1291, this Court held that the expression for the purpose of business occurring under the provision is wider in scope than the expression for the purpose of earning income, profits or gains, and this has been the consistent view of this Court.

21. In our opinion, the High Court in the impugned judgment, as well as the Tribunal and the Income-tax authorities have approached the matter from an erroneous angle. In the present case, the assessee borrowed the fund from the bank and lent some of it to its sister concern (a subsidiary) on interest free loan. The test, in our opinion, in such a case is really whether this was done as a measure of commercial expediency.

22. In our opinion, the decisions relating to section 37 of the Act will also be applicable to section 36(1)(iii) because in section 37 also the expression used is for the purpose of business. It has been consistently held in decisions relating to section 37 that the expression for the purpose of business includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if a third party also benefits thereby.

23. Thus in Atherton v. British Insulated & Helsby Cables Ltd. [1925] 10 TC 155, it was held by the House of Lords that in order to claim a deduction, it is enough to show that the money is expended, not of necessity and with a view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly to facilitate the carrying on the business. The above test in Athertons case, (supra) has been approved by this Court in several decisions e.g. Eastern Investments Ltd. v. CIT [1951] 20 ITR 1, CIT v. Chandulal Keshavlal & Co. [1960] 38 ITR 601 etc.

24. In our opinion, the High Court as well as the Tribunal and other income-tax authorities should have approached the question of allowability of interest on the borrowed funds from the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed.

25. The expression commercial expediency is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure, if it was incurred on grounds of commercial expediency.

26. No doubt as held in Madhav Prasad Jatias case (supra), if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under section 36(1)(iii) of the Act. In Madhav Prasad Jatias case (supra), the borrowed amount was donated to a college with a view to commemorate the memory of the assessees deceased husband after whom the college was to be named. It was held by this Court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.

27. Thus, the ratio of Madhav Prasad Jatias case (supra) is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed under section 36(1)(iii) of the Act.

28. In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.

29. It has been repeatedly held by this Court that the expression for the purpose of business is wider in scope than the expression for the purpose of earning profits vide CIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140, CIT v. Birla Cotton Spg. & Wvg. Mills Ltd. [1971] 82 ITR 166 etc.

30. The High Court and the other authorities should have examined the purpose for which the assessee advanced the money to its sister concern, and what the sister concern did with this money, in order to decide whether it was for commercial expediency, but that has not been done.

31. It is true that the borrowed amount in question was not utilized 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.

32. Learned counsel for the Revenue relied on a Bombay High Court decision in Phaltan Sugar Works Ltd. v. CWT [1994] 208 ITR 989 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. Hence, it was held that interest on the borrowed amount could not be allowed if such amount had been advanced to a subsidiary company of the assessee. With respect, we are of the opinion that the view taken by the Bombay High Court was not correct. The correct view in our opinion was whether the amount advanced to the subsidiary or associated company or any other party was advanced as a measure of commercial expediency. We are of the opinion that the view taken by the Tribunal in Phaltan Sugar Works Ltd.s case (supra) that the interest, was deductible as the amount was advanced to the subsidiary company as a measure of commercial expediency is the correct view, and the view taken by the Bombay High Court which set aside the aforesaid decision is not correct.

33. Similarly, the view taken by the Bombay High Court in Phaltan Sugar Works Ltd. v. CIT [1995] 215 ITR 585 also does not appear to be correct.

34. We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377 that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits.

35. We wish to make it clear that it is not 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 respective case. For instance, if the Directors of the sister concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, where it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans.

36. In view of the above, we allow these appeals and set aside the impugned judgments of the High Court, the Tribunals and other authorities and remand the matter to the Tribunal for a fresh decision, in accordance with law and in the light of the observations made above.

37. We also make it clear that we are not setting aside the order of the Tribunal or other income-tax authorities in relation to the other points dealt with by these authorities, except the point of deduction of interest on the borrowed funds.