Commercial expediency-Disallowance for loan-advance u/s 40A(2).Once commercial expediency established beyond doubt no further test to be applied -Allahabad High Court

Commercial expediency-Disallowance for loan-advance u/s 40A(2).Once commercial expediency established  beyond doubt no further test to be applied -Allahabad High Court

ABCAUS Case Law Citation:
ABCAUS 1152 (2017) (03) HC

Question for determination:
In short, the question sought to be answered by the Hon’ble High Court was whether the Income Tax Appellate Tribunal (ITAT) was justified in law in dismissing the appeal filed by the Revenue holding that loan given sister concern was a trade advance and that the Assessing Officer had not been able to establish that there was a direct nexus between borrowed funds and the advance given.

Brief Facts of the Case:
The assessee was a private limited company and was engaged in the manufacture and sale of leather shoe, leather and trading of detergents. The assessee company had got certain quantities of detergent manufactured by a sister concerned.

In the course of assessment proceedings the Assessing Officer (‘AO’) observed that the assessee had advanced money to the sister concern against which the supplies made buy the sister concern to the company was only approx 50% of the value of the advance made and the balance amount remained by way of advance under the head of sundry creditors. It was further noted by the AO that during the relevant assessment year, the total advance given by the assessee to its sister became more than Rs.18 crores  

On the contrary, the assessee’s case was that the sister concern was engaged in the activity of manufacturing branded detergent exclusively for the assessee. In view of the same the assessee claimed existence of commercial expediency for making advance to its sister concern.

However, not accepting the assessee’s submissions, the AO in view of the fact that no interest had been charged on the advance, made a disallowance under Section 40A(2) (b) read with Section 36 of the Income Tax Act, 1961 (‘the Act’) of interest paid on borrowed funds. 

Being aggrieved by the assessment order, the assessee carried it before the CIT (Appeals), who allowed the appeal of the assessee after accepting the contention with regard to the existence of commercial expediency for making advances. The CIT(A) also observed that the assessee company had sufficient share capital, Reserve, Surplus and current year profit etc of Rs.41 crores which were sufficient to cover the trade advance given.

The Tribunal, also dismissed the appeal of the Revenue and upheld the finding of the CIT (Appeals) with respect to commercial expediency and also the availability of surplus funds.

Observations made by the High Court:
The Hon’ble High Court observed that it was not disputed that the sister concern was engaged solely in manufacturing the goods for the exclusive use of the assessee and thus, the existence of commercial expediency was established beyond doubt.

The Hon’ble Court stated that No further test was possible to be applied to determine whether the amount of advance given was proportionate to the commercial expediency that had been established by the assessee especially when the Tribunal had further recorded that assessee had recorded sales of Rs.7 crore this year and Rs.44 crore next year. 

The Hon’ble High Court noted that the Hon’ble Apex Court in the case of S.A. Builders Ltd. had held that

“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.  

35. We agree with the view taken by the Delhi High Court in CIT vs. Dalmia Cement (Bhart) 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.”

Held:
Answering the questions of law raised in favour of the assessee and against the revenue, the Hon’ble High Court dismissed the appeal.