Income Tax Appellate Tribunal (ITAT) Kolkata in a recent judgment has upheld that there is no bar against advancing of loan interest-free or at a low rate of interest and No disallowance can be made of interest u/s 36(1)(iii) for advancing interest free loans advances out of own funds

Case Details:
I.T.A No. 356/Kol/2012 A.Y 2008-09
Income Tax Officer (Appellant) vs M/s. Snowtex Investment Ltd (Respondent)
Date of Order: 06-11-2015

Issue:
One of the issues to be decided in this appeal was whether in the facts and circumstances of the case, the interest on borrowed funds is to be disallowed as not meant for business purposes when loans and advances were advanced without interest?

Brief Facts of the Case:
The assessee had debited a sum of Rs. 62,84,112/- towards interest on loans in its profit and loss account. During the course of assessment proceedings the Assessing Officer (AO) found that the assessee on one hand had made borrowings amounting to Rs. 5,92,05,572/- and has also paid interest thereon, whereas on the other hand the assessee company had advanced monies to parties free of interest which is more than the borrowed funds and hence disallowed the entire interest payment of Rs. 62,84,112/- as not being incidental to the assessee’s business activity.

The assessee contested the disallowance before CIT(Appeals) granted relief to the assessee to the extent of availability of own funds with the assessee and partly disallowed interest on the utilization of borrowed funds to lend interest free advances. CIT(A) observed as under:

“….. … It is a contention of the A.R that once interest free funds are available to the company to give interest free advances, no disallowances should be made on interest paid. Therefore, the assessee company had deployed a sum of Rs.9.58 corres – 7.56 crores=Rs.2.02 crores as interest free advances out of interest bearing funds of Rs. 5.92 crores. The balance funds are utilized for business of share trading and giving loans and advances. Therefore, the disallowance of interest is restricted to the extent of Rs.2.02 crores/Rs.5.92 crores X Rs. 62,84,112/- = Rs.21,44,241/- and assessee is entitled to get relief of Rs.41,39,871/- (Rs.62,84,112/- - Rs.21,44,241/-). Therefore, ground no.5 is partly allowed.”

Important Excerpts from ITAT Judgment

We have heard the rival submissions and perused the materials available on record. We find that the Learned CITA had rightly granted relief to the assessee to the extent of availability of own funds with the assessee. This issue is now settled by the decision of the Bombay High Court in the case of Reliance Utilities and Power Ltd reported in 313 ITR 340 (Bom) wherein it was held that “Where an assessee has his own funds as well as borrowed funds, a presumption can be made that the advances for non-business purposes have been made out of own funds and that the borrowed funds have not been used for this purpose.”

It is further submitted that there is no bar against advancing of loan interest-free or at a low rate of interest. There may be very many considerations, including business considerations, for not charging interest or charging interest at a low rate. Dispute between the Revenue and the assessee often arises when money is borrowed with interest and loan is advanced interest-free or at a low rate of interest. In such a case the tendency of the AO generally is to disallow the interest paid on the money borrowed either in full or proportionately depending upon the quantum of loan advanced and interest, if any, charged. But whether the assessee charged interest on loan advanced or not is not at all a relevant consideration for determining allowability of interest paid under section 36(1)(iii) of the Act. As already explained, the relevant consideration is whether the moneys have been borrowed for the purposes of business or profession and whether interest paid.

In the interest of maintain good business relation, interest-free loans or loans at a low rate of interest may be given to others with whom the assessee has business relation or with whom he expects to establish business connection or with whom he has other business obligations, present or past. There may be many other reasons also, both business or non-business. If interest-free loan or loan at a low rate of interest is given for business consideration out of the capital borrowed with interest then also the borrowing would be for the purposes of business, and interest paid on the borrowed capital would be allowable as deduction under section 36(1)(iii) of the Act. There is no compulsion that interest should always be charged on any lending, nor there is any requirement that income must be earned by utilizing the capital borrowed with interest so as to be entitled to the deduction under section 36(1)(iii) of the Act.

Merely for the reason that interest was not charged or charged at a low rate on the lending, the interest paid for borrowing cannot be disallowed. It is a matter of business prudence and entirely upto the assessee as to how he utilizes the fund in the interest of his business. The basic requirement is that the borrowed capital should be used for the purposes of business or profession. An argument may be advanced that if interest-free loan had not been given then the assessee could have reduced his debt and consequently the interest payment”.

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