No Disallowance Of Interest In Absence of Nexus Between Borrowed Funds And Advances: ITAT New Delhi

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) on 27 February, held that interest disallowance under Section 36(1)(iii) of the Income-tax Act, 1961 cannot be sustained in the absence of a nexus between borrowed funds and interest-free advances, particularly where such advances were granted in years preceding the borrowings and were supported by commercial expediency.

A Bench comprising Judicial Member Satbeer Singh Godara and Accountant Member Amitabh Shukla deleted the addition of Rs. 43,86,674 made towards alleged diversion of interest-bearing funds and allowed the appeal filed by Shivam Agrioils Private Limited (the taxpayer) for Assessment Year 2018-19.

The Tribunal held:

"the borrowed funds on which interest was paid have no relation to the advances given by the assessee company. Further, the advancement of non-interest-bearing funds as loans and advances cannot be any reason for presuming that the assessee company had advanced interest-bearing funds as loans and advances."

The disallowance arose on the allegation that the taxpayer had diverted borrowed capital to grant interest-free long-term advances to third parties. The Assessing Officer held that the taxpayer failed to establish that the borrowed funds were utilised wholly and exclusively for business purposes. The CIT(A) affirmed the addition.

Before the Tribunal, the taxpayer submitted that the advances in question were granted during Financial Years 2014-15 and 2015-16 for the acquisition of industrial property. However, the interest-bearing unsecured loans, which formed the basis of the disallowance, were raised only in Financial Year 2017-18. It was argued that there could be no nexus between borrowings raised subsequently and advances already existing on the books.

Accepting this contention, the Bench observed that it was a temporal impossibility for funds borrowed in FY 2017-18 to have financed advances granted in earlier years. In the absence of any direct nexus, the foundational requirement for invoking Section 36(1)(iii) failed.

The Tribunal further noted that the taxpayer possessed sufficient own funds at the time the advances were made. In such circumstances, settled jurisprudence raises a presumption that interest-free advances are made out of interest-free funds and not from borrowed capital.

On the question of commercial expediency, the Bench recorded that the advances were made towards purchase of industrial property and that the transaction could not be completed due to default on the part of the seller. The taxpayer had initiated proceedings before the National Company Law Tribunal against the delinquent seller to recover its dues.

The Tribunal treated the initiation of NCLT proceedings as a strong indicator of a bona fide business transaction. It observed that while the lower authorities had acknowledged the pendency of such proceedings, they failed to draw the logical conclusion that the existence of recovery litigation substantiated business intent. Reliance on surmises and conjectures, despite admitted facts, could not justify the disallowance.

The Bench stated:

"the assessee has sufficiently proved that it has own funds to make such advances and that the same were utilized for business purposes only. The assessee has also granted advance for purchase of property in the earlier years and the amount on which interest was paid was borrowed during the year under consideration. Hence, there was no nexus between interest-bearing funds and interest-free advances given by the assessee company."

Holding that the Revenue had neither established diversion of borrowed funds nor rebutted the presumption arising from availability of own funds, the Bench directed deletion of the addition of Rs. 43,86,674.

Accordingly, the Tribunal allowed the appeal.

For Appellant: CA, Neeraj Mangla

For Respondent: Senior DR, Ankush Kalra