2025 (7) TMI 749 - AT - Income Tax

Disallowance of interest made u/s 36(1)(iii) - interest-free and interest-bearing loans and advances given by the assessee to its subsidiary companies - HELD THAT - In the present case it is an undisputed fact that during the year under consideration no interest-free loans were advanced by the assessee to the subsidiary companies and all the interest-free loans were granted in the preceding years. Therefore respectfully following the decisions in assessee s own case in preceding years 2020 (9) TMI 276 - ITAT MUMBAI the disallowance made under section 36(1)(iii) of the Act is deleted. As a result the grounds raised by the assessee are allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

- Whether the disallowance of interest under section 36(1)(iii) of the Income Tax Act, 1961 ("the Act") made by the Assessing Officer (AO) and upheld by the Commissioner of Income Tax (Appeals) (CIT(A)) is justified.

- Whether the National Faceless Appeal Centre (NFAC) erred in not following the Tribunal's earlier orders in the assessee's own case for assessment years (AYs) 2010-11 through 2014-15, wherein similar disallowances under section 36(1)(iii) were deleted.

- Whether the NFAC erred in not following the CIT(A)'s orders for AYs 2009-10 and 2015-16, which deleted the interest disallowance following the Tribunal's precedents.

- Whether the interest-free loans advanced by the assessee to its subsidiaries were out of its own surplus funds and not from interest-bearing borrowed funds, and thus, the interest disallowance is unwarranted.

- Whether the NFAC erred in ignoring the Bombay High Court's ruling in HDFC Bank Limited that where the assessee's own funds exceed investments, it is presumed that investments are made out of interest-free funds.

- Whether the interest-free loans were advanced out of commercial expediency, negating the basis for interest disallowance under section 36(1)(iii).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of Disallowance of Interest under Section 36(1)(iii) of the Act

Relevant Legal Framework and Precedents: Section 36(1)(iii) of the Act permits disallowance of interest expenses where interest-bearing borrowed funds are used for purposes other than business or profession. The principle is that interest paid on borrowed funds used for non-business purposes is not deductible. The Bombay High Court decision in CIT vs. HDFC Bank Limited (2014) 366 ITR 505 (Bom.) held that if the assessee's own funds exceed investments, it is presumed investments are made from interest-free own funds, negating disallowance.

Court's Interpretation and Reasoning: The AO disallowed Rs. 56,05,710/- of interest paid on working capital loans, reasoning that the assessee failed to prove that interest-bearing borrowed funds were not used to advance interest-free loans to subsidiaries. The CIT(A) granted partial relief by adjusting disallowance for amounts already disallowed under section 43B and excluding certain interest items. However, the NFAC upheld the disallowance.

Key Evidence and Findings: The assessee's books showed outstanding interest-free loans to subsidiaries amounting to Rs. 27.94 crores as on 31.03.2017, advanced in earlier years, and interest-bearing loans of Rs. 6.14 crores advanced during the year. The assessee submitted that interest-free loans were advanced out of surplus own funds and for commercial expediency, supported by operating cash inflows and the nature of the subsidiaries' business.

Application of Law to Facts: The Tribunal noted that no interest-free loans were advanced during the year under consideration; all interest-free loans were from prior years. The Tribunal relied on the Bombay High Court precedent and the assessee's own funds exceeding the amounts advanced interest-free, supporting the presumption that interest-free loans were out of own funds and not borrowed funds.

Treatment of Competing Arguments: The Revenue argued that the assessee failed to prove the nexus between interest-bearing loans and interest-free advances and the commercial necessity for such advances. The assessee countered by relying on consistent precedents in its own case and judicial authority. The Tribunal found the assessee's submissions and precedents persuasive and noted no contrary fact or law.

Conclusion: The disallowance under section 36(1)(iii) was not sustainable as the interest-free advances were out of own funds and made for commercial expediency. The interest paid on borrowed funds was thus allowable.

Issue 2: Applicability of Earlier Tribunal and CIT(A) Orders in the Assessee's Own Case

Relevant Legal Framework and Precedents: The principle of consistency and judicial discipline requires that identical issues in the same case be decided uniformly unless there is a change in law or facts. The Tribunal's earlier orders for AYs 2010-11 through 2014-15, and CIT(A)'s orders for AYs 2009-10 and 2015-16, had deleted similar disallowances under section 36(1)(iii).

Court's Interpretation and Reasoning: The Tribunal extensively referred to its coordinate benches' decisions in the assessee's own case, which had consistently held that no disallowance under section 36(1)(iii) arises when interest-free loans are advanced out of own funds and for commercial expediency. The Tribunal also noted that the Revenue's appeal against the Tribunal's order for AY 2010-11 was dismissed by the jurisdictional High Court, reinforcing the binding nature of those precedents.

Key Evidence and Findings: The Tribunal examined detailed records and orders from prior years, including the Tribunal's order dated 17.07.2020 for AY 2013-14 and the CIT(A)'s order for AY 2015-16, which followed the Tribunal's precedents. The Tribunal observed that the facts in the current year were identical to those in earlier years.

Application of Law to Facts: Given the identical facts and absence of any contrary legal position, the Tribunal applied the principle of judicial consistency and followed the earlier decisions, thereby deleting the disallowance.

Treatment of Competing Arguments: The Revenue contended that the AO and NFAC were correct in disallowing interest. However, the Tribunal found that the NFAC erred in not following the binding precedents and the CIT(A)'s own orders. The assessee's argument of commercial expediency and sufficient own funds was accepted.

Conclusion: The Tribunal held that the NFAC erred in disregarding the earlier orders and deleted the disallowance accordingly.

Issue 3: Whether Interest-Free Loans Were Advanced Out of Own Surplus Funds and for Commercial Expediency

Relevant Legal Framework and Precedents: The Bombay High Court in HDFC Bank Limited established the presumption that where own funds exceed investments, the investments are out of interest-free funds. Commercial expediency is recognized as a legitimate business reason for advancing interest-free loans to subsidiaries, negating disallowance under section 36(1)(iii).

Court's Interpretation and Reasoning: The Tribunal noted that the assessee had sufficient own funds and operating cash inflows during the year. The interest-free loans were advanced to subsidiaries engaged in the same line of business, supporting the claim of commercial expediency. The Tribunal found no evidence that borrowed funds were used to finance interest-free advances.

Key Evidence and Findings: The detailed loan account analysis showed that interest-free loans were outstanding from prior years, and no fresh interest-free loans were advanced during the year. The assessee's submissions and financial data supported the claim of surplus own funds.

Application of Law to Facts: The Tribunal applied the legal presumption from HDFC Bank Limited and accepted commercial expediency as a valid business purpose, thereby negating the basis for interest disallowance.

Treatment of Competing Arguments: The Revenue's argument that the assessee failed to prove nexus and commercial necessity was rejected in light of the evidence and binding precedents.

Conclusion: The interest-free loans were advanced out of own surplus funds and for commercial expediency; hence, the interest disallowance was unwarranted.

3. SIGNIFICANT HOLDINGS

The Tribunal's crucial legal reasoning includes the following verbatim excerpt from its earlier order relied upon in the present case:

"Respectfully following the decision of the Coordinate Bench in earlier assessment years, wherein it was held that the assessee has sufficient interest free funds available with it and the advances was given for commercial expediency; hence we are in agreement with the submissions of the assessee that this ground of appeal is covered in favour of the assessee. Hence, we are inclined to delete the addition/disallowance under Section 36(1)(iii) of the Act. No contrary fact or law is brought to our notice."

Core principles established:

• Interest disallowance under section 36(1)(iii) is not warranted where interest-free loans are advanced out of the assessee's own surplus funds and not out of interest-bearing borrowed funds.
• Commercial expediency is a valid business purpose for advancing interest-free loans to subsidiaries, negating disallowance.
• Precedents in the assessee's own case and binding judicial decisions must be followed unless there is a material change in facts or law.
• The presumption established by the Bombay High Court in HDFC Bank Limited applies, whereby if own funds exceed investments, investments are presumed to be out of interest-free funds.

Final determinations on each issue:

• The disallowance of interest under section 36(1)(iii) of the Act made by the AO and upheld by the NFAC was deleted.
• The NFAC erred in not following the Tribunal's and CIT(A)'s earlier orders in the assessee's own case.
• The interest-free loans were advanced out of own surplus funds and for commercial expediency, thus no nexus existed to justify disallowance.