1998 (2) TMI 162 - AT - Income Tax

Summary

Issues Involved:
1. Disallowance of interest on loans taken from financial institutions, banks, and inter-corporate loans.
2. Nexus between borrowed funds and investments in the subsidiary company.
3. Allowability of interest as a business expenditure.

Detailed Analysis:

1. Disallowance of Interest on Loans:
The assessee, a public limited company, claimed interest payments on loans taken from financial institutions, banks, and inter-corporate loans. The AO disallowed these interest claims for the assessment years 1989-90, 1990-91, and 1991-92, arguing that the loans were advanced to a subsidiary company without charging interest and for purposes not incidental to the assessee's legitimate business.

2. Nexus Between Borrowed Funds and Investments in Subsidiary Company:
The AO found that the assessee had invested substantial amounts in its subsidiary, Debikay Technology Ltd. (DTL), without receiving any allotment of shares. The AO concluded that the investments in DTL were not for business purposes, leading to the disallowance of interest on inter-corporate loans.

Before the CIT(A), the assessee contended that there was no nexus between the borrowings from PICUP and State Bank of Patiala and the investments in DTL. The AO's remand report confirmed that till the assessment year 1988-89, there was no investment of borrowed funds in DTL. However, for the assessment year 1989-90, the AO established a nexus between inter-corporate loans and investments in DTL, leading to a disallowance of Rs. 11,84,681.95.

3. Allowability of Interest as a Business Expenditure:
The CIT(A) upheld the AO's disallowance of interest on inter-corporate loans, stating that the investments in DTL were not for business purposes. The CIT(A) also disallowed interest on loans from PICUP and State Bank of Patiala, arguing that the funds generated from business activities could have been used to repay these loans, thereby reducing interest liability.

The Tribunal, however, found that the legal position as laid down by the Hon'ble Supreme Court and various High Courts does not warrant disallowance on this ground. The Tribunal cited the case of CIT vs. Madhav Prasad Jatia, which established that the conditions for claiming deduction of interest on borrowed capital are: (a) the money must have been borrowed by the assessee; (b) it must have been borrowed for the purpose of business; and (c) the assessee must have paid interest on the said amount and claimed it as a deduction.

The Tribunal concluded that the disallowance of interest on loans from PICUP and State Bank of Patiala for the assessment years 1989-90 and 1990-91 was unjustified, as there was no direct nexus between these loans and the investments in DTL. The Tribunal directed the AO to allow the interest claims accordingly.

For the assessment year 1991-92, the Tribunal noted that the assessee had recovered the amount due from DTL and had given a short-term loan of Rs. 50,00,000 out of its own funds, not borrowed funds. Therefore, the interest relating to this amount was allowable as a business expenditure.

Conclusion:
The Tribunal allowed the assessee's appeal partly, directing the AO to allow the interest claims on loans from PICUP and State Bank of Patiala for the assessment years 1989-90 and 1990-91. However, the disallowance of interest on inter-corporate loans invested in DTL was upheld, as the investments were not for business purposes and no shares were allotted to the assessee. For the assessment year 1991-92, the Tribunal allowed the interest claim on the short-term loan given to DTL, as it was made from the assessee's own funds.