Interest on borrowings for investment in group company cannot allowed u/s 36(1)(iii) – Mum ITAT


Ganjam Trading Co. (P.) Ltd. v DCIT ITA No: 3724 (MUM.) OF 2005, 932 (MUM.) OF 2006 and 1384 & 289 (MUM.) OF 2007] (Mum ITAT)

Background:

The assessee, in the business of trading and investment in goods, securities, etc., had declared income from interest, dividend and profit/loss from trading of shares. In the years under consideration, the assessee had declared huge losses from trading in shares which were treated by the Assessing Officer as speculation loss under the provisions of Explanation to section 73 of the Act. The assessee had also paid huge interest on borrowings. The Assessing Officer disallowed the interest relating to the investment made in shares under section 14A of the Income Tax Act, 1961 (for short “the Act”) and also disallowed interest on borrowings under section 36(1)(iii) of the Act holding that borrowings to that extent had not been utilised for the purpose of business.

AO observed that the assessee had made huge borrowings on which substantial interest running into crores had been paid in all the years under consideration. The assessee had advanced the borrowed funds for allotment of shares of group companies. The assessee had also advanced Rs. 25 crores to Panther Invest-trade Ltd. for acquisition of equity shares of companies. The AO made disallowance u/s 36(1)(iii) by computing interest @ 15%. CIT(A) confirmed the disallowance of interest under section 36(1)(iii) for assessment years 2001-02 and 2002-03. In assessment year 2003-04, the CIT(A) observed that the assessee had substantial interest free funds amounting to Rs. 169.09 crores. He held that the disallowance of interest has to be worked out on proportionate basis after taking into account the total interest free funds and interest bearing funds and investments made.

Assessee’s contentions:

  • Trading and investment in shares was business of the assessee and therefore, the borrowed funds used for making advances for acquisition of shares have to be considered as used for the purpose of business and no disallowance should be made.
  • The assessee advanced money as a part of financial participation which was the business of the assessee company. The purpose of business and were also justified on commercial expediency.
  • Reliance was placed on
    S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1/158 Taxman 74 (SC)
    Dy. CIT v. Core Health Care Ltd. [2008] 298 ITR 194/167 Taxman 206 (SC)
    CIT v. Phil Corpn. Ltd. [2011] 202 Taxman 368/14 taxmann.com 58 (Bom.)
  • For AY 2002-03 and AY 2003-04, there were sufficient owned funds/ interest free funds in the form of share application money received.

Tax authority’s arguments:

  • There was no business purpose served in giving the interest free advances.
  • The own funds of the assessee had been completely eroded and became negative due to loss.

HELD:

  • Under the provisions of section 36(1)(iii), interest on capital borrowed for the purpose of business is required to be allowed as deduction and, therefore, in case, any borrowed capital had been raised not for the purpose of business, the corresponding interest is to be disallowed.
  • The acquisition of controlling interest in companies was not the business of the assessee as the assessee had not acquired controlling interest in any company with a view to managing the same. Therefore, acquiring shares in the group companies for maintaining the controlling interest does not promote the business of the assessee
  • Assessee’s reliance on judgment of the Hon’ble Supreme Court in the case of S.A. Builders Ltd. (supra) was not acceptable as It has not been shown to us as to how business of those companies promotes the business interests of the assessee so that interest free advances to them could be justified on commercial expediency.
  • The assessee in years 2002-03 and 2003-04 had received interest free share application money and total capital including share capital and share application money was Rs. 117.50 crores for assessment year 2002-03 and Rs. 115.15 crores in 2003-04.
  • The interest free funds available at the time of making advances for purchases of shares are required to be taken into account while computing attribution of interest towards interest free advances. 
  • This aspect has been considered by CIT(A) only in assessment year 2003-04 but not considered in assessment year 2002-03. Both, the borrowed funds and own funds are admittedly mixed up and, therefore, in such cases, disallowance of interest has to be made on proportionate basis.

Other Issues:

  • 14A disallowance: Since capital of assessee was negative and there were neither reserves nor any other interest-free funds available to assessee in relevant assessment years, it was concluded that borrowed funds had been utilized for investment in shares and therefore, disallowance u/s 14A was upheld.
  • Losses u/s 73: Explanation to section 73 will also apply when there is only one business viz. trading in shares; there is no need of more than one business. Explanation to section 73 also applies to loss from valuation of closing stock and includes interest on borrowings used for trading in shares.

 

 

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