The High Court held that when an assessee has mixed funds in a common kitty, interest on advances for non-business purposes must be disallowed based on the average cost of debt, not specific transaction rates.
The order of the Tribunal was upheld; the appeal was dismissed.
This page shows the compact analysis of this judgement. The full analysis — procedural history, issue-by-issue holdings with ratio and obiter, advocates, and paragraph-level evidence for every claim — is being added to the record in batches and will appear here when this judgement has been through it.
IN THE HIGH COURT OF PUNJAB AND HARYANA AT CHANDIGARH
ITA No.388of2014(O&M)
RESERVED on:08.07.2015
DATE OF DECISION: 31.07.2015
Commissioner of Income Tax-I
…..Appellant
versus
M/s Kudu Industries
.....Respondents
CORAM:- HON'BLE MR.JUSTICE S.J.VAZIFDAR, ACTING CHIEF JUSTICE
HON’BLE MR. JUSTICE G.S. SANDHAWALIA
Present: Mr. Rajesh Katoch, Advocate for the appellant
Ms. Radhika Suri, Senior Advocate with
Ms. Rajni Paul, Advocate for the respondent
S.J. VAZIFDAR, ACTING CHIEF JUSTICE :
This is an appeal against the order of the Income Tax
Appellate Tribunal which pertains to the assessment year 2009-10.
2. By an order dated 25.03.2015, notice of motion was
issued in respect of the question of law raised in paragraph 5(i).
The order noted that the other questions raised have been answered
against the appellant by our order and judgment dated 03.03.2015 in
Commissioner of Income Tax-I, Ludhiana vs. M/s Kudu Industries,
Ludhiana, ITA No.382 of 2014.
3. The appeal is admitted on the following substantial
question of law:-
“i) Whether on the facts and in the
circumstances of the case, the Hon’ble ITAT was
right in law in directing the AO to recompute
the disallowance under section 36(1)(iii) of the
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ITA-388-2014
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Act by adopting the average cost of debt for the
year.”
4. The assessee was engaged in the manufacturing, trading
and job work of yarn and fabrics. The assessee had made interest
free advances to various parties including by way of advances to
suppliers and employees. These were in the normal course of
business. However, advances were made to two parties, namely, Smt.
Ritu Saluja and Shiv Narain Investments Private Limited due to
their temporary financial requirements.
5. The Assessing Officer following the judgment of this
Court in Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek
Industries, Ludhiana, [2006] 286 ITR 1 (P&H) disallowed on a
proportionate basis the interest pertaining to the said two advances
on the ground that they were not made on account of commercial
expediency. In Commissioner of Income Tax-I, Ludhiana vs. M/s
Abhishek Industries, Ludhiana (supra), it was held:
“15. Entire money in a business entity comes in a common
kitty. The monies received as share capital, as term loan,
as working capital loan, as sale proceeds etc. do not have
any different colour. Whatever are the receipts in the
business, that have the colour of business receipts and
have no separate identification. Sources have no concern
whatsoever. The only thing sufficient to disallow the
interest paid on the borrowing to the extent the amount is
lent to sister concern without carrying any interest for
non-business purposes would be that the assessee has some
loans or other interest bearing debts to be repaid. In case
the assessee had some surplus amount which, according to
it, could not be repaid prematurely to any financial
institution, still the same is either required to be
circulated and utilised for the purpose of business or to
be invested in a manner in which it generates income and
not that it is diverted towards sister concern free of
interest. This would result in not presenting true and
correct picture of the accounts of the assessee as at the
cost being incurred by the assessee, the sister concern
would be enjoying the benefits thereof. It cannot possibly
be held that the funds to the extent diverted to sister
concerns or other persons free of interest were required by
the assessee for the purpose of its business and loans to
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ITA-388-2014
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that extent were required to be raised. We do not subscribe
to the theory of direct nexus of the funds between
borrowings of the funds and diversion thereof for non-
business purposes. Rather, there should be nexus of use of
borrowed funds for the purpose of business to claim
deduction under Section 36(1)(iii) of the Act. That being
the position, there is no escape from the finding that
interest being paid by the assessee to the extent the
amounts are diverted to sister concern on interest free
basis are to be disallowed.”
6. The Assessing Officer held that in respect of the
advances given for non-business purposes, interest is to be
disallowed on a proportionate basis since all the funds of the
assessee are placed in a common kitty and it is not possible to
separate the borrowed funds from the assessee’s own funds. The
Assessing Officer accordingly computed the interest at 11.5% in
respect of the advances to the two parties and added the same back
to the income of the respondent/assessee. Penalty proceedings under
Section 271(1)(c) were also initiated separately. The CIT (Appeals)
upheld this order.
7. The Tribunal set aside the order of the CIT (Appeals) in
this regard. As rightly held by the Tribunal, the judgment of this
Court in Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek
Industries, Ludhiana (supra) does not deal with the question of the
rate of interest to be applied in cases where the assessee has mixed
funds available with it. We also agree with the Tribunal’s view that
where mixed funds are diverted towards interest free advances the
disallowance should be made up to the level of the average cost of
debt to the assessee. There is no justification in taking into
consideration the rate of interest in respect of any particular
transaction whereunder an assessee avails advances on interest. An
assessee may avail several advances from the same lender or from
different lenders and at varying rates of interest. In the absence
of anything to indicate that the interest free advance was made only
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ITA-388-2014
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from a particular corresponding advance received by the assessee,
the advance made by the assessee would obviously be from the common
pool of money. Money lying in a common pool has no identity. The
various amounts advanced to the assessee get merged into a common
pool. There is no justification then either for the assessee or for
the department to take into consideration the rate of interest in
respect of a particular advance or advances to the assessee. The
only logical approach is to take into consideration the average
interest rate at which the assessee has availed of the advances.
8. In the circumstances, the question of law is answered
against the appellant. The order of the Tribunal is upheld. The
appeal is dismissed.
(S.J.VAZIFDAR)
ACTING CHIEF JUSTICE
31.07.2015
parkash*
(G.S.SANDHAWALIA)
JUDGE
Note: Whether reportable: YES
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3 issues framed by the court
Whether the ITAT was right in directing the AO to recompute disallowance under section 36(1)(iii) by adopting average cost of debt when funds are in a common kitty.
Whether the rate of interest on specific advances should be considered when an assessee has mixed borrowed and own funds.
Whether disallowance of interest on non-business advances should be computed at the average cost of debt rather than specific transaction rates.
Colour shows how this judgement treated each authority
Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek IndustriesDistinguished¶5
Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek Industries, Ludhiana, [2006] 286 ITR 1 (P&H)
2 provisions across 1 enactments
Commissioner of Income Tax-I
M/s Kudu Industries
S.J. Vazifdar
G.S. Sandhawalia
As recorded by the court registry
Judgements on the same questions, provisions and authorities, from every court