If advances are for non-business purposes, the disallowance should be on the basis of average interest rate

The Hon’ble Punjab and Haryana High Court at Chandigarh in the case of CIT vs. M/s Kudu Industries being ITA No.388 of 2014(O&M) held that if advances are for non-business purposes, the disallowance should be on the basis of average interest rate.

Date of judgment:

The judgment was reserved on 08.07.2015 and was passed on 31.07.2015.

Facts of the appeal:

It was an appeal against the order of the Income Tax Appellate Tribunal relating to the assessment year 2009-10.

By an order dated 25.03.2015, notice of motion was issued for the question of law raised in paragraph 5(i). The order stated that the other questions were answered against the appellant by an order dated 03.03.2015 in Commissioner of Income Tax-I, Ludhiana vs. M/s Kudu Industries, Ludhiana being ITA No.382 of 2014.

Issues raised in the appeal:

The appeal was filed on the issue of law whether in the circumstances of the case, the Hon’ble ITAT was justified in law in directing the Assessing Officer to re- assess the disallowance made under section 36(1)(iii) of the act in ITA388 of 2014 by adopting the average cost of debt in the relevant year.

Backgrounds of the case:

The assessee was engaged in the manufacturing of yarn and fabrics. The assessee made interest free advances to many parties including advances to its suppliers and its employees in the normal course of its business. Advances were made to two parties namely, Smt. Ritu Saluja and Shiv Narain Investments Pvt. Ltd. due to their urgent financial requirements.

The Assessing Officer relied upon the judgment of the Hon’ble Punjab and Haryana High Court passed in the case of Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek Industries, Ludhiana, (2006) 286 ITR 1, disallowed the interest relating to the advances as they were not made towards commercial expediency. In that case it was held that whatever are the receipts in a business, they are to be treated as the business receipts and they cannot have any separate identity. Sources are not points to be concerned. The only essence to disallow the interest paid on the borrowing would be that the assessee has some loans or debts to be repaid.

The Assessing Officer held that for the advances given for non-business purposes, interest should be disallowed on a proportionate basis as the funds are placed in a common kitty and it is not possible to separate them from the assessee’s personal funds.

The Assessing Officer accordingly calculated the interest at 11.5% for the advances to the two parties and added it to the income of the assessee. Accordingly penalty proceedings under Section 271(1)(c) of the Income Tax Act were also initiated against the assessee.

The Ld.CIT (Appeals) upheld the said order. However the Income Tax Tribunal set aside the order of the CIT (Appeals).

It was held by the Income Tax Tribunal that the judgment in Commissioner of Income Tax-I, Ludhiana vs. M/s Abhishek Industries, Ludhiana, did not deal with the question of the rate of interest to be applied where the assessee has mixed funds.

The judgment:

The Hon’ble Punjab and Haryana High Court at Chandigarh also agreed with the Tribunal’s view that where mixed funds are used for interest free advances, dis allowance should be made up to the average cost of debt to the assessee.

It was not justified to take into consideration the rate of interest for any particular transaction where an assessee takes advances on interest. An assessee may take many advances from the same person or entity or from different entities and at separate rates of interest.

If there is nothing to indicate that the advance was made only from a particular source received by the assessee, the advance would be considered to be from the common money. Money in a common pool has no separate identity. The amounts advanced get merged into the same pool.

There is no justification for the department to consider the rate of interest in respect of a particular advance to the assessee.
The only logical view is to consider the average interest rate at which the assessee has availed the said advances.

In view of the above, the issue of law was answered against the appellant. The order of the Tribunal was upheld. The appeal was accordingly dismissed.