The Income Tax Appellate Tribunal, Agra (SMC Bench), in Girraj Cold Storage (P.) Ltd. v. Income-tax Officer (ITA No. 125/Agr/2022), examined the allowability of interest expenditure under Section 36(1)(iii) of the Income-tax Act, 1961, in a case where the assessee had advanced interest-free funds to potato growers while simultaneously incurring interest on borrowed capital.

The assessment for A.Y. 2011-12 was reopened under Section 147 on the basis of information relating to cash deposits of ₹74 lakh in a bank account. During reassessment proceedings, the Assessing Officer disallowed interest of ₹10,33,374 paid on a cash credit account on the ground that the assessee had diverted borrowed funds by granting interest-free advances amounting to ₹1.70 crore to farmers.

The assessee, engaged in the business of operating a cold storage, explained that advances were given to potato growers as a matter of commercial expediency to secure their commitment to store potatoes in the assessee’s cold storage, from which the assessee earned substantial rental income. It was submitted that without such advances, farmers might not store their produce with the assessee, thereby adversely affecting its business.

The Assessing Officer rejected this explanation and held that the advances were not made for business purposes. The disallowance was upheld by the CIT(A). In second appeal, the Tribunal examined the assessment records, affidavits of farmers, statements recorded by the Assessing Officer, and details of rental income earned from 549 farmers amounting to ₹77,76,480.

The Tribunal noted that the assessee had furnished complete details of advances, identity of farmers, affidavits, and evidence of rental income earned from storage of potatoes. It was further observed that neither the Assessing Officer nor the CIT(A) exercised their statutory powers to summon or verify the farmers, despite the assessee’s request. The Tribunal held that the Revenue cannot substitute its own view for that of a prudent businessman and decide how business should be conducted.

Relying on the Supreme Court judgment in S.A. Builders Ltd. v. CIT (158 Taxman 74), the Tribunal held that where advances are made out of commercial expediency, interest on borrowed funds cannot be disallowed merely because the advances are interest-free. The Tribunal accepted the assessee’s explanation that the advances were integrally connected with its business operations.

Accordingly, the Tribunal directed deletion of the disallowance of ₹10,33,374 and allowed the appeal filed by the assessee.

Source- https://itat.gov.in/public/files/upload/1733464800-T5PY3S-1-TO.pdf

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