Facts of the Case

  • The assessee, Reebok India Company, had borrowed unsecured loans amounting to ₹502.69 crores and paid interest on them.
  • It had also advanced ₹172.59 crores to third parties without charging interest.
  • The Assessing Officer (AO) disallowed ₹23.60 crores as proportionate interest expenditure.
  • The Dispute Resolution Panel upheld the disallowance.
  • The Income Tax Appellate Tribunal (ITAT) deleted the addition, holding that the loans were used for business purposes.

Issues Involved

  1. Whether interest paid on borrowed capital can be disallowed proportionately due to interest-free advances.
  2. Whether such advances fail the test of “commercial expediency” under Section 36(1)(iii).
  3. Whether absence of interest income justifies disallowance of interest expenditure.

Petitioner’s Arguments (Revenue)

  • The assessee advanced substantial funds without charging interest.
  • There was a direct nexus between borrowed funds and interest-free advances.
  • The AO is empowered to examine whether expenses meet the test of business expediency.
  • Failure to justify advances warranted proportionate disallowance.

Respondent’s Arguments (Assessee)

  • Advances were made for commercial and business purposes.
  • No diversion of funds for non-business or personal purposes.
  • Interest on borrowed capital was genuinely incurred for business.
  • Similar advances existed in earlier years without disallowance.

Court’s Findings / Order

  • The Delhi High Court upheld the ITAT’s decision and dismissed the Revenue’s appeal.
  • Key findings:
    • Interest paid on borrowed capital is allowable if used for business purposes.
    • No evidence of diversion of funds for non-business purposes.
    • Mere grant of interest-free advances does not justify disallowance.
    • The Tribunal’s findings were factual and legally sound.
  • Result: Appeal dismissed; no substantial question of law arose.

Important Clarification by Court

  • Relied on S.A. Builders Ltd. vs CIT (2007) 1 SCC 781:
    • “Commercial expediency” has wide scope.
    • Even if a third party benefits, deduction is allowable.
    • Revenue cannot sit in the armchair of a businessman to decide reasonableness.
  • Interest deduction is permissible if there is nexus with business purpose, not necessarily profit generation.

Sections Involved

  • Section 36(1)(iii), Income Tax Act, 1961 – Deduction of interest on borrowed capital
  • Section 260A, Income Tax Act, 1961 – Appeal to High Court

Link to download the order -

https://delhihighcourt.nic.in/app/case_number_pdf/2018:DHC:6220-DB/SKN25092018ITA11302017.pdf

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