Commissioner of Income Tax, Cochin v. O E N India Ltd.

## **IN THE HIGH COURT OF KERALA AT ERNAKULAM** ## **PRESENT** ## **THE HONOURABLE MR.JUSTICE K.VINOD CHANDRAN** **&** **THE HONOURABLE MR. JUSTICE ASHOK MENON** **FRIDAY ,THE 01ST DAY OF FEBRUARY 2019 / 12TH MAGHA, 1940** ## **ITA.No. 689 of 2009** **AGAINST THE ORDER/JUDGMENT IN ITA 932/2004 of I.T.A.TRIBUNAL,COCHIN BENCH DATED 31-03-2006** ## **APPELLANT/S:** **THE COMMISSIONER OF INCOME TAX, COCHIN.** **BY ADVS. SRI.P.K.R.MENON,SENIOR COUNSEL, GOI(TAXES) SRI.JOSE JOSEPH, SC FOR INCOME TAX** ## **RESPONDENT/S:** **O E N INDIA LTD., VYTTILA, COCHIN - 682 019.** **BY ADVS. SRI.E.K.NANDAKUMAR (SR.) SRI.P.BENNY THOMAS** **THIS INCOME TAX APPEAL HAVING BEEN FINALLY HEARD ON 01.02.2019, THE COURT ON THE SAME DAY DELIVERED THE FOLLOWING:** _ITA.689 of 2009_ _- 2 -_ ## **JUDGMENT** ## Vinod Chandran, J. One of the questions arising in the above appeal filed by the Revenue is as to whether indirect tax liability of the assessee should be taken in the computation of total turnover for the deductions as available in Section 80HHC. The Tribunal found that it has to be, which is challenged by the Revenue. 2. The issue stands covered in favour of the assessee and against the Revenue by the decisions of the Hon'ble Supreme Court in _**CIT v. Lakshmi Machine**_ _**Works, [2007] 290 ITR 667**_ and _**CIT v. Catapharma (India)**_ _**Pvt. Ltd.**_ , Appeal (Civil) No.3204/2007 dated 23.07.2007. The question stands answered in favour of the assessee and against the revenue. 3. There is a further question urged by the Revenue, which is re-framed as follows:- _Whether the First Appellate Authority and the Tribunal were correct in following its earlier decisions to find the disallowance of interest income on loans given to subsidiary companies to be bad for reason only of the assessee having own funds; especially when there is no examination of the quantum of funds available with the assessee ?_ _ITA.689 of 2009_ _- 3 -_ 4. We see that the First Appellate Authority had merely referred to the earlier order of the Tribunal and reversed the disallowance of interest. The assessee admittedly had advanced certain amounts, interest free to subsidiary companies. The assessee at the same time had borrowed funds, towards which the assessee had interest liability and was paying it; which was claimed for deduction. The Assessing Officer found that the assessee had borrowed funds from other institutions on which interest was paid, claimed as expenditure. Hence, the deduction towards interest paid on advances, were disallowed proportionately, on the ratio of the borrowed funds and own funds. 5. The learned Senior Counsel, Government of India (Taxes) would rely on the decision in _**C.I.T. v.**_ _**V.I.Baby & Co., [2002] 254 ITR 248**_ , wherein a Division Bench of this Court upheld the principle of such proportionate disallowance.There the assesee had availed advances which carried interest, which was claimed as an allowance. At the same time the assessee had debit balances in the accounts of its partners, their relatives and sister concerns; which did not _ITA.689 of 2009_ _- 4 -_ carry any interest. The assessee claimed that it had sufficient cash balance to make the interest free advances. It was also argued that the partners have utilised the money for making investments in the nature of construction of shop building etc, which were for business purposes. The Division Bench found that the investments made by the partners, only benifitted them and not the firm. As far as the assessee firm is concerned the debit balances were only interest free advances made by it to its partners. As for having sufficient cash balance, it was held, then there was no requirement to take advances with interest liability. The principle of propotionate reduction of interest claimed as allowance, as against interest free advances, was upheld. ## 6. _**S.A. Builders v.CIT (Appeals),[2007] 288 ITR 1**_ was a case in which the assessee was found to have made huge interest free advances to its sister concern; while claiming allowance for the interest paid on its advances from Banks. The assessing officer disallowed the interest, in proportion to the interest relating to the (interest free) advances made by the assessee to _ITA.689 of 2009_ _- 5 -_ its sister concern. The assessee claimed that they had own funds received from their own clients, which was utilised to make the interest free advances to the sister concern. Essentially it was argued that the advances to sister concern had no nexus with the interest bearing advances of the assessee. The Hon'ble Supreme Court found the allowance enabled by Section 36(1)(iii) to be for the amount of interest paid in respect of capital borrowed for the "purposes of business or profession"; which has a wider scope than for the "purpose of earning income, profits or gains". The test to be applied in such a case of interest free loans having been granted; was to examine whether this was done as a measure of commercial expediency. It was held so: _"27. The expression “commercial expediency” is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency._ _xxx xxx xxx_ _32. The High Court and the other authorities should have examined the purpose for which the assessee advanced the money to_ _ITA.689 of 2009_ _- 6 -_ _its sister concern, and what the sister concern did with this money, in order to decide whether it was for commercial expediency, but that has not been done._ _33. It is true that the borrowed amount in question was not utilised by the assessee in its own business, but had been advanced as interest-free loan to its sister concern. However, in our opinion, that fact is not really relevant. What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency._ _xxx xxx xxx_ _36. We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (B) Ltd., [2002] 254 ITR 377 that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximise its profit. The Income Tax Authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits._ _37. We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the_ _ITA.689 of 2009_ _- 7 -_ _assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the Directors of the sister concern utilise the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans."_ **==> picture [432 x 13] intentionally omitted <==** Hon'ble Supreme Court _**V.I.Baby & Co.**_ looses its precedential sheen insofar as a mechanical disallowance of interest in proportion to that amounts advanced free of interest. We notice that the quantum of borrowed funds and own funds have not been gone into by any of the authorities nor has the aspect of business or commercial expediency engaged the attention of either the assessee or the A.O. In such circumstances, we direct the Assessing Officer to look into the matter afresh based on the principles laid down by the Supreme _ITA.689 of 2009_ _- 8 -_ Court. The appeal is partly allowed. No order as to costs. **Sd/K.VINOD CHANDRAN JUDGE Sd/ASHOK MENON** _dkr_ **JUDGE** _ITA.689 of 2009_ _- 9 -_ ## **APPENDIX** **APPELLANT'S/S ANNEXURES:** **ANNEXURE A COPY OF ASSESSMENT ORDER DATED 26.2.1999 U/S 143 (3) OF THE INCOME TAX ACT 1961.** **ANNEXURE B COPY OF ORDER DATED 15.6.2004 OF THE COMMISSIONER OF INCOME TAX (APPEALS). ANNEXURE C COPY OF THE ORDER DATED 31.3.2006 OF THE INCOME TAX APPELLATE TRIBUNAL, COCHIN BENCH, COCHIN IN ITA NO. 932/COCH/2004.** **ANNEXURE D COPY OF THE ORDER DATED 31.1.2000 OF THE TRIBUNAL IN ITA NO. 13/COCH/1993.**