IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT : THE HONOURABLE MR. JUSTICE C.N.RAMACHANDRAN NAIR & THE HONOURABLE MR. JUSTICE V.K.MOHANAN TUESDAY, THE 6TH OCTOBER 2009 / 14TH ASWINA 1931 ITA.No. 47 of 2009() -------------------- ITA.717/COCH/2007 of I.T.A.TRIBUNAL,COCHIN BENCH .................... APPELLANT/APPELLANT: ------------------------------ THE COMMISSIONER OF INCOME TAX,COCHIN BY ADV. SRI.JOSE JOSEPH, SC, FOR INCOME TAX RESPONDENT(S): --------------- POPULAR VEHICLES & SERVICES LTD KUTTUKARAN CENTRE, MAMANGALAM, KOCHI-25. ADV. SRI.P.BALAKRISHNAN (E) SRI.MOHAN PULIKKAL SRI.K.C.KIRAN THIS INCOME TAX APPEAL HAVING BEEN FINALLY HEARD ON 06/10/2009, THE COURT ON THE SAME DAY DELIVERED THE FOLLOWING: C.R. C.N.RAMACHANDRAN NAIR & V.K.MOHANAN, JJ. .................................................................... I.T. Appeal No.47 of 2009 .................................................................... Dated this the 6th day of October, 2009. JUDGMENT Ramachandran Nair, J. Respondent-assessee is a limited company mainly engaged in servicing and sales of Maruti vehicles as dealer of the manufacturing company. Besides carrying on business, the company is a partner in several partnerships which are controlled by the same group. In the course of assessment under the Income Tax Act for the year 2004- 2005, the Assessing Officer noticed that assessee borrowed massive amounts from Banks and advanced the same to sister concerns namely, the partnership firms in which it was a partner, without collecting any interest. The Assessing Officer after verifying the interest bearing borrowals from Banks and the interest-free advances made from the beginning to the end of the relevant previous year, found that the interest expenses attributable for the interest-free loans advanced to the firms of which it was a partner works out to Rs.31,21,599/-. The 2 Assessing officer held that the diversion of borrowed funds by the respondent to other firms is not for business purpose and so much so, the interest paid on borrowed capital advanced to other Firms is not an allowable deduction under Section 36(1)(iii) of the Income Tax Act. Another item of disallowance made in assessment is in respect of the premium for gratuity contribution paid to the fund maintained with L.I.C. under Section 43B(b) of the Income Tax Act. The first appellate authority allowed appeal on the first question in the first round and on rectification application filed, the second issue also was allowed in favour of the assesee. On further appeal by the department, the Tribunal confirmed the orders of the first appellate authority against which this appeal is filed by the department. We have heard Standing Counsel appearing for the appellant and Adv. Sri.P.Balakrishnan appearing for the respondent. 2. Even though four questions are raised by the appellant for our decision, only two questions are to be decided i.e. question numbers 1 and 2, which are extracted hereunder: "1. Whether, on the facts and in the circumstances of the case and also in the light of Section 36(1)(iii) read with Section 14A 3 of the Income Tax Act, the assessee is entitled to claim deduction of the interest expenses attributable to investment in shares at Rs.31,21,599/-? 2. Whether, on the facts and in the circumstances of the case and since the assessee had not made payments before due date for filing the return under Section 139(1) read with the first proviso to Section 43B, is not disallowance of the amount of Rs.34,70,040/- payable by the assessee but not paid valid and in accordance with law?" 3. The contention of the appellant is that the finding of the Assessing Officer that funds advanced by the respondent to sister concerns which are partnership firms are out of borrowed funds on which interest is paid by the assessee, is not found against by any of the appellate authorities including the Tribunal. According to him, advancing of loan by the respondent-company to a firm of which it is partner is not a business expenditure and therefore, interest paid for borrowing funds for advancing interest-free loan to the sister firms is not an expenditure allowable under Section 36(1)(iii) of the Act. However, counsel appearing for the respondent-assessee has referred to the very same decision of the Supreme Court relied on by the Tribunal i.e. in S.A. BUILDERS LTD. V. COMMISSIONER OF INCOME- TAX & ANOTHER (2007) 288 ITR 1 and contended that the claim is 4 allowable as found by the Tribunal. However, we notice that the loan involved in that case was one advanced by a limited company to subsidiary companies. In this case the loan is advanced by respondent which is a limited company to partnership firms of which respondent is a partner. The clear finding of the Assessing Officer which is not found against by the appellate authorities is that the loan advanced to the firms by the respondent was out of borrowed funds on which interest is paid by the respondent. In fact, disallowance under Section 36(1)(iii) is in respect of interest payable on so much of the borrowed capital lend to sister concerns which are partnerships, without collecting interest. The facts are not disproved by the respondent before the Tribunal. However, Tribunal sustained the order of the first appellate authority merely by relying on the decision of the Supreme Court. As already stated, the decision of the Supreme Court does not squarely apply to the facts of this case. In the first place, the share income from the partnership firm which is the only consideration for advancing the loan to the firm does not constitute income of the respondent under Section 10(2A) of the Income Tax Act. Since the 5 share income from the firm do not constitute part of the taxable income of the assessee, Section 14A(1) applies which prohibits deduction of any expenditure incurred in relation to income not includable in total income. The said Section reads as under: "S.14A. (1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act." Standing Counsel appearing for the appellant contended that the Assessing Officer has not expressly referred to Section 14A(1) because according to him, advancing loan to a firm of which respondent is a partner is prima facie not a business expenditure entitling assessee for deduction of interest paid on borrowed capital used for advancing the loan to firms. Counsel for the assessee contended that going by the decision of the Supreme Court what is to be considered is whether business expediency required the assessee to advance interest-free loan to the firm of which it is a partner. The Supreme Court has in the decision abovereferred held that once it is established that there was 6 nexus between expenditure and the purpose of business, then the claim is allowable. If the loan was advanced to the firm on collection of interest, then such interest could not have become business income but for the specific categorisation of the same as business income by operation of Section 28(v) of the Income Tax Act. The Supreme Court has not considered the application of Section 14A because the case decided by it pertains to advancing of interest-free loan by limited company to subsidiary companies and not to partnership firms. In any case when Supreme Court has held that commercial expediency has to be considered, necessarily the respondent-company's role in the business activities of the firm and the requirement of interest-free loan for business purpose of such firm should have been considered by the Tribunal, which is not done by them. In our view, the finding of the Tribunal in any case cannot stand because the decision of the Supreme Court followed by them does not apply to the facts of the case. Even though the Assessing Officer has referred to Section 14A, the Tribunal has not referred to the Section, but allowed the claim just following the decision of the Supreme Court. A remand for the purpose of 7 considering eligibility for deduction based on commercial expediency, if at all the same exists, is not called for in this case because Section 14A(1) expressly bars allowance of any expenditure for earning income which do not constitute part of the total income of the assessee. It is the admitted position that the advancing of interest-free loan is made by the respondent-assessee only to partnership firms of which it is a partner and does not receive any interest from the same and the only benefit is receipt of share income from such firms which do not constitute income of the assessee under Section 10(2A) of the Act. Therefore, the disallowance of proportionate interest on borrowed funds diverted as interest-free loans to partnership firms of which respondent-assessee is a partner, was rightly made by the officer and we find no justification for the appellate authorities to allow the claim. Accordingly we allow the appeal on this issue by reversing the order of the Tribunal and that of the first appellate authority and restore the assessment pertaining to disallowance of interest. 4. The next question raised pertains to diallowance under Section 43B(b) of the Act for the premium paid to the Employees' Gratuity 8 Fund maintained by the L.I.C. Even though counsel for the respondent contended that the payment is not covered by Section 43B, we do not think the contention is tenable because admittedly the gratuity fund is maintained for the benefit of the employees and the payment of the premium was to the fund operated by the L.I.C. Therefore, Section 43B(b) is squarely attracted to the payment involved. The Tribunal allowed the claim by just relying on the decision of the Supreme Court in COMMISSIONER OF INCOME TAX V. VINAY CEMENT LTD. (2007) 213 CTR 268 wherein the Supreme Court has only held that deduction should be allowed if remittance is made atleast before the date of filing the return, even though such payment was not made before the end of the previous year. Standing Counsel for the appellant referred to the finding of the Assessing Officer that payment was not made before the date of filing the return. Strangely the Tribunal allowed the claim without verifying whether the remittance was made before filing the return by the assessee. Since this is a controversial fact, we give one more opportunity to the assessee to prove before the Assessing Officer with details of the payment of premium to the L.I.C. 9 and if payments were made before filing of the return, then the same should be allowed in terms of the order of the Tribunal or otherwise, the claim should be disallowed with right to the assessee to claim the payment in the succeeding year. Appeal is allowed in part as stated above. C.N.RAMACHANDRAN NAIR Judge V.K.MOHANAN Judge pms