Progressive Commercial Enterprises Ltd. vs Commissioner of Income Tax

Rajiv Shakdher, J.—In the captioned appeals the following questions of law have been framed for our adjudication.

ITA No. 40/1999

Whether the Tribunal was correct in law in holding that the interest on interest free loan advanced by the Assessee to its subsidiary company could not be allowed as business expenditure u/s 36(1)(iii) of the Income Tax Act, 1961?

Whether the Tribunal was correct in law in not accepting the alternative contention of the Assessee that, in any case, the disallowance could not be more than Rs. 14,480/-?

Whether the Tribunal was correct in law in sustaining the order of the Commissioner of Income Tax (Appeals) on the issue of addition of Rs. 2,50,000/- on the ground that no specific ground in respect of the said addition had been raised before him?

ITA No. 42/1999

Whether the Tribunal was correct in law in holding that the interest on interest free loan advanced by the Assessee to its subsidiary company could not be allowed as business expenditure u/s 36(1)(iii) of the Income Tax Act, 1961?

1.1 In ITA No. 40/1999 the judgment of the Income Tax Appellate Tribunal (in short ''ITAT'') passed in ITA No. 3199(Del)94 dated 23.11.1998 pertaining to assessment year 1986-87 is impugned. Similarly, in ITA No. 42/1999 the judgment of the ITAT passed in ITA Nos. 7541 & 7542(Del)91 dated 02.12.1998 pertaining to assessment year 1987-88 and 1988-89 is challenged before us.

A perusal of the aforesaid questions of law would show that out of the four questions of law framed, three pertain essentially to one issue. The issue being: whether interest paid by the Appellant/ Assessee in respect of loans availed by it ought to be disallowed under the provisions of Section 36(1)(iii) of the Income Tax Act, 1961 (in short ''IT Act'').

2.1 The disallowance of interest from the point of view of Respondent/department is pivoted on a singular allegation that the loan taken by the Appellant/Assessee was funneled as interest free loan to its alleged 100% subsidiary companies.

There were several pleas taken before us and authorities below, including the plea that the finding that: the loan taken on interest from the bank and other creditors had been funneled by Appellant/Assessee to its subsidiaries without interest; was perverse.

3.1 However, after addressing lengthy arguments in the captioned appeals Mr C.S. Agrawal gave up all other pleas save and except the plea that investment of funds in the share capital of its subsidiary companies was a "for the purpose of business" within the meaning of Section 36(1)(iii) of the IT Act.

3.2 After considering the submissions of the learned Counsels for both the Appellant/Assessee as well as Respondent/department, it appears to us that the said issue is primarily pivoted on the aspect as to whether the three companies, whose names are mentioned hereinafter, were at the relevant point in time wholly owned subsidiaries of the Appellant/ Assessee. The three companies in issue are: Adler Investment & Trading Co. (in short ''Adler''), Shivpuri Investment & Trading Co. (in short ''Shivpuri'') and Raipur Investment & Trading Co. (in short ''Raipur'').

3.3 What is also not disputed is that funds in the sum of ` 1,31,22,025/- were provided to Adler by the Appellant/ Assessee evidently towards purchase of shares of Adler. It is the case of the Appellant/Assessee that these funds were used to purchase 1,40,000 shares of Alder of the face value of Rs 100 each.

3.4 In so far as the sum of ` 78,73,215/- is concerned this was, according to the Appellant/ Assessee, a mere book entry towards renunciation of the rights in the shares of Oswal Agro Mills Ltd. These transactions occurred decidedly in the assessment year 1986-87.

3.5 As regards the monies advanced to Raipur and Shivpuri are concerned, funds to the extent of ` 20,25,000/- each were advanced in the previous year 1983-84 pertaining to assessment year 1984-85. The said funds were evidently furnished to Raipur and Shivpuri for the purposes of investment in the equity shares of two limited companies, namely, Oswal Agro Mills Ltd. and Bindal Agro Mills Ltd. Therefore, what logically follows is that no funds were advanced to Raipur and ShivpurI in the relevant assessment years, with which we are concerned.

3.6 Based on the aforesaid broad facts, in the assessment year 1986-87 interest to the extent of ` 2,13,283/- was disallowed. Similarly, interest to the extent of ` 7,25,246/- was disallowed in the assessment year 1987-88, while interest in the sum of ` 16,05,460/- was disallowed in the assessment year 1988-89. What has also been contended before us is that at the relevant point in time when funds were advanced to Raipur and Shivpuri they were wholly owned subsidiaries of the Appellant/Assessee.

Thus what is to be examined by us is: whether investment of funds in the shares of a wholly owned subsidiary, such as, Alder or, even to provide funds to Raipur and Shivpuri (also wholly owned subsidiaries) to purchase shares of another company, would constitute a business purpose of the Appellant/Assessee.

According to us, this issue has to be answered in the affirmative. There is no doubt in our minds that provision of funds to a wholly owned subsidiary to either purchase the shares of the said subsidiary or for purchasing the shares of another company cannot but be held to be the business purpose of Appellant/Assessee. These are decidedly funds infused by the Appellant/ Assessee in its own wholly owned subsidiaries, the usage of which is bound to have an impact on the investment made in these subsidiaries. Being wholly owned subsidiaries their affairs, whether with regard to policy or management, would have to have the explicit or tacit consent of the Appellant/ Assessee. Test evolved by courts is not that such a decision to funnel funds to a subsidiary results in profit but whether the infusion of funds is commercially expedient from the point of view of the Appellant/ Assessee. If an authority is required to fathom the ambit and scope of the expression "for the purpose of business" it would be apposite to refer to the observations of the Supreme Court in the case of S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another, . In this case the Supreme Court observed as follows:

In our opinion, the High Court in the impugned judgment, as well as the Tribunal and the Income Tax authorities have approached the matter from an erroneous angle. In the present case, the Assessee borrowed the fund from the bank and lent some of it to its sister concern (a subsidiary) on interest free loan. The test, in our opinion, in such a case is really whether this was done as a measure of commercial expediency.

In our opinion, the decisions relating to Section 37 of the Act will also be applicable to Section 36(1)(iii) because in Section 37 also the expression used is "for the purpose of business". It has been consistently held in decisions relating to Section 37 that the expression "for the purpose of business" includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if a third party also benefits thereby.

Thus in Atherton v. British Insulated & Helsby Cables Ltd. (1925) 10 TC 155 (HL), it was held by the House of Lords that in order to claim a deduction, it is enough to show that the money is expended, not of necessity and with a view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly to facilitate the carrying on the business. The above test in Atherton''s case (supra) has been approved by this Court in several decisions e.g. Eastern Investments Ltd. Vs. Commissioner of Income Tax, West Bengal, , The Commissioner of Income Tax, Bombay Vs. Chandulal Keshavlal and Co., Petlad, etc.

In our opinion, the High Court as well as the Tribunal and other Income Tax authorities should have approached the question of allowability of interest on the borrowed funds from the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest free loan was given to the sister company (which is a subsidiary of the Assessee) as a measure of commercial expediency, and if it was, it should have been allowed.

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.

No doubt, as held in Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, , if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed u/s 36(1)(iii) of the Act. In Madhav Prasad''s case (supra), the borrowed amount was donated to a college with a view to commemorate the memory of the Assessee''s deceased husband after whom the college was to be named. It was held by this Court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.

Thus, the ratio of Madhav Prasad Jatia''s case (supra) is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed u/s 36(1)(iii) of the Act.

In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.

It has been repeatedly held by this Court that the expression "for the purpose of business" is wider in scope than the expression " for the purpose of earning profits" vide Commissioner of Income Tax, Kerala Vs. Malayalam Plantation Ltd., , Commissioner of Income Tax, West Bengal I Vs. Birla Cotton Spinning and Weaving Mills Ltd., etc.

The High Court and the other authorities should have examined the purpose for which the Assessee advanced the money to 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.

It is true that the borrowed amount in question was not utilized 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.

Learned Counsel for the Revenue relied on a Bombay High Court decision in Phaltan Sugar Works Ltd. Vs. Commissioner of Wealth-tax., in which it was held that deduction u/s 36(1)(iii) can only be allowed on the interest if the Assessee borrows capital for its own business. Hence, it was held that interest on the borrowed amount could not be allowed if such amount had been advanced to a subsidiary company of the Assessee. With respect, we are of the opinion that the view taken by the Bombay High Court was not correct. The correct view in our opinion was whether the amount advanced to the subsidiary or associated company or any other party was advanced as a measure of commercial expediency. We are of the opinion that the view taken by the Tribunal in Phaltan Sugar Works Ltd. (supra) that the interest was deductible as the amount was advanced to the subsidiary company as a measure of commercial expediency is the correct view, and the view taken by the Bombay High Court which set aside the aforesaid decision is not correct.

Similarly, the view taken by the Bombay High Court in Phaltan Sugar Works Ltd Vs. Commissioner of Income Tax, also does not appear to be correct.

We agree with the view taken by the Delhi High Court in Commissioner of Income Tax Vs. Dalmia Cement (B.) Ltd., 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 arm-chair 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 maximize 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 view point 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.......

..... However, where 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.

(emphasis is ours)

A reading of the observations of the Supreme Court in S.A. Builders (supra) clearly brings to the fore the fact that the expression "for the purpose of business" is wider in scope than the expression for the purpose of ''earning profits''. The Supreme Court has laid down the test which is proximate to one which is applied under the provisions of Section 37 of the IT Act; which is "commercial expediency". In our view, if this test is applied to the stated purpose for which funds were provided to Adler, Raipur and Shivpuri then, the only conclusion which one can arrive at is; that it was, for the purpose of business of Appellant/Assessee, within the meaning of the provisions of Section 36(1)(iii) of the IT Act.

The learned Counsel for the Respondent/ department has, however, contended that reading of the orders of the authorities below for the assessment year 1986-87 would demonstrate to the contrary, that is, Adler, Raipur and Shivpuri were not wholly owned subsidiaries of the Appellant/Assessee at the relevant point in time. According to us, at best, what could be said in favour of the Respondent/department is that there is no finding of fact affirming the assertion of Appellant/Assessee. The authorities below seemed to have proceeded on the basis that, even if this state of affairs is taken to be correct, the deduction in respect of interest paid on loans had to be disallowed u/s 36(1)(iii) of the IT Act. In rebuttal Mr Agarwal emphasized before us that a specific issue was raised before the assessing officer as well as the Commissioner of Income Tax (Appeals) [in short ''CIT(A)''].

Be that as it may we are of the view that for this limited purpose, which is, whether there was material on record to establish in the relevant assessment years, (i.e., assessment years 1986-87, 1987-88 and 1988-89) that the three companies, i.e., Adler, Raipur and Shivpuri were wholly owned subsidiary companies of the Appellant/ Assessee, the appeals require to be remanded.

Accordingly, we direct the ITAT to examine the matter only from this perspective on this aspect of the matter. In this regard ITAT will examine not only the material already placed on record but also if necessary give opportunity to both sides to adduce relevant material on this aspect of the matter.

In these circumstances, question No. 1 framed in ITA No. 40/1999 is answered in favour of the Appellant/ Assessee and against the department with a caveat, which is, that if the ITAT were to find that Adler, Raipur and Shivpuri were not wholly owned subsidiaries, the necessary consequences of the deduction being disallowed, will follow. As regards question No. 2 framed in ITA No. 40/1999 is concerned; the same having been raised based on an alternative plea, this question does not have to be answered sine all alternative pleas, as noticed hereinabove, have been given up by Mr C S Aggarwal.

To be noted question No. 3 pertains to an addition of Rs. 2,50,000/- made by the Assessing Officer on account of the fact that since , evidently no books of accounts were produced by the Appellant/ Assessee, notional interest to the said extent would be required to be added in respect of interest free funds advanced to the subsidiaries. The ITAT in the order dated 23.11.1998 has confirmed the addition by recording in paragraph No. 12 that on a perusal of "....the order of the CIT (A) and the record filed before us, we find that the Assessee has neither taken these grounds in first appeal nor any additional ground was taken at the appeal stage. So CIT (A) in our considered view was justified in not adjourning (sic) (read adjudicating) upon this issue." Mr. Aggarwal has submitted before us that the said observation of the ITAT is not entirely accurate since a specific ground was taken before the CIT (A) even though it was not happily worded. The ground taken before CIT(A) reads as follows:

Books of Accounts along with the voucher were produced before the AO and the same were scrutinized by him.

11.1 Based on the aforesaid, Mr. Aggarwal had argued that the CIT(A) being the first appellate authority had the requisite power to examine this issue threadbare. According to Mr. Aggarwal, the ITAT, could not have taken an easy way out in rejecting a ground of appeal which emanated from the aforesaid ground taken before the CIT(A). For this purpose, Mr. Aggarwal referred to ground Nos. 10 to 13 taken in the appeal filed before the ITAT.

11.2 In our opinion, Mr. Aggarwal is right. The ITAT seems to have adopted an approach, which is far too technical. The ITAT is directed to examine this issue as well.

11.3 In view of the decision that we have arrived at qua question No. 1 arising in ITA 40/1999, the question of law framed in ITA No. 42/1999 will come to the same pass. Accordingly, the said question of law framed in ITA No. 42/1999 is answered in favour of the Appellant / Assessee and against the Respondent/department.

For the foregoing reasons, the appeals are disposed of with a direction to the ITAT to examine the matter, as indicated by us hereinabove.