Section 36(1)(iii)- Interest free loans given to sister concerns—if assessee held interest free funds and also interest bearing funds, presumption would be that investments were made from interest free funds available with assessee.
Section 40(a)(ia) and section 194A—Business expenditure—assessee claimed deduction of interest expenditure for which no accounting entry was passed in books of account— the event for deduction of tax at source arises when the amount of interest is credited to the account of the payee or when it is paid, whichever is earlier—Since the said interest was neither credited in the books of account nor paid in the year, section 194A cannot be attracted—Once there is no liability to deduct tax at source u/s. 194A, the provisions of section 40(a)(ia) cannot be attracted.
Facts I:
The assessee had given interest-free funds to its sister concerns. The AO observed that no interest was charged on such advances to sister concerns whereas substantial interest was paid on borrowed funds. In absence of any nexus between the interest-free funds advanced and interest-free funds available with the assessee, the AO made disallowance by applying 15% rate of interest. The CIT(A) also upheld the AO’s action.
Held I:
The Tribunal observed that the interest-free funds available at the disposal of the assessee were far in excess of the interest-free loans advanced to the sister concerns. Relying on the decision of Hon’ble jurisdictional High Court in the case of CIT vs. Reliance Utility and Power Limited [(2009) 313 ITR 340 (Bom.)], the Tribunal held that if the assessee has interest-free funds as well as interest-bearing funds at its disposal, it shall be presumed that investments were made from interest-free funds available with the assessee. The addition was deleted.
Facts II:
Assessee claimed deduction of interest expenditure in the computation of total income for which no accounting entry was passed in the books of account. The AO held that assessee followed cash system of accounting in respect of accounting of interest expenditure and as assessee had not made any payment of interest, the same was not deductible. The Ld CIT(A) held that the assessee had not deducted TDS on interest payable and hence u/s. 40(a)(ia) the deduction was not allowed.
Held II:
The Ld. AO was not justified in applying hybrid system of accounting i.e., applying cash system for accounting of interest expenditure and mercantile system for accounting for all other items. As per section 145, income under the head ‘Profits and gains of business or profession’ is to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. The assessee was regularly following mercantile system of accounting.
In the mercantile system of accounting, deduction is allowed on accrual of liability and it is not material whether the amount is paid or not or whether or not it is recorded in the books of account. Assessee’s similar claim of deduction of such interest expenditure was allowed in earlier assessment years also.
As per sections 40(a)(ia) and 194A, the event for deduction of tax at source arises when the amount of interest is credited to the account of the payee or when it is paid, whichever is earlier. The assessee did not credit such interest in the books of account under any account and further such interest had not been paid during the year. The deduction had been claimed on the basis of mercantile system of accounting straightway in the computation of income, without routing it through books of account, which had been held by us to be allowable. Hence, the mandate of section 194A cannot be attracted. As there is no liability to deduct tax at source u/s. 194A, the provisions of section 40(a)(ia) cannot be attracted.
This loophole was probably not contemplated by the Legislature while enacting the relevant provisions, which has been exploited by the assessee as a measure of tax planning.
