JUDGMENT
1. The Tribunal, Allahabad has referred the following questions of law under Section 256(1) of the IT Act, 1961 (hereinafter referred to as the Act), for opinion to this Court:
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in coming to the conclusion that the assessee got reasonable opportunity to meet the case in respect of accrual of interest on advances made to M/s Mohan General Trading Co., Calcutta and M/s Malik & Co., Kanpur ?
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in coming to the conclusion that interest @ 18 per cent per annum accrued to the assessee on the advances made to M/s Mohan General Trading Co., Calcutta and M/s Malik & Co., Kanpur ?
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the advance made to M/s Malik & Co. was not a business advance ?
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in upholding the disallowance of Rs. 1,98,607 made by the IT authorities under Section 36(1)(iii) of the IT Act, 1961 on the ground that the interest should have been charged on advances made to M/s Mohan General Trading Co., Calcutta and M/s Malik & Co., Kanpur ?
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in confirming the disallowance of Rs. 1,98,607 under Section 36(1)(iii) of the IT Act, 1961 for the asst. yr. 1980-81 ?
2. The reference relates to years 1978-79, 1979-80 and 1980-81.
Briefly stated the facts giving rise to the present reference are as follows:
The brief facts of the case are that the assessee lady had obtained import licence for importing certain machines for running a tannery. To finance the aforesaid imports, she had made arrangements with U.P. Financial Corporation. Originally, it was intended that the tannery would be run in the part of residential premises of the family situated in Civil Lines, Kanpur. The Municipality of Kanpur, however, did not permit her to do the said business there. The financial arrangement with U.P. State Financial Corporation accordingly fell through. The machines were, however, already on their way and were about to land at Calcutta port. The assessee, therefore, felt obliged to make alternative financial arrangement and accordingly she raised loans of Rs. 8,43,446.91 from her close relatives. The said loans were raised in the accounting period ended on 30th April, 1975. The cost of machines was Rs. 8,41,978, thus, the entire borrowings were more or less utilised for the purchase of aforesaid machine in the accounting period ending on 30 th April, 1975.
The assessee entered into an agreement with M/s Mohan General Trading Co., Calcutta on 15th May, 1973. As per the terms of the agreement, the Calcutta firm was to construct a new building to be used as the tannery of the assessee on a plot of land which was with the said firm on lease and during the construction period, the machines would be installed in the nearby plot.
On 2nd April, 1975, a fresh agreement was entered into between the assessee and HUF known as Malik Co. In terms of these agreements, the assessee started advancing funds to M/s Mohan General Trading Co., Calcutta. In respect of the advances to M/s Mohan General Trading Co., Calcutta and M/s Malik Co., Kanpur, the findings of the ITO for the three years were as under:
Asst yr. 1978-79 "As regards non-charging interest from parties mentioned above, the assessee has furnished details in his letter dt. 5th March, 1982 from perusal from this above letter, it appears that the assessee mainly accommodated the above parties for certain services to be rendered by them and accordingly did not charge any interest. The assessee had paid huge interest amounting to Rs. 2,04,837 to the parties from whom the loans were raised. Since the amount of borrowings had not been utilised for business purposes of the assessee and had been given to other parties without interest, I disallow the interest @ 12 per cent per annum chargeable on the amount advanced to various parties from the interest paid by the assessee as under:
Scrutiny of balance sheet showed that the assessee had advanced Rs. 3,88,057 to M/s Mohan General Trading Co. and Rs. 7,02,464 to M/s Malik Co. for known business purposes and interest income over it has not been shown whereas interest on debit balance of M/s Ideal Glass Co. has been shown by the assessee. The assessee paid Rs. 2,38,772 interest to her creditors. The assessee has not been able to establish as to how interest has not been charged from two debtors while same was charged from others. Considering the facts and circumstances of the case interest amounting to Rs. 1,09,685 is disallowed under Section 36(1)(iii) of the IT Act.
Asst. yr. 1980-81 The assessee has paid interest of Rs. 2,33,434 to the various creditors and has shown interest of Rs. 17,500 having been received from M/s Ideal Glass Co. The assessee has not charged interest from other debtors. Therefore, the interest amounting to Rs. 1,98,607 is disallowed under Section 36(1)(iii) of the IT Act last year.
The CIT(A) disposed of the appeals by a common order dt. 10th Feb., 1987 and his findings in para 8 of his order are reproduced below:
In the instant case, it is more than clear that while on the one hand, the appellant is having borrowing of money from various parties and for which in the asst. yr. 1978-79, as per P&L a/c it has claimed deduction for payment of interest amounting to Rs. 2,04,837, she has diverted funds to the tune of more than Rs. 8 lacs without charging interest, to its closely related concerns and, thus, it is clear these are very crude and obvious devices by the appellant to evade or at least avoid tax. The very fact that the agreement with M/s Mohan General Trading Co. dates back to 15th May, 1973 and with M/s Malik Co. on 2nd April, 1975 and still none of the projects has been completed till date, at least so far as its benefits being taken by the appellant is concerned, would clearly show, that those agreements were merely an eyewash. In these circumstances, I hold that disallowance of interest by the ITO in respect of interest free advances given to M/s Mohan General Trading Co. and M/s Malik Co. for all these three years are dismissed.
The Tribunal has dealt with disallowance under Section 36(1)(iii) of the IT Act, 1961 in paras 3 to 15 of order dt. 30th April, 1990. In para 12, the Tribunal has held as follows:
We have carefully examined the facts of the case and the rival submissions and have also perused the two contracts. So far as the advance to M/s Mohan General Trading Co. is concerned, it was, in our opinion, a trade advance given with a view to acquire the place for carrying on business.
In para 14, the Tribunal has held as under:
So far as loan given to M/s Malik Co. is concerned, it is undoubtedly true that the loan to M/s Malik Co. has not been given out of borrowings on which assessee was paying interest. Therefore, no part of the interest paid on the aforesaid borrowings could be disallowed that interest bearing loan was diverted to give the interest-free loan to M/s Malik Co. Therefore, the contention of the assessee against invoking the provisions of Section 36(1)(iii) in respect of M/s Malik Co. is also correct.
The ITO categorically mentioned in his order as "therefore, interest amounting to Rs. 1,98,607 is disallowed under Section 36(1)(iii) of the IT Act, 1961 like last year". As has been mentioned by the Tribunal in para 11 of the order, the Departmental Representative on behalf of the respondent only relied upon the orders of the authorities below and read in extenso the order of the CIT(A). None of the lower authorities had considered the aspect of the approval (sic-accrual) of income in terms of agreement even there was no submission on behalf of the Department that any opportunity was allowed to the assessee to explain his viewpoint on the question of accrual of income in terms of the aforesaid two agreements. On behalf of the assessee, specific argument was made that no opportunity was allowed to explain his case before the authorities below but this was rejected by the Tribunal and the relevant findings of the Tribunal contained in para 13 of the order are reproduced below:
The request of the assessee that it should be provided an opportunity to explain this point before the authorities below and for this purpose the matter should be restored to the ITO is not acceptable to us. After all, the viewpoint of the ITO and the disallowance in question was all along the bone of contention and the assessee's defence was the agreement with M/s Mohan General Trading Co. that the very agreement provided for charging of interest by the assessee. Had there been any variation in the aforesaid clause, the assessee should have brought it on record and in any case would point it out to us at the time of hearing. There has been no such attempt. We, therefore, refuse to accept the assessee's plea and to restore back the matter to the files of the ITO.
The Tribunal as per discussion in paras 13, 14 and 15 of its order, held that the interest accrued to the assessee in respect of the asst. yr. 1980-81 in terms of the two agreements.
3. We have heard Shri Shakil Ahmad, learned Counsel appearing for the assessee and Shri A.N. Mahajan, learned standing counsel for the Revenue.
4. Shri Shakil Ahmad, learned Counsel submitted that in respect of the two assessment years, namely, 1978-79 and 1979-80, the Tribunal itself has held that the proportionate amount of interest relatable to the advances made by the applicant to M/s Malik & Co., Kanpur and M/s Mohan General Trading Co., Calcutta, which were added by the assessing authorities had been deleted on the ground that the advances were made for business purposes. He further submitted that for the remand report submitted by the assessing authorities, it has been specifically mentioned that the photocopy of the agreement obtained from the assessee, copy of the accounts of the creditors and debtors and copy of reply of notice under Section 143(3) do not reveal that the borrowings from the creditors, whose interest has been paid were utilized as interest-free loans to the debtors, and therefore, in view of the categorical finding having been returned by the assessing authority in his remand report the question of disallowing proportionate amount of interest on interest-free advances to the two firms, did not arise. In support of his various pleas, he has relied upon the following decisions:
(i) CTT v. Orissa Cement Ltd. ;
(ii) CTT v. Tin Box Co. ;
(iii) CIT and Anr. v. Radico Khaitan Ltd. .
5. Shri A.N. Mahajan, learned standing counsel, on the other hand, submitted that under the agreement entered into by the applicant with the two firms has clearly established that if the project is not completed within a specified period, the firms would be liable to pay interest on the accrued rate and, therefore, the Tribunal was justified in relying upon the said clause of the agreement and upholding the disallowance of the proportionate amount of interest under Section 36(1)(iii) of the Act, which the applicant had paid on borrowed capital. He has relied upon a decision of this Court in the case of CIT v. H.R. Sugar Factory (P) Ltd. .
6. We have given our anxious consideration to the various pleas raised by the learned Counsel for the parties.
7. It is not in dispute that for the asst. yrs. 1978-79 and 1979-80, the Tribunal has reversed the disallowance of the proportionate amount of interest. In respect of the asst. yr. 1980-81, the Tribunal has confirmed the disallowance relying upon clause of the agreement, which provided charging of interest. However, we find that in the remand report, which was called for by the Tribunal, the assessing authorities had mentioned the following facts:
As desired I have examined the issue as to whether borrowings from the creditors have been utilized as interest-free loan to M/s Mohan General Trading Co. and M/s Malik Co. by the assessee, copy of the accounts of creditors and debtors, copy of the reply of notice under Section 143(3), photocopy of the agreement obtained from the assessee does not reveal that the borrowing from the creditors whom interest has been paid were utilized as interest-free loans to the debtors.
8. The factual position, thus, is that the borrowed money on which the applicant was liable to pay the interest to its creditors had not been diverted towards interest-free loans by it to the aforesaid two firms on which interest has not been charged. It is not the case of the Revenue that as the applicant is following the mercantile system of accounting and under the agreement, the interest even though not actually charged had accrued as income and, therefore, liable to pay tax. On the other hand, the specific stand taken by the Revenue is that as the applicant had not taken any interest on the advances made by it to M/s Malik & Co., Kanpur and M/s Mohan General Trading Co., Calcutta proportionate interest which the applicant could have realized from these two firms and which had not been realized should be disallowed under Section 36(1)(iii) of the Act. This Court in the case of Radico Khaitan (supra) after discussing its decision in the case of H.R. Sugar (supra), which has been heavily relied upon by Shri A.N. Mahajan has held that if the assessee has sufficient funds other than the borrowed money for giving the amount as loan to any other concern, the conditions of Section 36(1)(iii) of the Act had been complied with and the assessee is entitled to full allowance of the amount of interest paid by it on borrowed capital. Similar view has been taken by this Court in the case of CIT v. Prem Heavy Engineering Works (P) Ltd. . Similar view has been taken by the Delhi High Court in the case of Orissa Cement Ltd. (supra) and Tin Box Co. (supra).
9. In view of the foregoing discussions, we are of the considered opinion that the Tribunal was not justified in confirming the disallowance of Rs. 1,96,607 for the asst. yr. 1980-81.
10. In view of our answer to question No. 5, the other four questions have been rendered academic. We, accordingly, answer the question No. 5 referred to us in the negative, that is, in favour of the assessee and against the Revenue while the remaining four questions are returned unanswered.