ORDER
D.K. Srivastava, Accountant Member
1. The appeal filed by the assessee-company is directed against the order passed by the learned Commissioner (Appeals) on the following grounds:
1. The learned Commissioner (Appeals) erred in confirming the action of the assessing officer in disallowing deduction in respect of interest expenditure of Rs. 2,01,64,247 in computing the business income. The learned Commissioner (Appeals) ought to have directed the assessing officer to allow deduction of the interest expenditure of Rs. 2,01,64,247.
2. Without prejudice to the ground No. 1 above, the learned Commissioner (Appeals) erred in confirming the action of the assessing officer in restricting the deductionin respect of interest expenditure to Rs. 77,78,630 in computing the income under the head “Income from other sources” and in thereby disallowing an amount of Rs. 1,23,84,617 in respect of interest. The learned Commissioner (Appeals) ought to have directed the assessing officer to allow the full deduction of Rs. 2,01,64,247 in respect of interest.
3. The learned Commissioner (Appeals) erred in confirming the disallowance of Rs. 75,00,000 in respect of professional fees.
4. The learned Commissioner (Appeals) erred in holding that the payment of professional fees of Rs. 75,00,000 had no direct nexus with the business of the appellant.
5. The learned Commissioner (Appeals) erred in holding that the professional fees of Rs. 75,00,000 were in the nature of capital expenditure.
6. Each one of the above grounds of appeal is without prejudice to the other.
2. It is evident on bare perusal of the aforesaid ground of appeal that two issues arise for adjudication in the present appeal. First issue (ground Nos. 1 and 2) relates to the disallowance of interest amounting to Rs. 1,23,85,617 out of total claim of Rs. 2,01,64,247 made by the assessee while second issue (Ground Nos. 3 to 5) relates to the disallowance of Rs. 75,00,000 in respect of professional fees claimed by the assessee.
Disallowance of interest amounting to Rs. 1,23,85,617
3. The facts giving rise to the present dispute are, in brief, as under:
(a) The assessee-company was engaged in the business of investments during the previous year relevant to the assessment year under appeal. The main activity of the assessee is claimed to be to make investments and grant loans and advances to others. It furnished its return of income on 28-11-1997 declaring loss of Rs. 2,11,27,268 under the head “Income from business”. The main reason for loss under the head “Business” was on account of the claim made by the assessee for allowance of interest amounting to Rs. 2,01,64,247. The assessee had also declared dividend of Rs. 3,86,32,807 in the return under the head “Income from business” which included dividend amounting to Rs. 3,54,33,300 received from NOCIL. The important point to be noted here is that the main activity of the assessee under the head “Income from business” consist of interest receipts and interest payments which has generated a loss of Rs. 2,11,27,268. Another important point to be noted here is that dividend income amounting to Rs. 3,86,32,807 was shown by the assessee itself under the head “Income from other sources” in the return of income filed by the assessee and also in the computation chart attached thereto. It is equally important to observe that the assessee has claimed deduction for interest amounting to Rs. 2,01,64,247 under Section 36(1)(iii) of the Act out of its business income. In the alternative, the assessee has claimed deduction for the aforesaid interest under Section 57(iii) out of dividend income.
(b) The assessing officer enquired into the sources of loans in respect of which the impugned deduction on account of interest was claimed. He found that the assessee had initially received advance of Rs. 34.90 crore from Mafatlal Industries Ltd. towards subscription of shares. However, the shares were not allotted but the advances were retained on which impugned interest @ 10% was claimed as deduction under Section 36(1)(iii). It may be relevant to mention that the amount so received was reflected as advance in the balance sheet.
(c) Out of the aforesaid interest-bearing advance of Rs. 34.90 crore, the assessee utilized Rs. 15,60,00,000 for making investment in the equity shares of Gujarat Gas Carbon Company Ltd. and the balance amount was given to Vibhadeep Investments & Trading Ltd. (“Vibhadeep”) as interest-free advance allegedly towards subscription of shares. Proportionate amount of interest relatable to the investments made in purchasing the shares of Gujarat Gas Carbon Ltd. has been allowed by the assessing officer under Section 57(iii) following the judgment of the Hon’ble Supreme Court in CIT v. Rajendra Prasad Moody . He however disallowed the proportionate amount of interest relatable to the interest-free advance given to Vibhadeep during the previous year relevant to the assessment year under appeal, i.e., assessment year 1997-98 which is the subjectmatter of Ground Nos. 1 and 2 in the present appeal.
(d) it is the case of the assessee that it had given the remaining amount of interest bearing advance (Rs. 19,35,00,000) as interest-free advance to Vibhadeep allegedly towards subscription of shares. The assessee admitted before the assessing officer (page 4 of the assessment order) that there was direct nexus between the interest-bearing advance received from MIL and interest-free advance given to Vibhadeep in the words as follow:
…we are to state that the advance subscription received from Mafatlal Industries Ltd. was utilized for the purpose of making investments in shares of Vibhadeep Investments Ltd….
Thus the existence of direct and proximate nexus for establishing the diversion of interest-bearing advance as interest-free advance is clear and is not in dispute.
(e) The assessee has also fairly conceded before the assessing officer that all the three companies namely (i) the assessee-company; (ii) MIL; and (iii) Vibhadeep are part of the same group and are under common management, inasmuch as the directors are common.
(f) The Commissioner (Appeals) has recorded a categorical finding in his order that”there is no agreement for advancing the said loan also” to Vibhadeep. Before us also, the assessee has not filed copy of agreement or any other document to show the terms and conditions of loan upon which interest-free advance was given to them. The assessee has shown the amount given to Vibhadeep as advance in its Balance Sheet for the year under consideration : page 6 of the assessment order.
(g) The assessing officer also considered the statement of the assessee contained in its letter dated 6-124999 (page 3 of the assessment order) in which the assessee itself admitted that the (i) investments giving rise to the dividend income from NOCIL amounting to Rs. 3,54,33,300 were made mainly out of share capital and share premium received and (ii) interest paid and other expenses incurred during the year under appeal were not attributable to dividend received during the year under appeal. It is thus clear that the expenses including interest claimed this year have no nexus with the dividend income shown this year.
(h) It. is claimed by the assessee that it had given interest-free advance of Rs. 19,65,00,000 to Vibhadeep during the previous year relevant to the assessment year under appeal. It is stated that Vibhadeep had issued 11,50,000 Preference Shares Cq) Rs. 10 each in February, 1997 out of which 10,00,000 preference shares of Rs. 10 each (Total Face Value : Rs. 1,00,00,000) were allotted on 6-2-1997 and further 1,15,000 shares of Rs. 10 each (Face Value : Rs. 11,50,000) were allotted on 17-3-1997. The crucial fact that emerges is that the assessee has invested in 11,50,000 preference shares of Rs. 10 each in Vibhadeep and that too after the said shares were issued in February 1997 against the interest-free advance of Rs. 19,35,00,000 given to Vibhadeep.
4. It is in the aforesaid factual matrix of the case that the assessing officer considered the claim of the assessee but did not allow the deduction on account of interest to the extent of Rs. 1,23,85,617 with tile following observations:
I have considered the submissions of the assessee and find it not tenable. M/s. Mafatlal Industries Ltd. (MIL), M/s. Vibhadeep Investment and Training Ltd. (Vibhadeep) and President (Finance) of Mafatlal Industries Ltd., Shri Praful R. Amin is President Corporate Affairs of M/s. Mafatfal Industries Ltd., Shri Praful R. Amin is also Director of M/s. Vibhadeep Investment and Trading Ltd. This shows that all these companies are managed by the same group of persons. The assessee has not received loan from M/s. Mafatlal Industries Ltd., but it was just advances for subscription of shares. The company is not supposed to pay any interest on advance subscription of shares. The character of money was same i.e., advance subscription but the assessee diverted the same funds as advance subscription for shares to M/s. Vibhadeep Investment and Trading Ltd., and M/s. Gujarat Gas Carbon Ltd.
The assessee has himself admitted that advance subscription received from MIL has been invested as advance subscription for (Vibhadeep). The scrutiny of the copy of account of Mafatlal Industries Ltd. and M/s. Vibhadeep indicate that there is direct connection of receipt of funds from Mafatlal Industries and in turn paid to M/s. Vibhadeep. The assessee paid interest to M/s. Mafatlal Industries Ltd. but no interest was charged from M/s. Vibhadeep. The assessee has adopted a device to claim interest expenses as the assessee had huge dividend income. In order to reduce its taxable income, the assessee agreed to pay interest to M/s. MIL Ltd. even though there is no scope for paying interest on advance received subscription for shares. This is not loan received from Mafatlal Industries. One important feature of these transactions is that there is no effeet of any tax in the hands of M/s. Mafatlal industries Ltd. (MIL) because there are no provision of taxes, even after offering income from interest from assessee-company i.e. Sushmita Holdings Ltd. These facts show that the nature and spirit of payment of interest is not bona fide.
The various courts including Apex Court in various decisions have frowned upon the devices adopted by the assessee to reduce the incidence of tax. The reliance is placed on the ratio of following decision:
Juggilal Kamalpat v. CIT 73 ITR 702 (SC)
Union of India v. Playworld Electronics (P.) Ltd. 184 ITR 311 (SC)
Mycal (P.) Ltd. v. CIT 150 ITR 609 (Mad.)
The claim of interest pertaining to use of funds for the purpose of advance subscription of M/s. Vibhadeep Investments & Training is not tenable. Such interest is disallowed as the assessee has failed to establish the business necessity. The character of funds remained same i.e. advances subscription. At one hand, the assessee has paid interest and on the other hand the assessee has not received any interest. Normally there is no interest involved for advance subscription. Even if there is stipulation for charging of interest, then the assessee should have charged interest, from M/s. Vibhadeep Investment and Trading.
The arguments of the assessee that interest expenditure is for business purpose is not tenable as the amounts are invested for advance subscription for shares of M/s. Vibhadeep. It is a long-term investment. The shares of M/s. Vibhadeep have not been allotted to the assessee as in the Balance Sheet it is shown under head “Advances”. Similarly, the assessee has not allotted shares to MIL, as not is shown under the head “Advance subscription towards shares”.
The assessee has further stated, without prejudice that if interest is not allowable under Section 36(1)(iii), then it should be allowed under Section 57(iii).
This contention would be acceptable if it is held that payment of interest on advance received against subscription of shares should be allowable. It is held that such transactions are not bona fide as on the same nature of transactions, at one hand, the assessee is paying interest and on other hand, the assessee is not receiving interest. The assessee has attempted to reduce the incidence of tax as there was huge dividend income. The dividend income has been earned on such fund, which were share capital and Reserve & Surplus. Even if we consider that interest should be allowed, there is no corresponding income, which should justify the allowability. The stand of the assessee that such interest can be set off against Dividend income is also not tenable as there cannot be dividend income during the year in the absence of allotment of shares. However, the interest pertaining to shares of Gujarat Gas Carbon Ltd., would be apportioned under the head ‘Income from other sources’. The assessee has made total investment in Gujarat Gas Carbon Ltd. of Rs. 15.60 crore in October 1996. The said amount is received from MIL. In fact the shares were purchased from MIL. Its value was considered as advance subscription for shares. The assessee paid interest at the rate of 10% to MIL for 182 days. This is a long-term investment. Therefore, interest would be treated under the head ‘Income from other sources’ following 115 ITR 519. It is worked out as under:
15,60,00,000/365 X 10 X 182 = 77,78,630.
5. On appeal, the learned Commissioner (Appeals) confirmed the order of the assessing officer with the following observations:
14. I have addressed myself carefully to the submissions made by the learned Counsel vis-a-vis assessing officer’s order on this score. Relevant case records have also been meticulously scrutinised. The assessing officer has clearly brought out in the assessment order that the payment of interest to the tune of Rs. 2,01,64,247 to M/s. Vibhadeep was not actuated by commercial expediency. A critical look into the factual scenario given above throw up the case that the appellant-company has diverted the amount of share subscription by way of loan to M/s. Vibhadeep, simply to get deduction of the so-called interest paid by the appellant-company, and in its wake, has attempted to have substantial deduction of tax liability. There is no agreement for advancing the said loan also. The appellant-company had borrowed an amount of Rs. 34,90,00,000 in the form of advance subscription towards issue of shares and it was not proper on the part of the appellant-company to transfer the said advance subscription by way of advance to M/s. Vibhadeep to enable the appellant-company to make payment of the so-called interest. The assessing officer is perfectly justified in coming to the conclusion that the entire exercise seems to be a colourable device to reduce the incidence of taxation. Here, I will be failing in my duty if I do not make mention of an almost identical case law, decided by Madras High Court in the case of K. Somasundaram & Bros. v. CIT 238 ITR 939 wherein also the assessee had diverted the funds to sister-concerns, free of interest, and had claimed the payment of interest as deductible under Section 36(1)(iii) of the Act. It was in the said context, their lordship of Madras High Court in the said case of K. Somasundarain & Bros. (supra) have observed as under:
Under Section 36(1)(iii)of the Act amounts diverted not being used for the purposes of the business, interest relating to the operation diverted cannot be treated as an item of permissible deduction in the computation of income.
The submission of counsel for the assessee is that once the amount borrowed is found to have been used for sometime in the business, the subsequent diversion is of no consequence cannot be accepted. The words used in the statutory provisions are borrowed for the purposes of the business. The amount borrowed must continue to be used for the purposes of the business and the fact that it was used for some point of time, but later diverted would not entitle the assessee to claim the interest paid on the borrowing as a deduction even after such diversion. In cases where diversion occurs immediately after the borrowing and the borrowed amounts are not invested in the business at all, but diverted for other purposes, there can be no doubt that interest paid on such borrowed amounts are not allowable. The postponement of diversion, in cases, where such diversion is found to be clearly established from the facts on record, does not entitle the assessee to claim the benefit of deduction on interest paid on the amounts borrowed are not presently used in its business diverted for other purposes. The time at which the diversion takes place is not the only relevant criterion. It is the fact of the diversion, which is material and once it has been shown that there has been diversion of interest on the amount borrowed, but subsequently diverted would not qualify for deduction.
15. Placed in the above perspective, if the instant case is analysed, it emerges that the assessee- company had got ‘advance subscription’which it has conveniently diverted for the sake of claiming deduction under Section 36(1)(iii) of the Act, is reported to have sent to M/s. Vibhadeep. In my considered opinion, this is out and out diversion done, subterfuges resorted to, smacking of colourable device. As such, the assessing officer has rightly disallowed the claim of deduction of interest under Section 36(1)(iii) of the Act.
16. In addition, I am of the view that the assessing officer has rightly allowed the interest payment to the tune of Rs. 77,78,630 out of the income from other source. The assessing officer’s order, on this score, does not call for any interference. The submissions made by the assessee-company on this score are, on careful consideration, not acceptable.
17. On a careful consideration of the submissions made by the learned Counsel, the detailed reasoning given by the revenue in the assessment order and having regard to the discussion given in the preceding paras, I hold that the revenue has legally correctly and rightly disallowed the claim of deduction of interest under Section 36(1)(iii) of the Act. The contentions raised by the learned Counsel, being devoid of merits, are hereby rejected.
6. Aggrieved by the aforesaid order passed by the learned Commissioner (Appeals), the assessee has filed the present appeal before this Tribunal.
7. At the time of hearing before us, the learned authorized representative for the assessee reiterated the submissions already made before and considered by the assessing officer and the learned Commissioner (Appeals). He contended. that the claim of the assessee ought to be allowed under Section 36(1)(iii) as the assessee had borrowed funds for making investments and consequently paid interest on such borrowings. It was pointed out that the amount in question was received from MIL as advance subscription towards issue of shares but the assessee could not allot the shares to MIL against the aforesaid advances and consequently treated the said advance as interest-bearing. It was argued that the assessee was an investment company and hence borrowal of money was a normal incident of its business. He submitted that the borrowings were used for the purpose of the business and hence the interest claimed by the assessee on such borrowings ought to be allowed in full. In this connection, he referred to the decisions in CIT v. Bombav Samachar Ltd. and unreported orders of this Tribunal in Surekha Holdings (P.) Ltd. v. Dy. CIT (IT Appeal No. 1672 (Mum.) of 1999), Mafatlal Holdings Ltd. v. Addl CIT (IT Appeal No. 2935 (Mum.) of 2002) and Assistant Commissioner v. Altaab Investment Co. Ltd. (IT Appeal Nos. 1656 (Mum.) of 1998, 1560 to 1564/Mum./ 1994).
8. In the alternative, he submitted that the claim of the assessee should be allowed under Section 57(iii) of the Income Tax Act as the interest-bearing advances were utilized for making investment in shares in order to earn dividend. It was contended that the mere fact that the dividend was not received would not by itself defeat the claim of the assessee under Section 57(iii) in view of the judgment of the Hon’ble Supreme Court in Rajendra Prasad Moody’s case (supra).
9. In reply, the learned Departmental Representative supported the order of the departmental Authorities. He submitted that the case of the assessee was a clear case where interest-bearing funds were diverted for use by a sister-company without any business consideration. Inviting our attention to the decision of be Hon?ble Bombay High Court in Phalton Sugar Works Ltd. v. CIT , he submitted that interest paid on borrowed capital which was subsequently given as interest-free advances to a subsidiary company or a sister concern was not eligible for deduction under Section 36(1)(iii) of the Income Tax Act. He submitted that the entire arrangement was made between the assessee-company and two of its sister-concerns under the same management in order to reduce the taxable income of the assessee-company otherwise there was no need for the assessee-company to borrow the interest-bearing funds and retain them for giving advance to a sister concern without charging interest. He submitted that if interest bearing funds were not required for the business purposes, they could have been returned to MIL instead of diverting them as interest-free advances to a sister concern. He also submitted that the MIL could itself have advanced the aforesaid funds to Vibhadeep without roping in the ass esse e -company. According to him the sole purpose for involving the assessee-company was to enable the assessee to claim interest payments for reducing tax liability. Inviting our attention to the decision of the Hon’ble Delhi High Court in CIT v. Orissa Cement Ltd. (2002) 258 ITR 365, the learned Departmental Representative submitted that it looked illogical that on the one hand the assessee was raising interest-bearing loans and the other hand, it was also diverting those very loans as interest-free loans to its sister-company. He also relied upon the decision of the Hon’ble Punj. & Har. High Court in S.A. Builders Ltd. v. CIT and the decision of the Hon’ble Delhi High Court in Elmer Havell Electrics Ltd. v. CIT .
10. We have heard the parties and considered their submissions including the judicial authorities cited by them. The assessee has made its claim for deduction of interest under Section 36(1)(iii) failing which it submits that its claim should be considered under Section 57(iii). We shall first take up the assessee’s claim for deduction under Section 36(1)(iii). The legal position with regard to the allowability of interest on borrowed capital under Section 36(1)(iii) of the Income Tax Act is fairly well-settled. Section 36 occurs in Chapter IV, which deals with the computation of income under the head “Profits and gains of business or profession”. The deduction contemplated by the section is in relation to the expenditure, which can properly be regarded as legitimate for the purpose of the business or profession. Expenditure incurred on account of commercial expediency for the purpose of business would be allowable under this provision. The expenditure to be allowed must therefore have a direct and proximate nexus with the business of the assessee and of none else. If the expenditure incurred is ostensibly for the business but in reality is not for the own business of the assessee such expenditure is not allowable. It therefore follows that interest paid on borrowed capital is eligible for deduction under Section 36(1)(iii) only when the assessee establishes that the borrowed capital has been used for the purpose of his own business and that if it is found that it has been, in reality, used f or the purpose other than that of his own business then interest to the extent to which the capital is so used is not eligible for deduction under Section 36(1)(iii) : PRM.S. Ramanathan Chettiar v. CIT and M.S.P. Raja v. CIT . It is implicit in the provisions of Section 36(1)(iii) that the capital so borrowed should not only be invest in the assessee’s business, but that the amount borrowed should also continue to remain in the business of the assessee. So long as the amount borrowed is used by the assessee in his own business, the interest paid on such borrowing is an expenditure, which is required to be deducted in the computation of the income from the business. The interest payable on the capital borrowed is a liability, which continues till such time as the amount borrowed is repaid provided the amount continues to be utilized for the purposes of the business of the assessee. Such interest is allowable under Section 36(1)(iii) only for the reason that the amount on which interest is paid continues to be used in the business and the payment of such interest is, therefore, necessary for the purpose of running the business.
11. In K. Somasundaram v. CIT , it has been held that it is not the object of Section 36(1)(iii) to enable an assessee to make a large borrowing and create a liability for payment of interest thereon not only in the year in which the borrowing is made, but in the subsequent years as well, keep the loan outstanding and thereafter divert the amount initially borrowed by taking it out of the business by giving it interest-free to the relatives of partners and thereby continue to pay interest out of the income of the business and claim the amount of interest paid as a business expenditure. The payment of interest on the amount not used in the business cannot be regarded as business expenditure as the business does not derive any benefit by the outgoing by way of interest on an amount, which is no longer in the business, but had been diverted from the business. The Hon’ble High Court has further observed that this provision cannot, therefore, be construed as enabling an assessee to burden the business with interest when the amount was initially borrowed for the business but subsequently taken out of the business by diverting it as interest-free loans to relatives of the partners. The learned Commissioner (Appeals) has very aptly relied upon the observations (reproduced by the Commissioner (Appeals) in his order) made by the Hon’ble Madras High Court in the aforesaid case.
12. In Triveni Engg. Works Ltd. v. CIT , the legal position with regard to allowability of interest under Section 36(1)(iii) has been explained as under:
In other words, borrowing of capital should be genuine and not colourful or illusory transaction. Interest on such loans can be allowed under the aforesaid provision only if it is proved that the loans were utilised in the accounting year for the assessee’s own business. If the loan was incurred not for the purpose of the assessee’s business but for the benefit of someone else, the interest on such loans cannot legitimately be claimed under Section 36(1)(iii) of the Act. Such a claim would only be a device adopted to reduce the tax liability of the assessee. As noticed earlier, the findings of the tax authorities are that part of the loans borrowed from the bank were diverted. The assessee has not been able to prove that the disputed loans were taken for its own business purpose or that advancing loans to M/s. Triveni Engineering Works Ltd. was in connection with the assessee’s business. In fact, no such case was pleaded before the Tribunal. The deduction was sought on the ground that in view of the embarrassed financial condition, there was justification for not charging interest from the debtor. Such a consideration is not germane to the allowance of deduction within the scope of the provisions contained in Section 36(1)(iii) of the Act. In view of the aforesaid discussion, the disallowance sustained by the Income Tax Appellate Tribunal cannot be assailed.
13. In Orissa Cements Ltd.’s case (supra), the action of the assessing officer in disallowing interest was confirmed by the Hon’ble Delhi High Court as the Income Tax Officer had disallowed interest on borrowed capital on the ground that it looked illogical that on the one hand the assessee should have raised heavy interest-bearing loans and on the other hand given interest-free loans to various societies and subsidiary companies. Relevant observations made in the said judgment are as under:
This aspect of the matter has also been considered in CIT v. H.R. Sugar Factory (P.) Ltd. , wherein the Allahabad High Court held:
The court cannot shut its eyes to realities. What has actually happened is visible to the naked eye. The assessee, a private limited company closely held by three family groups, is made to lend huge amounts (up to 23 lakhs of rupees as per the compromise arrived at between the assessee and the directors/ shareholders in the civil suits referred to above) at a very low rate of interest and the entire difference of interest is being charged to the assessee. The assessee is not a finance company. It is engaged in the manufacture of sugar. No business purpose of the assessee-company is served by such lending to its directors/ shareholders. It cannot be said that it is expedient in the interest of business or is laid out for the purpose of the business of the assessee…. May be that the company borrows large amounts for the purpose of its business every year, but that does not explain the huge advances to the directors /shareholders. Had this money been not advanced to the directors, it would have been available to the assessee for its business purposes and to that extent it may not have been necessary to borrow from the banks. We are, therefore, of the opinion that the Income Tax Officer was right in dis-allowing the difference of interest under Section 36(1)(iii) of the Income Tax Act and that the Tribunal’s approach is not only superficial but too naive.
In Indian Metals & Ferro Alloys Ltd. v. CIT , the Orissa High Court held:
…it may be pointed out that, in a hypothetical case, an assessee can earn profits only after the date of investment and advance. It cannot be said that because, in the concerned assessment year, the profit was more than the investment and advance, those came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee.
Yet again in CIT v. H.R. Sugar Factory Pvt. Ltd. (1991) 190 ITR 643 (All), B.P. Jeevan Reddy, CJ. (as his Lordship then was) relying upon his earlier decision in H.R. Sugar Factory Pvt. Ltd.’s case , held that the assess ee-company was not entitled to the allowance of interest.
In Hira Lall and Sons v. CIT , a Division Bench of this Court held that the question whether the loan was taken for the purpose of business was a question of fact and that no question of law arose out of the order of the Tribunal.
14. In Phalton Sugar Works Ltd. v. CWT and Phalton Sugar Works Ltd. case (supra) 215 ITR 582 (Bom.), the Hon’ble jurisdictional High Court has held that a subsidiary company is a separate legal entity and the business of the subsidiary company cannot be considered as the business of the assessee itself. The Hon’ble High Court has further held that the interest on money borrowed by the assessee for advancing to its subsidiary company would not be deducted from the income of the assessee-company under Section 36(1)(iii) of the Income Tax Act. The Hon’ble High Court has further observed:
Section 36(1)(iii) of the Income Tax Act, 1961, provides for deduction for payment of interest only if the assessee borrows capital for its own business. The business of the subsidiary company cannot be considered in law as the business of the assessee. The finding of the Tribunal based on commercial expediency appears to us to be incorrect. The fact remains that the moneys borrowed were utilised for business of the subsidiary company and not for the business of the assessee as such. In this view of the matter, we hold that the Tribunal was not justified in holding that the interest on loans borrowed for advancing to its subsidiary company was allowable under Section 36(1)(iii) of the Income Tax Act, 1961. The plain language of Section 36(1)(iii) of the Income Tax Act, 1961, militates against the submissions urged on behalf of the assessee.
15. It is in the background of the aforesaid settled legal position that the factual aspects of case before us need to be examined. The assessee first received a sum of Rs. 34,90,00,000 from MIL as advance towards subscription of shares. The assessee did not allot the shares for which it had received advances from MIL. The assessee thus deliberately retained borrowed money amounting to Rs. 34,90,00,000 and thereby incurred liability for interest thereon. Having thus taken and retained the interest-
Incomplete
DB15486A
bearing funds, the assessee thereafter diverted a substantial part (Rs. 19.35 crores) of the same as interest-free advance to a sister-concern namely, Vibhadeep. There is no material before us to hold that it is the business of the assessee to raise interest-bearing advance and then to divert the same as interest-free advance. There is no material before us to indicate the employment of interest-bearing advances for earning the income from business assessable under Section 28. The assessee itself has declared dividend income as income from other sources under Section 56 and hence the earning of dividend cannot be said to be income from business under Section 28. Since the dividend income is admittedly not a part of the business income of the assessee under Section 28, any interest liability incurred on borrowals made for purchasing the shares and earning dividend thereon cannot be considered for deduction under Section 36(1)(iii). It can at the most be considered for deduction under Section 57(iii) provided the statutory conditions prescribed therein are satisfied. That apart, the assessee has given interest-free advance of Rs. 19.35 crores to Vibhadeep allegedly towards subscription of shares at a time when Vibhadeep had not even issued the shares. The assessee has placed no material before us to show the business expediency in giving such a large interest-free advance of Rs. 19.35 crores allegedly towards subscription of shares when the shares had not even been issued and for purchasing only 11,50,000 preference shares of the face value of just Rs. 1,15,00,000. On the facts of the case, we are satisfied with the finding concurrently recorded by both the assessing officer and the Commissioner (Appeals) that there is a direct nexus between borrowal of interest-bearing funds and/or their retention and interest-free advances given to the sister-company. The advance so given did not bring any business gain to the assessee during the year under consideration under Section 28. No business purpose is shown to have been served by diverting interest-bearing advances received from a sister-company to another sister-company of the group as interest-free advances. It is important to observe that all the aforesaid companies including the assessee-company are under the same management. We are, therefore, in agreement with the finding recorded by the departmental authorities that the sole purpose for obtaining and/or retaining interest-bearing advances and to incur huge interest liability thereon was to reduce the taxable income of the assessee-company. Retention of such huge interest-bearing advance from MIL was not at all guided by any business consideration. If such an advance was not required by the assessee for the purpose of its own business, the assessee ought to have returned the said advance instead of diverting the same as interest-free advances to a sister-company but it did not do so because its real intention was not to promote its genuine business interest but to reduce the taxable income. It also deserves to be noted, as observed by the assessing officer, that there is no tax effect in the hands of Mafatlal Industries Ltd. (MIL) because there is no provision for taxes in its books even after offering income from interest from the assessee-company, i.e. Sushmita Holdings Ltd. It is interesting to observe that advance was A initially received from MIL towards subscription of shares but the shares were not allotted to MIL and the said advance was converted into interest-bearing advance without there being any business necessity. Having perused the order of the learned Commissioner (Appeals) in the light of the rival submissions made by the parties, we are of the considered view that the learned Commissioner (Appeals) has correctly appreciated all the relevant factual and legal aspects of the case in his well-reasoned order which we do not propose to repeat here for the sake of brevity. We are in complete agreement with his reasoning and decision in this behalf. His order is duly covered by well-established legal propositions governing the allowability of interest under Section 36(1)(iii). We see no valid reason to take a view different from the one taken by the Commissioner (Appeals) in this behalf and hence we endorse and confirm the same.
16. We shall now consider the alternative claim of the assessee that it should be allowed deduction for interest under Section 57(iii) of the Act. Section 57 occurs in Chapter IV-F.-Income from other sources. Clause (iii) of Section 67 provides for deduction of any “expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.” In Seth R Dalmia v. CIT , the Hon’ble Supreme Court has explained the requirements of the aforesaid provisions as under:
“An analysis of this sub-section would show that in computing the income under this head the assessee is entitled to deduction in respect of the p expenditure incurred solely for the purpose of earning such income, provided the expenditure is not of a capital nature and does not include any personal expenses incurred by the assessee. In other words, before this provision could apply, the following conditions must be fulfilled:
(i) the expenditure must have been incurred solely and exclusively/or the purpose of earning income or making profit,
(ii) the expenditure should not be in the nature of a capital expenditure;
(iii) the amount in question should not be in the nature of personal expenses of the assessee;
(iv) that the expenditure should be incurred in the accounting year; and
(v) there must be a clear nexus between the expenditure incurred and the income sought to be earned.
17. It follows from the above that the assessee must establish, inter alia, that he has incurred the expenditure solely and exclusively for the purpose of earning income or making profit and also a clear nexus between the expenditure incurred and the income sought to be earned. The words “for the purpose of” making or earning the income mean “with a view to” or “intending to” make or earn the income by incurring the expenditure for which deduction is claimed : P.V. Mohatned Ghouse v. CIT . In Smt. Padmavati Jaykrishna v. CIT (affirmed by the Supreme Court in Smt. Padmavati A Jaikrishna v. Addl CIT , it has been held that “unless it is found that a particular item of interest had some sort of nexus between it and the income in question the deduction contemplated by Clause (iii) of Section 67 cannot be allowed.” Affirming the judgment in the aforesaid case, the Hon’ble Supreme Court has observed (166 ITR 176 supra). “In fact, unless the loan is incurred for meeting the liability connected with the source itself, it would ordinarily be difficult to entertain the claims for deduction.”
18. Keeping the aforesaid principles in view, we shall now examine as to whether the assessee has brought any material on record to establish that (i) it has incurred the impugned expenditure solely and exclusively for the purpose of earning income or making profit and (n) a clear nexus between the expenditure incurred and the income sought to be earned. At the outset, it needs to be clarified that there is a marked difference between advance towards subscription money and subscription money itself. Shares cannot be subscribed unless they are issued. It is the claim of the assessee that Vibhadeep had issued only 11,50,000 preference shares in February 1997 which were allotted in February and March, 1997 for a total sum of Rs. 1,15,00,000. Interest-free advance will continue to retain its character till it is converted into subscription money or till it is actually invested for purchasing the shares. Likewise, interest-free advance, which is not converted into subscription money or is not utilized for purchasing the shares, will continue to remain interest-free advance. The amount given to Vibhadeep was initially in the nature of interest-free advance. It is an admitted position that the amount was given interest-free and hence the obvious purpose was that no interest would be charged and accordingly no interest was charged. We cannot therefore hold that the purpose of giving interest-free advance to the extent the amount was not utilized for purchasing the shares was to earn income or make profit from such advance. Had the purpose of advance been to make profit or earn income therefrom, it would not have been given as interest-free but as interest-bearing advance. The fact that the amount was given interest-free itself makes it clear that the advance was not intended to fetch any income or yield. Besides, the assessee has placed no evidence before us to establish that the amount was given initially to Vibhadeep as subscription or allotment money for purchases of shares. In fact, it was not possible to do so as the shares were issued only in February 1997 as per the claim of the assessee. The amount of interest-free advance would retain its character till and to the extent it was not utilized for purchasing the shares. In this view of the matter, we hold that the assessee has squarely failed to bring any material on record to establish that the impugned liability to interest was incurred wholly and exclusively for the purpose of earning any income. Since the assessee, by giving interest-free advance to Vibhadeep, did not seek to earn any income from the said advance, the requisite nexus between the interest liability and the income sought to be earned is also absent. For these reasons the case of the assessee clearly falls outside the A scope of Section 67(iii) of the Income Tax Act.
19. The learned authorized representative for the assessee, however, heavily relied upon the decision in Rajendra Prasad Moody’s case (supra) and contended that the said decision was an authority for the proposition that interest on borrowed money could not be denied to the assessee merely because the assessee had not shown or received any income from the advance given to Vibhadeep. Before we deal with the argument g advanced by the learned authorized representative for the assessee, it may be useful to highlight the factual background of the case considered by the Hon’ble Supreme Court in the aforesaid matter. To quote from the aforesaid judgment, assessees in that case were “brothers and each of them had borrowed monies for the purpose of making investment in shares of certain companies and during the assessment year 1965-66 for which the relevant accounting year ended on 10-4-1965, each of the two assessees paid interest on the monies borrowed but did not receive any dividend on the shares purchased with those monies.” Thus, crucial fact in that case was that the assessees had made investments and purchased the shares out of borrowed money but the shares so purchased did not fetch any dividend. To put it alternatively the assessee had planted and nurtured a tree but the tree did not bear the fruit. It is in this context that the Hon’ble Supreme Court has observed : “The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of income.” It is again in the circumstances of that case that the Hon’ble Supreme Court has cited with approval the observation of Lord Thankerton in Hughes v. Bank of England that “it does not require the presence of a receipt on the credit side to justify the deduction of an expense.” What the judgment lays down is that an assessee would be entitled to deduction under Section 57(iii) in respect of the interest on interest bearing funds to the ex tent it is actually utilized for’ purchasing the shares notwithstanding that the shares so purchased have not yielded any dividend. It follows as a natural corollary (hat an assessee would not be entitled to deduction under Section 57(iii) unless he established the nexus between the interest-bearing funds and their actual utilization in the purchase of shares. Similarly, the assessee would not be entitled to claim the deduction under Section 57(iii) if it is shown that the transaction is illusory or a colourable device to achieve a purpose other than the purpose of earning dividend. The assessing officer, relying upon the said judgment, has already allowed deduction of Rs. 77,78,630 being the proportionate interest on the amount of interest-bearing advance utilized for purchasing the shares of Gujarat Gas Carbon Ltd. under Section 51 (Hi). It is however the case of the assessee that it has subscribed to 11,50,000 preference shares issued by Vibhadeep in February 1997 as a result of which shares were also allotted to it in February and March 1997. In our view, the ratio of the judgment in Rajendra Prasad Moody will apply only to the extent of interest relatable to the interest bearing funds actually utilised for purchasing the aforesaid shares during the year under consideration provided the transaction is not illusory or a colourable device. The assessee cannot be denied deduction under Section 57(iii) on the sole ground that the shares so purchased did not fetch any dividend. We find that the learned Commissioner (Appeals) has not adjudicated upon the claim of the assessee under Section 57(iii) though he has passed a well-reasoned order for rejecting the claim of the assessee under Section 36(1)(iii). In this view of the matter, we consider it appropriate to direct the Commissioner (Appeals) to consider the claim of the assessee for proportionate allowance of interest relatable to the actual utilization of interest borrowing funds for purchasing the shares during the year under consideration. If the assessee is found to have actually invested the interest-bearing funds and purchased the shares and thereby actually utilized interest-bearing funds and the impugned transaction is not illusory or a colourable device, it should be allowed deduction to the extent of interest liability relatable to interest bearing funds actually utilized for purchasing the shares and from the point of time the money was so utilized. Remaining amount not so utilized and for the period it was not so utilised will continue to be interest-bearing advance to Vibhadeep on which assessee will not be entitled to any deduction either under Section 57(iii) or Section 36(1)(iii). The matter is therefore restored to the file of learned Commissioner (Appeals) with the aforesaid directions for adjudicating upon the alternative claim of the assessee for deduction of interest under Section 57(1)(iii) after verification of facts.
20. In view of the foregoing, while the claim of the assessee for deduction under Section 36(1)(iii) is rejected, its claim for deduction under Section 57(iii) is restored to the file of the learned Commissioner (Appeals) for consideration and adjudication in accordance with law keeping in view the directions given earlier in this order. Consequently, Ground No. 1 is dismissed while Ground No. 2 is treated as allowed for statistical purposes.
Disallowance of professional fee amounting to Rs. 75,00,000
21. Facts of the case, in brief, are that the assessee had claimed deduction for a sum of Rs. 75,14,500 on account of legal expenses. The assessing officer examined the details of legal expenses and observed that a sum of Rs. 75,00,000 was paid to Mafatlal Industries Ltd., a sister concern, in connection with the assessee’s share of expenses incurred by MIL for restructuring programme conducted by McKinsey & Co. On being called upon to justify the claim for the aforesaid expenditure as deduction under Section 37, the assessee pointed out before the assessing officer that the said expenditure was incurred on account of the assessee’s share in the expenses incurred by MIL for having a study conducted by McKinsey & Co. for restructuring the companies of the Group. It was also submitted before the assessing officer that the impugned expenses would be deductible under Section 37(1) as they were incurred wholly and exclusively for the purpose of business. The assessing officer, after considering the submissions of the assessee, disallowed a sum of Rs. 75,00,000 paid to the sister concern, namely MIL mainly on two grounds : one, the impugned expenditure was in the nature of capital expenditure, and, two, the impugned expenditure had no nexus with the business of the assessee. He was of the view that the main source of income of the assessee was interest income and dividend income and that these sources of income did not have any relationship with the restructuring programme suggested by McKinsey & Co. He was also of the view that the amount payable to M/section McKinsey & Co. was the liability to those companies alone, which were likely to be benefited by the restructuring programme and hence it was incorrect in law on the part of the assessee to share that burden which did not legitimately belong to it.
22. On appeal, the learned Commissioner (Appeals) confirmed the action of the assessing officer. Besides, he also held that the assessee itself had not incurred the impugned expenditure and hence the assessee was not liable to claim any deduction. According to him, there was no legal liability on the assessee to meet the impugned expenditure. He also took the view that the arrangement for sharing the expenditure was basically an informal C arrangement arrived at between the family concerns. He also held that the claim of the assessee was outside the scope of Section 37 inasmuch as, the assessee-company itself had not incurred any expenditure in this behalf.
23. Aggrieved by the aforesaid order, the assessee is now in appeal before the Tribunal.
24. At the time of hearing before us, the learned authorised representative for the assessee pointed out that MIL (the flagship company of Arvind D Mafatlal Group (AMG)) appointed McKinsey & Co. Inc. to advise on the corporate strategy and restructuring plan for MIL and its group companies. According to him, McKinsey & Co. carried out the exercise of reviewing the business of the group and made several recommendations in pursuance of which the assessee-company also disposed of certain investments in shares and bonds amounting to Rs. 68,54,78,317. It was claimed that the disposal of shares and bonds was effected by the assessee p pursuant to the restructuring plans of the group concerns recommended by the McKinsey & Co. and hence it could not be said that the impugned expenditure was incurred for the purposes other than the purposes of business of the assessee.
25. In reply the learned DR supported the orders of the departmental Authorities.
26. We have considered the rival submissions including the judicial authorities cited by them. Section 37 of the Income Tax Act allows deduction for any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of the business or profession in computing the income chargeable under the head “Profits and Gains of Business or Profession”. In order to successfully claim the deduction under Section 37 the assessee must establish not only that the expenditure in question has been incurred wholly and exclusively for the purposes of the business but also establish that such expenditure is not in the nature described in Sections 30 to 36 and also not in the nature of capital expenditure or personal expenses of the assessee. In the case before us, no evidence has been placed before us to show that the assessee-company has entered into any agreement with MIL or McKinsey & Co. undertaking to share the impugned expenses. Secondly, the assessee-company, as rightly observed by the assessing officer and the learned Commissioner (Appeals), was having its income from interest and dividend and hence it was incumbent on the part of the assessee to place relevant materials on record to show as to how and what part of the business of the assessee was restructured on the recommendations of the McKinsey & Co. The assessee has, however, placed no such evidence before us. It is also observed that shares and bonds were sold in the past also without there being any recommendation by M/s. McKinsey & Co., to that effect. Thus, the mere fact that certain shares and investments were disposed of this year would not by itself prove that they were so done as a part of restructuring programme suggested by M/s. McKinsey & Co. Thirdly, the assessee claims expenditure but places no material to show the nature of services obtained by it in consideration thereof. Fourthly, the assessee has not placed any material before us to show as to what was the restructuring plan suggested by M/s. McKinsey & Co. for the assessee-company and as to how the assessee-company got any benefit out of the said restructuring plan. Fifthly, the assessee has not brought any material on record before us to establish direct and proximate nexus of the impugned expenditure with the business of the assessee. It is thus a case where the assessee has squarely failed to discharge the primary burden that lay upon it under Section 37. It has failed to establish that the impugned expenses were incurred wholly and exclusively for the purposes of its own business. Mere assertion that the restructuring programme suggested by McKinsey & Co. would benefit the assessee-company as it is a group company of MIL is not, in our view, sufficient to discharge the burden cast upon the assessee under Section 37 in the absence of any supporting evidence on record. In this view of the matter, the findings recorded by the learned Commissioner (Appeals) in this behalf are confirmed. Ground Nos. 3, 4 and 5 taken by the assessee are consequently dismissed.
27. The appeal filed by the assessee is partly allowed subject to the directions given above.