Case Summary: CIT (LTU) v. Reliance Industries Ltd. (2019) 410 ITR 466/175 DTR 1/307 CTR 121/261 Taxman 164 (SC)
During the period under examination, the assessee had extended a total of Rs. 3,727.14 billion in interest-free loans to its subsidiary companies. The Assessing Officer decided that the proportional interest on these loans should not be permitted since they were not considered to have been undertaken to do business.
The Tribunal decided that the assessee had sufficient interest-free funds, and in fact, the assessee’s net profit after taxes and before depreciation for the year under consideration exceeded not only the differential or incremental loan given to subsidiaries during the year, but it also exceeded the total interest-free loans given to the subsidiaries. This was because the year’s net profit was higher than both the differential and incremental loan amounts.
As a result, the Tribunal concluded that a presumption could be made that the investments were made using the interest-free funds that were available with the assessee, and that there was no need for a disallowance to be made following the provisions of subsection 36(1)(iii) of the Act. Following previous decisions made by the same court, the Bombay High Court acknowledged the validity of the Tribunal’s point of view.
Is it possible to take a deduction for the interest that is accrued on funds that have been provided to subsidiaries following the provisions of subsection (iii) of section 36 of the Act when such interest would not have been due to banks if funds had not been provided to subsidiaries?
The Act, under its section 36(1)(iii), allows for the deduction of interest expenses that have been expended to do business. This provision indicates that the funds that are accruing interest are being used to conduct business.
If an assessee is paying interest on any loan, the funds of which have been advanced to a group company, then, unless the businesses of both companies are linked and connected, and unless it can be proven that the advancing of loan to the group company was for business, then the interest on loan taken by the assessee is at risk of being disallowed for not satisfying the conditions of section 36(1)(iii) of the Act.
However, when the assessee has sufficient interest-free funds to take care of such advance to the subsidiary, then the Courts have laid down that a presumption can be made that such advance is out of the interest-free funds available with the assessee, thus requiring no disallowance under section 36(1)(iii) of the Act. This is the case when the assessee has sufficient interest-free funds to take care of such advance to the subsidiary.
When the funds of an assessee, both those funds that do not carry interest and those funds that do bear interest, are combined in a single account, which is subsequently used to make a variety of payments, a presumption of this kind becomes unavoidable. This presumption was accepted by the Supreme Court in the case of East India Pharmaceutical Works Ltd. v. CIT [(1997) 224 ITR 627 (SC)], even though the assessee, in that case, did not receive any relief because this particular argument was not presented to the lower courts where the case was originally heard.
In addition, the Calcutta High Court reached a conclusion that was comparable to this one in an earlier ruling titled Woolcombers of India Ltd. v. CIT [(1982) 134 ITR 219 (Cal)] (HC). The preceding judgments led to the Bombay High Court approving the theory of presumption in the case of CIT v. Reliance Utilities & Power Ltd. (2009) 313 ITR 340 (Bom)(HC), which was followed by several additional rulings. Even if this is not the case, one might argue that the money that accrues interest is used in the company to create interest-free funds that may be put to use for any purpose that is not related to the company.
The appeal of the Revenue was turned down by the Supreme Court, which held that when an assessee has sufficient interest-free funds available to meet investments, there is a presumption that investments in subsidiaries were made using interest-free funds, and as a result, there cannot be a disallowance made under section 36(1)(iii).
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Judgement Reviewed by Jay Kumar Gupta