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'REPORTABLE' IN THE SUPREME COURT OF INDIA CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 514 OF 2008

HERO CYCLES (P) LTD.                          ... Appellant VERSUS

COMMISSIONER OF INCOME TAX (CENTRAL),  LUDHIANA      ... Respondent

J U D G M E N T A. K. SIKRI, J.

The present appeal preferred by the assessee pertains to the Assessment Year 1988-1989. In the income tax return filed by the assessee for the aforesaid Assessment year, the assessee, inter alia, claimed deduction of interest paid on borrowed  sums  from  Bank  under  the  provisions  of  Section 36(1)(iii) of the Income Tax Act (hereinafter referred to as 'Act').   The  aforesaid  deduction  was  disallowed  by  the Assessing  Officer  vide  his  Assesssment  Order  dated 26.03.1991 on the following two points: -

(1) The  assessee  had  advanced  a  sum  of Rs.1,16,26,128/- to its subsidiary company known as M/s. Hero Fibers Limited and this advance did not carry any interest.   According  to  the  Assessing  Officer,  the assessee had borrowed the money from the banks and paid interest thereupon.  Deduction was claimed as business expenditure but substantial money out of the loans taken from the Bank was diverted by giving advance to M/s. Hero

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Fibres Limited on which no interest was charged by the assessee.  Therefore, he concluded that money borrowed on which interest was paid was not for business purposes and no deduction could be allowed. (2) In addition, the assessee had also given advances to its own directors in the sum of Rs. 34 lakhs on which the assessee  charged  from  those  directors  interest  at  the rate of 10 per cent, whereas interest payable on the money taken by way of loans by the assessee from the Banks carried interest at the rate of 18 per cent.  On that basis, the Assessing Officer held that charging of interest  at  the  rate  of  10  per  cent  from  the  above mentioned persons and paying interest at much more rate, i.e., at the rate of 18 per cent on the money borrowed by the  assessee  cannot  be  treated  for  the  purposes  of business of the assessee.

We  may  note  here  that  the  assessee  had  claimed deduction of interest in the sum of Rs.20,53,120/-.  The Assessing  Officer,  after  recording  the  aforesaid  reasons, did  not  allow  the  deduction  of  the  entire  amount  and re-calculated the figures, thereby disallowed the aforesaid claim to the extent of Rs.16,39,010/-.   

The assessee carried the matter in appeal before the Commissioner of Income Tax (Appeals).  The CIT (Appeals) set aside the order of the Assessing Officer holding that the interest  paid  by  the  assessee  of  which  deduction  was

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claimed,  on  the  facts  of  this  case,  was  for  business purposes  and,  therefore,  the  entire  interest  paid  by  the assessee should have been allowed as business expenditure.

It would be pertinent to mention that insofar as the advance given to M/s. Hero Fibres Limited is concerned, the case  put  up  by  the  assessee  even  before  the  Assessing Officer  was  that  it  had  given  an  undertaking  to  the financial institutions to provide M/s. Hero Fibres Limited the  additional  margin  to  meet  the  working  capital  for meeting any cash loses.  It was further explained that the assessee company was promotor of M/s. Hero Fibres Limited and since it had the controlling share in the said company that  necessitated  giving  of  such  an  undertaking  to  the financial institutions.  The amount was, thus, advanced in compliance  of  the  stipulation  laid  down  by  the  three financial  institutions  under  a  loan  agreement  which  was entered into between M/s. Hero Fibres Limited and the said financial  institutions  and  it  became  possible  for  the financial  institutions  to  advance  that  loan  to  M/s.  Hero Fibres Limited because of the aforesaid undertaking given by the assessee.  It was also mentioned that no interest was to be  paid  on  this  loan  unless  dividend  is  paid  by  that company.

On  that  basis,  it  was  argued  that  the  amount  was advanced  by  way  of  business  expediency.   CIT  (Appeals) accepted the aforesaid plea of the assessee.

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Insofar  as  the  loan  given  to  its  own  Directors  is concerned  at  the  rate  of  10  per  cent  is  concerned,  the explanation of the assessee was that this loan was never given  out  of  any  borrowed  funds.   The  assessee  had demonstrated that on the date when the loan was given that is  on  25.03.1987  to  these  directors,  there  was  a  credit balance in the account of the assessee from where the loan was  given.   It  was  demonstrated  that  even  after  the encashment of the cheques of Rs. 34 lakhs in favour of those directors by way of loan, there was a credit balance of Rs.4,95,670/-  in  the  said  bank  account.   The  aforesaid explanation was also accepted by the CIT (Appeal) arriving at a finding of fact that the loan given to the Directors was  not  from  the  borrowed  funds.   Therefore,  interest liability of the assessee towards the Bank on the borrowing which  was  taken  by  the  assessee  had  no  bearings  because otherwise,  the  assessee  had  sufficient  funds  of  its  own which the assessee could have advanced and it was for the Assessing  Officer  to  establish  the  nexus  between  the borrowings and advancing to prove that expenditure was for non-business purposes which the Assessing Officer failed to do.   

The Department/ Revenue challenged the order of the CIT(Appeal)  before  the  Income  Tax  Appellate  Tribunal (hereinafter referred to as 'ITAT').  The ITAT upheld the aforesaid view of the CIT(Appeal) and thus, dismissed the

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appeal preferred by the Revenue.   

Further appeal of the Revenue before the High Court filed under Section 260A of the Income Tax Act, however, has been allowed by the High Court vide impugned judgment dated 06.12.2006.  Challenging  that  judgment,  special  leave petition was filed in which leave was granted and that is how the present appeal comes up for hearing.

A perusal of the order passed by the High Court would reveal that the High Court has not at all discussed the aforesaid facts which were established on record pertaining to  the  interest  free  advance  given  to  M/s.  Hero  Fibres Limited  as  well  as  loans  given  to  its  own  Directors  at interest at the rate of 10 per cent.

On the other hand, the High Court has simply quoted from its own judgment in the case of 'Commissioner of Income Tax-I, Ludhiana  v.  M/s.  Abhishek  Industries  Limited, Ludhiana' [ITA No. 110/2005 decided on 04.08.2006].  On that basis, it has held that when loans were taken from the banks at which interest was paid for the purposes of business, the interest  thereon  could  not  be  claimed  as  business expenditure.   

We are of the opinion that such an approach is clearly faulty in law and cannot be countenanced.

Insofar as loans to the sister concern / subsidiary

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company are concerned, law in this behalf is recapitulated by  this  Court  in  the  case  of  'S.A.  Builders  Ltd. v. Commissioner  of  Income  Tax  (Appeals)  and  Another'  [2007 (288) ITR 1 (SC)].  After taking note of and discussing on the scope of commercial expediency, the Court summed up the legal position in the following manner: -

“26.  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. 27. No doubt, as held in Madhav Prasad Jatia v. CIT [1979 (118) ITR 200 (SC)], 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 under section 36(1)(iii) of the Act.  In  Madhav Prasad's case [1979 (118) ITR 200 (SC)], 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. 28. Thus, the ratio of  Madhav Prasad Jatia's case [1979 (118) ITR 200 (SC)] is that the borrowed fund advanced to a third party should be for commercial expediency  if  it  is  sought  to  be  allowed  under section 36(1)(iii) of the Act. 29. 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. 30.  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  CIT  v.  Malayalam Plantations Ltd.  [1964  53  ITR  140  (SC),  CIT  v.  Birla  Cotton Spinning  and  Weaving  Mills  Ltd.  [1971  82  ITR  166 (SC)], etc.”

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In the process, the Court also agreed that the view taken by the Delhi High Court in 'CIT v. Dalmia Cement (B.) Ltd.' [2002 (254) ITR 377] wherein the High Court had held that once it is established that there is nexus between the expenditure  and  the  purpose  of  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.   It  further  held  that  no  businessman  can  be compelled to maximize his profit and that 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.  

Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s.  Hero  Fibres  Limited  became  imperative  as  a  business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide  additional  margin  to  M/s.  Hero  Fibres  Limited  to meet the working capital for meeting any cash loses.   

It would also be significant to mention at this stage that, subsequently, the assessee company had off-loaded its

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share  holding  in  the  said  M/s.  Hero  Fibres  Limited  to various  companies  of  Oswal  Group  and  at  that  time,  the assessee  company  not  only  refunded  back  the  entire  loan given to M/s. Hero Fibres Limited by the assessee but this was  refunded  with  interest.   In  the  year  in  which  the aforesaid interest was received, same was shown as income and offered for tax.

Insofar as the loans to Directors are concerned, it could not be disputed by the Revenue that the assessee had a credit balance in the Bank account when the said advance of Rs. 34 lakhs was given.  Remarkably, as observed by the CIT (Appeal) in his order, the company had reserve/surplus to the tune of almost 15 crores and, therefore, the assessee company could in any case, utilise those funds for giving advance to its Directors.

On  the  basis  of  aforesaid  discussion,  the  present appeal is allowed, thereby setting aside the order of the High Court and restoring that of the Income Tax Appellate Tribunal.

......................., J. [ A.K. SIKRI ]

......................., J. [ ROHINTON FALI NARIMAN ]

New Delhi; November 05, 2015.

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