The Hindu Business Line : Entire money comes into the common kitty of business entity

Colour of money was one of the points that the Punjab and Haryana High Court spoke about recently in a tax case. The dispute, between Rico Auto Industries Ltd, Ludhiana, and the Commissioner of Income Tax, was that Rico had diverted its interest-bearing funds to its sister concern, Rico Agriculture Oil Ltd, free of interest, for non-business purposes.

Earlier, Rico had won the issue, at the Tribunal level, arguing that it had lent out of its own funds. So, it was an aggrieved taxman who brought the case before the High Court. To help him, there was an earlier verdict of the court, in the Abhishek Industries Ltd case, decided in August this year. In that, the court had observed that it was not the Department's responsibility to establish the nexus between funds borrowed vis-à-vis funds diverted towards sister concern on interest-free basis.

Section 36(1)(iii) of the Income-Tax Act, 1961 provides for deductions of interest on the loans raised for business purposes. "Once the assessee claims any such deduction in the books of accounts, the onus will be on the assessee to satisfy the Assessing Officer (AO) that whatever loans were raised by the assessee, the same were used for business purposes," the court had noted, in the Abhishek case.

What happens if in the process of examination of genuineness of such a deduction the AO finds that the assessee had advanced certain funds to sister concerns or any other person without any interest? There would then be `very heavy onus on the assessee' to prove to the AO that `in spite of pending term loans and working capital loans on which the assessee is incurring liability to pay interest, still there was justification to advance loans to sister concerns for non-business purposes without any interest and, accordingly, the assessee should be allowed deduction of interest being paid on the loans raised by it to that extent.'

What if the assessee were to say that he made the loans out of `sale proceeds or share capital or different account'. Not acceptable as reason enough to allow deduction, the court had said. Why so? Because the entire money in a business entity comes in a common kitty, the court had reasoned. "The monies received as share capital, as term loan, as working capital loan, as sale proceeds, etc., do not have any different colour."

Thus, whatever are the receipts in the business, these have `the colour of business receipts and have no separate identification' and `source has no concern whatsoever'.

Accordingly, in situations where the assessee lends interest-free to sister concerns, the only thing sufficient for the AO to disallow interest paid on the borrowing would be that the assessee has some loans or other interest bearing debts to be repaid.

"We do not subscribe to the theory of direct nexus of the funds between borrowings of the funds and diversion thereof for non-business purposes. Rather, there should be nexus of use of borrowed funds for the purpose of business to claim deduction under Section 36(1)(iii) of the Act," reads the text of the Rico verdict dated November 16, on www.taxindiaonline.com, citing a snatch from the Abhishek decision.

What if the assessee had some surplus amount which, according to it, could not be repaid prematurely to any financial institution? "Still the same is either required to be circulated and utilised for the purpose of business or to be invested in a manner in which it generates income," rather than diverted towards sister concern free of interest, said the court.

Else, "This would result in not presenting true and correct picture of the accounts of the assessee as at the cost being incurred by the assessee, the sister concern would be enjoying the benefits thereof."

Assessee's plea that it had lent out of its own funds, in the form of capital introduced in business, could be a `camouflage', said the court. How so? "At the time of raising of loan, the assessee will show the figures of capital introduced by it as a margin for loans being raised and after the loans are raised, when substantial amount is diverted to sister concerns for non-business purposes without interest, a plea is sought to be raised that the amount advanced was out of its capital, which in fact stood exhausted in setting up of the unit."

On the strength of the Abhishek decision, the court set aside the Tribunal's order and ruled in favour of the Revenue, and against Rico.

Tailpiece

"I wished the taxman a Happy New Year!"

"Just that?"

http://Detaxification.blogspot.com

D. Murali

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