THE issue before the Bench is - Whether if an expenditure has been incurred as a prudent businessman for business purpose, even if it has not been incurred under any legal obligation, yet it is allowable on grounds of commercial expediency. YES is the verdict.
Facts of the case
The assessee is engaged in the business of providing cellular services in the Delhi Region. It had actually commenced its business from June, 2002. During the AY 2002-03, Assessee availed of financing facilities from the HSBC Bank, Barakhamba Branch, New Delhi. HSBC's sanction letter offered the assessee a combined credit limit of Rs.340 crores. The fixed rate of interest was 11.5% for the first year but the letter mentioned that this was "an indicative rate and will be firmed up closer to date of drawdown." The interest was payable quarterly. The terms and conditions set out in the Appendix to the said sanction letter stated that assessee could advance the funds availed by it to any other concern, other than in the usual course of business, after receiving the bank's prior approval. By a Board Resolution, it was resolved that assessee would make available to its holding company Sterling Cellular Limited a sum of Rs.100 crores on terms and conditions to be decided by the Director of assessee company. The assessee had placed on record a copy of the relevant statement of account which showed that an amount of Rs. 25 crores was availed of by the Assessee as a loan from HSBC at 11.60% interest per annum on 24th December 2001. Immediately thereafter, the Assessee advanced a loan of Rs.25 crores to SCL.
A letter from SCL dated 15th April, 2008 addressed to the Assessee confirmed that the aforementioned loan of Rs.25 crore was disbursed to it by the assessee @ 11.75% interest p.a. Assessee filed its return for AY 2002-03 on 30th October 2002 declaring a loss of Rs. 35,69,97,065, which it subsequently revised at a profit of Rs. 1,00,690. In the revised return filed on 2nd December 2003 the Assessee showed income from other sources after adjusting interest expenses of Rs. 77.86 lakhs. For AY 2003-04 assessee filed its return declaring loss of Rs. 2,62,87,59,740. AO by an order noted that for AY 2003-04 the assessee had received interest in the sum of Rs. 81,00,165 on the loan advanced and had sought to set it off against the interest expenses. AO held that setting off the interest income of the pre-operative period against the interest expense was not allowed. It was held that "interest expense will form part of the pre-operative expenses pending capitalization and the interest income will be taxed separately as income from other sources." The interest income of Rs. 81,00,165 was added to the income of the Assessee for AY 2003-04.
As far as the return for AY 2002-03 was concerned, AO issued a notice u/s 148 in response to which the Assessee stated that the revised return already filed on 2nd December 2003 may be treated as return in compliance with the said notice. The AO had disallowed the set off on the ground that there was no nexus between the earning of the interest income by assessee and the payment of the interest to the bank on the loans borrowed by it for business purposes. AO observed that the total loans raised by assessee as on 31st March 2002 for the purpose of its business was Rs. 598,01,05,218 and "since the assessee had surplus funds, part of these funds of Rs. 25 crores" had been given to SCL. AO referred to the decision in Tuticorin Alkali and held that the interest paid to the bank would have been treated as business expenses but since the business was yet to commence they would form part of the pre-operative expenses to be capitalised. The interest earned from advancing of the loan to SCL would be taxed separately as income from other sources. The AO accordingly made an addition of Rs.78,86,987/- to the income of the Assessee for AY 2002-03. On appeal, CIT (A) held that "there is no nexus between the expenditure incurred and the income sought to be earned in the instant case." Observing that the interest expense related to the pre-operative period and the giving of loan to SCL was not the business activity of the Assessee, the CIT (A) held that SCL on its own could have approached the bank for loan.
On further appeal, Tribunal noted that the Assessee had commenced its business only in June 2002. The Tribunal adopted the AO's finding that assessee had made a total borrowing of Rs. 598,01,05,218 up to 31st March 2002 and that it was out of the aforementioned total borrowings that a sum of Rs. 25 crores had been advanced and interest earned thereon. The Tribunal also observed that assessee was not engaged in the business of money lending. The interest income earned by the Assessee was to be considered under the head 'income from other business'. The Assessee's contention that the interest expenditure incurred should be netted off against the interest income was held to be "not sustainable."
++ ultimately, the SC while allowing the appeal in the case of Eastern Investments Limited v. CIT 2002-TIOL-519-SC-IT-LB observed that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question u/s 12 (2)." Subsequently in CIT v. Rajendra Prasad Moody 2002-TIOL-751-SC-IT-LB the SC addressed the question whether interest paid on money borrowed for investment in shares would be allowable as expenditure u/s 57 (iii) even where such shares had not yielded any dividend during the relevant AY. The SC explained that while Section 37 (1) provided for deduction of expenditure "laid out or expended wholly and exclusively for the purpose of the business or profession in computing the income chargeable under the head 'profits or gains business or profession", what was relevant for the applicability of Section 57 (iii) was the purpose of expenditure i.e. the expenditure must be laid out or expended wholly and exclusively for the purpose of "making or earning income". It was not necessary that the expenditure "should fructify into any benefit by way of return in the shape of income." SC answered the question urged in the affirmative, i.e., in favour of the Assessee and against the Revenue;
++ in S.A. Builders Limited v. CIT (A) Chandigarh 2007-TIOL-614-HC-P&H-IT, assessee company had advanced loans to its subsidiary without charging any interest. The loans were transferred out of the cash-credit account of the Assessee in which there was a debit balance. The AO disallowed the proportionate interest earned on the said loan out of the total interest paid to the bank by the Assessee. The disallowance for both the AYs, although partially modified by the CIT (A), was upheld by the ITAT which observed that there was no material on record to show that the Assessee had derived any business advantage by advancing the interest-free amounts to its subsidiary. The HC upheld the order of the ITAT. Reversing the aforementioned orders and remitting the matter to the ITAT for a fresh decision, the SC in S.A. Builders Limited explained that expression 'commercial expediency' was of wide import and included "such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, yet it is allowable as business expenditure if it was incurred on grounds of commercial expediency." In the said case, what was relevant was "whether the interest-free loan was advanced to the sister company (which was a subsidiary of the Assessee) as a measure of commercial expediency, and if it was, it should have been allowed." In CIT v. Taj International Jewellers 2012 Law Suit (Del) 4834, the Assessee had availed loan from a bank and converted it into fixed deposit receipts (FDRs) on which it earned interest. This Court upheld the order of the ITAT which permitted the netting of the interest paid from the gross interest earned on the FDRs. It observed that "the interest paid was expenditure laid out and expended wholly and exclusively for the purpose of making or earning the interest income;
++ in the present case, the advancing of loan to SCL was a business decision taken by the Assessee out of commercial expediency. Further, the sanction letter of HSBC made it clear that the Assessee could draw loans up to the sanctioned limit as and when needed. The sanction letter also permitted the assessee to further utilise the money borrowed to advance loans to others. The sum of Rs. 25 crores drawn by assessee on 24th December 2001 in terms of HSBC's sanction letter was transferred to SCL on the very same date. Without the facility of credit by the HSBC, the Assessee could not have advanced the loan to SCL. Therefore, there was a direct nexus between the earning of interest on the loan advanced by the Assessee to SCL and payment of interest to HSBC on the loan drawn in terms of the sanction letter dated 2nd August 2001. The income earned on the loan advanced to SCL was rightly offered to tax by the Assessee as 'income from other sources'. Since the interest paid to HSBC on the loan availed was in the nature of an expenditure wholly and exclusively laid out for the purpose of earning the interest income, it ought to be permitted to be netted against such 'income from other sources' in terms of Section 57 (iii). There is also merit in the contention of the Assessee that for AY 2003-04, the CIT (A) and the ITAT mechanically followed the earlier order for the AY 2002-03 although the business of the Assessee had commenced in June 2002. Since this was no longer a pre-operative phase, the interest paid to HSBC would in any event have been allowable as business expenditure u/s 36 for AY 2003-04. For the aforementioned reasons, the question framed is answered in the affirmative i.e. in favour of the Assessee and against the Revenue. The addition made by the AO is directed to be deleted and the netting of the interest paid on the borrowed sum against the interest income earned is allowed. Consequently, the impugned order dated 7th February, 2014 of the ITAT is set aside and the appeals are allowed but in the circumstances, with no orders as to costs.