Whether when assessee decides not to charge any interest on loans given to third party and loan is recovered after a civil suit is filed, any notional disallowance for said interest is warranted u/s 36(1)(iii) - NO: HC

THE issues before the Bench are - Whether when assessee decides not to charge any interest on loans given to third party and loan is recovered after a civil suit is filed, any notional disallowance for said interest is warranted u/s 36(1)(iii); Whether provisions of Section 2(22) (e) can be invoked, in case there is a genuine business transaction between two entities and funds of the appellant director were infact lying with the company for most of the time and no profit is derived out of the said loan transaction and Whether in that case such a transaction would be

considered as of business expediency. And the verdict goes against the Revenue.

Facts of the case

The assessee is an individual. It was engaged in trading of vehicle and spare parts, running of vehicle workshop, insurance commission, DMA commission from banks and finance companies and C&F agent. It had filed its return of Income for the AY under consideration declaring loss of Rs. 30,61,523/-. During assessment, additions/disallowances of Rs. 2,75,00,000/- u/s 2(22) (e), Rs. 7,90,796/- u/s 14A and Rs. 3,50,000/- u/s 36(1) (iii) were made. On appeal, CIT(A) partly allowed the appeal and deleted the above additions. Not satisfied with the order, the revenue filed appeal before the Tribunal, where the appeal was partly allowed.

Before HC, the Revenue's counsel had submitted that there was no commercial expediency and in such a situation, the interest paid by the assessee to M/s Dada Motors Pvt. Limited was rightly disallowed by the AO u/s 36(1) (iii). Reference was made to the judgment of the SC in S.A.Builders Limited v. CIT (Appeals) and another,(2006-TIOL-179-SC-IT). On the other hand, counsel for the assessee supported the orders passed by the CIT(A) and the Tribunal.

Held that,

++ taking up question regarding disallowance u/s 36(1) (iii), it would be apposite to notice the observations of the CIT(A), that the AO disallowed interest of Rs. 3,50,000/- on notional basis on the ground that the loan advanced to the said party without any commercial expediency. From a perusal of copy of reply of the appellant reproduced as above, it reveals that the principal amount of said loan was recovered after filing suit in civil courts and with the help of some influential persons. The ITAT, Chandigarh Bench in appellant's own case for the preceding assessment year has also upheld the order of the CIT(A) on this issue. Considering the totality of the facts and circumstances of the case and documents filed alongwith submissions, I am in agreement with the appellant's counsel that the appellant not charged any interest on the amount advanced to M/s Nalanda Spinners, therefore, the AO's action to charge interest on notional basis is not sustainable and is directed to be deleted. Thus, this ground of the appellant is hereby allowed. In view of the findings recorded by the CIT(A) as well as the Tribunal, there was no justification for making an addition of Rs. 3,50,000/- under Section 36(1)(iii) of the Act. The assessee had not charged any interest on the amount advanced to M/s Nalanda Spinners as the amount advanced to Nalanda Spinners was not returned for which a civil suit was filed and with the assistance of influential people, the same was recovered. Moreover, for the assessment years 2006-07 and 2007-08, similar additions had been deleted which has attained finality.The judgment in S.A.Builders's case, thus, does not help the revenue;

++ the counsel for the revenue argued that no reasons have been assigned while declining question nos. (i) and (ii), which are substantial questions of law and in view of Proviso to Section 260A(4), are required to be adjudicated by this Court. Accordingly, we proceed to decide question Nos. (i) and (ii) as well. It would be apposite to refer to the findings of CIT(A) and the Tribunal on question nos. (i) and (ii). The CIT (A) with respect to Question Nos. (i) and (ii) had noticed that section 2(22) (e) is a deeming provision which assumes existence of certain facts if the conditions specified in a particular section are fulfilled. We agree that these provisions are to be construed strictly. This legal fiction has to be carried out to logical ends and not to illogical length. The copy of account of the appellant in the books of the company clearly shows that appellant has running current account with the company and infact appellant had been advancing monies to the company as and when required for the purpose of business of the company. It was only for 55 days in between the year that balance of appellant in books of accounts turned credit. It is beyond doubt that this section can be invoked to curtail the misuse of the funds belonging to a private limited company by its shareholders but not when there is running current account of appellant with the company and appellant has infact for most the time lent the money to the company. This section had been inserted to stop the misuse of the taxing provisions by the assessees by taking the funds out of the company by way of loans or advances instead of dividends and thus avoid tax. But in this case where there is no such intention of the appellant and he had infact advanced money to the company, credit in that account for some days cannot be treated as deemed dividend under section 2(22) (e). It is evident fact that the appellant in real sense not derived any benefit from the funds of the company and therefore by no stretch of imagination it can be said that the company has disbursed or given dividend to its shareholder/director in the guise of loan. It will be travesty of law to apply the provisions of Section 2(22) (e) to the facts of the present case whether infact the person concerned has not gained any benefit from the funds of the company and the one has to consider totality of the facts and circumstances of the case before applying provisions of this section. Hence provisions of Section 2(22) (e) could not be invoked when there is a genuine business transaction between two entities and funds of the appellant director were infact lying with the company for most of the time. In view of the above discussed position of the case, the addition made by the Assessing Officer is not sustainable and deserves to be deleted. Hence the same is hereby deleted. Therefore, this ground of appeal of the appellant is allowed. The aforesaid findings were affirmed in appeal by the Tribunal;

++ from the above, it emerges that CIT(A) and the Tribunal had concurrently recorded that the assessee had running account with the company – M/s Dada Motors Pvt. Limited and had been advancing money to it. It was further observed that the provisions of Section 2(22)(e) of the Act were not attracted in the present case as this provision was inserted to stop the misuse by the assessee by taking the funds out of the company by way of loan advances instead of dividends and thereby avoid tax. In the present case, the assessee had infact advanced money to the Company and there was credit for only 55 days for which provisions of Section 2(22) (e) of the Act could not be invoked. These findings were not shown to be erroneous or perverse in any manner. In view of the above, no substantial question of law arises in this appeal. Consequently, finding no merit in the appeal, the same is hereby dismissed.