Holding

Interest on borrowed funds is allowable as a deduction if the interest‑free advance to a sister concern is made as a measure of commercial expediency.

Summary

S.A. Builders Ltd borrowed funds from banks and advanced a portion of those funds interest‑free to its subsidiary, M/s SAB Credits Ltd. The Assessing Officer disallowed the interest paid on the borrowed funds, holding that the advance to the sister concern was not for the assessee’s own business. The CIT(A) partially allowed the deduction, the Tribunal upheld the full disallowance and the High Court affirmed that view. The Supreme Court held that the correct test is whether the interest‑free loan was made as a measure of “commercial expediency” under Section 36(1)(iii) and Section 37, and that the authorities had failed to examine this purpose. Consequently, the Court allowed the appeals, set aside the lower courts’ orders on the interest deduction, and remitted the matter to the Tribunal for fresh consideration. The decision clarifies that interest on borrowed funds is deductible when the advance to a sister concern is made for commercial expediency, even if the funds are not used directly by the assessee.

Issues considered

Whether interest on borrowed funds can be disallowed when the borrowed amount is advanced interest‑free to a sister concern.
Whether the concept of ‘commercial expediency’ under Section 36(1)(iii) and Section 37 applies to such advances.
Interpretation of ‘for the purpose of business’ in the Income Tax Act.
Whether the tax authorities correctly examined the purpose of the advance to the sister concern.

Legislation cited

Income Tax Act, 1961s. 154, s. 28, s. 36(1)(iii), s. 37

Subjects

Income TaxSection 36(1)(iii)commercial expediencyinterest deductionborrowed fundssister concernsubsidiarytax deductionassessment yeartribunalhigh court

Judgment

--
S.A. BUILDERS LTD. A
v.
COMMISSIONER OF INCOME TAX (APPEALS)
CHANDIGARH AND ANR.

DECEMBER 14, 2006
B
[S.B. SINHA AND MARKANDEY KATJU, JJ.]

Income Tax Act, 1961-Sections 36(i)(iii) and 37-Borrowed funds
lent to sister concern without charging interest, for commercial expediency- C
Held, interest paid on borrowed funds not disal/owable.

Words and Phrases-Expression 'commercial expendiency'-Meaning
of-Discussed.

The question which arose for consideration in these appeals is D
whether the Tribunal and High Court was justified in disallowing interest
on borrowed funds on the ground that the assessee transferred same to
its sister concern without charging any interest.

Allowing the appeals and remitting the matter to the Tribunal for
fresh consideration, the Court. E
HELD: 1. The assessee borrowed the funds from the banks and lent some
of it to its sister concern (a subsidiary) on interest free loan. The test in such
a case is whether this was done as a measure of commercial expediency. To
claim a deduction, it is· enough to show that the· money is expended, not of
necessity and with a view to direct and immediate benefit, but voluntarily and F
on grounds of commercial expediency and to facilitate the carrying on the
business. The High Court as well as the Tribunal and other Income Tax
authorities should have approached the question of allowability of interest on
the borrowed funds from this angle. (1082-H; 1083-A, B, C, D, E)

Atherton v. British Insulated & Helsby Cables Ltd., (1925) lO TC 155 G
(HL), referred to.

Eastern Investments Ltd. v. CIT, (1951) 20 ITR 1 and C/Tv. Chandulal
Keshavlal and Co., (1960) 38 ITR 601, referred to.

1077 H
1078 SUPREME COURT REPORTS [2006] SUPP. 10 S.C.R. ......
A 2. The expression "commerical expediency" is of wide import and
includes such expenditure as a prudent businessman incurs for the purpose
of business. The expenditure may not have been incurred any legal
obligation, but yet it is allowable as business expenditure if it was incurred
on grounds of commercial expediency. [1083-F)

B CIT v. Malayalam Plantations Ltd, (1964) 53 ITR 140, CIT v. Bir/a
Cotton Spinning & Weaving Mills Ltd, (1971) 82 ITR 166, referred to.

3. The High Court and the other authorities should have examined
the purpose for which the assessee advanced the money to its sister
concern, and what the sister concern did with this money, in order to
c decide whether it was for commercial expediency, but that has not been
done. It is true titat the borrowed amount in question was not utilized by
the assessee in its own business, but had been advanced as interest free
loan to its sister concern. However, that fact is not really relevant. What
is relevant is whether the assessee advanced such amount to its sister
D concern as a measure of commercial expediency. (1084-D-E)

Phaltan Sugar Works Ltd v. Commissioner of Wealth-Tax, (1994) 208
ITR 989 and CIT v. Dalmia Cement (Bhart) Ltd., (2002) 254 ITR 377
referred to.

E CIVIL APPELLATE JURISDICTION: Civil Appeal No. 581 l of2006.

From the Final Judgment and Order dated 13.5.2004 of the High Court
of Punjab and Haryana at Chandigarh in LT.A. Nos. 6, 7, 119 and 120/2003.

Nidhesh Gupta, Vinod Shukla, Deepak Goel and S. Janani for the
F Appellant.

Ravindra Srivastava, Ranvir Chandra, Shilpa Singh and B. V. Balaram
Das for the Respondents.

The Judgment of the Court was delivered by
G
MARKANDEY KATJU, J. Leave granted.

These two appeals involve common questions of law and fact and
hence are being disposed of by a common judgment.

H Since the leading case is that of S.A. Builders [SLP(C) 21707-21710/
... S.A. BUILDERS LTD. v. COMMNR. OF INCOME TAX (APPEALS) CHANDIGARH [KATJU, J.) 1079

2004], we shall be taking note of the facts of this case. A
These appeals have been filed against the impugned judgment of the
Punjab and Haryana High Court dated 13.5.2004 in Income Tax Appeal Nos.
6, 7, 119 and 120 of 2003, and the judgment dated 21.5.2004 in ITA No.
117/118 of2003.
B
Heard learned counsel for the parties and perused the record.

During the course of the proceeding for the relevant assessment year
(s), the Assessing Officer under the Income Tax Act observed that the assessee
had transferred a huge amount of Rs. 82 lakhs to its subsidiary company M/
s. SAB Credits Limited out of the cash credit account of the assessee in C
which there was a huge debit balance. He, therefore, held that since the
assessee had diverted its borrowed funds to a sister concern without charging
any interest, proportionate interest relating to the said amount out of the total
interest paid to the bank deserved to be disallowed. Accordingly, he disallowed
a sum of Rs. 5,66,729/-. D
The assessee preferred an appeal to the Commissioner of Income Tax
(Appeals) Chandigarh [for short hereinafter referred to as the CIT(A)], who
vide his order dated 15.4.1993 partially accepted the claim of the assessee.
According to the CIT (A), out of the total amount of Rs. 82 lacs advanced
by the assessee in the relevant assessment year to Mis. SAB Credit Limited, E
only a sum of Rs. 18 lacs had a clear nexus with the borrowed funds, as the
balance amount had been paid out of the receipts from other parties to whom
no interest had been paid. Accordingly, the CIT(A) directed the Assessing
Officer to calculate disallowance of interest only relating to the sum of Rs.
18 lacs, and the disallowance was reduced accordingly.
F
Both the assessee as well as the Revenue filed appeals before the Income
Tax Appellate Tribunal (hereinafter referred to as the 'Tribunal'). The Tribunal
by its order dated 20.6.2002 allowed the appeal of the Revenue, and held
that the entire amount of Rs. 82 lacs had been advanced by the assessee by
utilizing the overdraft account, and hence it was of the view that disallowance G
made by the Assessing Officer was justified. Accordingly, the appeal filed
by the Revenue was allowed and the appeal filed by the assessee was
dismissed.

Against the order of the Tribunal, the assessee filed appeals in the High
Court which were dismissed by the impugned judgment. H
A
1080 SUPREME COURT REPORTS (2006] SUPP. 10 S.C.R.

In the assessment year 1991-92, the Assessing Officer noticed that in
-
addition to the sum of Rs. 82 lacs advanced in the assessment year 1990-91,
a further sum of Rs. 37,85,000/- had been advanced to M/s. SAB Credits Ltd
which also had a clear nexus with the amounts borrowed by the assessee on
payment of interest. Accordingly, the Assessing Officer disallowed
B proportionate interest relatable to .these amounts amounting to Rs. 20,08,836/

On appeal by the assessee, the CIT(A) upheld the finding of the
Assessing Officer that the sum of Rs. 37,85,000/- advanced during assessment
year 1990-91, was relatable to the borrowed funds. However, in view of the
C findings of her predecessor in assessment year 1990-91, that out of Rs. 82
lacs advanced during that year, advance of Rs. 64 lacs had no nexus with the
borrowed funds, she reduced the disallowance from Rs. 20,08,836 to Rs.
10,03,538/- vide her order dated 28. 7.1994. The assessee was granted further
relief of Rs. 1,48,464/- by the CIT(A) vide order dated 6.9.1995 under Section
154 of the Act. On the cross-appeals filed by the assessee as well as the
D Revenue, the Tribunal following its order for assessment year 1990-91, upheld
the disallowance as made by the Assessing Officer. Accordingly, the appeal
of the revenue on this issue was allowed and that of the assessee dismissed.

Against this decision also, the assessee fi'led an appeal before the High
Court.
E
In the impugned judgment dated 13.5.2004, the High Court held that
the Tribunal had recorded a categorical finding of fact that .the amount
advanced by the assessee to Mis. SAB Credits Limited by utilizing the overdraft
account and that on the date on which the amount was advanced there was
F no credit balance in the bank account of the· assessee. The Tribunal further
observed that the assessee has not been able to explain the purpose for which
the amount had been advanced to its sister concern without charging any
interest and there was no material on record to show that the assessee had
derived any business benefit by advancing the interest free amounts to its
sister concern.
G
The High Court held that since it stands established that the amount of
Rs. 82 lacs and Rs. 37.85 lacs had been advanced by the assessee to its sister
concern from out of the overdraft account with the bank in which there was
already a debit balance, the order of the Tribunal does not suffer from any
factual or legal infinnity. Accordingly, the High Court dismissed the appeal.
H
S.A. BUILDERS LTD. v. COMMNR. OF INCOME TAX(APPEALS)CHANDIGARH [KATJU, l.] } Q8}

Learned counsel for the appellant-assessee submitted that the High A
Court has erred in failing to consider the fact that the appellant had made the
advances to its sister concern by withdrawals from its bank accounts in which
there was sufficient credit balance as the appellant had received payments
from its clients. It is an admitted fact that the appellant had received these
payments from its clients and had deposited these in the account out of which B
advances were subsequently made to the sister concern. These deposits/
payments/advances of Rs. 82 lacs as and when received and made by the
appellant to its sister concern, namely, SAB Credits Ltd in the Assessment
Year 1990-91 are reproduced hereunder in a tabular form:

c
Date Ch. No. Amount Name of Bank Course of funds
16.9.1989 683366 24.00 lacs State Bank of
Patiala, CC Account Amount received from
R.C.I., Hyderabad, a client
25.9.1989 684404 18.00 lacs -do- From cash credit account
(Debit balance account) D
27.12.1989 676546 20.00 lacs -do- From Indian Acrylics Ltd ..
a client
12.01.1990 476582 20.00 lacs -do- do-
Rs. 82.00 lacs

E
Learned counsel for the appellant submitted that a perusal of the above
tabular statement makes it apparent that such payments as claimed were in
fact received and deposited. Thus, there is no direct nexus between the
amount borrowed by the appellant-assessee from the bank and the loans
advanced by the appellant-assessee to its sister concern, as no amount was so F
advanced by raising an interest bearing loan.

Learned counsel submitted that the High Court has erred in not
considering the categorical finding of the CIT(A) in this regard. He further
stated that the CIT(A) in its order dated 11-4.1993 had given a clear finding G
of fact that except a sum of Rs. 18 lacs therie was no clear nexus between the
amount received on interest and the interest free advance made to Mis. SAB
Credits Limited. He further stated that t~e amount of Rs. 24 lacs, 20 lacs
and 20 lacs respectively, were not paid out of the cash credit account but
were paid out of the receipts from other parties to whom no interest had been
paid. The amount of Rs. 18 lacs was paid out of the cash credit account H

'
1082 SUPREME COURT REPORTS [2006) SUPP. 10 S.C.R.
....
A because there was a debit balance of Rs. I 8 lacs on that date and, therefore,
a clear nexus is proved in respect of the amount of Rs. 18 lacs in the interest
bearing loans and interest free advances. On this view, the CIT(A) held that
the Assessing Officer should have only disallowed interest relatable to Rs. 18
lacs and not the entire amount of Rs. 82 lacs.

B Learned counsel for the appellant submitted that even this disallowance
of Rs. 18 lacs by the CIT(A) was erroneous and the entire sum of Rs. 82 lacs
should have been allowed.

In paragraph 35-41 of its order the Tribunal has considered in detail the
C question of allowability of the interest amount on the borrowed funds. The
Tribunal was of the view that the assessee had given an advance of Rs. 82
lacs to its sister concern without charging any interest. The Tribunal further
observed that there was no material on record to show that the assessee
derived any business advantage by advancing an interest free amount of Rs.
82 lacs to its sister concern. It referred to several decisions in support of the
D view which it took.

We have considered the submission of the respective parties. The
question involved in this case is only about the allowability of the interest on
borrowed funds and hence we are dealing only with that question. In our
opinion, the approach of the High Court as well as the authorities below on
E the aforesaid question was not correct.

In this connection we may refer to Section 36(l)(iii) of the Income Tax
Act, I 96 I (hereinafter referred to as the 'Act') which states that "the amount
of the interest paid in respect of capital borrowed for the purposes of the
business or profession" has to be allowed as a deduction in computing the
F income-tax under Section 28 of the Act.

In Madhav Prasad Jantia v. Commissioner of Income Tax U.P. AIR
(1979) SC 1291, this Court held that the expression "for the purpose of
business" occurring under the provision is wider in scope than the expression
G "for the purpose of earning income, profits or gains", and this has been the
consistent view of this Court.

In our opinion, the High Court in the impugned judgment, as well as
the Tribunal and the Income Tax authorities have approached the matter from
an erroneous angle. In the present case, the assessee borrowed the fund from
H
S.A. BUILDERS LTD. v. COMMNR. OF INCOME TAX (APPEALS) CHANDIGARH [KATJU, J.] 1083

the bank and lent some of it to its sister concern (a subsidiary) on interest A
free loan. The test, in our opinion, in such a case is really whether this was

- done as a measure of commercial expediency.

In our opinion, the decisions relating to Section 37 of the Act will also
be applicable to Section 36(l)(iii) because in Section 37 also the expression B
used is "for the purpose of business". It has been consistently held in decisions
relating to Section 37 that the expression "for the purpose of business" includes
expenditure voluntarily incurred for commercial expediency, and it is
immaterial if a third party also benefits thereby.

Thus in Atherton v. British Insulated & He/shy Cables Ltd, (1925)10 C
TC 155 (HL), it was held by the House of Lords that in order to claim a

.. deduction, it is enough to show that the money is expended, not of necessity
and with a view to direct and immediate benefit, but voluntarily and on
grounds of commercial expediency and in order to indirectly to facilitate the
.· carrying on the business. The above test in Atherton's case (supra) has been
approved by this Court in several decisions e.g. Eastern Investments Ltd v. D
CIT ,(1951) 20 ITR I, CIT v. Chandulal Keshavlal & Co., (I 960) 38 ITR
601, etc.

In our opinion, the High Court as well as the Tribunal and other Income
Tax authorities should have approached the question of allowability of interest E
on the borrowed funds from the above angle. In other words, the High Court
and other authorities should have enquired as to whether the interest free loan
was given to the sister company (which is a subsidiary of the assessee) as a
measure of commercial expediency, and if it was, it should have been allowed.

The expression "commercial expediency" is an expression of wide import F
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.

No doubt, as held in Madhav Prasad Jantia v. CIT (supra), if the G
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 (supra), the borrowed amount was donated to a college with a view to
commemorate the memory of the assessee's deceased husband after whom
H
1084 SUPREME COURT REPORTS [2006) SUPP. 10 S.C.R.

A 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.

Thus, the ratio of Madhav Prasad Jantia 's case (supra) is that the
borrowed fund advanced to a third party should be for commercial expediency
B if it is sought to be allowed under Section 36(l)(iii) of the Act.

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.

C 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 !TR
140, and C/Tv. Bir/a Cotton Spinning & Weaving Mills Ltd, (1971) 82 ITR
166, etc.
D The High Court and the other authorities should have examined the
purpose for which the assessee advanced the money to its sister concern, and
what the sister concern did with this money, in order to decide whether it was
for. commercial expediency, but that has not been done.

It is true that the borrowed amount in question was not utilized by the
E
assessee in its own business, but had been advanced as interest free loan to
its sister concern. However, in our opinion, that fact is not really relevant.
What is relevant is whether the assessee advanced such amount to its sister
concern as a measure of commercial expediency.

F Learned counsel for the Revenue relied on a Bombay High Court
decision in Phaltan Sugar Works Ltd. v. Commissioner of Wealth-Tax (1994)
208 ITR 989, in which it was held that deduction under Section 36(l)(iii) can
only be allowed on the interest if the assessee borrows capital for its own
business. Hence, it was held that interest on the borrowed amount could not
be allowed if such amount had been advanced to a subsidiary company of the
G assessee. With respect, we are of the opinion that the view taken by the
Bombay High Court was not correct. The correct view in our opinion was
whether the amount advanced to the subsidiary or associated company or
any other party was advanced as a measure of commercial expediency. We are
of the opinion that the view taken by the Tribunal in Phaltan Sugar Works
H
S.A BUILDERS LTD. 1-. COMMNR. OF INCOME TAX (APPEALS) CHANDIGARH (KATJU, J] } 085

Ltd,,(supra) that the interest was deductible as the amount was advanced to A
the subsidiary company as a measure of commercial expediency is the correct
view, and the view taken by the Bombay High Court which set aside the
aforesaid decision is not correct.

Similarly, the view taken by the Bombay High Court in Phaltan Sugar
Works Ltd v. Commissioner of Wealth-Tax, (1995) 215 ITR 582, also does B
not appear to be correct.

We agree with the view taken by the Delhi High Court in CIT v.
Dalmia Cement (Bhart) Ltd., (2002) 254 ITR 377, that once it is established
that there was nexus between the expenditure and the purpose of the business
(which need not necessarily be the business of the assessee itself), the Revenue C
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. No businessman can be compelled to maximize its profit. The income
tax authorities must put themselves in the shoes of the assessee and see how D
a prudent businessman would act. The authorities must not look at the matter
from their own view point but that of a prudent businessman. As already
stated above, we have to see the transfer of the borrowed funds to a sister
concern from the point of view of commercial expediency and not from the
point of view whether the amount was advanced for earning profits.
E
We wish to make it clear that it is not our opinion that in every case
interest on borrowed loan has to be allowed if the assessee advances it to a
sister concern. It all depends on the facts and circumstances of the respective
case. For instance, if the Directors of the sister concern utilize the amount
advanced to it by the assessee for their personal benefit, obviously it cannot F
be said that such money was advanced as a measure of commercial expediency.
However, money can be said to be advanced to a sister concern for commercial
expediency in many other circumstances (which need not be enumerated
here). However, where it is obvious that a holding company has a deep
interest in its subsidiary, and hence if the holding company advances borrowed
money to a subsidiary and the same is used by the subsidiary for some G
business purposes, the assessee would, in our opinion, ordinarily be entitled
to deduction of interest on its borrowed loans.

In view of the above, we allow these appeals and set aside the impugned
judgments of the High Court, the Tribunals and other authorities and remand
H
1086 SUPREME COURT REPORTS [2006] SUPP. 10 S.C.R.

A the matter to the Tribunal for a fresh decision, in accordance with law and
in the light of the observations made above.

We also make it clear that we are not setting aside the order of the
Tribunal or other Income Tax authorities in relation to the other points dealt
with by these authorities, except the point of deduction of interest on the
B borrowed funds.

D.G. Appeals allowed.