P Natarajan, Kollam v. Assistant Commissioner of Income Tax, Kollam

IN THE INCOME TAX APPELLAT E TRIBUNAL COCHIN BEN CH COCHIN BEFORE S/SHRI N.VIJAYAKUMARAN JM AND SANJAY AR ORA AM I.T.A. NO. 204/COCH/2009 ASSESSMENT YEAR :2006-07 SHRI P.NATARAJAN KAILAS BHAVAN MARANADU EZHUKONE KOLLAM. [PAN: ADCPP 2408H] VS. THE ASSISTANT COMMISSIONER OF INCOME-TAX CIRCLE-1 KOLLAM. (ASSESSEE -APPELLANT) (REVENUE- RESPONDENT) ASSESSEE BY SHRI K.DEVARAJAN ADV.-AR REVENUE BY SHRI T.J.VINCENT DR O R D E R PER SANJAY ARORA AM: THIS APPEAL BY THE ASSESSEE ARISES OUT OF THE ORD ER BY THE COMMISSIONER OF INCOME-TAX(APPEALS) IV KOCHI (CIT(A) FOR SHORT ) DATED 29.1.2009 AGAINST ITS ASSESSMENT U/S. 143(3) OF THE INCOME-TAX ACT 1961 ('THE ACT' HEREINAFTER) DATED 21.11.2008 FOR A.Y. 2006-07. 2. THE APPEAL RAISES A SINGLE ISSUE I.E. QUA THE DISALLOWANCE OF CLAIM FOR BANK INTEREST EFFECTED IN ITS ASSESSMENT FOR THE RELEVAN T YEAR. THE FACTS IN BRIEF ARE THAT THE ASSESSEE AN INDIVIDUAL IS IN THE BUSINESS OF PROC ESSING AND EXPORT OF CASHEWNUTS. HE TOOK OVER THE BUSINESS AFTER THE DEMISE OF HIS WIFE SMT. K.MONY (ON 15.8.2005) WHO WAS A CARRYING ON THE SAID BUSINESS AS HER LEGAL H EIR. THE RELEVANT PREVIOUS YEAR IS THUS FROM 16.8.2005 TO 31.3.2006. THE ASSESSING OFFICER (AO) OBSERVED THE ASSESSEE TO HAVE CLAIMED BANK INTEREST AT ` 111.85 LAKHS ON BANK LOANS WHICH OUTSTOOD AT ` 2375.89 LAKHS AS ON 31.3.2006. HE FURTHER OBSERVED THE FOLLOWING APP LICATIONS BY THE ASSESSEE DURING THE YEAR AS TOWARD NON-BUSINESS PURPOSES:- PARTICULARS AMOUNT IN (LAKHS) I) ADVANCES TO SISTER CONCER NS AND RELATIVES 87.70 ITA.NO. 204/COCH/2009 2 II) BUILDING UNDER CONSTRUCTION 249.93 III) DRAWINGS 129.42 . 467.05 HE THEREFORE RELYING ON THE DECISIONS IN THE CAS E OF CIT VS. V.I.BABY AND CO . 254 ITR 248 (KER.) AND K. SOMASUNDARAM & BROS. VS. CIT 238 ITR 939 (MAD.) MADE PROPORTIONATE DISALLOWANCE WORKING OUT THE SAME AT ` 21 98 744/-. IN APPEAL THE ASSESSEE SECURED FAVOURABLE DIRECTIONS FROM THE LD. CIT(A) QUA THE FIRST AND THIRD APPLICATIONS I.E. SUBJECT TO THE AOS VERIFICATIO N THAT AS CLAIMED THE ADVANCE OF ` 87.70 LAKHS PERTAINS TO THE EARLIER YEAR/S AND FURTHER IF ANY PART OF THE DRAWINGS IS FOR BUSINESS PURPOSES SO THAT IF FOUND SO THE AO SHALL ALLOW R ELIEF TO THE ASSESSEE ACCORDINGLY. QUA THE SECOND AMOUNT SHE FOUND THE BUILDING BEING CON STRUCTED TO BE A NON-BUSINESS ASSET SO THAT THE DISALLOWANCE IN ITS RESPECT WAS JUSTIFI ED. AGGRIEVED THE ASSESSEE IS IN APPEAL. 3.1 BEFORE US IT WAS PLEADED BY THE LD. AR THE AS SESSEES COUNSEL THAT THE ENTIRE DISALLOWANCE IS UNWARRANTED AS THE ASSESSEE HAD SU FFICIENT INTEREST FREE FUNDS WITH IT I.E. TO FINANCE THE NON-BUSINESS APPLICATION OF FUNDS. TOWARD THIS HE DREW OUR ATTENTION TO THE OPENING (AS ON 16.8.2005) AND CLOSING (AS ON 31 .3.2006) PROFILE OF THE SOURCES AND APPLICATION OF FUNDS (EXTRACTED FROM THE BALANCE-SH EETS AT THE RELEVANT DATES) BREAKING THE SAME INTO INTEREST-FREE (AND CORRESPONDINGLY I NTEREST-BEARING) FUNDS AND THE BUSINESS ASSETS FINANCED THROUGH BANK BORROWINGS (AND OTHER ASSETS) (REFER: THE `STATEMENT OF FACTS FORMING PART OF THE RECORD ). ON BOTH THE DATES THE BUSINESS ASSETS FAR EXCE EDED THE BANK BORROWINGS IMPLYING APPLICATION OF INTEREST-FREE F UNDS TO MEET THE SHORTFALL IN THE BANK BORROWINGS FOR FINANCING THE SAME. AS SUCH THERE WAS NO OCCASION TO INFER DIVERSION OF BANK (INTEREST BEARING FUNDS) FOR NON-BUSINESS PURP OSES. AS REGARDS THE SPECIFIC DIRECTIONS BY THE LD. CIT(A) THE SAME THOUGH ACCE PTABLE YET LED TWO CAUSES OF GRIEVANCE; THE AO IN GIVING EFFECT TO THE SAID DIR ECTIONS THOUGH FINDING THE FACTS TO BE IN AGREEMENT WITH THE ASSESSEES CLAIMS YET DENIE D RELIEF TO THE ASSESSEE ON THE AMOUNT OF TAX PAID (OVER ` 23 LAKHS) WHICH STOOD PARTLY DEBITED TO THE `DRAWI NGS ACCOUNT (8.69 LAKHS) AND PARTLY TO THE `ADVANCE ACCOUNT. HOW COULD THE SAME BE CONSIDERED AS A NON- BUSINESS APPLICATION ? DOES THE REVENUE THEREBY IMPLY THAT WHILE THE PR OFITS ARE TO BE ITA.NO. 204/COCH/2009 3 RETAINED IN THE BUSINESS TAX THEREON HAS TO BE MET BY THE ASSESSEE FROM HIS OWN SOURCES AND PUMP IN FURTHER MONEY TO PAY THE TAX. WITH REG ARD TO THE BUILDING ADMITTEDLY A NON- BUSINESS ASSET THE INVESTMENT DURING THE YEAR WAS ONLY TO THE EXTENT OF ` 172.19 LAKHS SO THAT THE DISALLOWANCE COULD NOT BE WITH REFERENCE T O THE TOTAL AMOUNT INVESTED AND THE OPENING BALANCE IN THE ACCOUNT HAD TO BE EXCLUDED. 3.2 THE LD. DR ON THE OTHER HAND RELIED ON THE OR DER OF THE AUTHORITIES BELOW. 4.1 WE HAVE HEARD THE PARTIES AND PERUSED THE MATE RIAL ON RECORD. AT THE VERY OUTSET IT WAS CONFIRMED BY THE BENCH FROM BOTH THE PARTIES IF THE REVENUE WAS IN APPEAL TO WHICH BOTH EXPRESSED IGNORANCE. THIS IS FOR THE RE ASON THAT THE LD. CIT(A) HAD ISSUED DIRECTIONS TO THE AO WHICH ARE SINCE NOT MAINTAINA BLE I.E. IN VIEW OF THE AMENDMENT TO SECTION 251 OF THE ACT BY THE FINANCE ACT 2001 WIT H EFFECT FROM 1.6.2001. 4.2 WE PROCEED FORWARD TAKING THE ASSESSEES FIRST CLAIM FIRST. THIS IS AS IF THERE IS ON FACTS NO DIVERSION OF INTEREST-BEARING FUNDS I.E. FOR NON-BUSINESS PURPOSES NO DISALLOWANCE OF INTEREST EXPENDITURE COULD HOLD. T HE MATTER IS ESSENTIALLY ONE OF FACT. WHAT IS TO BE SEEN FOR THE PURPOSE IS THAT IF THERE HAS BEEN ANY APPLICATION OF THE BORROWED FUNDS AVAILABLE WITH THE ASSESSEE DURING T HE YEAR ON WHICH INTEREST HAS BEEN PAID FOR NON-BUSINESS PURPOSES AND IF SO INTERES T TO THE PROPORTIONATE EXTENT I.E. ON THE NON-BUSINESS APPLICATION SO FINANCED AND FOR THE PE RIOD IT IS SHALL HAVE TO BE DISALLOWED. HOWEVER THE ASSESSEE AS AFORE-STATED PROFILED HI S OPENING AND CLOSING BALANCE-SHEETS ALONG WITH THE RELEVANT LINES (PER THE STATEMENT OF FACTS) ALSO SUBMITTING COPIES OF THE SAME BY WAY OF PAPER-BOOK. WE FIND AS ALSO OBSERV ED DURING THE HEARING THE SAME TO BE NOT PROPERLY DRAWN INASMUCH AS THE INTEREST-FREE FU NDS TO THE EXTENT THESE ARE AGAINST GOODS OR STOCK-IN-TRADE (OR FOR THAT MATTER VALUE O F SERVICES IN RELATION THERE-TO) HAVE TO BE EXCLUDED IN ARRIVING AT THE AMOUNT OF STOCK-IN-T RADE OR OTHER CURRENT ASSETS CLAIMED TO BE FINANCED OUT OF THE INTEREST-BEARING FUNDS. THI S IS AS WHEN GOODS (OR SERVICES) ARE BOUGHT (OR PROCURED) ON CREDIT THE SAME ARE SELF-F INANCED SO THAT THERE IS NO QUESTION OF FINANCING OR A CONCOMITANT APPLICATION OF FUNDS WH ICH HAS THUS TO BE NECESSARILY CONSIDERED ONLY FOR THE PAID-UP STOCK (OR SERVICES) . EXC ITA.NO. 204/COCH/2009 4 LUDING SUCH CREDITS (SOURCES OF FINANCE) IN THE OPE NING BALANCE-SHEET FROM THE TOTAL INTEREST-FREE FUNDS AVAILABLE ( ` 527.65 LAKHS) FROM THE TOTAL CURRENT ASSETS ( ` 3022.73 LAKHS) YIELDS A FIGURE OF 2495.08 LAKHS REPRESENT ING NET CURRENT ASSETS. AGAINST THE SAME THE TOTAL INTEREST-BEARING BORROWINGS ARE AT ` 1859.17 LAKHS. AS SUCH THE ENTIRE BORROWED CAPITAL IS UTILIZED TOWARDS CURRENT (BUSIN ESS) ASSETS SO THAT THERE IS NO DIVERSION OF THE SAME ; RATHER BEING FINANCED TO THE EXTENT OF THE BALAN CE ` 635.91 LAKHS BY OWN CAPITAL. COMING TO THE CLOSING BALANCESHEET ( AS ON 31/3/2006) THE CORRESPONDING FIGURES OF NET CURRENT ASSETS; INTEREST BEARING FUN DS; AND SELF-FINANCED CURRENT ASSETS ARE AT ` 2761.79 LACS ` 2375.89 LAKHS AND ` 385.90 LAKHS RESPECTIVELY. AGAIN THE ENTIRE BORROWED CAPITAL STANDS APPLIED TOWARD CURRENT (BUS INESS) ASSETS. AS SUCH IT IS NOT POSSIBLE TO SAY THAT THERE HAS BEEN ANY DIVERSION O F BORROWED CAPITAL FOR NON-BUSINESS PURPOSES AT ANY TIME DURING THE RELEVANT PREVIOUS Y EAR . PERHAPS WHAT HAS LED THE REVENUE AUTHORITIES TO INFER OTHERWISE IS THE LARGE SCALE SPENDING BY THE ASSESSEE FOR NON- BUSINESS PURPOSES DURING THE RELEVANT YEAR. HOWEVE R WHAT IS RELEVANT FOR THE PURPOSE IS TO SEE HOW THE SAME IS FINANCED. IF IT IS FROM OWN CAPITAL AS RIGHTLY CLAIMED THERE IS NO OCCASION FOR ANY DISALLOWANCE. AS CAN BE READILY S EEN OWN CAPITAL SUPPORT TO CURRENT ASSETS HAS DECLINED FROM ` 635.91 LAKHS (AT THE BEGINNING OF THE PERIOD) TO ` 385.90 LAKHS AT ITS END. AS SUCH THE FUNDS TO THE EXTENT OF A DIFFERENCE I.E. ` 250.01 LAKHS HAS BEEN WITHDRAWN FROM OWN ACCOUNT AND APPLIED FOR NON-BUSI NESS PURPOSES. BUT THEN THAT WOULD ONLY MEAN THAT CURRENT ASSETS TO THAT EXTENT HAVE BEEN REALISED AND MONIES RATHER THAN BEING INVESTED THEREIN STAND WITHDRAWN LEADI NG TO A FALL IN THE CURRENT ASSETS TO THAT EXTENT WITH THE FRESH ACQUISITION OF CURRENT ASSET S BEING FINANCED FROM BORROWED CAPITAL. ONE CANNOT INFER DIVERSION (OF BORROWED CAPITAL) WH ENEVER THERE IS A DECLINE IN THE LEVEL OF OWN FUNDING WHICH COULD VARY ACCORDING TO THE D EMANDS OF BUSINESS AS WELL AS FOR NON-BUSINESS PURPOSES. THE ASSESSEE IS NOT OBLIGED TO MAINTAIN HIS FUNDS AT A PARTICULAR LEVEL. JUST BECAUSE A HIGHER LEVEL OF CAPITAL IS AV AILABLE AT THE BEGINNING OF THE YEAR IT DOES NOT MEAN THAT HE IS OBLIGED TO MAINTAIN THE SA ME AT THAT (OR HIGHER) LEVEL AT ALL THE TIMES AND WHICH WOULD RATHER IMPLY A CONSTANT (OR DECLINING) LEVEL OF BORROWED CAPITAL. WHAT IS RELEVANT IS NOT THE MAINTENANCE OF THE BORR OWED CAPITAL AT A PARTICULAR LEVEL WHICH IS AT 74.5% OF THE NET CURRENT ASSETS AS AT 1 6.8.2005 AS AGAINST 86% THEREOF AS ON 31.3.2006 BUT ITS APPLICATION OR UTILIZATION WHIC H IS SOLELY FOR CURRENT (BUSINESS) ASSETS. ITA.NO. 204/COCH/2009 5 THIS POSITION OBTAINS THROUGHOUT THE YEAR EVEN ON F ACTORING AS IS MUST THE RS. 1.77 CR. INFUSED BY THE ASSESSEE DURING THE YEAR IMPLYING THUS A LOWER CAPITAL TO THAT EXTENT FOR A PART OF THE YEAR. THIS IS AS THE OWN CAPITAL SUPPOR T TO THE CURRENT ASSETS I.E. THE NET WORKING CAPITAL (NWC) REMAINS POSITIVE THROUGHOUT THE YEAR. 4.3 CONTINUING FURTHER THEREFORE AS LONG AS THE E NTIRE BORROWED CAPITAL FINDS APPLICATION IN THE CURRENT (BUSINESS) ASSETS BEING FINANCED THEREBY THERE IS NO SCOPE TO INFER DIVERSION THEREOF. IN FACT THE BANKS/FINANC IAL INSTITUTIONS THEMSELVES FOLLOW THE SAME MECHANISM BOTH THROUGH PERIODIC REPORTING BY THE BUSINESS (FINANCED) ENTITY AND CONDUCT OF SURPRISE CHECKS TO MONITOR THE APPLICAT ION OF THEIR FUNDS. AN ADEQUATE LEVEL OF ASSETS BEING FINANCED I.E. KEEPING THE REQUIRED M ARGIN IN VIEW WHICH MAY BE AND RATHER IS STIPULATED DIFFERENTLY FOR DIFFERENT ASSETS IN DICATES A REGULAR APPLICATION OF THE BANK FUNDS. IN OTHER WORDS THE BORROWER HAS THE REQUIS ITE DRAWING POWER (DP). FOR THE PURPOSE OF THE ACT HOWEVER IT IS NOT RELEVANT IF THE BORROWER HAS MAINTAINED THE DP I.E. IF THE MARGIN REQUIREMENT PRESCRIBED BY THE BANK IS MET BUT WHETHER ANY OF THE BANK (INTEREST BEARING) BORROWINGS COULD BE SAID TO HAVE BEEN APPLIED FOR ANY NON-BUSINESS PURPOSE WHICH WE FIND AS NOT GIVEN THE RELEVANT A SSETS TO BE IN EXCESS OF THE BORROWINGS BOTH AT THE BEGINNING AND CLOSE OF THE `YEAR AND THUS THROUGHOUT THE RELEVANT TIME PERIOD. 4.4 COMING TO THE CASE LAW CITED. THE MATTER AS AFORE-NOTED IS ESSENTIALLY ONE OF FACT. IN THE CASE OF K. SOMASUNDARAM & BROS. VS. CIT (SUPRA) THE BANK BORROWINGS WERE FOUND TO BE DIVERTED FOR LOANS TO FRIENDS AND RELAT IVES A NON-BUSINESS PURPOSE SO THAT THE MONIES THOUGH INITIALLY APPLIED FOR BUSINESS DID NOT CONTINUE TO BE RETAINED THEREIN. IN FACT THE COURT CAUTIONED THAT DIVERSION SHOULD NOT A MATTER OF SPECULATION AND BE NOT LIGHTLY INFERRED BUT CLEARLY ESTABLISHED; THE MONI ES LENT IN THAT CASE BEING AT THREE TIMES THE ASSESSEES CAPITAL. THE FACTS IN OUR CASE ARE OTHERWISE AS PROVED BY THE FACTS AND FIGURES I.E. THE ASSESSEES CAPITAL FINANCING BOT H THE CURRENT (PARTLY) AS WELL AS FIXED (TOTALLY) BUSINESS ASSETS I.E. APART FROM NON-BUS INESS PURPOSES. IN THE CASE OF CIT VS. V.I.BABY & CO. (SUPRA) THE ISSUE CLARIFIED BY THE HONBLE COURT WAS WHETHER LOANS AND ADVANCES TO RELATIVES AND SISTER CONCERNS COULD BE SAID TO BE FOR BUSINESS PURPOSES. IT ITA.NO. 204/COCH/2009 6 UPHELD THE REVENUES STAND STATING THAT THE INVEST MENTS BY THE PARTNERS (AND THEIR RELATIVES) WERE NOT FOR THE BENEFIT OF THE ASSESSEE -FIRM AND THUS COULD NOT BE SAID TO BE FOR THE PURPOSES OF THE BUSINESS. 4.5 COMING TO THE SPECIFIC DIRECTIONS BY THE LD. CI T(A) AND THE ASSESSEES OBJECTIONS THERETO. THE SAME WOULD BE TO NO CONSEQUENCE WITH WE HAVING HELD THAT NO DISALLOWANCE IS MERITED IN THE INSTANT CASE. HOWEVER WE SHALL D EAL THEREWITH FOR THE SAKE OF COMPLETENESS OF THE ORDER. THE ASSESSEE MUST FAIL. WITH REGARD TO THE TAX PAID THE SAME CANNOT BE CONSIDERED AS AN APPLICATION FOR BUSINESS PURPOSES. A BUSINESS PURPOSE BY DEFINITION WOULD BE ESSENTIALLY FOR MAINTAINING IT (I.E. THE BUSINESS) WHICH IS OPERATING FOR EARNING PROFITS SO THAT AN EXPENDITURE INCURRE D FOR ITS PURPOSES IS A CHARGE AGAINST THE PROFITS WHILE THE TAX LIABILITY IN CONTRADISTINCT ION IS A CHARGE ON THE `PROFITS SO EARNED AND DETERMINED. THE ASSESSEES CLAIM WOULD IN FACT IMPLY THE INCOME-TAX LIABILITY AS QUALIFIED FOR TAX-DEDUCTION! IT IS ONLY WHERE TAX I S PAID IN EXCESS OF THE ASSESSEES TAX LIABILITY AS SAY UNDER A MISTAKEN BELIEF THAT THE SAME ONLY REPRESENTING AN ASSET OF THE BUSINESS IN THE FORM OF A REFUND DUE FROM THE DEPA RTMENT THAT IT COULD TO THAT EXTENT BE CONSIDERED AS AN ASSET OF THE BUSINESS. AS REGARDS THE ASSESSEE OBJECTIONS THE SAME WOULD NOT HOLD ONCE IT IS UNDERSTOOD THAT JUST AS T HE PROFITS MERGE IN AND FORM PART OF THE FIRMS CAPITAL THE TAX LIABILITY ON THE PROFITS MU ST NECESSARILY BE REGARDED AS A DIMINUTION OF THE CAPITAL TO THAT EXTENT. AS REGARDS THE SECON D OBJECTION I.E. THE OPENING VALUE OF THE BUILDING BEING CONSTRUCTED AN ADMITTED NON-BUSINES S ASSET WHAT AS SOUGHT TO BE EXPLAINED HEREINABOVE IS RELEVANT IS NOT WHETHER IT OUTSTANDS FROM AN EARLIER PERIOD BUT WHETHER THE SAME CAN BE SAID TO BE FINANCED FROM IN TEREST-BEARING FUNDS AT ANY TIME DURING THE RELEVANT YEAR. AS ALSO CLARIFIED IN THE CASE OF K. SOMASUNDARAM & BROS . V. CIT (SUPRA) FUNDS MAY HAVE BEEN APPLIED FOR THE BUSIN ESS PURPOSE IN THE PAST BUT THE CLAIM FOR INTEREST FOR A PARTICULAR YEAR IN THEIR R ESPECT WOULD BE ACCEPTABLE ONLY IF THEY CONTINUE TO BE SO APPLIED DURING THE SAID YEAR. IN OUR CASE IF THE CAPITAL HAD FALLEN BELOW A PARTICULAR LEVEL (WITH A CORRESPONDING INCREASE I N INTEREST-BEARING FUNDS) THE FUNDING OF THE SAME THERE-FROM WOULD BECOME IMMINENT AND CONS EQUENTLY THE DISALLOWANCE OF CLAIM FOR INTEREST THEREON FOLLOW. WE DECIDE ACCORD INGLY. ITA.NO. 204/COCH/2009 7 5. IN THE RESULT THE ASSESSEES APPEAL IS ALLOWED. SD/- SD/- (N.VIJAYAKUMARAN) (SANJAY ARORA) JUDICIAL MEMBER ACCOUNTANT MEMBER PLACE: ERNAKULAM DATED: 11TH FEBRUARY 2011 GJ COPY TO: 1. SHRI P.NATARAJAN KAILAS BHAVAN MARANADU EZHUK ONE KOLLAM. 2. THE ASSISTANT COMMISSIONER OF INCOME TAX CIRCLE -1 KOLLAM. 3. THE COMMISSIONER OF INCOME-TAX (APPEALS)-IV KOC HI. 4. THE COMMISSIONER OF INCOME-TAX TRIVANDRUM. 5. D.R. I.T.A.T. COCHIN BENCH COCHIN. 6. GUARD FILE. BY ORDER (ASSSI TANT REGISTRAR) ITA.NO. 204/COCH/2009 8