ITAT Chandigarh Clarifies Tax Implications of Interest-free Advances to Subsidiaries

ITAT Chandigarh Clarifies Tax Implications of Interest-free Advances to Subsidiaries

Tax tribunal decisions shaping corporate advance and interest disallowance policies

In a significant ruling reinforcing the principle of commercial expediency in intra-group transactions, the Income Tax Appellate Tribunal, Chandigarh Bench, has provided relief to M/s Hero Cycles Ltd. by directing the deletion of disallowed interest expenditures amounting to over ₹31 crore. The case primarily cantered around advances made to group entities and the q``treatment of interest expenses under Section 36(1)(iii) of the Income Tax Act, 1961.

Background of the Case

Hero Cycles Ltd., the appellant, filed its return of income for the Assessment Year (AY) 2012–13, during which it had advanced funds to two group entities: Munjal Hospitality Pvt. Ltd. and Hero Exports Pvt. Ltd. Simultaneously, the company had claimed substantial interest expenses on its borrowings. The Assessing Officer, upon scrutinizing the balance sheet, noted debit balances in the accounts of the said concerns, classifying them as interest-free advances unrelated to business purposes.

On this basis, invoking Section 36(1)(iii) of the Income Tax Act, the AO disallowed interest expenditure of ₹8,39,55,267. Additionally, Hero Cycles had suo moto disallowed a further ₹22,86,36,462 in its return of income, a figure the company later contended was mistakenly offered.

Findings of the Assessing Officer and CIT(A)

The AO concluded that the advances were made from borrowed funds and lacked demonstrable business necessity. The disallowance was thus made under the provisions of Section 36(1)(iii), which governs the deductibility of interest on borrowed capital used for business purposes.

The matter was initially contested before the Commissioner of Income Tax (Appeals) [CIT(A)], who upheld the AO’s findings and confirmed the disallowance of ₹8.39 crore. However, the CIT(A) refrained from making any observation on the suo moto disallowance of ₹22.86 crore, leading to an appeal before the ITAT.

Arguments Presented by the Assessee

Hero Cycles, represented by Ashwani Kumar, Ashish Aggarwal, and Deepali Aggarwal, contended that the advances were made in the interest of commercial expediency and were supported by ample own funds. The legal defence was primarily rooted in the landmark judgment of the Supreme Court in S.A. Builders Ltd. v. CIT (2007), which recognized the validity of advancing funds to subsidiaries if such action is commercially expedient for the business.

Advance to Munjal Hospitality Pvt. Ltd.

The assessee argued that Munjal Hospitality was a subsidiary, and the funds advanced served a legitimate business interest. Relying on the Supreme Court’s judgment in Hero Cycles Ltd. v. CIT, it was emphasized that advances made to group concerns in the course of business cannot be subjected to disallowance under Section 36(1)(iii), provided commercial expediency is established.

Advance to Hero Exports Pvt. Ltd.

Regarding the advance to Hero Exports, the assessee maintained that it was a longstanding financial arrangement consistently accepted in prior assessments without any disallowance. Since no new facts had emerged to warrant a different view, the AO’s changed stance for the relevant assessment year lacked legal justification.

Suo Moto Disallowance of ₹22.86 Crore

The assessee clarified that the self-imposed disallowance of ₹22.86 crore was made under a mistaken belief and that tax must be levied based on correct legal interpretation rather than inadvertent admissions or concessions made in the return.

Arguments by the Revenue

Represented by Manav Bansal, the Revenue defended the disallowances, asserting that the advances to the group companies were unconnected to business operations. It was contended that the interest expenditure claimed on such advances could not be justified under the principle of commercial expediency.

Tribunal’s Observations and Ruling

The ITAT Bench, comprising Vice President Rajpal Yadav and Accountant Member Krinwant Sahay, considered the arguments and legal precedents thoroughly. The Tribunal concurred with the assessee’s reliance on the Supreme Court’s decision in Hero Cycles Ltd., emphasizing that commercial expediency, when proven, justifies the deductibility of interest on such advances.

The Bench noted that:

• The AO had failed to demonstrate that the assessee lacked sufficient own funds.

• Advances to a subsidiary and longstanding group concern clearly fell within the realm of commercial expediency.

• Prior year assessments had accepted these advances without adverse findings.

Consequently, the ITAT directed the deletion of the disallowance of ₹8,39,55,267 made in respect of advances to Munjal Hospitality and Hero Exports.

On the Suo Moto Disallowance

Regarding the ₹22.86 crore disallowed suo moto by the assessee, the Tribunal held that taxation must be based on legal merit, not on an erroneous concession. Referring to established principles, it ruled that mistaken offers in a return cannot override substantive law and hence the disallowance was liable to be reversed.

This ruling reinforces critical jurisprudence on the applicability of Section 36(1)(iii) and provides clarity on the treatment of intra-group advances. The ITAT’s decision in favour of Hero Cycles underscores the importance of commercial expediency as a guiding principle in determining the deductibility of interest expenditures. It also serves as a reminder that tax liability must be determined by the letter of the law, not by mistakes or assumptions in tax filings.

Hero Cycles’ successful appeal sets a precedent for corporates facing scrutiny on similar grounds, particularly in scenarios involving group company transactions and internal capital allocations.