1989-VIL-557-MAD-DT
Equivalent Citation: [1990] 185 ITR 324, 77 CTR 28, 45 TAXMANN 267
MADRAS HIGH COURT
Date: 17.04.1989
COMMISSIONER OF INCOME-TAX
Vs
P. GANU RAO AND SONS
BENCH
Judge(s) : BAKTHAVATSALAM., RATNAM
JUDGMENT
The judgment of the court was delivered by
RATNAM J.-In this reference under section 256(2) of the Income-tax Act, 1961, at the instance of the Revenue, the following question of law has been referred to the opinion of this court :
"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in deleting the disallowance of interest of Rs. 17,123 representing interest attributable to the advances made by the firm to the Hindu undivided family of Shri Ganu Rao for non-business purposes, viz., construction of building for the Hindu undivided family ?"
The assessee is a firm carrying on business in supplying leather goods, metal goods, textiles and woollen goods to the police and military departments. While finalising the assessment for the assessment year 1975-76, the Income-tax Officer considered the question of allowing the payment of interest on advances secured by the firm and it was found that the firm had advanced monies to the Hindu undivided family for the construction of a house. Thereupon, the assessee was asked to state why interest attributable to diversion of funds to the Hindu undivided family should not be disallowed and the assessee maintained that the entire loans were utilised for purposes of business only and adequate funds were available in the partners' current and capital accounts and there was, therefore, no diversion of bank borrowals towards the building account. However, the Income-tax Officer found that the stand of the assessee that the entire borrowals from the bank were utilised for business purposes cannot be accepted and the assessee had no other interest-free capital or other funds and in that view disallowed the interest of Rs. 17,123. On appeal by the assessee, the Appellate Assistant Commissioner found that the firm was not in possession of other funds on which it paid no interest and, therefore, all the funds available to the firm bore interest and the diversion of funds from the firm to the family, free of interest, called for disallowance of interest paid by the firm and in that view, upheld the disallowance. On further appeal before the Tribunal, it took the view that the authorities below had disallowed interest on a misconception and that though the amounts paid to the Hindu undivided family for purposes of house construction were not reflected in the accounts of the firm, as relating to personal drawings, yet, the circumstance that the partners of the firm chose to debit these amounts invested in the construction of the family house in separate account and there was no nexus between a particular or specific borrowing by the assessee and its investment in the building constructed established that there was no justification for the disallowance and accordingly deleted the addition of Rs. 17,123. That is how the question of law set out earlier has come up before this court.
Learned counsel for the Revenue submitted that the assessee-firm and the Hindu undivided family are two distinct and separate entities and that even as per the statement of accounts relied on by the assessee-firm, there is nothing to indicate that the amounts borrowed by the firm had not been utilised by it for the purpose of house construction and this justified the disallowance of the interest, as done by the authorities below. Reference was made in this connection to Milapchand R. Shah v. CIT [1965] 58 ITR 525 (Mad) and P. RM. S. Ramanathan Chettiar v. CIT [1969] 72 ITR 534 (Mad).
On the other hand, learned counsel for the assessee contended that there is no acceptable proof of diversion of funds by the firm for the purpose of construction of the family house and that, in any event, the circumstance that from out of the borrowed amounts as well as the other funds, the expenditure in connection with the construction of the house had been incurred, would not make any difference to the allowability of the interest paid by the firm on its borrowals. Reference in this connection was made to CIT v. Gopikrishna Muralidhar [1963] 47 ITR 469 (AP) and CIT v. Coimbatore Salem Transport (P.) Ltd. [1966] 61 ITR 480 (Mad).
The Tribunal proceeded to hold that there was no justification for the disallowance of interest by the authorities below on the ground that there was adequate credit balance in the capital and current accounts of all the partners of the firm and that there was no nexus established between any particular borrowing by the firm and the incurring of expenditure on the house construction by the partners of the firm. Even while holding so, the Tribunal noticed that the assessee had shown the amounts spent for the house construction relating to the Hindu undivided family as a loan by the firm for the purpose of such house construction. The Tribunal also stated that if the drawings for the house construction had been made in the respective personal accounts of the partners, then, the objection regarding the disallowance of interest would not be sustainable, as there was adequate credit balance in the capital and current accounts of all the partners. It is thus seen even from the accounts maintained by the assessee-firm that the amounts borrowed by the firm for its business purposes had been entered as having been advanced as a loan to the Hindu undivided family for purposes of house construction instead of being shown as drawings in the partners' personal accounts. It would thus, even on the findings of the Tribunal, follow that borrowed funds had been utilised not for the purposes of the business of the firm, but had been advanced as a loan to the Hindu undivided family for the purpose of meeting the house construction expenses. Undoubtedly, this would constitute a diversion justifying the disallowance of interest on the borrowals in the assessment of the firm. Further, even on the entries in the accounts, the assessee-firm and the Hindu undivided family have been treated as two distinct and different entities altogether and advances by the firm to the Hindu undivided family cannot be considered to be for the purpose of meeting the expenditure connected with the firm and its business activities. Such amounts as have been advanced by the assessee to the Hindu undivided family during the accounting year relevant to the assessment year 1975-76, could not, therefore, be regarded as amounts utilised by the firm for the purposes of its business. It may be that the partners' capital accounts and current accounts during the relevant accounting year may show availability of substantial funds, but the funds advanced to the Hindu undivided family have not been shown to have been paid out of the capital account or current account of the partners of the firm and though this has been noticed by the Tribunal, yet it took the view that this would not justify the disallowance of the interest on the amounts diverted to the Hindu undivided family from the firm for the purposes of house construction. We are unable to agree with this view, even on the accounts relied on by the assessee which, as pointed out earlier, clearly show that no amount from the capital and current accounts of the partners has been paid out to the Hindu undivided family, and it follows that such payments should have come only out of the funds of the firm borrowed for its business purposes. From out of the funds so borrowed, the assessee-firm had diverted the borrowed funds for purposes other than its business requirements and to that extent, the interest on borrowals should have been disallowed On the facts and in the circumstances of the case and the state of accounts relied on by the Tribunal, we hold that the Tribunal was not right in deleting the disallowance of interest. We find it unnecessary to make a reference to any of the cases relied on either by counsel for the Revenue or the counsel for the assessee. We, therefore, answer the question referred to us in the negative and in favour of the Revenue.
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