The Judgment of the Court was delivered by
N.V Balasubramanian, J.:— An interesting question of law on the power of the Income-tax Officer to disallow any portion of the interest the asses-see has paid on the borrowing for the purpose of business under clause (iii) of section 36(1) of the Act arises on the facts of the case.
2. The assessee is a registered firm and its original assessment for the assessment year 1972-73 was completed allowing certain amount of interest paid by the assessee on its borrowing for the purpose of business. Later, the Revenue audit pointed out that some of the moneys which the assessee has borrowed have been utilised for the advance of loans to a private limited company known as Savera Hotels (P.) Ltd., hereinafter referred to as the hotel, and on such lending no interest was charged by the assessee. The Income-tax Officer, therefore, pointed out that the money borrowed to the extent of the money advanced to the hotel was not put to business purpose and, therefore, the corresponding interest attributable to such lending should be taken as if the money was not borrowed for business purpose and the interest should be disallowed. The Income-tax Officer, on receipt of the audit objection, issued a notice under section 148 of the Income-tax Act and called upon the assessee to file the return. In the reassessment proceedings initiated by the Income-tax Officer, the Income-tax Officer indicated that he would disallow a sum of Rs. 72,769 towards interest. The assessee objected to the disallowance on the ground that in the accounts of the partners there was enough credit balance and the amount advanced to the hotel should be regarded as having come out of the money standing to the credit of the partners. The assessee also pleaded that the partners instead of directly advancing the money to the hotel, advanced the money through the medium of the firm, which in effect meant that it was the partners' advance. The Income-tax Officer, in the reassessment proceedings, held that the three partners of the assessee-firm were also the directors of the hotel and there was no interest due from the hotel to the credit of the profit and loss of the assessee-firm and, therefore, he held that a sum of Rs. 72,769 being the interest arrived at at the rate of 10 per cent, on the average balance should be disallowed. The assessee carried the matter in appeal before the Appellate Assistant Commissioner and raised similar contentions as were earlier raised before the Income-tax Officer. The Appellate Assistant Commissioner perused the balance-sheet of the assessee-firm and came to the conclusion that it cannot be contended that the advance to the hotel should be deemed to have come entirely out of the partners' fund. However, he also held that a portion of the interest is liable to be disallowed under section 36(1)(iii) of the Act and in that view of the matter he held that the advances made to the hotel should have come proportionately out of the assessee's own funds as well as out of the borrowed funds and he determined the sum of Rs. 51,000 as interest paid on borrowing, and that amount should be reduced and sustained the disallowance to an extent of Rs. 30,063. The Appellate Assistant Commissioner also held that there is no provision in the Income-tax Act to charge notional interest on the advance made by the assessee free of interest. In this view of the matter, he partly allowed the appeal preferred by the assessee.
3. Dissatisfied with the order of the Appellate Assistant Commissioner, the assessee preferred an appeal before the Income-tax Appellate Tribunal. The Income-tax Appellate Tribunal noticed that the total amount in the partners' capital and the current account was Rs. 10,95,010 and the advance to the hotel was Rs. 10,34,656 and the amount advanced to the hotel was less than the total amount standing to the credit of the partner's account. It also found that the amount advanced to the hotel during the year ended March 31, 1971 was Rs. 4.21 lakhs and a further sum of Rs. 6 lakhs was advanced during the accounting year ended March 31, 1972, making a total of Rs. 10.34 lakhs. It also found that the amount that was credited to the partner's account as on March 31, 1971, was Rs. 14 lakhs which was reduced to Rs. 10.95 lakhs by March 31, 1972, after debiting the partner's account against the drawings and loss incurred during the year ended March 31, 1972. The Appellate Tribunal held that even after debiting the drawings and loss there was sufficient capital in their account to cover the entire amount of advance to the hotel. The Tribunal also applied the principles laid down by the Andhra Pradesh High Court in CIT v. Gopikrishna Muralidhar, [1963] 47 ITR 469, and held that where the money borrowed had been mixed up with their own funds and held that it was impossible to come to the conclusion that from which fund the amounts were advanced to the hotel free of interest and the presumption as enunciated by the Andhra Pradesh High Court would apply to the facts of the case on hand. The Tribunal also found that the working done by the Appellate Assistant Commissioner in disallowing a portion of the interest was not based on any principle and the estimate based by the Appellate Assistant Commissioner was found to be incorrect. In this view of the matter, the Tribunal allowed the appeal preferred by the assessee. The Revenue had challenged the finding of the Appellate Tribunal and in compliance with the directions of this court in T.C.P No. 206 of 1992 by order dated February 15, 1993, the Appellate Tribunal has stated a case and referred the following three questions of law for our consideration under section 256(2) of the Income-tax Act, 1961:
“1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in deleting the sum of Rs. 30,063 sustained by the Appellate Assistant Commissioner as interest on borrowals not used for the purpose of the business for the assessment year 1972-73?
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that no part of the interest on borrowals should be disallowed especially when part of the money borrowed was advanced to Savera Hotels (P.) Ltd., free of interest?
3. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal's view that there was sufficient credit balance in the partner's accounts and, therefore, the amounts advanced to Savera Hotels (P.) Ltd., were not out of the borrowed amounts is based on valid and relevant materials and is sustainable in law especially when the firm had paid interest to the partners on their credit balances?”
4. Mr. C.V Rajan, learned counsel for the Revenue, submitted that the Appellate Tribunal was not correct in holding that the money advanced to the hotel came out of the credit balance standing in the name of the partners' account and it cannot be presumed that the partners' capital account was debited by advance of money to the hotel. He submitted that the partners' capital account is made by notional figure and, therefore, the Appellate Tribunal was not correct in holding that the assessee-firm had advanced money from out of the income credited in their capital account. He also submitted that the documents clearly establish that the money was available only with the firm and therefore submitted that the principle of the decision in CIT v. Gopikrishna Muralidhar, [1963] 47 ITR 469, would not apply to the facts of the present case, as according to him, the statement of the Appellate Tribunal was not correct in holding that the Income-tax Officer as well as the Appellate Assistant Commissioner admitted that the money borrowed by the assessee had been utilised for the business purpose. According to learned counsel for the Revenue, the case of the Department was that the borrowed money had been utilised for non-business purposes of the assessee and, therefore, interest should be disallowed under section 36(1)(iii) of the Act. Mr. Ramakrishna, learned counsel for the assessee, on the other hand, contended that the presumption laid down by the Andhra Pradesh High Court in CIT v. Gopikrishna Muralidhar, [1963] 47 ITR 469, would apply to the facts of the case as the money available with the assessee-firm was Rs. 10,95,010 as against the advance made to Savera Hotels (P.) Ltd., viz., a sum of Rs. 10,34,656, and when the firm had sufficient funds as well as the borrowed money the presumption is that the money was advanced out of its own capital instead of the borrowed money. He also submitted that there is no finding either by the Income-tax Officer or by the Appellate Assistant Commissioner that the money was utilised for non-business purpose and in the absence of any finding it is impermissible for the Revenue to invoke the provisions of section 36(1)(iii). He strongly placed reliance on the decision of the Madhya Pradesh High Court in the case of D & H Secheron Electrodes P. Ltd. v. CIT, [1984] 149 ITR 400, in support of his submission that no part of the capital borrowed was utilised for the purpose of advance made to the hotel. He also placed reliance on a certain passage in the book titled Sampath Iyengar's Law of Income-tax at page 2349.
5. We have carefully considered the submissions made by learned counsel for the Revenue as well as learned counsel for the assessee. The fact remains that there was a total amount credited in the partners' capital as well as current account. A sum of Rs. 10,95,010 was arrived at in the partners' account after taking note of all the drawings made by them and the losses that were incurred in the business for the year ended March 31, 1972. Even after debiting the drawings and the loss in the business, the facts show that there are sufficient funds with the firm to cover the entire advance to the hotel. The Revenue has not made any attempt before the Tribunal to show that the firm has paid interest on the amount outstanding in the accounts of the partner. Though the third question raised proceeds on the basis that the firm had paid interest to the partner on the credit balance, there was no finding either by the assessing authority or by the Appellate Assistant Commissioner that the firm had paid interest to the partners on the credit balance. It is significant to note that there is also no finding by the Appellate Tribunal that the firm had paid interest on the credit balance to the partners. In such a situation, the position that remains is that the firm had its own funds as well as borrowed funds. It is not clear that the firm had not advanced money out of its own funds and in the absence of any material or evidence to indicate that the firm had advanced moneys to the hotel out of funds borrowed for business purpose the presumption would arise, where there is a common fund that the money advanced came only out of its own funds. The decision of the Andhra Pradesh High Court in the case of Gopikrishna Muralidar, [1963] 47 ITR 469, would support the case of the Revenue (?) to that extent. In that case, the assessee—a Hindu undivided family—had a large capital of Rs. 20 lakhs and also made large borrowings during the relevant year and had paid interest amounting to Rs. 93,611. During the relevant previous year a sum of Rs. 1,77,984 was withdrawn from time to time for household expenses and the question that arose before the Andhra Pradesh High Court was whether a part of interest paid on the borrowed capital could be disallowed. The Andhra Pradesh High Court held that it was not a case that where any particular sum purported to be borrowed on behalf of the business was spent for household expenses and this was a case where the loans were taken for carrying on the business of the assessee-firm, but the family used to withdraw some amounts from the business and which were within the limit of capital supplied by the family. In that situation the court held that presumption can arise that where the assessee had both his own money as well as borrowed capital, the money lent came out of his own funds.
6. The above decision of the Andhra Pradesh High Court was followed by the Gujarat High Court in the case of Shree Digvijay Cement Co. Ltd. v. CIT, [1982] 138 ITR 45, and the Gujarat High Court held that where the material on record showed that the assessee had a common fund it cannot be predicated that the money lent came only out of borrowed funds. The learned author, Sampath Iyengar in his book Sampath Iyengar's Law of Income-tax, 9th edition, at page 2349, observed as under:
“For the same reason a presumption appears to be permissible that where the assessee has his own capital as also the borrowed funds, the former rather than latter to have been utilised for the non-business or personal expenses.”
7. In the facts of the case the Tribunal has found that the money borrowed has been inextricably mixed up with the own funds of the assessee and it was impossible to delineate whichever funds were advanced to Savera Hotels (P.) Ltd., free of interest, and in that factual situation, we are of the opinion that the finding of the Appellate Tribunal that no disallowance is called for is a finding of fact and the finding of the Tribunal that it can be inferred that Savera Hotels made the advance out of its own funds and not the borrowed capital is sustainable in law.
8. Further there is no finding by the Income-tax Officer or the Appellate Assistant Commissioner that the money borrowed has been spent for non-business purposes. The addition made by the Income-tax Officer was on the basis that the money advanced to Savera Hotels (P.) Ltd., should carry notional interest of 10 per cent, and in that view he disallowed the amount of Rs. 72,769. The Appellate Assistant Commissioner held that the advance to Savera Hotels (P.) Ltd., would have come proportionately out of the own funds as well as borrowed funds is not based on any principle of law. There is no finding even by the Appellate Assistant Commissioner that the money borrowed by the assessee was actually diverted for non-business purposes. In the absence of any clear finding both by the assessing authority and the appellate authority and in the absence of any such finding by the Appellate Tribunal we have to hold that the Income-tax Officer was not justified in disallowing the sum of Rs. 72,769 or by the Appellate Assistant Commissioner a sum of Rs. 30,063.
9. We hold that the Appellate Tribunal was correct in deleting the sum of Rs. 30,063 and it is also right in holding that no part of the interest should be disallowed especially in the absence of any finding that the money borrowed was advanced to Savera Hotels (P.) Ltd., free of interest. The questions raised need reframing as they proceed on some wrong assumption and accordingly we reframe the first question as under:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in deleting the sum of Rs. 30,063 sustained by the Appellate Assistant Commissioner?”
10. In so far as the second question is concerned, that also is reframed as under:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that no part of interest should be disallowed?”
11. The third question is also reframed as under:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is right in holding that there was sufficient credit balance and, therefore, the amount advanced to Savera Hotels (P.) Ltd., were not out of the borrowed amount was not based on valid and relevant materials?”
12. We answer the questions referred to us in the affirmative and against the Revenue. However, in the circumstances, there will be no order as to costs.