C.N Ramachandran Nair, J.:— These income-tax reference cases arise out of the assessments of the respondent-assessee for the assessment years 1981–82, 1982–83 and 1983–84. The common questions referred by the Tribunal at the instance of the Revenue are the following:
“1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in granting deduction of the amounts, paid by way of interest referable to the amounts which the assessee had lent to various parties as mentioned in the Tribunal's order?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the withdrawals were for the construction of a shop building for the assessee's business?”
2. The assessee is a registered partnership firm dealing in piece goods. During the accounting years, relevant for these three assessment years, the assessee has paid bank interest for the borrowings made for business purposes. However, the Assessing Officer found that the assessee has transferred sizable amounts to the personal accounts of the partners, and also advanced amounts to relatives of the partners and also to sister concerns.
3. The Assessing Officer disallowed proportionate interest payments to the bank in respect of the amounts so advanced by the assessee to the partners, their relatives and the sister concerns. The first appeals were not successful and therefore further appeals were filed by the assessee before the Tribunal. The Tribunal relying on the decision of this court in N. Sundareswaran v. Commissioner Of Income-Tax, Kerala, [1969] 72 ITR 219, allowed the appeals. The reference cases are at the instance of the Revenue. We have heard senior standing counsel for the Department, Sri P.K.R Menon, and counsel for the assessee, Sri O.V Radhakrishnan.
4. Learned counsel for the Department contended that if borrowed funds are diverted for non-business purposes, there is no provision for allowing interest under section 36(1)(iii) of the Income-tax Act, 1961. It is admitted that the assessee has paid huge interest to the banks for the borrowings made for business purposes. However, on scrutiny, it was noticed that huge debit balances are in the accounts of the firm in the name of the partners, their relatives and the sister concerns. According to counsel for the Department, this is only a diversion of the funds without charging any interest. Therefore, the disallowances are rightly made and the decision relied on by the Tribunal in allowing the claim is not applicable to the facts and circumstances of the case. On the other hand, counsel for the assessee contended that there is no finding that the borrowings or part of it were advanced to the partners, their relatives and the sister concerns of the assessee. According to him, there were cash balances available with the firm for such advances, and until it is established that the borrowed amount is advanced to the partners, their relatives and the sister concerns, disallowances cannot be made.
5. We are inclined to accept the argument raised by counsel for the Revenue, because the advances to the partners, their relatives and the sister concerns are not for business purposes and the assessee has not derived any benefit out of the same. Admittedly, no interest was charged on these advances. The Tribunal appears to have placed reliance on the fact that the partners and their relatives have utilised the amounts for business purposes, such as construction of a shop building, etc. So long as the assessee-firm is not the beneficiary of such investments, the nature of investment or the utilisation of such advances has no relevance. So far as the assessee is concerned, it is only an interest free advance. The claim of the assessee's counsel that cash balances were available with the firm for advances to the partners, their relatives and the sister concerns does not advance the assessee's case. If cash balances are available, the borrowing itself is not for the purpose of the business. An assessee with liquidity cannot claim that it can give interest free advances to the partners and others and then borrow funds from the bank on interest for business purposes. Such borrowings will not be for business purposes, but for supplementing the cash diverted by the assessee without any benefit to it. Therefore, so long as the assessee is not the beneficiary of the investments made by the partners, their relatives and the sister concerns, and so long as the advances are interest free, the Assessing Officer is perfectly justified in disallowing the interest in proportion to the advances made. There is no dispute with regard to working out of the proportionate disallowance of interest. The decision relied on by the Tribunal and referred to above does not appear to be applicable to the facts of this case, because that was an individual-assessee advancing interest free loan to a firm engaged in a related business as the assessee and in which he is also a partner along with his wife and minor children. Whatever benefit accrued to that firm will also be treated as income of the assessee assessable in his individual capacity. Therefore such an advance also should be taken as for business purposes of the assessee, and we do not see how that decision will apply to the facts of this case. We are of the view that the Tribunal went wrong in relying on the said decision and allowing the appeals.
6. We, accordingly, reverse the order of the Tribunal by answering the questions referred to us in favour of the Revenue and against the assessee.