1. In this appeal against the order of CIT(A)-I, Lucknow, dt. 27th March, 1998, for the asst. yr. 1995-96, the assessee has taken as many as eight grounds. However, since these grounds are in the nature of arguments, we do not consider it necessary to repeat the same. In ground Nos. I to IV, the only issue involved relates to the confirmation of the disallowance of Rs. 1,31,566 being the interest of amount debited to P&L a/c paid on loans taken by the assessee. In ground Nos. V to VII, the issue relates to the sustenance of disallowance of Rs. 31,405 out of telephone expenses.
2. Shri Kanchan Kaushal, the learned counsel for the assessee, who appeared on behalf of the assessee made by detailed submissions in support of the grounds taken by the assessee, whereas Shri Prasenjit Singh, the learned Departmental Representative supported the order of the AO and that of the learned CIT(A).
3. The assessee-firm in its P&L a/c showed expenses of Rs. 1,31,566 as interest payment. This interest related to borrowings from the bank and from other parties. On scrutiny of balance sheet and other books of account, the AO noticed that in the current account with the firm, one of the partners, Shri Uma Shankar Halwasia, had opening balance as on 1st April, 1994, at Rs. 2,69,089.12. This amount was increased to Rs. 3,98,489.12 by 31st March, 1995, No interest was charged on this debit balance. Likewise, there were other advances also on which no interest was charged. A sum of Rs. 27,44,672.81 was given to different persons including sister concerns, relatives of the partners and others from these parties, neither any recovery was made nor interest charged. The AO disallowed the deduction claimed at Rs. 1,31,566 relating to interest payment on the ground that on the one hand the assessee was making interest-free advances to its relatives and sister concerns, whereas money borrowed was yet to be repaid. He also concluded that the money borrowed was not utilised for business purposes as no new project was undertaken for work by the firm. He also observed that the cash available could have been utilized for repayment of loan instead of that it has been provided to relatives.
4. The assessee went in appeal against the disallowance of deduction made by the AO. Before the learned CIT(A), the contention of the assessee was that so far as debit balance in the name of Shri U.S.Halwasia is concerned no interest could be charged on such debit balance in view of the partnership deed, wherein it has categorically been stated that no interest will be charged on the debit balances. It was also contended that the findings of the AO for money borrowed was not utilised for business purposes, was erroneous. It was also argued that the interest cannot be disallowed only on the ground that the investment made with the borrowed money have not yielded an income or because the borrowings were unjustified on the ground that the assessee had ample funds and need not have borrowed and/or even on the ground that moneys borrowed were advanced without interest or at a concessional rate of ' interest. The learned CIT(A) considered the contentions raised on behalf of the assessee as well as the case law referred on its behalf in support of its contention, but sustained the disallowance of deduction by observing as under: "11.1. In the instant case the appellant's business in noway require it to give loans to sister concerns or relatives of partners, and in noway is the explanation credible, that a firm running a service agency business has to give loans to different persons entirely unconnected with the tenants occupiers and holders of the flats. In view of the legal and factual position that advancing of loans was not for a business purpose, the ground of the appellant fails and the disallowance of interest amounting to Rs. 1,31,566 is confirmed." 5. Before us, learned counsel for the assessee, Shri Ka'nchan Kaushal, submitted the following specific points : (i) That the borrowings were earlier advanced. In this regard, he made reference to the chart at p, 1 of the paper book, according to which, four transactions of borrowing are on 17th April, 1989, fifth transaction of Rs. 1 lakh is of 16th Oct., 1991, two transactions of Rs. .1 lakh and Rs. 3 lakhs each of 13th April, 1991, and 17th April, 1991, and the seventh transaction is about the overdraft limit.
(ii) The advances of Rs. 27,44,672 made to various parties are prior to 31st March, 1991, and therefore, barring loan of Rs. 80,000 relating to four transactions dt. 17th April, 1989, other borrowings are subsequent to the advances. This argument was supported by him with reference to the details contained in the chart available at p.
2 of the paper book.
(iii) From sister concern, advances to the tune of Rs. 17,41,631.71 were outstanding as on 31st March, 1991.
(iv) Out of Rs. 8,09,350, the interest was paid on Rs. 6.80 lakhs and not on the balance of Rs. 1,19,350.
(v) The Department was not able to prove that the borrowed funds were not utilized for business purposes.
(vi) No nexus could be established by the Department between the borrowed funds and the advances made by the assessee free of interest.
6. The learned counsel also placed reliance on the following cases in support of his arguments : 7. The learned counsel further submitted that the decision relied upon by the CIT(A) 'for rejecting the contention of the assessee are distinguishable on facts and are not applicable to the facts of this case. The learned Departmental Representative, on the other hand, submitted that the assessee has not been able to show any business expediency for continuing the borrowings particularly when the funds were available with the assessee and he could have satisfied the debt.
The learned Departmental Representative also submitted that the assessee has not been able to establish that the borrowings were necessary for business needs of the assessee. The learned Departmental Representative also placed reliance on the case of Ram Krishna Oil Mills v. CIT (1965) 56 ITR 186 (MP), and other cases referred to in the decision of the learned CIT(A).
8. We have carefully considered the entire material on record and the rival submissions including the case law referred to by the learned representatives of the parties at the time of hearing of this appeal and after thorough consideration of the same, we find sufficient force in the contentions raised by the learned counsel for the assessee before us.
9. So far as the requisite conditions for allowing the claim of deduction under Section 10(2)(iii) and Section 10(2)(xv) of IT Act, are concerned in the case of Madhav Prasad Jatia (supra), the Hon'ble Supreme Court of India has laid down the same. In the above-mentioned case, the assessee had donated a sum of Rs. 10 lakhs to an engineering college and the paid Rs. 5.5 lakhs after borrowing the same from bank, On the remaining amount of Rs. 4.5 lakhs, she claimed interest on the ground that this amount was due from her to the engineering college.
The claim of deduction was disallowed by the Departmental authorities, the Tribunal and also by the Hon'ble High Court. The main ground of disallowing the claim was that the assessee had enough funds and that it was only where the money is borrowed for the purpose of business that interest paid thereon becomes admissible as a deduction and as in that case, a sum of Rs. 5.5 lakhs was admittedly borrowed from the bank for making payment to the engineering college, it was not a payment directed to business purpose. The Hon'ble High Court was of the view that the mere circumstance that otherwise the assessee would have to resort to the liquidation of her income-yielding assets would not stamp the interest paid on such borrowings with the character of business expenditure. The Hon'ble Supreme Court, on the other hand, reversed the approach of the Hon'ble High Court by observing as under : "Proceeding to consider the claim for deduction made by the assessee under Section 10(2)(iii) or Section 10(2)(xv), we may point out that under Section 10(2)(iii) three conditions are required to be satisfied in order to enable the assessee to claim a deduction in respect of interest on borrowed capital, namely, (a) that money (capital) must have been borrowed by the assessee, (b) that it must have been borrowed for the purpose of business, and (c) that the assessee must have paid interest on the said amount and claimed it as a deduction. As regards the claim for deduction in respect of expenditure under Section 10(2)(xv) the assessee must also satisfy three conditions, namely, (a) it (the expenditure) must not be an allowance of the nature described in els. (i) to (xiv), (b) it must not be in the nature of capital expenditure or personal expenses of the assessee, and (c) it must have been laid out or expended wholly and exclusively for the purpose of his business. It cannot be disputed that the expression" for the purpose of business" occurring in Section 10(2)(iii) and also is Section 10(2)(xv) is wider in scope than the expression" for the purpose of earning income, profits of gains" occurring in Section 12(2) of the Act and, therefore, the scope for allowing a deduction under Section 10(2)(iii) or Section 10(2}(xv) would be made wider than the one available under Section 12(2) of the Act. This Court in the case of CIT v. Malayalam Plantations Ltd (1964) 53 ITR 140 (SC) has explained that the former expression occurring in Sections 10(2)(iii) and 10(2)(xv), its range being wide, may taken in not only the day-today running of a business but also the rationalisation of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes imposed as a precondition to commence or for the carrying on a business; it may comprehend many other acts incidental to the carrying on the business but, however, wide the meaning of the expression may be, its limits are implicit in it; the purpose shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business." 10. In the case of Bombay Samachar Ltd. (supra), the Hon'ble Bombay High Court, had the occasion to consider the requirements of Section 10(2)(iii) and clarified the conditions required to be satisfied in order to enable the assessee to claim a deduction in respect of interest on borrowed capital under Section 10(2)(iii). According to the Hon'ble Court, these conditions are as follows : Secondly, it must have been borrowed for the purpose of business; and : Thirdly, the assessee must have paid interest on the said amount and claimed it as a deduction." The Hon'ble Court further held that it is not the requirement of the provisions that the assessee must further show that the borrowings of the capital was necessary for the business, so that if at the time of borrowing, the assessee had sufficient amount of its own, the deduction could not be allowed. The Hon'ble Court also observed that the fact that the assessee had ample resources at its disposal and need not have borrowed is not a relevant matter for consideration. On the issue relating to interest-free advances also, the Hon'ble Court made the following observations : "The view that if the assessee had collected the outstandings which were due to it from others, it would have been able to reduce its indebtedness and thus save a part of the interest which it had to pay on its own borrowings, that the assessee would not be justified in allowing its outstandings to remain without charging any interest thereon while it was paying interest on the amounts borrowed by it and that to the extent to which it would have been in a position to collect interest on the outstanding due to it from others, it could not be permitted to claim as an allowance interest paid by it, is not correct." The issue also came for consideration before the Hon'ble Delhi High Court in the case of Regal Theatre (supra). In that case also, following the decision of Bombay High Court in the case of Bombay Samachar Ltd. (supra) and that of Hon'ble Supreme Court of India in the case of Madhav Prasad Jatia and also after considering the same in the case of Ram Krishna Oil Mitts v. CIT (supra) the Hon'ble Delhi High Court has held that the conditions, for getting the deduction under Section 36(1)(iii) of the IT Act in respect of interest are : (iii) the assessee must have paid interest on the same amount and claimed it as a deduction.
The Hon'ble Court also held that once these three conditions laid down in Section 36(1)(iii) are satisfied, the deduction under that section must be given.
In the case of CIT v. Shridev Enterprises (1991) 59 Taxman 439 (Kar), the Hon'ble Karnataka High Court has held that if on the balance outstanding from a person, no interest was charged against that advance and even if the person to whom the advance was made having close relationship, then also, the deduction cannot be disallowed to the extent of interest-free advances standing in the name of person in whose name advance was made on the ground that the amount borrowed was not utilized by the assessee for its own business. It was also held that if no addition has been made in earlier years, the opening balance could not be considered in the year in question and the inquiry had to be limited only to the increase in the year in question.
11. In the light of the abovementioned decisions, the legal position on the issue relating to allowability of deduction on account of interest on borrowed funds is amply clear.
12. Coming to the facts of the present case, the Department has not been able to show that the borrowed funds have not been utilized for business purposes. The business activities of the assessee being rendering service to let out properties and other activities, the funds should have naturally been utilized for the purpose of business. So far as the question of advances free of interest is concerned, most of these advances are prior to the borrowings and, therefore, it cannot be said that borrowed funds have been diverted to interest-free advances.
A perusal of the chart submitted by the assessee in its paper book, clearly reveals that the advances are very old and the borrowings are subsequent to the advances. Therefore, it cannot be said that borrowed money has been utilized for making advances. It is true that there was debit entry standing against one of the partners on which no interest has been charged, but the partners may agree for such a condition. This executly is the case so far as the present matter is concerned. Thus, the claim of deduction cannot be disallowed also on the ground that no interest is charged from the partner on the amount debited to its account.
13. So far as the efforts of recovering the amount of advances is concerned, there may be several conditions or difficulties. However, merely on that basis, it cannot be said that the claim for deduction on account of payment of interest on borrowed funds should be disallowed if other necessary conditions to justify the claim as laid down above, are fulfilled.
14. In view of this position and in view of the totality of the circumstances relating to this issue, we are unable to concur with the findings recorded by the CIT(A) in sustaining the disallowance of deduction claimed by the assessee. We, therefore, reverse his findings and delete the addition made on account of disallowance of deduction of Rs. 1,31,566 relating to payment of interest.
Disallowance of Rs. 31,450 out of telephone expenses--Ground Nos. V. VI & VII : 16. The AO disallowed 50 per cent of the telephone expenses being Rs. 31,450. The contention of the assessee against this disallowance before the CIT(A) was that the two partners were allowed the facilities of telephone in the capacity of directors/partners and thus it was not necessary to use the perquisite of telephone available to them, rather than to use the telephone of G.R. Agencies for their personal use. The learned CIT(A) considered the resolution at 8th Feb., 1994, which provided that telephone at residence of the directors shall be provided for long distance calls and the company will bear the bills. However, the CIT(A) was of the view that the said resolution did not controvert the findings of the AO that the telephone could be used for personal use by the partners. According to learned CIT(A), the resolution itself made it clear that partners were themselves liable for their long distance phone calls.
17. The AO as well as learned CIT{A) have disallowed the claim to the extent of 50 per cent on the ground that the telephone might have been used for personal purposes. It was pointed out before us that there was huge volume of business and telephone was used exclusively for the business of the firm. However, no register for showing exclusive business use could be produced. After considering the totality of the circumstances and in view of the volume of the business of the assessee as well as the status of the persons using the telephones in the firm, we are of the considered opinion that it would be reasonable if the disallowance is restricted to 1/4th i.e., 25 per cent instead of 50 per cent. The AO is, therefore, directed to work out the relief accordingly to the assessee. These grounds are, therefore, partly allowed.