Madras HC directs AO to determine borrowed funds were used for advancing loans to Subsidiary Company or Surplus Funds of Company were diverted [Read Judgment]

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The Madras High Court directed the Assessing Officer to determine whether borrowed funds used for advancing loans to Subsidiary Company or Surplus Funds of Company were diverted.

The Revenue has preferred these Appeals raising the following substantial questions of law, whether the disallowance of Rs.4.43 crores made under Section 36(1)(iii) is to be allowed especially when the Assessee has diverted interest bearing funds to its sister concern without charging any interest and such diversion of funds is covered by Section 36(1)(iii).

The CIT(A) held that the AO had erred by disallowing the interest incurred by the appellant on the premise that interest bearing funds have been diverted to the sister concerns and consequently allowed the appeal in favour of the appellant, which was upheld by the tribunal.

The Revenue submitted that since the Assessee Company did not have any interest-free Surplus Fund with it to advance loan to its Subsidiary Company, and therefore, diversion of such funds cannot be meant for that purpose and consequently, the disallowance under Section 36(1)(iii) of the Act out of the amount of interest paid by the Assessee Company to its Bank was justified.

On the other hand, the Assessee submitted that no interest was charged from the Subsidiary Company on such outstanding amount of unpaid consideration for transfer of its Sodium Perborate Division.

The division bench of Justice Vineet Kothari and Justice M.S. Ramesh held that the matter is required to be remanded back to the Assessing Authority for holding enquiry into the matter as to whether the interest bearing borrowed funds were used for advancing loans to the Subsidiary Company or the Surplus Funds of the Company were so diverted.

The court observed that prima facie, it appears that it was a case of unpaid sale price for transfer of of the Sodium Perborate Division made by the Assessee Company to its Subsidiary Company M/s.Chemasia Industries Limited and the outstanding loan liability to the 7.88 crores was also taken over by the Assessee Company.

“Therefore, even though borrowed funds might have been diverted, the fact remains that the Assessee did not charge any interest on such unpaid price from the Subsidiary Company and even took over another loan liability of the Subsidiary Company,” the court said.

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