SUPREME COURT OF
Munjal Sales Corpn.
v
Commissioner of Income-tax,
S. H. KAPADIA AND B. SUDERSHAN REDDY, JJ.
Civil Appeal Nos. 1378 to 1382 of 2008
Arising out of SLP (C) Nos. 4317,4392,4395, 4397 and 6442 of 2007
February 19, 2008
Section 36(1)(iii), read with section 40(b), of the Income-tax Act, 1961 -Interest on borrowed capital - Assessment years 1993-94 to 1997-98 - Whether section 40 is not a stand alone action; it is corollary to sections 30 to 38 and its object is to put limitation on amount of deduction which assessee is entitled to under sections 30 to 38 - Held, yes - Whether after enactment of the Finance Act, 1992 every assessee including a firm has to establish, in first instance, its right to claim deduction under one of sections between sections 30 to 38 and in case of firm, if it claims special deduction, it has also to prove that it is not disentitled to claim deduction by reason of applicability of section 40(b) - Held, yes - Whether, therefore, in case of a firm to claim deduction in respect of interest paid on capital borrowed from third parties (apparently partners), firm is required to establish, in first instance, that it is entitled to claim deduction under section 36(1)(iii), and secondly that it is not disentitled to claim such deduction on account of applicability of section 40(b)(iv) - Held, yes
Section 36(1)(iii), read with section 40(b), of the Income-tax Act, 1961 - Interest on borrowed capital - Assessment years 1993-94 to 1997-98 - Assessee’s claim for deduction under section 36(1)(iii) was disallowed on ground that it had given interest free advances to its sister concern from interest bearing loan taken from third parties - On appeal Tribunal deleted disallowance for assessment years 1992-93 and 1993-94 holding that assessee had given such advance from its own funds but upheld disallowances for assessment years 1994-95 to 1996-97 - Whether once it was found that interest free loans granted in August/September 1991 continued up to assessment year 1997-98; that said loans were advanced for business purpose; and that interest paid to third parties (partners) did not exceed 18/12 per cent per annum, assessee was entitled to deduction under section 36(1)(iii), read with section 40(b)(iv) - Held, yes
In August/September 1999, the assessee-firm granted interest free advances to its sister concerns which were disallowed by the department on the ground that the said advances were not given from the assessee’s own fund, but from the interest bearing loans taken by the assessee from third parties. Accordingly, the assessee’s claim for deduction under section 36(1)(iii) was disallowed. The Tribunal deleted the disallowance for the assessment years 1992-93 and 1993-94, holding that interest free advances were given out of assessee’s own funds, but upheld the disallowance for the assessment years 1994-95 to 1996-97. The High Court affirmed the order of the Tribunal.
On appeal to the Supreme Court, the assessee contended that section 40(b) is a stand-alone section having no connection with the provisions of section 36(1)(iii). Further, according to the assessee, section 36(1)(iii) had no application in the instant case, as it was a case of payment of interest to the partner on his capital contribution which could not be equated to monies borrowed by the firm from third parties and, hence, the instant case fell only under section 40(b)(iv) and not under section 36(1)(iii).
Legal Position explained:
Prior to the Finance Act 1992,
payment of interest to the partner was an item of business disallowance.
However, after the Finance Act 1992, the said section 40(b) puts
limitations on the deductions under sections 30 to 38 from which it follows
that Section 40 is not a stand-alone section.
Section 40, before and after the Finance Act 1992, has remained the same
in the sense that it begins with a non-obstante clause. It starts with
the words ‘Notwithstanding anything to the contrary in sections 30 to 38’ which
shows that even if an expenditure or allowance comes within the purview of
sections 30 to 38, the assessee could lose the benefit of deduction if the case
falls under section 40. In other words, every assessee, including a firm, has
to establish, in the first instance, its right to claim deduction under one of
the sections between sections 30 to 38 and in the case of the firm, if it
claims special deduction, it has also to prove that it is not disentitled to
claim deduction by reason of applicability of section 40(b)(iv).
Therefore, in the instant case, the assessee was required to establish in the
first instance that it was entitled to claim deduction under section 36(l)(iii)
and that it was not disentitled to claim such deduction on account of
applicability of section 40(b)(iv). It is important to note that section 36(1)
refers to other deductions whereas section 40 comes under the heading ‘amounts
not deductible’. Therefore, sections 30 to 38 are other deductions, whereas
section 40 is a limitation on that deduction. Therefore, even if an assessee is
entitled to deduction under section 36(l)(iii), the assessee(firm) will
not be entitled to claim deduction for interest payment exceeding 18/12 per
cent per se. This is because
section 40(b)(iv) puts a limitation on the amount of deduction
under section 36(1)(iii).
[
It was vehemently urged on
behalf of the assessee that the
partner's capital is not a loan or borrowing in the hands of a firm.
According to the assessee, section 40(b)(iv) applies to partner's
capital, whereas section 36(l)(iii) applies to loan/borrowing.
Conceptually, the position may be correct, but in the instant case, the scheme
of Chapter IV-D is in question. After the enactment of the Finance Act, 1992,
section 40(b)(iv) was brought to the statute book not only to
avoid double taxation, but also to bring on par different assessess in the
matter of assessment. Therefore, the assessee-firm, in the instant case, was
required to prove that it was entitled to claim deduction for payment of
interest on capital borrowed under section 36(l)(iii), and that it was
not disentitled under section 40(b)(iv). There was one more way
of answering the above contention. Section 36(l)(iii) and section 40(b)(iv)
both deal with payment of interest by the firm for which deduction could be
claimed. Therefore, keeping in mind the scheme of Chapter IV-D, every assessee,
who claims deduction under sections 30 to 38, is also required to establish
that it is not disentitled under section 40. The object of section 40 is to put
limitation on the amount of deduction which the assessee is entitled to under
sections 30 to 38. Section 40 is a corollary to sections 30 to 38 and,
therefore, section 40 is not a stand-alone section. [
In the instant case, the
Tribunal, for the assessment year 1992-93, held that loans were given for
business purposes. Similarly, for the assessment year 1993-94, the Tribunal had
taken the view that the said loans given to the firm's sister concerns were for
business purposes. Accordingly, the Tribunal had deleted the disallowances
during the assessment years 1992-93 and 1993-94. However, for the assessment
year 1994-95, the Tribunal took a contrary view in view of change in law
brought about by the Finance Act 1992. Prior to 1-4-1993, payment of interest
to the partner had to be added back to the assessable income of the firm
whereas after the Finance Act, 1992, such payment became an item of deduction
for computing the assessable income of the firm and it became part of the
business income of the partner. In view of this change of law, the
Tribunal disallowed payment of the interest in the instant case for the assessment years
1994-95 to 1997-98. However, the point,
which had been left out from consideration, was that the loans, which
were given in August/September 1991 to the sister concerns, got wiped out only in the assessment year 1997-98. Once,
it was found that the loans granted in August/September 1991 continued up to
the assessment years 1997-98, that the said loans were advanced for business
purposes, and that the interest paid thereon did not exceed 18/12 per cent per
annum, the assessee was entitled to deductions under section 36(l)(iii) read with section 40(b)(iv).
Further
during the assessment year 1995-96, apart from the loan given in
August/September 1991, the assessee advanced interest free loan to its sister
concern amounting to Rs.5 lakhs. According to the Tribunal, there was nothing
on record to show that the loans were given to the sister concerns by the
assessee-firm out of its own funds and, therefore, it was not entitled to claim
deduction under section 36(l)(iii). That finding was erroneous. The
opening balance as on 1-4-1994 was Rs. 1.91 crores, whereas the loan given to
the sister concerns was a small amount of Rs.5 lakhs. Thus, the profits earned
by the assessee during the relevant year were sufficient to cover the impugned
loan of Rs.5 lakhs. [para 17]
Accordingly,
the impugned judgment of the High Court was set aside. The appeal was allowed.
[para 19]