Chennai ITAT Clarifies: Interest Cannot Be Disallowed on Business Advances Funded from Own Capital
Background and Context
The Chennai Bench of the Income Tax Appellate Tribunal, in the case of Anbazhagan Ranganathan Vs ACIT (ITAT Chennai), has reiterated an important principle regarding disallowance of interest where business advances are made out of sufficient own funds. The Tribunal held that the Assessing Officer is not justified in imputing notional overdraft interest on advances extended in the normal course of business when the assessee has adequate surplus capital and reserves to support such advances.
This decision is particularly relevant for assessees engaged in contract and project-based businesses where advances to various parties for execution of work are common, and the Revenue often attempts to attribute such advances to borrowed funds and disallow corresponding interest.
Case Overview
Parties and Forum
- Case Name: Anbazhagan Ranganathan Vs ACIT
- Forum: ITAT Chennai
- Assessment Year: 2020-21
- Nature of proceedings: Appeal by the assessee against order of the ld. Commissioner of Income Tax (Appeals), NFAC, Delhi
The assessee is a civil contractor executing works for Government undertakings. In the relevant assessment year, the assessee was subjected to an interest disallowance by treating business advances as having been funded out of bank overdraft, and imputing notional interest accordingly.
Facts of the Case
Nature of Business and Receipts
The assessee was carrying on civil contract work for Government entities. For the year under consideration:
- Contract turnover declared was ₹9,57,59,964.
- Business income returned was ₹47,90,730, approximately 5% of the contract receipts.
- The Revenue authorities did not dispute that these were genuine business receipts or that the assessee was engaged in genuine civil contract activities.
Cash Withdrawals, Asset Purchases and Interest Income
During assessment, the Assessing Officer recorded the following key points:
- The assessee had withdrawn cash to the tune of ₹1,22,00,000.
- The assessee had invested in motor vehicles and other assets.
- Interest income of ₹9,11,301 was earned from State Bank of India.
Advances to Four Parties
A central issue related to advances made by the assessee to four entities. The advances were stated to have been given for arranging labour and facilitating execution of civil contracts. These parties were listed in the assessment order (page 9) as recipients of advances for labour arrangement.
However, during the assessment proceedings, the Assessing Officer noted that:
- No ledger accounts for these four parties were produced before him.
- Based on this, the AO treated these advances as if they were funded from overdraft.
On this assumption, the AO:
- Applied overdraft (OD) interest rates to these advances.
- Computed notional interest chargeable on such advances.
- Disallowed interest expenditure to that extent, treating it as not incurred for business purposes.
Order of the CIT(A)
The assessee challenged the disallowance before the ld. CIT(A). On appeal:
- The ld. CIT(A) examined the assessee’s explanations and partly accepted them.
- Interest disallowance to the extent of ₹4,80,920 was deleted as unsustainable, based on the explanation and material considered at that stage.
- However, the balance portion of interest disallowance was sustained.
Aggrieved by the remaining disallowance, the assessee filed a further appeal before the ITAT Chennai.