ITAT Mumbai rules notional interest on interest-free share-related advances not taxable

Background of the dispute

The matter in Robust Transportation Pvt. Ltd. Vs ITO (ITAT Mumbai) revolved around whether the Assessing Officer (AO) was justified in taxing notional interest on interest-free advances reflected in the assessee’s balance sheet for Assessment Year 2017–18. The Income Tax Appellate Tribunal, Mumbai Bench, had to decide if such hypothetical interest could be brought to tax in the absence of any contractual right to receive it and without any specific deeming provision in the Income Tax Act 1961.

The assessee-company, incorporated with expansive objects in the transportation sector (covering land, air, water and space), had not yet commenced its primary business activities during the relevant previous year. Its activities during this period included making investments and entering into corporate arrangements aligned with its long-term business plans.

For Assessment Year 2017–18, the assessee filed a nil return of income on 30 October 2017, which was initially processed under Section 143(1). Subsequently, the case was picked up for limited scrutiny under CASS, particularly on:

  • Low returned income
  • Significant loans and advances shown in the balance sheet

The AO ultimately added a sum of ₹1,73,68,000 as notional interest at 8% on aggregate advances of ₹21,71,00,000, treating it as income that had accrued to the assessee. This addition was sustained by the National Faceless Appeal Centre (CIT(A)), leading to the appeal before the ITAT.

Key financial facts and advances in question

Nature and quantum of advances

During the scrutiny, the AO noted that as on 31 March 2017, the assessee’s balance sheet disclosed interest-free loans and advances aggregating to ₹21,71,00,000 given to four entities, including:

  • ₹21,68,00,000 to M/s Tremendous Minerals and Mining Pvt. Ltd.
  • ₹1,00,000 each to:
    • M/s Zip Minerals & Mining Pvt. Ltd.
    • M/s Luminous Cement Pvt. Ltd.
    • M/s Coalition Agency Pvt. Ltd.

The AO proceeded on the premise that such large advances should normally yield interest, and concluded they were funded out of borrowed capital, even though no specific borrowings were identified in the accounts.

Assessee’s explanation on the nature of advances

In response, the assessee clarified that:

  • These amounts were not loans in the ordinary commercial sense, but advances linked to:
    • proposed acquisition of unquoted shares, and
    • corporate restructuring / equity participation arrangements with the recipient companies.
  • There was no agreement or understanding for payment of interest, and
    • No interest had been contracted,
    • No interest had been charged,
    • No interest had been received.

On the source of funds, the assessee drew attention to its audited financial statements, which showed:

  • Substantial interest-free funds, including:
    • Share capital
    • Reserves and surplus
    • Amounts received in relation to proposed issue of shares
  • Interest-free funds (capital, reserves and share issue–linked liabilities) aggregating to ₹13,58,59,880
  • In addition, a large sum of ₹125,49,99,625 received as advance for purchase of shares, on which no interest was payable
  • Crucially:
    • No secured or unsecured loans in the balance sheet
    • No interest expenditure debited to the Profit & Loss account

On this basis, the assessee argued that the AO’s assumption of borrowed funds was completely inconsistent with the books of account.

Approach of the Assessing Officer

Despite these explanations, the AO:

  • Rejected the assessee’s claim that the advances were linked to share acquisition or equity arrangements.
  • Asserted, without identifying any borrowings, that the assessee did not have “sufficient reserves and surplus” to justify such advances.
  • On that unsupported presumption, concluded that the advances “must have” been made out of borrowed funds.

For quantification, the AO:

  1. Looked at the RBI Marginal Cost of Funds Based Lending Rate (MCLR) for the year.
  2. Noted that the MCLR ranged approximately between 8%–8.5%.
  3. Adopted a flat 8% rate as a “reasonable” lending rate.
  4. Calculated notional interest at 8% on the entire advances of ₹21,71,00,000, thereby computing ₹1,73,68,000 as deemed interest income.

This amount was taxed as income allegedly accrued, even though it was undisputed that no interest was chargeable or received.

Findings of the CIT(A)

The assessee’s appeal before the CIT(A) also failed.