Proprotionate disallowance of Interest paid on unsecured loan given to third party

Case: REEBOK INDIA COMPANY [2018] (Delhi)

Fact of the case: The assessee- company had taken unsecured loans of (let say) Rs. 500 Crores. Out of the said sum, it had advanced (let say) Rs. 150 Crores to 3rd party on which no interest was charged. Pursuant to this, for the relevant AY, the Assessing Officer proportionately disallowed, under section 36(1)(iii) an amount of (let say) Rs. 45 Crores paid by the assessee. 

Issue: The issue under consideration is whether part of the interest paid by the assessee on unsecured loans can be disallowed due to the reason that, out of the said loan, the assessee had advanced certain sum of money to 3rd party without charging any interest. 

High Court's Decision: The High Court relied upon the Supreme Court ruling in S. A. Builders Ltd, which interpreted the expression "for purpose of business or profession " in section 36(1)(iii) as being wider in scope than the expression "for the purpose of earning income, profits or gains". Accordingly, expenditure voluntarily incurred and meeting the "commercial expediency" test is to be allowed as a deduction, The expression "commercial expediency" is of wide import and is satisfied once it is established that there was a connection and nexus between the interest paid (claimed as expenditure) and assessee's business.

High Court Observation: The High Court observed that merely because non-interest bearing advances were given to 3rd party, that would not justify a finding that the rest of "commercial expediency" was not satisfied, Interest-free advances were advanced to the parties connected with the business of the assessee, Money taken on loan was not diverted for non- business purpose. The unsecured loan were not used for personal purpose. Therefore, according to section 36(1)(iii), interest paid on capital borrowed for the purpose of business had to be allowed as a deduction.