Disallowance of Interest on borrowed capital advanced without interest

In the case of S.A.Builders Ltd. 288 ITR 1 (SC), the Hon’ble Apex Court have examined the issue of disallowance of interest on account of advance of interest free funds to sister concerns. The Hon’ble Apex Court have held in this decision that the issue of lending of funds to the sister concern should have been examined from the view point as to whether this was done as a measure of commercial expediency.
It was noted that the expression “for the purpose of business included expenditure voluntarily incurred for commercial expediency and it was immaterial if a third party also benefited thereby. It was held that the High Court as well as the Tribunal and other Income Tax Authorities should have approached the question of allowability of interest on the borrowed funds from this angle and they should have inquired as to whether the interest free loan was given to the sister company as a measure of commercial expediency and if it was, it should have been allowed. They further held that the expression “commercial expediency” was an expression of wide import and included such expenditure as a prudent businessman incurred for the purpose of business. The expenditure may not have been incurred under any legal obligation, but it was allowable if it was incurred on ground of commercial expediency. It was held that the High Court and the other authorities should have examined the purpose for which the assessee advance the money to its sister concern, and what the sister concern did with the money in order to decide whether it was for commercial expediency. The Hon’ble Apex Court remanded the matter to the Tribunal for
fresh decision in accordance with law.
Punjab and Haryana High Court in CIT vs.Marudhar Chemicals & Pharmaceuticals (P) Ltd. 319 ITR 75, held that disallowance of interest in respect of interest free advance to sister concern was not warranted where the advance was given as a measure of “commercial expediency”. They have held that it was not relevant as to whether the assessee had utilized the borrowed amount in its own business or had advanced the same as interest free loan to its sister concern, but held that there should be some nexus between
the funds and purpose of business. The Hon’ble High Court followed the decision of the Hon’ble Apex Court in the case of S.A. Builders (supra) while referring to the earlier decision of the Hon’ble Jurisdictional High Court in the case Abhishek Industries Ltd. 285 ITR 1 (P&H).

In another Supreme Court Judgement in case of Tulip Star Hotels Ltd dismissing SLP of the revenue on 30-4-2012, supreme court has held that SA Builders 285 ITR 1 needs reconsideration.
In Tulip Hotels case ITAT had held that interest is allowable both under 36(1)(iii) as well as 57(iii). SC has held that allowability under 57(iii) is controversial.