The Income Tax Appellate Tribunal, Bangalore, has clarified that disallowance of interest under Section 36(1)(iii) of the Income Tax Act cannot be sustained when an assessee’s interest-free funds exceed the amount of non-interest-bearing advances made to related parties. This ruling reinforces the principle that the source of funds, not the destination, determines the applicability of interest disallowance.
Background & Facts
The Dispute
The appeals before the Tribunal arise from orders of the Commissioner of Income Tax (Appeals) deleting disallowances of interest under Section 36(1)(iii) of the Income Tax Act, 1961. The Assessing Officer had disallowed interest expenses claimed by M/s. Brigade Enterprises Limited on the ground that funds advanced to sister concerns without interest were presumed to have been financed through borrowed capital, thereby rendering the interest cost non-deductible.
Key Facts
- The assessee is engaged in the development and construction of residential and commercial complexes.
- For Assessment Year 2011-12, the assessee made non-interest-bearing advances of Rs. 42,48,70,000 to a related private limited company.
- For Assessment Year 2013-14, the assessee made non-interest-bearing advances of Rs. 30,56,62,5039 to sister concerns.
- In both years, the assessee claimed interest expenses of Rs. 2,32,49,384 (AY 2011-12) and Rs. 82.88 crores (AY 2013-14).
- The Assessing Officer disallowed Rs. 2,32,49,384 in AY 2011-12 and Rs. 5,32,41,623 in AY 2013-14 under Section 36(1)(iii), alleging that the advances were funded through borrowed money.
- The assessee’s balance sheet showed substantial interest-free funds:
- AY 2011-12: Share capital of Rs. 11,250.20 lakhs and reserves and surplus of Rs. 1,09,585 lakhs, totaling Rs. 1,20,835.20 lakhs.
- AY 2013-14: Share capital of Rs. 11,225 lakhs, reserves and surplus of Rs. 1,09,585 lakhs, and interest-free customer advances of Rs. 13,219 lakhs, totaling Rs. 1,34,029 lakhs.
- The cash flow from operating activities for AY 2013-14 was Rs. 24,738 lakhs.
- The advances made were significantly lower than the aggregate interest-free funds available in both years.
- The Assessing Officer relied on the ITAT’s earlier remand order dated 11.10.2021 for AY 2013-14, directing verification of cash flow, but failed to produce any evidence contradicting the balance sheet position.
Procedural History
- 29.11.2023: Assessee filed return of income for AY 2013-14 declaring total income of Rs. 1,45,82,610.
- 30.03.2016: Original assessment under Section 143(3) completed for AY 2011-12 at Rs. 17,28,83,640.
- 02.11.2017: Search and seizure u/s 132 conducted; proceedings u/s 153A initiated.
- 31.12.2019: Assessment u/s 143(3) r.w.s. 153A passed for AY 2013-14.
- 30.08.2019: CIT(A) dismissed appeal for AY 2011-12.
- 21.08.2025: CIT(A) allowed appeal for both AY 2011-12 and AY 2013-14, deleting disallowances.
- 11.10.2021: ITAT remanded AY 2013-14 issue for verification of cash flow.
- 20.04.2026: ITAT pronounced order on both appeals.
Relief Sought
The Revenue sought to restore the disallowances of:
- Rs. 2,32,49,384 for AY 2011-12
- Rs. 5,32,41,623 for AY 2013-14
The Parties' Positions
The Revenue contended that advances to sister concerns were funded through borrowed capital, triggering disallowance under Section 36(1)(iii). The assessee argued that the advances were funded entirely from interest-free funds, including share capital, reserves, and customer advances, and that the disallowance was legally unsustainable.
The Legal Issue
The central question was whether Section 36(1)(iii) of the Income Tax Act permits disallowance of interest on borrowed capital when the assessee has sufficient interest-free funds to finance non-interest-bearing advances to related parties, and no contrary evidence is produced by the Revenue.
Arguments Presented
For the Appellant (Revenue)
The Revenue relied on the ITAT’s earlier remand order dated 11.10.2021, arguing that the CIT(A) had not conducted an independent verification of cash flow beyond the balance sheet. It contended that the mere existence of interest-free funds does not conclusively prove that the advances were not funded through borrowed capital, and that the burden of proof remained on the assessee to demonstrate a direct link between the source and application of funds.
For the Respondent (Assessee)
The assessee relied on CIT v. Core Healthcare Limited (298 ITR 194) and SA Builders Limited v. CIT (288 ITR 1), where the Supreme Court held that if an assessee has sufficient interest-free funds, disallowance under Section 36(1)(iii) is not justified. It further relied on the Karnataka High Court’s decision in its own case for AY 2009-10 and 2010-11, which had already held that no disallowance could be made where interest-free funds exceeded advances. The assessee emphasized that the Revenue had failed to produce any evidence to rebut the balance sheet position.
The Court's Analysis
The Tribunal examined the balance sheet figures and found that in both assessment years, the interest-free funds available to the assessee substantially exceeded the amount of non-interest-bearing advances made to sister concerns. In AY 2011-12, interest-free funds of Rs. 12,083.52 lakhs far surpassed advances of Rs. 4,248.70 lakhs. In AY 2013-14, interest-free funds of Rs. 13,402.90 lakhs exceeded advances of Rs. 30,566.25 lakhs.
"Therefore, the presumption rises in favour of the Assessee that the amount of interest free advances given by the Assessee emanated from interest free funds available with the Assessee unless any contrary income is available."
The Tribunal held that once the assessee demonstrates that its interest-free funds exceed the advances, the burden shifts to the Revenue to prove that the advances were funded through borrowed capital. The Revenue failed to discharge this burden. The Tribunal noted that the CIT(A) had correctly applied the Supreme Court’s rulings in Core Healthcare and SA Builders, and had also relied on the Karnataka High Court’s binding precedent in the assessee’s own case.
The Tribunal further observed that the Revenue’s reliance on the earlier remand order was misplaced, as the remand was for verification of cash flow, not for disregarding the balance sheet. The CIT(A) had verified the balance sheet and found no inconsistency. The Tribunal concluded that the Revenue’s appeal was based on mere suspicion and not on any concrete evidence.
The Verdict
The appeals filed by the Revenue were dismissed. The disallowances of Rs. 2,32,49,384 for AY 2011-12 and Rs. 5,32,41,623 for AY 2013-14 were upheld as deleted by the CIT(A). The Tribunal affirmed that where interest-free funds exceed non-interest-bearing advances, disallowance under Section 36(1)(iii) is legally unsustainable in the absence of contrary evidence from the Revenue.
What This Means For Similar Cases
Interest-Free Funds Create a Presumption in Favor of the Assessee
- Practitioners must now argue that if an assessee’s interest-free funds (share capital, reserves, customer advances) exceed non-interest-bearing advances, the Revenue must prove the advances were funded through borrowed capital.
- Balance sheet analysis is not merely procedural - it is a decisive evidentiary tool under Section 36(1)(iii).
Revenue Cannot Rely on Generic Remand Orders to Reopen Substantive Issues
- A remand order directing verification of cash flow does not negate the evidentiary value of a verified balance sheet.
- The Revenue must produce specific, credible evidence to rebut the presumption arising from the balance sheet; mere procedural objections are insufficient.
Precedents from High Courts and Supreme Court Are Binding on ITAT
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Decisions of the Karnataka High Court in the assessee’s own case, and Supreme Court rulings in Core Healthcare and SA Builders, are binding on the ITAT.
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Tax officers must align their assessments with these precedents and avoid mechanical disallowances based on form over substance.
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Always compare the quantum of interest-free funds against the quantum of non-interest-bearing advances.
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If funds exceed advances, file a detailed submission citing Core Healthcare and SA Builders.
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Demand that the Revenue produce evidence of borrowing if they contest the source of funds.
