Availability of sufficient interest-free funds creates a legal

Availability of sufficient interest-free funds creates a legal presumption that investments were made out of them.

Issue

Whether a disallowance of interest under section 36(1)(iii) of the Income-tax Act, 1961 is legally sustainable when the assessee possesses mixed funds (both interest-bearing and interest-free) and the available interest-free funds are sufficient to cover the investments made in its subsidiary and sister concerns.

Facts

The assessee-company, engaged in manufacturing and trading electrical equipment, filed its return for AY 2010-11 declaring Nil income under normal provisions and a book profit of Rs. 50.59 crores under section 115JB.
During scrutiny assessment, the Assessing Officer (AO) disallowed interest of approximately Rs. 86.29 lakhs and ordered capitalization of interest amounting to Rs. 9.69 crores regarding investments and advances made to subsidiary and sister concerns (including Kirsons BV, Netherlands).
The CIT(A) sustained the AO’s interest disallowance and capitalization, dismissing the assessee’s appeal.
Financial records revealed that the assessee possessed an equity capital of Rs. 6,599.32 lakhs and accumulated reserves and surplus of Rs. 12,928.29 lakhs, culminating in a total interest-free net worth of Rs. 19,527.61 lakhs.
The total investments made by the assessee stood at Rs. 8,579.43 lakhs (which included Rs. 8,429.62 lakhs in the subsidiary company, Kirsons BV).

Decision

Held, yes: The issue was decided in favor of the assessee, and the AO was directed to completely delete the interest disallowance and capitalization.
Presumption of Source: The court ruled that where a business possesses a mix of commercial interest-bearing loans and interest-free capital, a legal presumption arises that investments are sourced from the interest-free funds.
Sufficiency Threshold Satisfied: Because the assessee’s interest-free net worth (Rs. 19,527.61 lakhs) vastly exceeded the total quantum of investments (Rs. 8,579.43 lakhs), it can be safely concluded that no borrowed capital was diverted for non-business investments.

Key Takeaways

The Principle of Presumption: If an enterprise has sufficient internal, interest-free funds (reserves and capital) to cover an investment, the law presumes the investment came from those interest-free sources rather than interest-bearing bank loans.
No Automatic Disallowance: The Revenue cannot automatically disallow interest expenses under section 36(1)(iii) simply because an assessee holds investments in subsidiaries alongside interest-bearing debts.
Burden Shifting via Financial Ratios: Once the assessee proves that its internal interest-free net worth is greater than the investments made, the burden shifts to the Revenue to provide direct evidence linking borrowed funds to the specific investments before making a disallowance.

IN THE ITAT BANGALORE BENCH ‘A’

Kirloskar Electric Company Ltd.

Deputy Commissioner of Income-tax

SOUNDARARAJAN K., Judicial Member
and BALAKRISHNAN S., Accountant Member

IT Appeal Nos.1316, 1317 & 1318 (Bang) of 2024
[Assessment years 2010-11to 2012-13]

JUNE 22, 2026

iii.

Capitalization of interest – Rs.9,69,40,630/-

4. On being aggrieved by the Order of the learned AO, assessee carried the matter before the learned CIT(A). The learned CIT(A) partly allowed appeal of the assessee.

5. On being aggrieved by the order of the learned CIT(A), the assessee carried the matter before the Tribunal. The Tribunal remanded the matter back to the CIT(A) for examining the matter afresh. Thereafter, the learned CIT(A), in compliance of the direction of the Tribunal, after examining the submissions made by the assessee, being not satisfied, dismissed the appeal of the assessee.

6. The learned AR submitted that the assessee has made investments in its subsidiary viz., M/s. Kirsons BV, Netherlands, out of the accumulated interest free funds available with the assessee. He further submitted that the learned AO, observing that the assessee has secured and unsecured loans and has claimed interest expenditure of Rs.22,56,74,000/-, concluded that assessee has utilized borrowed funds for the purpose of granting advances and investing in subsidiary companies. He further submitted that the company has accumulated share capital and reserves amounting to Rs.19527.61 lakhs whereas the advances to sister concern is only Rs.9118.76 lakhs. The learned AR drew our attention to Page No.28 of the Annual report for the Financial Year 2009-10 demonstrating the availability of share capital, reserves and surplus and the investments correspondingly made against them. He also drew our attention to Page No.29 wherein the interest and finance charges on the loans taken by the assessee stood at Rs.225 lakhs in the Profit and Loss account for the Financial Year 2009-10. He further submitted that interest on the borrowings has not increased when compared to the previous year and hence no additional borrowings made during the Financial Year for the purpose of making investments in subsidiary companies. He also referred to the cash flow statements in Page No.30 wherein the assessee had net cash from operating activities an amount of Rs.5224 lakhs. He therefore vehemently argued that assessee has utilized own funds for the purpose of investing in subsidiary companies and hence interest need not be capitalized. The learned AR relied on the decision of Hon’ble Supreme Court of India in the case of CIT v. Reliance Industries Ltd 410 ITR 466 (SC) and decision of Hon’ble High Court of Bombay in the case of CIT v. Reliance Utilities & Power Ltd. 313 ITR 340 (Bombay). He therefore pleaded that interest disallowed by the AO be deleted.

7. Per contra, the learned Departmental Representative [in short ‘DR’] referred to Page No.28 of the Annual Report and stated that the assessee has availed loans and there is no divisible pool maintained by the assessee between the own funds and the borrowed funds. He vehemently supported the orders of the learned AO wherein the AO has analyzed the cash flow statement filed by the assessee and concluded that the assessee does not have sufficient cash balance for making investments / advances to assessee concern. He, therefore, pleaded that the order of the learned CIT(A) be upheld.

8. We have heard rival contentions and perused the material available on record including the written submissions filed by the assessee. The main contention of learned AO is the assessee has invested huge sums in the subsidiary companies out of the borrowed funds by stating that the percentage of borrowings to net worth stood at 72% for the Financial Year 2009-10. He therefore was of the view that the assessee has partly utilized the loan funds for the purpose of investments and hence interest should be proportionately disallowed and capitalized along with the investments. However, on perusal of the Balance Sheet as on 31.03.2010, it is evident that the assessee has equity capital amounting to Rs.6599.32 lakhs and Rs.12,928.29 lakhs as accumulated reserves and surplus aggregating to Rs.19527.61 lakhs as net worth of the company. The investments stood at Rs.8579.43 lakhs out of which investments in subsidiary viz., Kirsons BV stood at Rs.8429.62 lakhs. On a plain observation of the above shareholder funds, the investments made by the assessee it can be safely concluded that the assessee had sufficient own funds which is non-interest bearing for the purpose of investments in the subsidiary companies.

9. The Hon’ble Supreme Court in the case of Reliance Industries Ltd. , (supra), relied on by the learned AR in paragraphs 7 and 8 observed as follows:

Insofar as the first question is concerned, the issue raises a pure question of fact. The High Court has noted the finding of the Tribunal that the interest free funds available to the assessee were sufficient to meet its investment. Hence, it could be presumed that the investments were made from the interest free funds available with the assessee. The Tribunal has also followed its own order for Assessment Year 2002-03.

In view of the above findings, we find no reason to interfere with the judgment of the High Court in regard to the first question. Accordingly, the appeals are dismissed in regard to the first question.

10. Similarly, the Hon’ble High Court of Bombay in the case of Reliance Utilities and Power Ltd. , (supra) on identical facts and circumstances in para 10 has held as follows:

10. If there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest-free funds available. In our opinion the Supreme Court in East India Pharmaceutical Works Ltd.’s case (supra) had the occasion to consider the decision of the Calcutta High Court in Woolcombers of India Ltd.’s case (supra) where a similar issue had arisen. Before the Supreme Court it was argued that it should have been presumed that in essence and true character the taxes were paid out of the profits of the relevant year and not out of the overdraft account for the running of the business and in these circumstances the appellant was entitled to claim the deductions. The Supreme Court noted that the argument had considerable force, but considering the fact that the contention had not been advanced earlier it did not require to be answered. It then noted that in Woolcombers of India Ltd.’s case (supra) the Calcutta High Court had come to the conclusion that the profits were sufficient to meet the advance tax liability and the profits were deposited in the overdraft account of the assessee and in such a case it should be presumed that the taxes were paid out of the profits of the year and not out of the overdraft account for the running of the business. It noted that to raise the presumption, there was sufficient material and the assessee had urged the contention before the High Court. The principle therefore would be that if there are funds available both interest-free and overdraft and/or loans taken, then a presumption would arise that investments would be out of the interest-free fund generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption is established considering the finding of fact both by the CIT (Appeals) and ITAT.

11. In the instant case, Revenue is not disputing the availability of shareholders own funds but Revenue’s objection is with respect to nonavailability of divisible pool between own funds and borrowed funds for the purpose of making investments / advances to subsidiary / sister concerns. Various judicial decisions have consistently held and affirmed the view that when funds available, in the form of both interest free and loan funds, the presumption would arise that investments would be out of funds generated from the company provided the said funds are sufficient to making the investments. In the instance case, the share capital and reserves and surplus as at 31^st March 2010, aggregating to Rs.19527.61 lakhs are sufficient enough to making an investment of Rs.8579.43 lakhs. Respectfully following the judicial pronouncements as discussed above, we are of the opinion that since the interest free funds are available, it can be safely presumed that the investments were out of interest free funds of the assessee. Hence the learned AO is directed to delete the disallowance of Rs.9,69,40,630/-. We therefore allow the grounds raised by the assessee. It is ordered accordingly.

12. ITA Nos.1317 & 1318/Bang/2024 (AY: 2011-12 & 2012-13)

In these appeals, the assessee has raised the similar grounds involving the identical issues with that of the assessee’s appeal in ITA No. 1316/Bang/2024 for the AY 2010-11, which is adjudicated in the foregoing paragraphs of this order. Considering the identicalness of the issues involved in all these appeals, our decision rendered while adjudicating the ITA No. 1316/Bang/2024 (supra) mutatis mutandis applies to the assessee’s appeals in ITA No. 1317 & 1318/Bang/2024 also. Accordingly, by applying the same analogy, we allow the grounds raised by the assessee in its appeals for the AY 2011-12 and 2012-13.

13. In the result, all the appeals of the assessee are allowed.

Pronounced in the open court on the date mentioned on the caption page.