Interest disallowance on interest-free advances is not justified if there is commercial expediency.

Assessee Relief on Interest Disallowance, Provision for Expenses, and Other Issues

I. Interest on Borrowed Capital (Section 36(1)(iii))

Issue 1: Disallowance of interest on advances to three companies.
- Decision: Commissioner (Appeals) justified in deleting disallowance as there was commercial expediency and the advances continued from earlier years without disallowance. (In favor of assessee)
Issue 2: Disallowance of interest on advance to a certain person.
- Decision: Commissioner (Appeals) justified in restoring the issue to AO, as this advance was given out of interest-free funds in an earlier year. (Matter Remanded)
Issue 3: Disallowance of interest on capital balances of partners.
- Decision: Commissioner (Appeals) justified in holding that these amounts were not loans/advances and deleting the disallowance, as these were debit balances of partners from an erstwhile firm, brought forward from earlier years, and sufficient interest-free funds were available. (In favor of assessee)
Issue 4: Disallowance of interest on advance to a certain company.
- Decision: Commissioner (Appeals) justified in deleting disallowance, as the advance was given in connection with a business deal in an earlier year, and there was commercial expediency. (In favor of assessee)
Issue 5: Disallowance of interest on advances to certain parties.
- Decision: Commissioner (Appeals) justified in deleting disallowance, as the advances were given for business purposes, sufficient interest-free funds were available, and these advances were given in earlier years without disallowance. (In favor of assessee)

Key Takeaways (Section 36(1)(iii)):

Commercial expediency and availability of interest-free funds are crucial factors in determining the allowability of interest expenses.
Consistency in the treatment of advances in earlier years is important.
Advances for business purposes are generally allowable.

II. Provision for Various Expenses (Section 145)

Issue: Disallowance of provision for various expenses due to a lack of supporting vouchers.
- Decision: Commissioner (Appeals) justified in deleting disallowance, as the assessee had incurred the liability, and actual cash outflow is not required. The assessee followed the mercantile system, and the provisions were made based on estimates and routinely made to reflect a true financial position, a practice accepted in prior years. (In favor of assessee)

Key Takeaways (Section 145):

Provisions for expenses are allowable under the mercantile system if the liability has accrued, even without actual payment.
Estimated provisions made on a consistent basis are acceptable if they reflect a true financial position.

IN THE ITAT MUMBAI BENCH ‘E’

Asst. CIT

T Bhimjyani Realty (P.) Ltd.

ANIKESH BANERJEE, Judicial member
and B.R. Bhaskaran, Accountant member

IT Appeal NO. 4901(MUM) of 2024
[Assessment Year 2018-19]

JANUARY 16, 2025

Hemanshu Joshi, Sr. DR for the Appellant. Vijay Mehta for the Respondent.

ORDER

B.R. Baskaran, Accountant Member. – The revenue has filed this appeal challenging the order dated 08-07-2024 passed by Ld CIT(A), NFAC, Delhi and it relates to the assessment year 201819. The revenue is aggrieved by the decision of Ld CIT(A) in deleting the disallowance of interest and expenses made by the AO.

2. The assessee is a Private Limited Company and engaged in the real estate business of developing residential project named “Neelkanth Woods by T Bhimjyani” at Mullabaug, Ghodbunder Road, Manpada, Thane. The assessee company was succeeded by a partnership firm originally named as ‘Ravechi Property Developers’. Subsequently, the name of the Partnership firm was changed into “Ravechi Infrastructure Projects”. Later on, it was converted into Private Limited Company with the name “Ravechi Infrastructure Projects Pvt. Ltd.” w.e.f 15.09.2011. The name of this company was subsequently changed to the present name “T. Bhimjyani Realty Pvt. Ltd.”

3. During the course of assessment proceedings, the AO noticed that the assessee has borrowed interest bearing loans and was paying interest thereon. However, the assessee has given interest free advances to various persons. Accordingly, the AO took the view that the interest expenditure attributable to interest free advances are not allowable as deduction. Accordingly, he disallowed a sum of Rs.16,98,85,448/- out of interest expenditure. Besides the above, the AO also disallowed claim of “Provision for expenses” of Rs.3,80,67,574/- and rent expenses of Rs.1,56,00,583/-. The Ld CIT(A) partly allowed the appeal of the assessee. Hence the revenue has filed this appeal challenging the relief granted in respect of interest disallowance and “Provision for Expenses” disallowance.

4. We heard the parties and perused the record. We notice that the AO has taken the view that the assessee should have charged interest on advances given by it, since it had borrowed loans at interest. We notice that the Ld CIT(A) has followed two legal principles in deciding these issues. The first legal principle is the examination of existence of commercial expediency in the transaction. The settled principle is that the question of charging of interest or not shall usually be decided by the assessee and its customers in a commercial transaction. Accordingly, it has been held by Hon’ble Supreme Court in the case of S A Builders Ltd v. CIT (SC))(SC) that if there is commercial expediency in giving interest free advances, then it is not necessary that the said advance should carry interest. The relevant discussions made by Hon’ble Supreme Court in the above said case are extracted below:-

“We have considered the submission of the respective parties. The question involved in this case is only about the allowability of the interest on borrowed funds and hence we are dealing only with that question. In our opinion, the approach of the High Court as well as the authorities below on the aforesaid question was not correct.

In this connection we may refer to Section 36(1)(iii) of the Income Tax Act, 1961 (hereinafter referred to as the ‘Act’) which states that “the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession” has to be allowed as a deduction in computing the income tax under Section 28 of the Act.

In Madhav Prasad Jantia v. Commissioner of Income Tax U.P. AIR 1979 SC 1291, this Court held that the expression “for the purpose of business” occurring under the provision is wider in scope than the expression “for the purpose of earning income, profits or gains”, and this has been the consistent view of this Court.

In our opinion, the High Court in the impugned judgment, as well as the Tribunal and the Income Tax authorities have approached the matter from an erroneous angle. In the present case, the assessee borrowed the fund from the bank and lent some of it to its sister concern (a subsidiary) on interest free loan. The test, in our opinion, in such a case is really whether this was done as a measure of commercial expediency.

In our opinion, the decisions relating to Section 37 of the Act will also be applicable to Section 36(1)(iii) because in Section 37 also the expression used is “for the purpose of business”. It has been consistently held in decisions relating to Section 37 that the expression “for the purpose of business” includes expenditure voluntarily incurred for commercial expediency, and it is immaterial if a third party also benefits thereby.

Thus in Atherton v. British Insulated & Helsby Cables Ltd (1925)10 TC 155 (HL), it was held by the House of Lords that in order to claim a deduction, it is enough to show that the money is expended, not of necessity and with a view to direct and immediate benefit, but voluntarily and on grounds of commercial expediency and in order to indirectly to facilitate the carrying on the business. The above test in Atherton’s case (supra) has been approved by this Court in several decisions e.g. Eastern Investments Ltd. vs.[1960] 38 ITR 601 (SC) etc. In our opinion, 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 the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed.

The expression “commercial expediency” is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.

No doubt, as held in Madhav Prasad Jantia v. CIT (supra), if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under Section 36(1)(iii) of the Act. In Madhav Prasad’s case (supra), the borrowed amount was donated to a college with a view to commemorate the memory of the assessee’s deceased husband after whom the college was to be named. It was held by this Court that the interest on the borrowed fund in such a case could not be allowed, as it could not be said that it was for commercial expediency.

Thus, the ratio of Madhav Prasad Jantia’s case (supra) is that the borrowed fund advanced to a third party should be for commercial expediency if it is sought to be allowed under Section 36(1)(iii) of the Act.

In the present case, neither the High Court nor the Tribunal nor other authorities have examined whether the amount advanced to the sister concern was by way of commercial expediency.

It has been repeatedly held by this Court that the expression “for the purpose of business” is wider in scope than the expression ” for the purpose of earning profits” vide CIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140 (SC), CIT v. Birla Cotton Spinning & Weaving Mills Ltd [1971] 82 ITR 166 (SC) etc. The High Court and the other authorities should have examined the purpose for which the assessee advanced the money to its sister concern, and what the sister concern did with this money, in order to decide whether it was for commercial expediency, but that has not been done.

It is true that the borrowed amount in question was not utilized by the assessee in its own business, but had been advanced as interest free loan to its sister concern. However, in our opinion, that fact is not really relevant. What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency.

Learned counsel for the Revenue relied on a Bombay High Court decision in Phaltan Sugar Works Ltd. v. Commissioner of Wealth-Tax Bombay) in which it was held that deduction under Section 36(1)(iii) can only be allowed on the interest if the assessee borrows capital for its own business. Hence, it was held that interest on the borrowed amount could not be allowed if such amount had been advanced to a subsidiary company of the assessee. With respect, we are of the opinion that the view taken by the Bombay High Court was not correct. The correct view in our opinion was whether the amount advanced to the subsidiary or associated company or any other party was advanced as a measure of commercial expediency. We are of the opinion that the view taken by the Tribunal in Phaltan Sugar Works Ltd (supra) that the interest was deductible as the amount was advanced to the subsidiary company as a measure of commercial expediency is the correct view, and the view taken by the Bombay High Court which set aside the aforesaid decision is not correct.

Similarly, the view taken by the Bombay High Court in Phaltan Sugar Works Ltd. v. Commissioner of Wealth-Tax 215 ITR 582 (Bombay) also does not appear to be correct.

We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (Bhart) Ltd. (Delhi) that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits.

We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the Directors of the sister concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, where it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans.”

The ratio of above said decision is it is required to be seen as to whether there was “commercial expediency” in giving interest free advances or loans. If it exists so, then the same cannot be considered as diversion of interest bearing funds, since the same is for the purposes of business. U/s 36(1)(iii) of the Act, the interest payable on the capital borrowed for the purposes of business is allowable as deduction.

4.1. The second legal principle followed by Ld CIT(A) is that, if the assessee is having both interest free funds and interest bearing borrowed funds, then the presumption is that the investments have been made first out of interest free funds. In that case, the disallowance u/s 36(1)(iii) of the Act shall not arise. It has been so explained by Hon’ble Bombay High Court in the case of Reliance Utilities and Power (Bombay))(Bom as under:-

“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.”

4.2 One more legal principle relied upon by Ld A.R before us is that the AO is not correct in making interest disallowance in respect of an advance, which was granted in the earlier year and in those years, the AO did not make such disallowance. In support of this proposition, the Ld A.R placed his reliance on the following case laws:-

(a)

ITO v. M/s Abhinand Investment Ltd (ITA No.982/Kol/2016 dated 07-02-2018)

(b)

CIT v. Sridev Enterprises

(c)

Virendar R Gandhi v. ACIT (Tax Appeal No.20 of 2004 and 124 of 2005 dated 27-11-2014).

5. We shall now examine the disallowance of interest expenses made by the AO in respect of each of the loans given by the assessee.

5.1 The first item of interest disallowance is Rs.2,28,90,000/-, which is related to the following advances given by the assessee:-

Name of Company	Principal Amount	Interest added
(a) M/s Atlanta Land Pvt Ltd. –	1,75,00,000	36,75,000
(b) M/s Orange Land P Ltd –	4,25,00,000	89,25,000
(c) M/s Paramount Township P Ltd –	4,90,00,000	1,02,90,000
		2,28,90,000

The Ld A.R submitted that all these advances were given in the earlier year and the corresponding interest expenditure was not disallowed in the earlier years. We also notice that the Ld CIT(A) has considered that there was commercial expediency in giving this loan. The explanation given by the assessee in respect of this advance is extracted as under by Ld CIT(A):-

“The appellant company is into the business of real estate and for further future prospects of the company, it has entered into Memorandum of Understanding (MOU) with Paramount Township Pvt. Ltd. on 30.06.2011 and as per the terms of the said MOU the appellant company has given advance of Rs. 4,90,00,000/-. As per the terms of the MOU the said advance given will be interest free, however in consideration Paramount Township Pvt. Ltd. will repay entire amount of advance given of Rs.4,90,00,000/- alongwith 80% share in profits earned by Paramount Township Pvt. Ltd. upon resale of the said property. The present value of the said land is approximately Rs. 9,00,00,000/-.

During the course of assessment proceedings the appellant has submitted MOU between Ravechi Property Developers and Paramount Township Pvt. Ltd., Purchase agreement entered by Paramount Township Pvt. Ltd. For Purchase of said Land at Village Boris from its original vendors dated 08/09/2011 and current stamp duty valuation as per ready reckoner.

Further the appellant company has entered into Memorandum of Understanding (MOU) with Atlanta Land Pvt. Ltd. and Orange Land Pvt. Ltd. on 07.06.2011 and as per the terms of the said MOU the appellant company has advance Rs. 1,75,00,000/- to Atlanta Land Pvt. Ltd. and Rs. 4,25,00,000/- Orange Land Pvt. Ltd. The total Purchase value of the said land is Rs. 10,11,00,000/- and advance translates into 60% of the total value of Land. As per the terms of the MOU the said advance given will be interest free, however in consideration Atlanta Land Pvt. Ltd. and Orange Land Pvt. Ltd. will repay entire amount of advances given viz Rs. 4,25,00,000/- and 1,75,00,000/- alongwith 60% share in profits earned by Atlanta Land Pvt. Ltd. and Orange Land Pvt. Ltd. upon resale of the said property. The present stamp duty value of the said land is approximately Rs. 20,00,00,000/- and current market value is approximately Rs. 50,00,00,000/-. During the course of assessment proceedings, the appellant has submitted MOU executed between Ravechi Property Developers and Atlanta land Pvt. Ltd. and Orange Land Pvt. Ltd., Articles of Agreement by Atlanta Land Pvt. Ltd. and Orange Land Pvt. Ltd. from its original vendors dated 04.09.2007 for purchase of said land and current stamp duty valuation as per ready reckoner.”

On perusal of above said explanations, we notice that the advances have been given to these three companies during the course of carrying on business for business purposes, i.e., these payments have been given in connection with business ventures with the expectation of profits from the deal that will be entered by the respective parties. Accordingly, the Ld CIT(A) has held that there was commercial expediency in giving these advances without charging interest, since the assessee is expected to get the share of profits from the deal. Further, these three advances continue from the earlier years and the AO did not make any disallowance of interest in the earlier years. Accordingly, we are of the view that the Ld CIT(A) was justified in deleting the proportionate interest disallowance of Rs.2,28,90,000/-.

5.2 The next item of interest disallowance of Rs.62,27,243/- pertains to the advance given to Shri Kishore Devani. The following explanation was given by the assessee before Ld CIT(A):-

“The appellant company has advance Rs. 5,18,93,699/- to Kishore Devani for business purpose for purchase of real estate property during FY 201516, however due to some difference in opinion between the appellant and Kishore Devani the said business transaction did not go further, thereafter Kishore Devani has returned certain portion of the amount during FY 201617 and balance amount was returned during FY 2019-20. Further we would like to inform your good selves that interest bearing funds were not utilized for giving said advances and complete working showing interest bearing fund and noninterest bearing funds and utilization thereof was also submitted during the course of assessment proceedings. The assessing officer has erred in disallowing interest @ 12% i.e. Rs. 62,27,243/- on business advance given of Rs. 5,18,93,699/-.”

The Ld CIT(A) decided this issue as under:-

“I observe that the AO has not given any reasoning for this addition. He simply concludes that the reply filed by the appellant was considered but not found acceptable as it had simply stated that the issue has already been examined in the earlier year’s assessment years. The AO is directed to examine the accounts relating to AY 2016-17 and AY 20-21, and if indeed the submission of the appellant as above is found true, he is directed to delete the addition, since it would be clear that there is no relevance to the year under appeal.”

We notice that the Ld CIT(A) has restored this issue to the file of the AO. In any case, it is stated that this advance was given out of interest free funds in an earlier financial year 2015-16. According to Ld A.R, the AO did not make any disallowance of proportionate interest in the earlier years. Hence, we do not find any infirmity in the decision rendered by Ld CIT(A) on this issue.

5.3 The next item is interest disallowance of Rs.35,80,786/- pertaining to amount outstanding in the following names:-

Name of Party	O/s Amount	Interest added
Bhavik R Bhimjyani	1,12,05,852	13,44,702
Rashmi C Bhimjyani	28,07,160	3,36,859
Rekha R Bhimjyani	1,58,26,878	18,99,225
		35,80,786

The assessee has offered following explanations before Ld CIT(A):-

“The appellant company was incorporated on 15.09.2011 by way of conversion of same from partnership firm namely Ravechi Infrastructure Projects (old name Ravechi Property Developers) into private limited company under the name and style of Ravechi Infrastructure Projects Pvt. Ltd. presently known as T Bhimjyani Realty Pvt. Ltd.

M/s. Ravechi Property Developers was managed by families of 2 persons namely Rashmi Bhimjyani Family and Tulsi Bhimjyani Family both brothers. However due to dispute between 2 brothers the family members of the Rashmi Bhimjyani Family viz. Bhavik R. Bhimjyani, Rashmi C.Bhimjyani and Rekha R. Bhimjyani have retired from said partnership firm and debit balance of above mentioned partners were outstanding to be received since retirement.

Later on, during FY 2019-20 both the families have amicably resolved the dispute and outstanding debit balance of the erstwhile partners have been received.

However, the assessing officer has erred by treating debit balance of capital account of erstwhile partners as loans and advances given and disallowed interest @ 12% paid on loan taken.”

The Ld CIT(A) took the view that it is not in the nature of loan and advance, as presumed by the AO. Since it was capital balances (debit) of partners of erstwhile partnership firm, the Ld CIT(A) took the view that there is no requirement of disallowing proportionate interest expenses. We also notice that all these balances have been brought forward from earlier years and no disallowance of interest was made in those years. Secondly, the interest free funds available with the assessee are in far excess of these outstanding amounts. Accordingly, we are of the view that there is no requirement of disallowing any interest expenses vis-a-vis these outstanding balances. Accordingly, we confirm the order passed by Ld CIT(A) on this issue.

5.4 The next item is interest disallowance of Rs.15,16,236/- pertaining to advance given to M/s Suburbia Realtors P Ltd. Before Ld CIT(A), the assessee offered following explanations:-

“The appellant company has advance Rs. 1,26,35,300/- to Suburbia Realtors Pvt. Ltd. for business purpose for purchase of real estate property during FY 2012-13, however due to some difference in opinion between the appellant and Suburbia Realtors Pvt. Ltd. the said business transaction did not go further, the balance amount is still outstanding to be received. Further we would like to inform your good selves that interest bearing funds were not utilized for giving said advances and complete working showing interest bearing fund and non-interest-bearing funds and utilization thereof was also submitted during the course of assessment proceedings. The assessing officer has erred in disallowing interest @ 12% i.e. Rs.15,16,236/- on business advance given of Rs. 1,26,35,300/-. “

The ld CIT(A) noticed that this amount was given in the financial year 2012-13 in connection with a business deal. Accordingly, the ld CIT(A) took the view that there was commercial expediency in giving this advance and deleted the interest disallowance following decision of Hon’ble Supreme Court rendered in the case of S A Builders Ltd (supra). We also notice that this account has been brought forward from earlier years and no disallowance of interest was made in those years. Accordingly, we do not find any infirmity in the decision rendered by Ld CIT(A) on this issue.

5.5 The next items are interest disallowance of Rs.1.32 crores on the advance given to M/s Gammon Neelkanth Realty Corporation and Rs.33.00 lakhs on the advance given to Shri Harsh Kaushal Developers. Before Ld. CIT(A), the assessee has offered following explanations:-

“DISALLOWANCE OF INTEREST U/S 36(1)(iii) – RS. 1,32,00,000/-

The appellant company has advance Rs. 11,00,00,000/- to Gammon Neelkanth Realty Corporation for business purpose for purchase of real estate property during FY 2007-08, however due to some difference in opinion between the appellant and Gammon Neelkanth Realty Corporation the said business transaction did not go further, thereafter Gammon Neelkanth Realty Corporation has returned the said amount of Rs.11,00,00,000 during FY 2019-20. Further we would like to inform your goodselves that interest bearing funds were not utilized for giving said advances and complete working showing interest bearing fund and non interest bearing funds and utilization thereof was also submitted during the course of assessment proceedings. The assessing officer has erred in disallowing interest @ 12% i.e. Rs. 1,32,00,000/- on business advance given of Rs. 11,00,00,000/-.

DISALLOWANCE OF INTEREST U/S 36(1)(iii) – RS. 33,00,000/-

The appellant company has advance Rs. 2,75,00,000/- to Harsh Kaushal Developers for business purpose for purchase of real estate property on 07.10.2014, however due to some difference in opinion between the appellant and Harsh Kaushal Developers, the said business transaction did not go further, the balance amount is still outstanding to be received. Further we would like to inform your goodselves that interest bearing funds were not utilized for giving said advances and complete working showing interest bearing fund and non interest bearing funds and utilization thereof was also submitted during the course of assessment proceedings. The assessing officer has erred in disallowing interest on loan taken @ 12% i.e. Rs. 33,00,000/- on business advance given of Rs. 2,75,00,000/-.

The Ld CIT(A) accepted the submission of the assessee that these advances have been given on commercial expediency during the course of carrying on of its real estate business. He also noticed that the sufficient interest free funds were also available with the assessee. Accordingly, he deleted interest disallowances made on both the advances. We also notice that these advances have been given in the earlier years and no disallowance of interest was made in those years. Since these advances have been given for business purposes, we are of the view that the Ld CIT(A) has rightly deleted the disallowance of proportionate interest in respect of both these advances.

5.6 The next item is interest disallowance of Rs.3,14,45,722/- in respect of advance given to Shri Tulsi Bhimjyani and Rs.8,77,25,460/- given to M/s Neelkanth Propinfra LLP. The assessee offered following explanations before Ld CIT(A):_

“DISALLOWANCE OF INTEREST U/S 36(1)(iii) – RS. 3,14,45,722/-

The appellant company is into the business of real estate and for further future prospects of the company, it has entered into Memorandum of Understanding (MOU) with Tulsi Bhimjyani on 07.01.2013 for purchase of area on the 11th to 14th Floor on bare shell basis in Sea Green Cooperative Housing Society Ltd, Khan Abdul Gaffar Khan Road, Worli, Mumbai – 400018 for a consideration of Rs. 40,00,00,000/- and as per the terms of the said MOU the appellant company has given advance of Rs.26,20,47,686/-. During the course of assessment proceedings the appellant has submitted MOU. However the assessing officer has erred in accepting the said legitimate business advances as speculation business. The assessing officer has erred in considering that as the advances given were interest free, it were not utilized for Business purpose, without verifying the commercial expediency of such advance given. The assessing officer has erred by disallowing interest on loan taken @ 12% i.e. Rs. 3,14,45,722/- on business advance given of Rs. 26,20,47,686/-.

DISALLOWANCE OF INTEREST U/S 36(1)(iii) – RS. 8,77,25,460/-

The appellant company is into the business of real estate and for further future prospects of the company, it has entered into Memorandum of Understanding (MOU) with Partners of Neelkanth Propinfra LLP viz Leena Bhimjyani, Anshul Bhimjyani and Devang Bhimjyani on 25.08.2015 for purchase of area on 11th to 14th Floor on bare shell basis in Sea Green Cooperative Housing Society Ltd, Khan Abdul Gaffar Khan Road, Worli, Mumbai – 400018 for a consideration of Rs. 90,00,00,000/- and as per the terms of the said MOU the appellant company has given advance of Rs.73,10,45,500/-. During the course of assessment proceedings the appellant has submitted MOU and amendments thereafter. However the assessing officer has erred in accepting the said legitimate business advances as speculation business. The assessing officer has erred in considering that as the advances given were interest free it were not utilized for Business purpose, without verifying the commercial expediency of such advance given. The assessing officer has erred by disallowing interest on loan taken @ 12% i.e. Rs. 8,77,25,460/- on business advance given of Rs. 73,10,45,500/-.”

6 The next issue contested by the revenue relates to the relief granted by Ld CIT(A) in respect of the disallowance of claim of Provision for expenses of Rs.3.80 crores.

6.1 The AO examined the Sundry creditors account and noticed that the assessee has created “Provision for various expenses” aggregating to Rs.5,01,65,609/-. Out of the above provisions, the assessee had voluntarily disallowed a sum of Rs.1,20,98,035/-. The AO took the view that these claims are not supported by vouchers and in the absence of relevant details, he disallowed the net amount of Rs.3,80,67,574/-.

6.2 The Ld CIT(A) noticed that the assessee has made provision for expenses in respect of which, it had already incurred liability. The Ld CIT(A), by placing reliance on the decision rendered by Hon’ble Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 (SC) held that there is no requirement of actual cash outflow in order to claim a liability as expenditure. He also relied upon the decisions rendered in the case of Calcutta Company Ltd In the case of Rotork Controls India (P.) Ltd. (supra), the Supreme Court explained the meaning of provision with respect to claiming deduction u/s. 37 of the Act:

“10. What is a provision? This is the question which needs to be answered. A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized.

11. Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

12. A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that is recognized as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation………

13 In our view, on the facts and circumstances of this case, provision for warranty is rightly made by the appellant-enterprise because it has incurred a present obligation as a result of past events. There is also an outflow of resources. A reliable estimate of the obligation was also possible. Therefore, the appellant has incurred a liability, on the facts and circumstances of this case, during the relevant assessment year which was entitled to deduction under section 37 of the 1961 Act.”

There is no dispute that the assessee is following mercantile system of accounting. Under that system, it is mandatory for the assessee to make provision for all known expenses and losses, even if the payments in respect of those expenses have not been made. Unless such kind of provision for expenses are made in the books as at the year end, the financial statements cannot be considered to reflect true and fair view of the company. The provision for expenses is usually made on some scientific basis at the year end, since the concerned bills would not have been received by the assessee at the time of finalization of accounts. Hence, the assessee would not be in a position to furnish relevant bills in respect of all items. The ld AR submitted that the provision for expenses are made every year in a routine manner in order to provide for all known expenses and losses in accordance with accounting principles. In the earlier years, the AO had accepted claim of the provision for expenses. Accordingly, we are of the view that the AO was not justified in disallowing the provision for expenses made by the assessee. Accordingly, we confirm the order passed by Ld CIT(A) on this issue.

7. In the result, the appeal filed by the revenue is dismissed.