ITAT Overturns CIT(A) Order Confirming Interest Disallowance; Deletes Rs. 2.88 Crore Addition

R.K. Industries Unit-II LLP has filed the present appeal against the Assistant Commissioner of Income Tax in the Income Tax Appellate Tribunal (ITAT) in Ahmedabad, challenging an order passed by the CIT(A) dated May 14, 2024, for the assessment year 2016-17.

The assessee is a Limited Liability Partnership firm engaged in the business of ship recycling, had filed its return of income on November 30, 2016, declaring a total income of Rs. 76,925,170. The case was selected for investigation, and notices were issued. AO assessed the total income of the company at Rs 10,57,38,760, making a principal addition of Rs 2,88,13,592 to the assessee’s income under section 36(1)(iii) of the Act on account of the alleged diversion of borrowed funds for non-business purposes.

In addition, the Assessing Officer initiated proceedings for the levy of a penalty under section 270A and computed interest chargeable under sections 270A and 234A, 234B, 234C and 234D.

The assessee filed an appeal before the CIT(A). The assessee also argued that on a net basis, after adjusting interest receivable from one partner and interest notionally chargeable to others at 7.95%, the firm was required to pay net interest of only Rs. 56.58 lakh to partners, which demonstrated that interest-bearing funds were not diverted. However, the CIT(A) did not accept this argument. The CIT(A) also held that merely showing interest-free funds on paper was not enough when the overdraft was not reduced. Therefore, the disallowance of interest was confirmed, along with the levy of interest and initiation of penalty, and the assessee’s appeal was dismissed.

The assessee, still aggrieved with the order of the CIT(A), thereafter approached the ITAT. During the hearing, AR submitted that AO made a wrong assumption. AO believed on the assumption that only because two of the partners had debit balances on the first day of the year, the assessee did not have interest-free funds and had diverted interest-bearing funds for non-business purposes, whereas such an inference ignores the complete financial matrix.

AR further added that both CIT(A) and the Assessing Officer had overlooked the basic nature of the assessee’s business, wherein ships are purchased against usance letters of credit with a 360-day credit period, resulting in a continuous free float of funds from shipbreaking activities. The assessee also submitted other relevant details.

After considering all the facts, the Tribunal directed the deletion of the entire disallowance of interest. Since the main addition was deleted, the other grounds relating to the levy of interest and initiation of penalty were treated as merely consequential and were not separately adjudicated. As a result, the assessee’s appeal was allowed in full.