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Hero Cycles (P) Ltd. v. Commissioner of Income Tax (Central), Ludhiana

Civil Appeal · Neutral citation not assigned (Civil Appeal No. 514 of 2008)Decided 5 Nov 2015
Civil Appeal No. 514 of 2008
Justice A.K. Sikri · Justice Rohinton Fali Nariman

Background

For assessment year 1988-89, the company claimed a deduction for interest it paid to banks on borrowed money. The Assessing Officer disallowed it on two grounds: the company had lent Rs 1.16 crore, interest-free, to its subsidiary Hero Fibres Ltd., and had lent Rs 34 lakh to its own directors at 10% interest while paying banks 18%. The High Court sided with the tax department, and the company appealed.

Decision Breakdown

The Supreme Court allowed the appeal, set aside the High Court's order, and restored the Income Tax Appellate Tribunal's decision in the company's favour. The Court applied the "prudent businessman" test: tax authorities must judge a business decision by how a prudent businessman would act, not by second-guessing it with hindsight. The advance to the subsidiary was business expediency, because the company had undertaken to its financial lenders to provide that subsidiary with margin money for working capital. The company later recovered the loan with interest, and the director loans were justified because the company had a credit balance and reserves of about Rs 15 crore when it made them.

Lesson Learnt

Whether a business expense is allowed as a tax deduction depends on whether a reasonable business owner would have made the same decision at the time, not on whether the decision later looked unwise. Businesses should keep clear records of why money was lent, especially to related parties.

Official source (sci.gov.in)View Judgment (PDF)

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