ITAT Delhi: Interest Disallowance Under Section 36(1)(iii) Invalid Without Nexus Between Borrowed Funds and Interest-Free Advances

February 28, 2026 : The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that disallowance of interest under Section 36(1)(iii) of the Income-tax Act, 1961 cannot be sustained unless the Revenue establishes a clear nexus between borrowed funds and interest-free advances granted by the assessee.

The Bench comprising Judicial Member Satbeer Singh Godara and Accountant Member Amitabh Shukla allowed the appeal filed by Shivam Agrioils Private Limited for the Assessment Year 2018–19 and deleted the addition of ₹43,86,674 made by the tax authorities on account of alleged diversion of interest-bearing funds.

The dispute arose after the Assessing Officer disallowed interest expenditure on the ground that the assessee had granted interest-free long-term advances to certain parties while simultaneously paying interest on unsecured loans. According to the Revenue, the assessee had failed to prove that the borrowed capital was used wholly and exclusively for business purposes. The Commissioner of Income Tax (Appeals) had upheld the disallowance.

Before the Tribunal, the assessee submitted that the advances in question were made during the financial years 2014–15 and 2015–16 for the purpose of acquiring an industrial property. However, the unsecured loans on which interest was paid were raised only during the financial year 2017–18. It was argued that borrowings made in a later year could not have been used to finance advances that had already been made in earlier years.

Accepting the contention, the Tribunal observed that there was no material on record to establish any direct nexus between the borrowed funds and the advances given by the assessee. The Bench noted that the advancement of interest-free funds cannot by itself lead to a presumption that interest-bearing borrowed funds were diverted for that purpose.

The Tribunal further observed that the advances had been made in earlier financial years, whereas the borrowings were raised during the year under consideration. In such circumstances, it was not possible to link the borrowed funds with the advances.

On the question of availability of funds, the Bench recorded that the assessee had sufficient interest-free funds at the time the advances were granted. It reiterated the settled legal position that when an assessee has adequate own funds, a presumption arises that interest-free advances are made out of such funds unless the Revenue proves otherwise.

The Tribunal also considered the commercial background of the transaction. It noted that the advances were paid towards the purchase of industrial property, but the deal could not be completed due to default by the seller. The assessee had subsequently initiated proceedings before the National Company Law Tribunal to recover the amount, which the Bench treated as evidence of a genuine business transaction.

In the absence of any evidence demonstrating diversion of borrowed funds and in view of the availability of sufficient own funds, the Tribunal held that the disallowance under Section 36(1)(iii) was unsustainable. Accordingly, the addition of ₹43,86,674 was deleted and the appeal of the assessee was allowed.

Case Title: M/s Shivam Agrioils Pvt. Ltd. v. Deputy Commissioner of Income Tax
Case Number: ITA No. 1030/Del/2025