No proportionate disallowance of interest expenditure is called for in respect of interest free advances if an assessee has sufficient interest free funds:

AO found that the assessee had obtained funds from bank in form of working capital on which interest was paid and had advanced interest free loan to a related party. Hence, he disallowed proportionate interest expenditure. Hon’ble ITAT found that increase in the amount of reserves and surplus of the assessee for the given year was itself much more than the interest free loan advanced by the assessee. Further, Revenue had not brought any evidence on record to prove that interest bearing funds obtained by the assessee had been utilised for such interest free advances. Neither AO nor CIT(A) had established direct nexus between interest bearing funds and interest free advances. The Hon’ble ITAT, following the ratio laid down in the cases of “CIT Vs. Reliance Utilities and Power Ltd. – 313 ITR 340 (Bom)” and “CIT vs. Raghuvir Synthetics Ltd. – 354 ITR 222 (Guj)”, held that if an assessee has both, interest bearing funds as well as interest free funds, then it shall be presumed that interest free advances have been made out of interest free funds if the same are sufficient to meet such interest free advances.

[GUJARAT INSECTICIDES LTD. Vs. ACIT – ITA 556 & 675/Ahd/2013]