Summary
The Supreme Court held that a trust carrying on a composite business, including investment in shares, was entitled to deduct under Section 36(1)(iii) of the Income Tax Act, 1961 the interest paid on a bank loan whose proceeds were routed through a group company to acquire shares, since the transfer of borrowed funds is to be tested by commercial expediency; it restored the Tribunal's view and set aside the High Court.
Issues
- Whether the assessee was entitled to deduct under Section 36(1)(iii) the interest of Rs.21,74,234 paid on Rs.3.80 crore borrowed from a bank and transferred to a group company for the purchase of shares.
- Whether the High Court erred in holding that the borrowed money was used for the business of a subsidiary and not of the assessee.
Provisions considered
- Section 36(1)(iii), Income Tax Act, 1961The Court read the clause as turning on three elements: interest, capital borrowed, and use for the purpose of business or profession. It noted the expression 'for the purpose of business' is wider than 'for the purpose of making or earning income' in Section 57(iii), and, following Sharp Business System and S.A. Builders, held that borrowed funds passed to a sister concern are tested by commercial expediency. (¶¶ 12, 13, 15, 16, 19, 20, 21, 22)
- Section 2(28A), Income Tax Act, 1961The Court noted the definition of interest as interest payable on moneys borrowed or debt incurred, and observed that for Section 36(1)(iii) the deduction is confined to interest on money borrowed, interest being compensation to the creditor for being deprived of the use of the money. (¶¶ 14, 15)
Held
- Section 36(1)(iii) concerns capital borrowed, meaning money, and not other debts or liabilities; interest is compensation to the creditor for being kept out of the use of the money. (¶¶ 14, 15)
- The phrase 'for the purposes of the business or profession' in Section 36(1)(iii) is wider than the phrase used in Section 57(iii), so the scope for deduction under Section 36(1)(iii) is correspondingly wider. (¶ 16)
- Where borrowed funds are transferred to a sister or group concern, the question is whether the transfer was commercially expedient, not whether the amount was advanced to earn profits; interest on borrowed funds invested in a sister concern to acquire a controlling interest is allowable. (¶¶ 19, 20, 21)
- The High Court erred in holding that the borrowing was used for the subsidiary's business and not the assessee's and in rejecting the Tribunal's commercial-expediency reasoning; the Court agreed with the Tribunal's interpretation of Section 36(1)(iii), which had treated the assessee's business as composite and including investment in shares. (¶¶ 17, 18, 22)
Result
Appeal allowed; impugned High Court judgment set aside; assessee declared entitled to deduct the interest paid on capital of Rs.3,80,00,000 borrowed for the purposes of business; pending applications disposed of.