2003 (9) TMI 53 - HC - Income Tax

Interest paid on capital borrowing deductibility under section 36(1)(iii) - Assessing Officer disallowed the claim on the ground that the assessee had wilfully and deliberately chosen not to collect its outstanding dues from the sister concern in order to accommodate the sister concern and had, on the other hand, borrowed capital from the market and paid interest thereon for which deduction had been claimed. The Assessing Officer was of the view that this amounted to diversion of funds by the assessee to its sister concern to the detriment of the Revenue and, accordingly, disallowed the claim of the assessee under section 36(1)(iii) - The language of section 36(1)(iii) is very clear in that an assessee would be entitled to deduction on interest paid on capital borrowings for the purpose of its business Hence assessee was entitled to the benefit of section 36(1)(iii)

Summary

Issues:
Interpretation of section 36(1)(iii) of the Income-tax Act, 1961 in the context of diversion of funds to a sister concern.

Analysis:
The appeal in question challenged the judgment upholding the diversion of funds to the assessee's sister concern, as determined by the Assessing Officer and the Commissioner of Income-tax (Appeals). The agreement between the assessee and the sister concern involved marketing activities and commissions. The Assessing Officer disallowed the interest deduction claimed under section 36(1)(iii) due to alleged diversion of funds. The Commissioner of Income-tax (Appeals) upheld this decision, leading to the appeal before the Income-tax Appellate Tribunal.

The Tribunal affirmed the diversion of funds finding, prompting the assessee to argue that the lower forums misunderstood section 36(1)(iii) by implying diversion without evidence of benefit to either party. The assessee contended that the deduction should be allowed as long as borrowed capital was used for business purposes, irrespective of outstanding dues collection. Reference was made to a Bombay High Court case supporting this interpretation.

The Revenue's argument centered on the assessee's failure to charge interest on overdue payments, alleging a reduction in capital for its own business benefit. However, the High Court disagreed with this view, citing the clear language of section 36(1)(iii) which only requires borrowed capital to be used for business purposes. The Court emphasized that no evidence suggested misuse of capital by the assessee.

Ultimately, the High Court allowed the appeal, setting aside previous orders and directing the authorities to grant the benefit of section 36(1)(iii) to the appellant for the relevant assessment years. The judgment highlighted the importance of the plain language of the statute in determining the eligibility for interest deduction on capital borrowings for business purposes.

In conclusion, the High Court's decision clarified the interpretation of section 36(1)(iii) in the context of fund diversion to a sister concern, emphasizing the necessity of borrowed capital being utilized for the assessee's business to claim the interest deduction, irrespective of outstanding dues collection practices.