2000 (11) TMI 64 - HC - Income Tax

Summary

Issues:
1. Interpretation of section 36(1)(iii) of the Income-tax Act, 1961 regarding the treatment of salaries due to directors but not paid by a company.
2. Determination of whether interest paid by the assessee to directors on undisbursed salaries constitutes interest on capital borrowed for business purposes under section 36(1)(iii) of the Act.

Analysis:
1. The case involved the interpretation of section 36(1)(iii) of the Income-tax Act, 1961 concerning the treatment of salaries due to directors but not paid by a company. The company credited interest to the directors' accounts for the outstanding salaries, which were claimed as a deduction under section 36(1)(iii). The Income-tax Officer disallowed the claim, stating the absence of conditions required for section 36(1)(iii) application. The Appellate Assistant Commissioner accepted the claims, but the Revenue appealed to the Tribunal, arguing no capital was borrowed, a fundamental requirement for section 36(1)(iii). The Tribunal disagreed, stating if payments were made, the company would have needed to borrow funds for interest, thus linking the utilized funds to potential borrowings. The Tribunal held the amounts were allowable under section 36(1)(iii).

2. The second issue revolved around whether the interest paid by the assessee to directors on undisbursed salaries constituted interest on capital borrowed for business purposes under section 36(1)(iii) of the Act. The court analyzed the definition of "capital borrowed," emphasizing it refers to money, not other assets. Interest must be paid in respect of the capital borrowed to be allowed as a deduction. The court clarified that interest on borrowed capital relates only to money borrowed, not debt incurred. The court found that the amounts due to directors as salaries, although not disbursed, did not qualify as capital borrowed. The hypothetical need to borrow capital to meet obligations did not transform the outstanding salaries into borrowed capital for business purposes. Consequently, the court ruled in favor of the Revenue, holding that the Appellate Assistant Commissioner and the Tribunal were unjustified in considering the amounts as capital borrowed.

In conclusion, the court answered both questions in the negative, favoring the Revenue and rejecting the assessee's claims regarding the treatment of outstanding salaries and interest paid to directors under section 36(1)(iii) of the Income-tax Act, 1961.