2010 (6) TMI 612 - HC - Income Tax

Whether assessee is entitled to deduction of substantial amount paid towards interest on the borrowed funds utilised for acquisition of shares in a company of which the assessee acquired controlling interest of up to 90 per cent - assessee had received dividend income and no other benefit is derived from the company for the business carried on by it - Held that - reasoning given by the Tribunal for disallowance by applying section 14A, squarely applies for the interest paid on the borrowed funds because it is on record that the entire funds borrowed were utilised for acquisition of shares by the assessee in the company, assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in-trade which arises only if the assessee is engaged in trading in shares. So far as acquisition of shares is in the form of investment and the only benefit the assessee derived is dividend income which is not assessable under the Act, the disallowance under section 14A is squarely attracted and the Assessing Officer, in our view, rightly disallowed the claim, dividend income received by the assessee during the previous year was a meagre sum of Rs. 3 lakhs. This only shows that the business carried on by the leasing company was not very substantial to justify the assessee s investment through borrowed funds. Therefore, principle of commercial expediency gone into by the Supreme Court does not apply to the facts of this case. Therefore, we hold that the Tribunal in principle rightly held that the utilisation of the borrowed funds for acquisition of shares will not entitle the assessee for claiming deduction of interest paid on such borrowed funds. However, we hold that the Tribunal was not justified in allowing the claim in excess of Rs. 2 lakhs. For the same reasoning applied by the Tribunal, the assessee is not entitled to deduction of any amount towards interest paid on funds borrowed by way of fixed deposits taken for acquisition of shares in the company, which helped the assessee only to earn some dividend. Consequently we allow the appeal by reversing the order of the Tribunal and by restoring the disallowance confirmed in first appeal.

Summary

Issues:
- Deduction of interest paid towards borrowed funds for acquisition of shares
- Applicability of section 36(1)(iii) of the Income-tax Act
- Disallowance under section 14A for expenditure not forming part of total income
- Interpretation of Supreme Court and Calcutta High Court decisions

Deduction of Interest Paid Towards Borrowed Funds for Acquisition of Shares:
The case involved an appeal by the Department against the Tribunal's decision allowing the assessee to claim a deduction for interest paid on funds borrowed for purchasing shares in a company. The assessee argued that the acquisition of shares was for controlling the company engaged in leasing business, making it a business purpose under section 36(1)(iii) of the Income-tax Act. However, the Assessing Officer disallowed the claim citing section 14A, as the only benefit derived was dividend income. The Tribunal partially allowed the claim but made a disallowance of Rs. 2 lakhs attributable to the dividend income earned. The High Court found that the entire borrowed funds were utilized for share acquisition, leading to the disallowance under section 14A, as the dividend income was not taxable under the Act. The Court held that the assessee was not entitled to the deduction of interest paid on borrowed funds for share acquisition due to lack of commercial expediency.

Applicability of Section 36(1)(iii) of the Income-tax Act:
The assessee contended that the borrowed funds were utilized for a business purpose, linking her business with the leasing company's operations. However, the Court found that since the only benefit derived was dividend income, which is exempt under the Act, the disallowance under section 14A was justified. The Court emphasized that for claiming a deduction under section 36(1)(iii), shares must be held as stock in-trade, which was not the case here as the acquisition was for investment purposes.

Disallowance Under Section 14A for Expenditure Not Forming Part of Total Income:
The High Court upheld the disallowance under section 14A, which prohibits deductions for expenditures not forming part of the total income. As the dividend income earned from the shares acquired with borrowed funds was exempt under section 10(33) of the Income-tax Act, the disallowance was deemed appropriate.

Interpretation of Supreme Court and Calcutta High Court Decisions:
The Court analyzed the applicability of the Supreme Court decision in S. A. Builders Ltd. v. CIT and the Calcutta High Court decision in CIT v. Rajeeva Lochan Kanoria. It found that the principles of commercial expediency discussed in these cases did not align with the facts of this case, where the investment in shares did not yield substantial benefits. The Court held that the Tribunal was correct in disallowing the deduction of interest paid on borrowed funds for share acquisition and reversed the Tribunal's decision, restoring the disallowance confirmed in the first appeal.