2015 (10) TMI 22 - HC - Income Tax

Expenditure on interest claimed - whether could not be allowed in terms of Section 57 (iii) - Held that - In the present case, the advancing of loan to SCL was a business decision taken by the Assessee out of commercial expediency. Further, the sanction letter of HSBC made it clear that the Assessee could draw loans up to the sanctioned limit as and when needed. The sanction letter also permitted the Assessee to further utilise the money borrowed to advance loans to others. The sum of ₹ 25 crores drawn by the Assessee on 24th December 2001 in terms of HSBC s sanction letter was transferred to SCL on the very same date. Without the facility of credit by the HSBC, the Assessee could not have advanced the loan to SCL. Therefore, there was a direct nexus between the earning of interest on the loan advanced by the Assessee to SCL and payment of interest to HSBC on the loan drawn in terms of the sanction letter dated 2nd August 2001. The income earned on the loan advanced to SCL was rightly offered to tax by the Assessee as income from other sources . Since the interest paid to HSBC on the loan availed was in the nature of an expenditure wholly and exclusively laid out for the purpose of earning the interest income, it ought to be permitted to be netted against such income from other sources in terms of Section 57 (iii). There is also merit in the contention of the Assessee that for AY 2003-04, the CIT (A) and the ITAT mechanically followed the earlier order for the AY 2002-03 although the business of the Assessee had commenced in June 2002. Since this was no longer a pre-operative phase, the interest paid to HSBC would in any event have been allowable as business expenditure under Section 36 of the Act for AY 2003-04.For the aforementioned reasons, the question framed is answered in the affirmative i.e. in favour of the Assessee and against the Revenue. The addition made by the AO is directed to be deleted and the netting of the interest paid on the borrowed sum against the interest income earned is allowed. - Decided in favour of assessee.

Summary

Issues Involved:
1. Validity of the Assessing Officer's (AO) disallowance of interest expenditure.
2. Applicability of Section 57(iii) of the Income Tax Act, 1961.
3. Nexus between the expenditure incurred and the income earned.
4. Classification of interest income and expenses during the pre-operative phase.

Detailed Analysis:

1. Validity of the Assessing Officer's (AO) disallowance of interest expenditure:
The AO disallowed the set-off of interest income against interest expenses for AY 2002-03 and 2003-04, arguing that there was no nexus between the interest income earned by the Assessee and the interest paid to the bank. The AO held that the interest expenses would form part of pre-operative expenses pending capitalization and the interest income would be taxed separately as income from other sources.

2. Applicability of Section 57(iii) of the Income Tax Act, 1961:
The Court examined Section 57(iii) of the Income Tax Act, 1961, which allows for the deduction of expenditure incurred wholly and exclusively for the purpose of making or earning income from other sources. The Court cited several precedents, including Eastern Investments Limited v. Commissioner of Income-Tax, Commissioner of Income Tax v. Rajendra Prasad Moody, and S.A. Builders Limited v. Commissioner of Income Tax (Appeals) Chandigarh, to establish that it is not necessary for the expenditure to result in immediate profit, but it should be incurred on grounds of commercial expediency.

3. Nexus between the expenditure incurred and the income earned:
The Court found that there was a direct nexus between the interest paid to HSBC and the interest earned from the loan advanced to Sterling Cellular Limited (SCL). The Assessee had borrowed funds from HSBC and immediately advanced a loan to SCL, earning interest income. The Court noted that the Assessee's decision to advance the loan was a business decision taken out of commercial expediency, and the interest paid to HSBC was an expenditure wholly and exclusively laid out for the purpose of earning the interest income.

4. Classification of interest income and expenses during the pre-operative phase:
The Court distinguished the present case from the Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT case, where the company had invested surplus funds in fixed deposits during the pre-operative phase. In the present case, the Assessee had advanced the loan to SCL as a business decision, and the interest earned was rightly offered to tax as income from other sources. The Court held that the interest paid to HSBC should be allowed to be netted against the interest income earned under Section 57(iii).

Conclusion:
The Court concluded that the Tribunal erred in holding that the expenditure on interest claimed by the Assessee could not be allowed under Section 57(iii) of the Income Tax Act, 1961. The Court directed the deletion of the addition made by the AO and allowed the netting of the interest paid on the borrowed sum against the interest income earned. The impugned order of the ITAT was set aside, and the appeals were allowed with no orders as to costs.