2008 (5) TMI 673 - SC - Income Tax

AO disallowed the interest expenses on borrowed capital u/s 36(1)(iii) on the ground that borrowed funds were deployed by the assessee Company in order to purchase equity shares of AEC, which Company is subsequently taken over not by the assessee but by its sister companies - after acquiring the shares of AEC Ltd., the assessee herein has sold the shares at profit whether it amounts to circular trading with idea of evading tax matter restored to HC

Summary

Issues:
1. Interpretation of Section 36(1)(iii) of the Income Tax Act regarding the allowability of interest expenses.
2. Determination of whether the acquisition of shares was with the objective of gaining control over a company.
3. Examination of circular trading practices aimed at evading tax.

Analysis:
The case involved Civil Appeals filed by the Department against a decision of the Gujarat High Court. The High Court had dismissed the Department's appeals, stating that the facts were similar to a previous case where the Tribunal ruled in favor of the assessee. The main issue before the High Court was whether the acquisition of shares by the assessee was to gain control over a company and if the interest paid to a financier was allowable as expenditure under Section 36(1)(iii) of the Income Tax Act.

The Assessing Officer disallowed the interest expenses, stating that the borrowed funds were used to acquire control of a company. The AO found that the assessee had acquired shares using borrowed funds, subsequently sold them at a higher price, and the company was later taken over by another group. The Supreme Court noted that the High Court had overlooked crucial facts that could indicate circular trading aimed at tax evasion. The Court expressed a prima facie view that the High Court erred in dismissing the appeals without considering all relevant aspects.

Therefore, the Supreme Court set aside the High Court's judgment and directed the High Court to reconsider the appeals in accordance with the law. The Civil Appeals were allowed, and no costs were imposed. The decision highlighted the importance of thoroughly examining all aspects of a case, especially concerning tax-related matters and potential tax evasion schemes involving circular trading practices.