2016 (8) TMI 739 - HC - Income Tax

Deduction of interest expenses - admissibility under section 36(1)(iii) - Held that - Merely because ultimately such shares could not be acquired for the reasons stated hereinabove, would not detract from the fact that the amount had been borrowed for the purpose of business. When funds are invested for business purposes, there can be no guarantee that the purpose would be achieved. What has to be looked into is whether the funds were expended as a measure of commercial expediency, which includes such expenditure which a prudent businessman incurs for the purposes of business. Once it is established that there was a nexus between the expenditure and the purpose of the business, the revenue cannot justifiably claim to put itself in the armchair of the businessman and assume the role to decide the reasonableness of such expenditure. In the facts and circumstances narrated hereinabove, the court is of the view that the amount in question having been borrowed for the purposes of its business, the requirements of section 36(1)(iii) of the Act stand satisfied and the assessee was entitled to deduction of the interest paid on such borrowed funds notwithstanding the fact that ultimately, the purpose for which the capital was borrowed was not served and the shares were not actually allotted to the assessee. The findings recorded by the Assessing Officer that the amount was paid under the guise of share application money to the sister concern, stand dislodged by the facts which emerge from the record, inasmuch as, the amount was directly paid by the concerned bank to the sister concern and in fact, share applications had been made for 4,29,000 shares which was reflected in the records of the assessee as well as the sister concern. As regards the contention of the learned advocate for the revenue that the borrowed funds were advanced towards share application money which shares would have ultimately yielded dividend which would be exempted income and hence, in the light of the decision of the Kerala High Court in the case of Leena Ramachandran (2010 (6) TMI 612 - Kerala High Court ), the expenditure incurred by the assessee towards purchase of shares would not be an admissible expenditure is concerned, in the opinion of this court, the view adopted in the above decision is contrary to the view adopted by this court in the case of Additional Commissioner of Income tax v. Laxmi Agents (1975 (12) TMI 7 - GUJARAT High Court) wherein the court has upheld the finding of the Tribunal that though the income from the dividend has to be assessed under a separate head, payment of interest by the assessee and amounts borrowed for the purpose of earning interest must be allowed as business expenditure and not expenditure incurred for earning dividend. The court has also held that if it is once established that capital was borrowed for the purpose of business, it is immaterial how the borrowed capital was applied because all that clause (iii) of section 36(1) of the Act requires is that borrowings on which interest is paid should be for the purpose of business. In the light of the above discussion, it is not necessary to refer to and deal with the other decisions on which reliance had been placed by the learned advocate for the appellant. For the foregoing reasons, the appeals succeed and are accordingly allowed. The questions are answered in the negative namely, in favour of the assessee and against the revenue. The Income Tax Appellate Tribunal was not right in law in holding that deduction of interest expenses was not admissible under section 36(1)(iii) of the Income Tax Act, 1961 merely because shares were never allotted to the appellant in response to the share application. The Income Tax Appellate Tribunal accordingly was not right in law in confirming the disallowance of interest for each of the assessment years. In the light of the fact that this court has held that section 37(1) (iii) is applicable to the facts of the present case, the issue regarding application of section 57(iii) of the Act is left unanswered. The impugned order passed by the Tribunal is accordingly quashed and set aside and the order passed by the Commissioner (Appeals) is hereby restored.

Issues Involved:
1. Deductibility of interest expenses under section 36(1)(iii) of the Income Tax Act, 1961.
2. Confirmation of disallowance of interest expenses by the Income Tax Appellate Tribunal (ITAT).

Detailed Analysis:

Issue 1: Deductibility of Interest Expenses under Section 36(1)(iii) of the Income Tax Act, 1961

The appellant, a private limited company engaged in manufacturing and trading industrial gases, borrowed funds from Baroda Peoples’ Co-operative Bank Limited to acquire shares in its sister concern, Akshar Private Limited. The appellant applied for 4,29,000 shares and paid the full face value. However, due to unfavorable market conditions, the shares were never allotted, and the money was eventually returned.

The Assessing Officer disallowed the interest expense, arguing that the borrowed funds were transferred to the sister concern in the guise of share application money without any business purpose. This stance was supported by the ITAT, which reversed the Commissioner (Appeals)' decision that had allowed the interest expense deduction.

The appellant contended that the interest expense should be deductible under section 36(1)(iii) as the borrowed funds were used for business purposes, specifically to acquire controlling interest in the sister concern, which is a measure of commercial expediency. The appellant cited several judgments supporting the view that interest on borrowed capital for business purposes is deductible, regardless of the ultimate outcome of the investment.

Issue 2: Confirmation of Disallowance of Interest Expenses by ITAT

The ITAT confirmed the disallowance of interest expenses, reasoning that since no shares were allotted, the interest could not be considered an allowable deduction. The ITAT distinguished the present case from other cited judgments, noting that the appellant did not acquire any controlling interest due to the non-allotment of shares.

The appellant argued that the ITAT erred in its judgment, emphasizing that the intention behind borrowing the funds was for business expansion through acquiring controlling interest in the sister concern. The appellant maintained that the deduction should be allowed as the borrowed funds were used for business purposes, even if the shares were not ultimately allotted.

Court's Analysis and Judgment:

The court examined the facts and found that the borrowed funds were indeed advanced for acquiring shares in the sister concern, reflecting a business purpose. Citing the Supreme Court's judgment in S.A. Builders Ltd. v. Commissioner of Income Tax (Appeals), the court highlighted that commercial expediency includes expenditures a prudent businessman incurs for business purposes, even if the intended outcome is not achieved.

The court noted that the appellant's intention to acquire shares for business expansion satisfied the requirements of section 36(1)(iii). The borrowed funds were used for a business purpose, and the interest paid on these funds should be deductible. The court rejected the ITAT's finding that the funds were advanced under the guise of share application money, as the records clearly indicated the purpose of acquiring shares.

The court also addressed the argument regarding dividend income being exempt under section 14A, clarifying that the interest expense is allowable as business expenditure if the borrowed capital was for business purposes.

Conclusion:

The court allowed the appeals, holding that the ITAT was not right in disallowing the interest expenses merely because the shares were not allotted. The court restored the order of the Commissioner (Appeals), allowing the deduction of interest expenses under section 36(1)(iii) of the Income Tax Act, 1961. The issue regarding the application of section 57(iii) was left unanswered as it was deemed unnecessary.

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