2016 (11) TMI 607 - HC - Income Tax

Interest on the amount borrowed for declaring dividend - allowability as deduction u/s 36(1)(iii)- Held that - The learned counsel for the respondent/assessee placed before us bank statements of Axis Bank and Bank of India to the effect that as on the dates when the dividend was, in fact declared, there was a credit balance on account of prior foreign inward remittances. Thus, and the Learned Standing Counsel does not dispute this, the assesssee did have required resources internally to effect the declaration of dividend and did not have to resort to bank borrowings for the said purpose. In any event, even if borrowed funds had been utilized for the purposes of declaration of dividend, the payment of interest on such borrowings constitutes expenditure for the purpose of the business of the assessee and is an allowable deduction in terms of Section 36(1)(iii) of the Act. See CIT vs. Tingri Tea Company Ltd 1970 (2) TMI 25 - CALCUTTA High Court - Decided in favour of assessee

Summary

Issues:
1. Whether interest on borrowed amount for declaring dividend is allowable as deduction u/s 36(1)(iii) in absence of profits/reserves and treating such dividend as loans in books?
2. Applicability of Section 14A of the Income Tax Act to the assessment.
3. Whether interest on borrowed capital used for paying dividend to preferential shareholders is a deductible expense under Section 36(1)(iii) of the Act?

Analysis:

Issue 1:
The Tax Case Appeal challenges the Tribunal's order regarding the deductibility of interest on borrowed funds for declaring dividends under Section 36(1)(iii) of the Income Tax Act. The Commissioner of Income Tax initiated revision proceedings, contending that interest on borrowed capital used for dividend payment was not a valid deduction. The Tribunal allowed the appeal, citing precedents that support the deduction of interest on borrowings for dividend declaration as a business expense. The Revenue appealed against this decision.

Issue 2:
The Commissioner of Income Tax raised concerns about the applicability of Section 14A of the Act to the assessment. The Commissioner noted a deficit in the profit and loss account, indicating that dividends were paid from borrowed funds. This raised questions about the deductibility of such interest under Section 36(1)(iii) of the Act. The assessee argued that there were adequate cash profits when dividends were declared, justifying the deduction under Section 36(1)(iii).

Issue 3:
The Court analyzed various decisions on the matter and concluded that interest paid on borrowings for declaring dividends constitutes a business expense deductible under Section 36(1)(iii) of the Act. The Court considered bank statements showing adequate internal resources for dividend payments and rejected the Revenue's argument based on a Karnataka High Court decision. The Court dismissed the Revenue's appeal, upholding the Tribunal's decision in favor of the assessee.