2018 (9) TMI 1618 - AT - Income Tax

Disallowance of interest expenses - capitalization of interest paid as part of the cost of any asset - Held that - The first condition for applicability of the proviso is that there should be acquisition of an asset. The second condition is that such acquisition should be for extension of existing business. In the present case both the conditions are not satisfied. There was no acquisition of any asset by the Assessee from NGEF or HUDA and both the transactions did not ultimately fructify. Assessee had to abandon its idea of carrying out development on these properties. Assessee was already in the business of acquiring properties and constructing flats. In the ordinary course of its business, the Assessee sought to acquire properties from NGEF and HUDA. Therefore it cannot be said that the Assessee indulged in any extension of existing business or profession. It is clear that at no point of time the Assessee was certain of acquiring the properties either from NGEF or HUDA. As far as the transaction with NGEF is concerned, the Division Bench dismissed the Assessee s claim for acquiring the property much prior to the end of the relevant previous year. Though the Assessee preferred appeal before the Hon ble Supreme Court against the order of the Division Bench of the Karnataka High Court, the same was ultimately dismissed on 25.9.2008 and the Assessee was to get back only the EMD paid by it to the Official Liquidator together with interest. The interest income was offered to tax by the Assessee in AY 2008-09 and the interest expenditure in connection with borrowing funds for paying the EMD was also claimed as deduction and revenue expenditure for the relevant previous year. The interest expenditure was therefore rightly held by the CIT(A) to be for the purpose of business of the Assessee and an allowable deduction u/s.36(1)(iii). As far as the EMD paid to HUDA is concerned, Assessee as early as 27.11.2006 has rescinded the agreement to acquire property from HUDA. The expenditure incurred in the form of interest on borrowings to pay the EMD to HUDA has to be considered as borrowing for the purpose of business of the Assessee allowable u/s.36(1)(iii) of the Act. - Decided against revenue.

Summary

Issues Involved:
1. Justification of CIT(A)'s relief to the assessee under section 36(1)(iii).
2. Classification of capital expenditure as revenue expenditure due to aborted acquisition of capital assets.

Issue-wise Detailed Analysis:

1. Justification of CIT(A)'s relief to the assessee under section 36(1)(iii):

The primary issue was whether the CIT(A) was justified in allowing the assessee's claim for deduction of interest expenses under section 36(1)(iii) of the Income Tax Act, 1961. The assessee, a company engaged in purchasing lands and constructing properties, had made earnest money deposits (EMD) with NGEF and HUDA. To finance these deposits, the assessee borrowed funds and paid interest on these borrowings, which was claimed as a deduction under 'income from business or profession.'

The Assessing Officer (AO) disallowed the interest deduction, arguing that the interest should be capitalized as it was incurred for acquiring an asset. However, the CIT(A) allowed the deduction, stating that the interest paid on borrowings for EMD was for the purpose of business and should be allowed under section 36(1)(iii). The CIT(A) emphasized that the liability for deduction is not conditional upon corresponding income being offered during the same period.

The Tribunal upheld the CIT(A)'s decision, noting that the proviso to section 36(1)(iii) applies only when there is an acquisition of an asset for the extension of an existing business. Since the transactions with NGEF and HUDA did not result in the acquisition of any asset, the conditions for applying the proviso were not met. The Tribunal concluded that the interest expenditure was for the purpose of the assessee's business and thus allowable as a deduction.

2. Classification of capital expenditure as revenue expenditure due to aborted acquisition of capital assets:

The second issue was whether the CIT(A) was justified in allowing capital expenditure as revenue expenditure because the acquisition of the capital asset was aborted. The assessee participated in bids for properties from NGEF and HUDA, making significant EMD payments. However, both transactions did not fructify, and the assessee did not acquire the properties.

The AO argued that the interest on borrowings for EMD should be capitalized. However, the CIT(A) held that since no asset was ultimately acquired, the interest could not be capitalized and should be treated as revenue expenditure. The CIT(A) pointed out that the interest income from the refunded EMD was offered for tax, and thus the interest expenditure should be allowed as a deduction.

The Tribunal agreed with the CIT(A)'s view, emphasizing that the assessee's business involved acquiring properties and constructing flats, and the EMD payments were part of this business activity. Since the transactions were abandoned, the interest expenditure was rightly classified as revenue expenditure and allowed as a deduction under section 36(1)(iii).

Conclusion:

The Tribunal dismissed the revenue's appeal, affirming the CIT(A)'s decision to allow the deduction of interest expenses under section 36(1)(iii). The Tribunal concluded that the interest expenditure was for the purpose of the assessee's business and did not meet the conditions for capitalization under the proviso to section 36(1)(iii). Consequently, the appeal by the revenue was dismissed.