2018 (12) TMI 1147 - HC - Income Tax

Interest paid on the borrowed funds as claimed as an allowable expenditure by the assessee u/s 36(1)(iii) read with Section 57 - Tribunal ruled that the said interest payment by the assessee in acquiring control of the two companies would result in earning exempt dividend income and, therefore, the same was not allowable - Held that - Section 37 covers expenditure of a general nature which are not classifiable under Sections 30 to 36. But, they ought not to be capital expenditure or personal expenses of the assessee. That expenditure which is wholly and exclusively laid out for the purpose of business or profession shall be allowed in computing the income chargeable. The Tribunal had to go into this question only. What the Tribunal has done is simply amazing. Now Section 14A provides that in respect of exempt income the expenditure for earning the said income shall not be allowed. Tribunal ruled that the said interest payment by the assessee in acquiring control of the two companies would result in earning exempt dividend income and, therefore, the same was not allowable. It was as if an imaginery income and expenditure of a subsequent assessment year was taken into account for calculating the income of a particular previous year. All that the Tribunal was required to ascertain was whether the interest paid on fund generated for the purpose of gaining control of the two companies would be allowed as an expenditure and not delve into the question whether the income which that investment would produce in the future would be dividend. It had to see whether any part of the income of the assessee for the assessment year was dividend income; and whether any part of the expenditure for acquiring control of the two companies were being applied to claim deduction from that income. The impugned order of the tribunal dated 11th April, 2008 is set aside.

Summary

Issues:
1. Allowability of interest paid on borrowed funds as an expenditure under Section 36(1)(iii) and Section 57 of the Income Tax Act, 1961.
2. Invocation of Section 37 for claiming the expenditure.
3. Interpretation of Section 14A in relation to exempt income and its impact on the deduction of expenditure.

Issue 1:
The appellant claimed that the interest paid on borrowed funds used to acquire control of two companies should be considered as an allowable expenditure under Section 36(1)(iii) and Section 57 of the Income Tax Act, 1961. The appellant's counsel invoked Section 37, arguing that the expenditure was incurred to augment its business. The Tribunal, however, ruled against this claim, stating that the interest payment would result in earning exempt dividend income, making it non-allowable. The Tribunal's decision was criticized for delving into future income considerations rather than focusing on the current assessment year's income and expenditure relationship.

Issue 2:
Section 37 allows for the deduction of expenditure laid out wholly and exclusively for the purposes of business or profession. The Tribunal's decision was based on the belief that the interest payment made by the assessee in acquiring control of the two companies would lead to earning exempt dividend income, hence not allowable. The Tribunal's reasoning was considered flawed as it did not focus on whether the interest paid on funds generated for acquiring control should be allowed as an expenditure, rather than speculating on future dividend income.

Issue 3:
Section 14A deals with the treatment of expenditure for earning exempt income. The Tribunal's decision was based on Section 14A, stating that the interest payment would not be allowed as it was related to earning exempt dividend income. However, the Court found fault with the Tribunal's reasoning, emphasizing that the focus should have been on the direct nexus between the investments made and the income earned by the assessee. The Court set aside the Tribunal's order and upheld the Commissioner of Income Tax (Appeals) decision, allowing the appeal.

In conclusion, the High Court of Calcutta ruled in favor of the appellant, allowing the interest paid on borrowed funds to acquire control of two companies as an allowable expenditure under Section 37. The Court criticized the Tribunal's decision for considering future income implications and not focusing on the current assessment year's income and expenditure relationship. The Court emphasized the importance of a direct nexus between investments made and income earned by the assessee when applying Section 14A in relation to exempt income.