2020 (3) TMI 1022 - HC - Income Tax

Deduction u/s 36(1)(iii) or 57(iii) - interest paid by the assessee on borrowed capital to the extent it was utilised for purchasing shares - ITAT disallowed interest under both i.e. Section 36(1)(iii) and Section 57(iii) - HELD THAT - In order to grant deduction of interest paid by the assessee, it would be necessary to determine the dominant purpose for which the expenditure was incurred, meaning thereby that if the expenditure incurred is not to earn the income, then such expenditure would not be allowable as deduction under Section 57(iii) of the Act. In the facts of the case, the JCIT in the remand report as well as the CIT(A) found that the interest borrowed for the purchase of shares was allowable expenditure under Section 57(iii) of the Act without taking into consideration as to whether the capital borrowed for the purchase of shares by the assessee was for the purpose of business or for the purpose of earning income. Where the borrowings are made for the purchase of shares, a question that would often arise is whether the interest paid should be allowed as deduction under Section 36(1)(iii) or under Section 57(iii). At this stage, it is worthwhile to mention that the income by way of dividends on shares, whether held on investment portfolio or as stock-in-trade, is specifically assessable, under Section 56(2)(i), as the Income from other sources . Although the shares are held, on the investment portfolio, as an integral part of the business, yet the interest on such borrowings is allowable under Section 36(1)(iii). Thus, the qualifying factor in this case is to ascertain whether the borrowings for purchasing shares is an integral part of the business of the assessee. The appellant assessee had borrowed the capital to purchase the shares of the IHFC Ltd so as to have effective control of the IHFC Ltd in order to expand its real estate business. Thus, the investment in share was nothing but the expansion of business of the assessee. Therefore, all the conditions necessary for deduction under Section 36(1)(iii) were prima facie satisfied by the appellant assessee. The CIT(A) was, therefore, not justified to allow deduction under Section 57(iii) of the Act as the appellant assessee did not borrow the capital for earning dividend or for making profit and gains. The dominant purpose of the appellant assessee to borrow the capital was to acquire the shares to have effective control over the IHFC Ltd so as to expand the business of the assessee. In that view of the matter, the CIT(A) was not justified in granting deduction of interest paid by the assessee under Section 57(iii) of the Act. But the assessee is entitled to deduction of interest paid on capital borrowed for investment in the shares of IHFC for the purpose of expansion for its business under Section 36(1)(iii) of the Act. The Tribunal was, therefore, not justified in holding that the purpose of the assessee for purchase of shares of IHFC was not for the purpose of business of the assessee as the business of the assessee was only sale and purchase of land. Question of law as framed is answered in favour of the assessee and against the Revenue. The assessee is entitled to deduction of interest paid on borrowed capital to the extent it was utilized for purchasing shares of IHFC Ltd under Section 36(1)(iii)

Summary

Issues Involved:
1. Whether the interest paid by the assessee on borrowed capital used for purchasing shares is deductible under Section 36(1)(iii) or Section 57(iii) of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Deductibility of Interest under Section 36(1)(iii):

The primary issue was whether the interest paid by the assessee on borrowed capital used for purchasing shares of IHFC Ltd. could be deducted under Section 36(1)(iii) of the Income Tax Act, 1961. Section 36(1)(iii) allows for the deduction of interest paid on capital borrowed for the purposes of the business or profession. The assessee argued that the borrowed capital was used to purchase shares to retain controlling interest in IHFC Ltd., which was a measure of commercial expediency and integral to expanding its real estate business. The Supreme Court in S.A. Builders Ltd. v. CIT held that the expression "for the purpose of business" is wider in scope and includes expenditure voluntarily incurred for commercial expediency. The High Court agreed with the assessee, stating that the investment in shares was for expanding the business, thus satisfying the conditions for deduction under Section 36(1)(iii).

2. Deductibility of Interest under Section 57(iii):

The alternative issue was whether the interest could be deducted under Section 57(iii), which allows for the deduction of any expenditure laid out or expended wholly and exclusively for the purpose of making or earning income from other sources. The CIT(A) had allowed the deduction under Section 57(iii), but the ITAT disagreed, stating that the purpose of purchasing shares was not to earn dividend income but to retain controlling interest. The High Court referred to the Supreme Court's ruling in Rajendra Prasad Moody, which clarified that the expenditure must be for the purpose of earning income, and actual income need not be earned. However, the High Court concluded that since the dominant purpose of borrowing was to acquire shares for business expansion, the interest should not be deducted under Section 57(iii) but under Section 36(1)(iii).

3. Commercial Expediency:

The High Court emphasized the concept of "commercial expediency" as interpreted in S.A. Builders Ltd., noting that the borrowed funds were used for business purposes, which included retaining control over IHFC Ltd. to benefit the assessee's real estate business. The court observed that the Revenue cannot assume the role of a businessman to decide the reasonableness of the expenditure and must consider the businessman's perspective.

4. Tribunal's Findings:

The ITAT had disallowed the interest deduction under both sections, arguing that the investment in shares was not for the purpose of the assessee's business. The High Court found this conclusion untenable, stating that the investment was indeed for business purposes and integral to the assessee's business strategy.

Conclusion:

The High Court ruled in favor of the assessee, holding that the interest paid on borrowed capital used for purchasing shares of IHFC Ltd. was deductible under Section 36(1)(iii) of the Income Tax Act, 1961. The court quashed the ITAT's order and allowed the appeals, emphasizing the broader interpretation of "for the purpose of business" and the concept of commercial expediency.