2021 (12) TMI 305 - AT - Income Tax

Deduction u/s. 36(1)(iii) - interest paid on loan borrowed for purchase of current assets - CIT(A) opined that the AO has erred in disallowing proportionate interest u/s. 36(1)(iii) - HELD THAT - The assessee is in the business of developers and builders. The assessee has borrowed capital for the purpose of its business and interest paid on such capital has been claimed as deduction u/s. 36(1)(iii) of the Act in the year in which such interest has been paid. If you go through the nature of business of the assessee and the purpose for which loan was borrowed, then deduction claimed by the assessee in respect of interest paid on borrowed capital for the purpose of business or profession is deductable for the year in which such interest has been paid, because as per provisions of section 36(1)(iii) of the Act, any interest paid on capital borrowed for the purpose of business shall be allowed as deduction in the year of payment unless such interest is paid in respect of capital borrowed for acquisition of an asset. In this case, although the assessee has paid interest for acquisition of an asset, the said asset is in the nature of stock in trade of business and the moment, the assessee acquires the asset which partakes the nature of stock in trade and thus, interest paid on capital borrowed for acquisition of stock in trade is deductable irrespective of the fact that said stock in trade was sold or not during the relevant financial year. This legal position is supported by the decision in the case of Taparia Tools Ltd 2015 (3) TMI 853 - SUPREME COURT where it was held that interest paid on capital borrowed for the purpose of business shall be allowed as deduction for the year of payment irrespective of accounting system given by the assessee in its books of accounts. Hon ble Gujarat High Court in the case of Torrent Pharmaceuticals 2016 (7) TMI 1301 - GUJARAT HIGH COURT has considered an identical issue and held that interest paid on capital borrowed for the purpose business shall be allowed as deduction in the year of payment of said interest. In this case, the assessee has paid interest on borrowed capital for the purpose of business and the same has been claimed as deduction as and when the said interest was paid. CIT(A) after considering the relevant facts has rightly deleted additions made by the AO - Decided against revenue.

Issues Involved:
1. Deletion of disallowance made under Section 36(1)(iii) of the Income Tax Act, 1961.
2. Applicability of the matching principle of accounting.
3. Classification of assets as stock in trade versus other current assets.
4. Interpretation of judicial precedents related to interest expenses.
5. Treatment of interest expenses in relation to capital borrowed for business purposes.

Issue-wise Detailed Analysis:

1. Deletion of Disallowance Made Under Section 36(1)(iii):
The primary issue revolves around the deletion of the disallowance made by the Assessing Officer (AO) under Section 36(1)(iii) of the Income Tax Act, 1961. The AO disallowed a proportionate interest expense of ?2.22 crore on the grounds that the interest was related to an outstanding loan used for acquiring land and project costs, which were classified under other current assets. The AO argued that these expenses should be capitalized and not deducted. However, the Commissioner of Income Tax (Appeals) [CIT(A)] deleted this disallowance, stating that the interest paid on capital borrowed for business purposes should be allowed as a deduction in the year it was paid, as per the provisions of Section 36(1)(iii).

2. Applicability of the Matching Principle of Accounting:
The AO contended that the matching principle of accounting required the interest expense to be capitalized since it was related to the acquisition of assets not sold during the relevant assessment year. The CIT(A), however, relied on judicial precedents, including the Supreme Court's decision in Taparia Tools Ltd. vs JCIT, to conclude that the interest expense should be allowed in the year it was incurred, irrespective of whether the corresponding asset was sold.

3. Classification of Assets as Stock in Trade versus Other Current Assets:
The AO classified the land and project costs as other current assets, arguing that the borrowed funds were not used for stock in trade but for acquiring these assets. The CIT(A) disagreed, stating that the assessee, being in the business of real estate development, treated these assets as stock in trade. Consequently, the interest paid on borrowed capital for acquiring stock in trade should be deductible in the year of payment.

4. Interpretation of Judicial Precedents Related to Interest Expenses:
The CIT(A) relied on several judicial precedents to support the deletion of the disallowance. Notably, the Supreme Court's decision in Taparia Tools Ltd. vs JCIT and the Gujarat High Court's decision in Torrent Pharmaceuticals vs CIT were cited. These cases established that interest paid on capital borrowed for business purposes should be allowed as a deduction in the year it was paid, regardless of the asset's classification or whether it was sold during the relevant year.

5. Treatment of Interest Expenses in Relation to Capital Borrowed for Business Purposes:
The CIT(A) emphasized that the interest expense met the three limbs of Section 36(1)(iii): (1) the interest was paid, (2) the capital was borrowed, and (3) it was for the purpose of business. The CIT(A) also noted that the assessee's business involved purchasing properties to be sold as stock in trade, and thus, the interest on borrowed capital for such purchases should be deductible. The CIT(A) further highlighted that the assessee's claim of interest for the previous assessment year was allowed, reinforcing the consistency of the assessee's treatment of interest expenses.

Conclusion:
The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)'s decision to delete the disallowance made under Section 36(1)(iii). The ITAT agreed that the interest paid on capital borrowed for business purposes should be allowed as a deduction in the year it was paid, aligning with judicial precedents and the provisions of the Income Tax Act. The appeal filed by the Revenue was dismissed, affirming the CIT(A)'s findings and the assessee's treatment of interest expenses.

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