2022 (7) TMI 376 - AT - Income Tax

Rectification of mistake - Deduction u/s. 57(iii) - set off of interest paid with interest income - interest income earned on mutual funds that was offered to tax under the head 'Other Sources' - as submitted that the Petitioner had earned interest income from deposits made in the Capital Gains Account Scheme CGDA against which deduction was claimed for interest paid on loans availed from HSBC Invest Direct Financial Services I ltd and the same is also clearly brought out in the impugned order passed u/s. 263 - petitioner prayed that the Tribunal may be pleased to amend the order by holding that there was a direct nexus between the borrowed funds and the income earned from deposits made in the CGDA scheme and accordingly, the Petitioner is entitled to deduction u/s. 57 iii of the Act, for the advancement of substantial cause of Justice - HELD THAT - We find that there are certain errors in the orders of the Tribunal which is required to be corrected. Accordingly, para 34 of the order as modified - Unless funds are borrowed for making deposits to earn interest income, such interest paid on borrowings cannot be allowed as deduction in the computation of income from other sources, which in this case, is interest earned from CGDA Scheme. In the facts stated above, there is no doubt that the funds borrowed from HSBC Bank was used for investment to earn interest income in the CGDA Scheme. The assessee wants to set off the interest paid to HSBC Bank with interest earned from CGDA Scheme. As per section 54F of the Act, the whole consideration of capital asset to be used for deposit in CGDA Scheme. In the present case, the assessee diverted the sale consideration of capital asset in investment in mutual funds. However, the assessee borrowed money from HSBC Bank to make investment in CGDA Scheme. The funds which ought to have been used for investment in CGDA Scheme is the amount received on sale consideration of capital asset. Because the assessee has mis-used the sale consideration to invest in mutual fund, the self-made mistake cannot be a reason to set off the interest paid to HSBC Bank out of interest earned from CGDA Scheme. Therefore, in our opinion, there is no merit in the arguments of the assessee that interest paid to HSBC Bank is to be allowed as a deduction u/s. 57(iii) of the Act out of interest earned from CGDA Scheme. Accordingly, these ground of the assessee in both the appeals are dismissed.

Issues Involved:
1. Error in Tribunal's observation regarding the source of interest income.
2. Nexus between borrowed funds and income earned from deposits.
3. Applicability of section 57(iii) of the Income Tax Act.
4. Reliance on inapplicable case law by the Tribunal.
5. Rectification of errors in the Tribunal's order.

Detailed Analysis:

1. Error in Tribunal's Observation Regarding the Source of Interest Income:
The Tribunal initially observed that the petitioner earned interest income from mutual funds and not from the Capital Gains Account Scheme (CGDA). The Tribunal's order stated, "interest paid on borrowings cannot be allowed as deduction in the computation of income from other sources, which in this case, is interest earned from mutual funds." This observation was challenged as incorrect because the petitioner had actually earned interest from deposits made in the CGDA scheme, not mutual funds.

2. Nexus Between Borrowed Funds and Income Earned from Deposits:
The petitioner argued that there was a direct nexus between the borrowed funds and the deposits made in the CGDA scheme. The Tribunal's initial order erroneously stated that the funds borrowed from HSBC Bank were used to make investments in mutual funds, which was independent of the borrowings. However, it was clarified that the borrowed funds were used for deposits in the CGDA scheme, and the interest earned from these deposits should be considered under the head "Other Sources."

3. Applicability of Section 57(iii) of the Income Tax Act:
The petitioner argued that the interest paid on borrowed funds for making deposits in the CGDA scheme should be deductible under section 57(iii) of the Income Tax Act. This section allows for the deduction of any expenditure laid out wholly and exclusively for the purpose of earning income from other sources. The Tribunal initially rejected this claim, stating that the borrowed funds were not used to earn interest income from mutual funds. However, the Tribunal later acknowledged that the funds were indeed borrowed for the CGDA scheme and modified its order to reflect this.

4. Reliance on Inapplicable Case Law by the Tribunal:
The Tribunal initially relied on the judgment of the Karnataka High Court in the case of Karnataka Forest Plantations Corporation Limited, which was not cited by either party. This case was deemed inapplicable as it dealt with funds borrowed for business purposes, not for earning interest income. The petitioner highlighted that the decision of the Karnataka High Court in the case of Master Subraya M Pai, which supported the deduction of interest paid on borrowed funds used for earning income, was not considered by the Tribunal.

5. Rectification of Errors in the Tribunal's Order:
The Tribunal recognized the errors in its initial order and rectified them. The modified order acknowledged that the borrowed funds were used for the CGDA scheme and not for mutual funds. The Tribunal concluded that the interest paid on these borrowed funds could not be set off against the interest earned from the CGDA scheme. The Tribunal emphasized that the petitioner had misused the sale consideration of a capital asset to invest in mutual funds, and this self-made mistake could not justify the deduction of interest paid to HSBC Bank under section 57(iii).

Conclusion:
The Tribunal allowed the miscellaneous petitions, rectifying the errors in its initial order. It clarified that the borrowed funds were used for the CGDA scheme, and the interest paid on these funds could not be deducted from the interest earned from the CGDA scheme under section 57(iii) of the Income Tax Act. The final result of the appeals remained unchanged. The judgment was pronounced on May 13, 2022.

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