2022 (11) TMI 673 - HC - Income Tax

Deduction u/s 36(1)(iii) on the interest - Tribunal and the CIT(A) justification in holding that interest expenditure is liable to be treated as capital expenditure and allowance u/s 36(1)(iii) on the ground that the assessee has incurred the same for business purpose - HELD THAT - It is not in dispute that the EMD paid by the assessee has been received back with interest and the said interest has been offered to tax. It is also not in dispute that the assessee is in the business of Real Estate Development and the EMD amount was paid to acquire properties as a part of its business, which should be treated as Stock-in-trade. The Tribunal has rightly noticed that the proviso was inserted with effect from 01.04.2004 and the amount borrowed was not for acquisition of any asset for extension of existing business. Therefore, assessee was entitled for the benefit under Section 36(1)(iii) - The question of law is answered in favour of the assessee and against the Revenue.

Summary

Issues:
1. Interpretation of Section 36(1)(iii) of the Income Tax Act regarding the treatment of interest expenditure as capital expenditure for business purposes.

Analysis:
The High Court of Karnataka considered an appeal by the Revenue challenging an order disallowing deduction under Section 36(1)(iii) of the Income Tax Act for interest expenditure incurred by an assessee in the business of Real Estate development. The primary issue was whether the interest expenditure should be treated as capital expenditure and allowed under Section 36(1)(iii) since it was incurred for business purposes.

The assessee had claimed a deduction for interest paid amounting to Rs.16,68,11,932 for the assessment year 2008-09. The Assessing Officer disallowed the deduction, arguing that the interest payable on borrowed funds should have been capitalized as the assessee had deposited an Earnest Money Deposit (EMD) for the purchase of an asset. The CIT(A) later held that since the interest received on the EMD had been offered to tax in subsequent years as revenue, the interest paid on borrowings need not be capitalized as no asset was acquired. This decision was upheld by the ITAT, leading to the Revenue's appeal.

The Revenue contended that since the assessee borrowed money to acquire capital assets and treated the EMD as an asset in the balance sheet, the interest paid on the borrowings should be disallowed. However, the High Court analyzed Section 36(1)(iii) of the IT Act, specifically the proviso, which restricts the deduction of interest paid for acquiring assets for an existing business. The Court noted that the EMD was returned to the assessee with interest, and as the amount borrowed was not for acquiring any asset for extending the existing business, the assessee was entitled to the benefit under Section 36(1)(iii).

Ultimately, the High Court upheld the decision of the lower authorities, dismissing the Revenue's appeal and ruling in favor of the assessee. The Court found no error in the impugned order and held that the interest expenditure was allowable under Section 36(1)(iii) for the assessee engaged in Real Estate development.