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TMI BlogCapital gains: INTEREST ON BORROWED CAPITAL ALLOWED AS COST OF ACQUISITION OF ASSET - recent decision in favor of assessee. However, with respect the author feels otherwise about post acquisition interest.X X X X Extracts X X X X X X X X Extracts X X X X ..... Capital gains: INTEREST ON BORROWED CAPITAL ALLOWED AS COST OF ACQUISITION OF ASSET - recent decision in favor of assessee. However, with respect the author feels otherwise about post acquisition interest. - By: - C.A. DEV KUMAR KOTHARI - Income Tax - Dated:- 5-10-2010 - - Relevant links and references: Section 45 , 48 , and 55 of Income Tax Act, 1961 relating to capital gains. Section 24 , 36 , 37 and 57 in which interest is allowed under different heads. CIT Vs. Sri Hariram Hotels P. Ltd. 325 ITR 136 (Kar.) = [2010- 2010 -TMI - 77531 - KARNATAKA HIGH COURT] CIT v. Maithreyi Pai [1985] 152 ITR 247. = [2008 -TMI - 27586 - KARNATAKA High Court] . CIT v. Mithlesh Kumari [1973] 92 ITR 9 (Delhi). = [2008 -TMI - 8847 - DELHI High Court] Computation of capital gains: For computation of capital gains one need to deduct the 'cost of acquisition' as one of item deductible from the consideration accruing on transfer. In section 48(ii) the expression used is as follows: (ii) the cost of acquisition of the asset and the cost of any improvement thereto. The article 'the' has been used, that indicates that the cost of acquisition is to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e a definite amount and it cannot be fluctuating, except in circumstances when law permit substitution. In those cases also the expression will be used in a definite manner in the sense that the amount substituted under law will be the cost of acquisition. For example when assessee lawfully exercise option to take fair market value of capital asset on specified date (at present 31.03.1981). Thus once FMV as on 31.03.1981 is fixed, it will remain fixed. For allowing price escalation effect law provide under separate provisions to increase the allowable cost and that is popularly called as the indexed cost of acquisition. Meaning of 'cost of acquisition': We find that definite meanings have been given to the term 'cost of acquisition', for this purpose of section 48 and 49 in s. 55 (2) in relation to different type of assets acquired in different circumstances as mentioned therein. Furthermore the expressions used in the heading of section 55 and in the sections indicates that there is definite meaning given and the meaning so given are not subject to the context as is case in relation to many other clauses defining various words, expressions , phrases or terms used i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n definition clauses. Therefore, we can say that the language used is indicative of a definite amount which can be considered as 'cost of acquisition'. Date of acquisition: It is also important to notice that in the context of 'capital gains' the date of acquisition is also a very vital point. The date of acquisition is relevant to workout character of capital asset as short term or long term. The cost incurred to acquire and on the day of acquisition is important. Cost of improvement: The cost of improvement, if any can be claimed and allowed separately as per specific provisions. Therefore, the date of acquisition and the cost of acquisition seems to be a definite figures and cannot be a fluctuating item, except when the law specifically provide for the same. Interest on borrowed capital: One may acquire a capital asset with borrowed funds. Interest paid till the date of acquisition shall definitely be part of 'actual cost' as well as 'cost of acquisition'. The element of interest during process of acquisition or till the date the asset is completed in all manners for use or holding can definitely be capitalized as 'actual cost' or 'cost of acquisition'. Fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r example: Advance payment made for purchase of land 01.10.2003 Purchase of land for construction of building on 01.01.2004 Construction of building started on 01.01.2004 and completed on 31.12.2005 Furnishing of building completed on 30.06.2006 Suppose in the above case borrowed capital was used to purchase land, construction and furnishing. The interest on capital borrowed and used for these purposes can definitely be capitalized. Interest on borrowed funds used to acquire land will form part of cost of acquisition of land for the period upto purchase of land that is 01.01.2004. Interest after 01.01.2004 will form part of cost of acquisition of building and furnishings for respective period up to 30.06.2006. However, post completion of building, the interest and other costs incurred to hold, use and carry building are cost of holding and not cost of acquisition. Now suppose building is put to use for own residential use or business use or by letting out w.e.f. 01.07.2006. The interest from 01.07.2006 cannot be regarded as cost of acquisition of building. Interest after acquisition: In view of author, the element of interest after the acquisition of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he capital asset (or completion of the assets in a ready to use form) is completed cannot be regarded either as 'actual cost' or as 'cost of acquisition'. In case of business asset interest during construction period or during process of putting to use the asset can be considered as 'actual cost'. However, 'cost of acquisition' is a restricted term in comparison to 'actual cost'. Interest after acquiring capital asset can be considered as interest for holding and carrying capital asset because it is acquired with borrowed funds. In case the capital asset is used in business or earning other income, interest may be allowed as an allowable expenditure as per relevant provisions. However, interest paid for the period falling after the date of acquisition, in view of author cannot be considered as 'cost of acquisition' of a capital asset. Recent judgment of Karnataka High Court: In CIT Vs. Sri Hariram Hotels P. Ltd. [2010- 2010 -TMI - 77531 - KARNATAKA HIGH COURT] matter about allowability of interest paid on borrowed capital came for consideration while computing income under the head 'capital gains'. The questions before the Court were as follows: "1. Whether the Tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ibunal was correct in holding that interest pay-able of a sum Rs. 37,45,042 to the directors by the assessee company towards loan availed of for purchase of the property (asset) should be added to the cost of acquisition of the asset when computing long-term capital gains by quantification of the interest after sale of the property ? 2. Whether the Tribunal failed to take into account that the interest component was worked out under the board meeting minutes dated January 24, 2003, which was the due vide letter dated January 25, 2006, after the sale of property dated January 23, 2003, indicating only a book entry and actual interest having been not paid prior to the sale could not be added as of cost of acquisition and consequently recorded a perverse finding ?" The facts of this case are analysed and summarized below: The appellant is revenue which has challenged the judgment and order of ITAT. The respondent is the assessee which is a company. Assessee company borrowed loan from some of the directors and purchased an immovable property with a view to put up a hotel building. The project of hotel could not be materialized due to various reasons. Thus the company sold ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the property which was held as a 'capital asset'. Assessee computed 'capital gain' on transfer of the property and claimed a sum of Rs. 37,45,042 towards interest paid to the directors on the loan borrowed from them in order to purchase the property sold. The Assessing Officer has disallowed the claim made by the assessee (reasons are not given in the judgment). The order of AO was confirmed by the Commissioner of Income-tax (Appeals). On further appeal before the Income-tax Appellate Tribunal, the Tribunal after hearing the parties and having considered the case of the assessee held that out of the borrowed loan from the directors, the property has been acquired and any interest paid thereon would also to be accounted towards the cost of acquisition of the asset. Accordingly the relief has been given to the assessee. The revenue challenged the legality and correctness of the same before the High Court. Contentions of revenue: The main contention on behalf of the Revenue was that after selling the property a resolution is passed by the company to pay the interest to the directors. In view of such resolution, there was no liability of the company to pay the interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t as on the date of sale. In the circumstances the Tribunal has committed a serious error in granting the relief to the assessee as the decision to pay the interest is subsequent to the date of sale. Observation and comments of author about contentions raised by revenue: It appears that the counsel of revenue has not at all pointed out relevant provisions as discussed by author earlier. The counsel of revenue was mainly challenging the aspect of accrual of interest. It seems that provisions as to 'date of acquisition' and 'cost of acquisition' were not at all pressed before the High Court. Observations and decision of High Court: Their lordship held that "we are unable to agree with the arguments advanced by the learned counsel for the Revenue for the simple reason on the facts that even the Commissioner of Income-tax (Appeals) has held that interest had accrued as on March 31, 2003, and therefore the Tribunal is justified in granting the relief to the assessee since the property has been purchased out of the loan borrowed from the directors and any interest paid thereon is to be included while calculating the cost of acquisition of the asset. Therefore, question N ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o. 1 has to be answered against the Revenue". Regarding the question No. 2 the court held that the same does not arise for consideration for the following reasons: According to the Revenue, the interest was not paid till the property is sold and therefore the assessee is not entitled to claim the amount paid towards interest subsequent to the sale under the head cost of acquisition of the property. This fact has been squarely covered by the judgment of this court in CIT v. Maithreyi Pai [2008 -TMI - 27586 - KARNATAKA High Court] . Therefore, court did not find any substantial question of law arises in the appeal and the appeal was dismissed. CIT v. Maithreyi Pai [2008 -TMI - 27586 - KARNATAKA High Court] : In this case the following question was considered: " Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the interest on borrowings for the purchase of shares constituted part of the cost of the shares for the purpose of working out the capital gains on the sale of shares ? " The facts were as follows: The assessee, an individual, sold shares of the value of Rs. 74,902 and returned capital gains of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 28,402 after deducting Rs. 30,478, being interest paid to M/s. MGA Pai Sons on the money borrowed for the purchase of the shares. The ITO disallowed this claim on the ground that the said expenditure had been allowed in computing her income from dividends, hence, such allowance was not permissible as per provisions of s. 55 . The assessee's claim was allowed by the AAC and the Tribunal also agreed with that view, on an appeal by the Department. The main source of the assessee's income was by way of dividends on her shareholdings. The assessee claimed deduction of Rs. 30,478, being the cost incurred for the acquisition of the shares. The ITO did not allow the claim on the ground that a sum of Rs. 29,116 was already allowed as an expense in computing the assessee's income from dividends in the assessment for the year and that a further deduction of interest paid was not called for. The question apparently deals with the mode of finding out the cost of acquisition of a capital asset for purposes of s. 48 . Section 48 deals with the mode of computation and deduction permissible while computing the capital gains chargeable to tax. " Cost of acquisition " include ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s all expenditure related to the acquisition of the asset. Interest paid on money borrowed for purchasing the shares is also one such expenditure which is included in the cost of asset for computing the capital gains. Under s. 55(2) , the expression " cost of acquisition " is defined for purposes of s. 48 and 49 , with reference to the dates of acquisition in clauses (i) and (ii). These provisions are relevant for finding out the " actual cost for purposes of computation of cost of acquisition under s. 48 . Court considered that the question that really arises for its opinion, on the facts stated, relates to the mode of computing the taxable income of the assessee. The interest paid by the assessee for the acquisition of the shares on the money borrowed for that purpose, undoubtedly is an expenditure incurred for the acquisition of the shares and, hence, constitutes " cost of acquisition " for purposes of s. 48 . But the ITO has disallowed this expenditure claimed, for the reason that a sum of Rs. 29,116 paid towards interest and collection charges had already been allowed as an expenditure while computing the income from dividends, and that, therefore, the claim fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r allowance of Rs. 30,478 again is not permissible. The ITO relied upon the provisions of s. 55 to disallow the interest. On behalf of the Revenue one of the contentions urged before the Tribunal was that the deduction claimed by the assessee was already allowed as revenue expenditure under s. 57 of the Act and the same amount cannot be allowed again under s. 48 . It was contended that if such deduction was allowed, it would amount to double deduction which is contrary to the scheme of the I.T. Act . The Tribunal unfortunately brushed aside that contention. It followed the decision in CIT v. Mithlesh Kumari [2008 -TMI - 8847 - DELHI High Court] and held that the interest paid by the assessee on money borrowed for the purchase of shares constitutes part of the actual cost of acquisition which is liable to be deducted under s. 48 . But Mr. Bhat, learned counsel for the assessee, submitted that the sum of Rs. 30,478 disallowed is quite different from the sum of Rs. 29,116 allowed as interest. If these two sums are different, the ITO may not be justified in disallowing the sum of Rs. 30,478, being the interest paid to M.G.A. Pai and Sons on the borrowings for the pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... chase of shares. But, if the said amount represents the same interest payable on the said borrowings, it seems to us that the assessee cannot get the benefit over again under s. 48 . The counsel of assessee Mr. Bhat, submitted that s. 48 should be examined independently without reference to s. 57 . Section 48 provides for deducting from the full value of consideration received the cost of acquisition of the capital asset and the cost of improvements, if any. The interest paid, on borrowings for the acquisition of a capital asset must fall for deduction under s. 48 . Court held that if the same sum is already the subject-matter of deduction under other heads like those under s. 57 , then it cannot find a place again for the purpose of computation under s. 48 . No assessee under the scheme of the I.T. Act could be allowed deduction of the same amount twice over. "We are firmly of the opinion that if an amount is already allowed under s. 57 while computing the income of the assessee, the same cannot be allowed as deduction for the purpose of computing the " capital gains" under s. 48 ." "The statement of law thus being made clear, it is not possible to answer t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he question one way or the other, since there is no finding recorded by the Tribunal in regard to the contention raised by the Department that it would amount to double deduction. We, therefore, decline to answer the question for want of a required finding and remit the matter to the Tribunal for fresh disposal in the light of the observations made." CIT v. Mithlesh Kumari [2008 -TMI - 8847 - DELHI High Court] This decision was followed by the Karnatak High Court. In this case the question involved was "whether interest on money borrowed for purchase of plot and ground rent are deductible in the computation of capital gains arising from the sale of open land? The court held that the interest paid on the borrowals for the purpose of buying the land constituted a part of actual cost within the meaning of s. 12B(2)(ii) of Indian Income-tax Act, 1922. It is therefore deductible in the computation of capital gains but the ground rent was not paid for the purpose of acquisition of the capital asset. It was actually incurred for keeping the capital in the assessee's possession. This does not constitute part of the actual cost. Therefore, it could not be deducted in computing capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al gains arising from the sale of capital asset. Observations of author: In the above cases courts have held that interest on capital borrowed to acquire the capital asset shall be part of cost of acquisition. It has also been held that if interest has been allowed u/s 57 , then the same cannot again be allowed while computing capital gains. The same rule will apply where interest has been allowed under other provisions of S. 24 while computing income from house property or under section 36 or section 37 while computing business or professional income. Author feels that the ruling about allowability of interest against capital gains are very favorable to taxpayers and it may be that the above rulings have not been challenged, so they can be considered as binding all over India ( except where jurisdictional High Court has taken different view). However, with due respect, the author feels that the ruling that interest (for period after acquisition) shall be part of cost of acquisition appears to be not according to the provisions and need reconsideration. The reason is that once a capital asset is acquired the date of acquisition and cost of acquisition need to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e fixed on that day. All expenses related to the capital asset can be considered while computing income being earned, which may fall under one or more heads of income. However, after acquisition, any cost incurred including interest on borrowed funds to acquire the asset cannot be considered as 'cost of acquisition'. Interest on borrowed funds for the period till acquisition (or completion of asset to usable condition) can only be capitalized. Interest thereafter is interest incurred to hold, possess, use and carry the property and not to acquire the property. The Delhi High Court has held that rent was to hold the plot so it was not cost of acquisition. Similarly in view of author the interest on capital borrowed for the period after acquisition of can only be considered as a recurring cost to hold the property and not cost of acquisition. Suppose after acquiring the plot assessee construct building then the interest on capital borrowed (including for making payment of land and to meet construction cost) ground rent, security charges and all incidental costs can be considered as 'cost of acquisition' of building. However, once construction is completed and the building is read ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y for use/put to use, no further interest can be capitalized or considered as 'cost of acquisition' of building. If interest for period even after acquisition of land / completion of building is considered as cost of acquisition, then the cost of acquisition shall not be a fixed amount. On passing of each day the cost of acquisition shall increase by the amount of interest payable for each day. That cannot be the meaning of 'the cost of acquisition', for the purpose of S. 48 . The interest for each day of holding may be allowed under other heads of income but not as cost of acquisition of asset while computing 'capital gains'. 'Actual cost' The expression 'actual cost' for the purpose of income falling under head business or profession is defined in S. 43(1). Earlier some courts took view that entire interest on borrowed capital incurred while purchasing asset under Deferred payment basis was part of 'actual cost'. Some courts held that interest only up to date of putting to use can be regarded as 'actual cost'. To make the legal position clear, The Explanation 8 was inserted below S. 43(1) vide the Finance Act, 1986 w.r.e.f.01.04.1974. As discussed earlier, the expre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssion 'actual cost' is much wider than the expression 'cost of acquisition' as used in context of the head 'capital gains'. Therefore, interest for the period after a capital asset is acquired and / or completed for intended use cannot be regarded as cost of acquisition. Some senior counsels have been speaking in seminars that they can make out case for allowability of interest on capital borrowed for purchase of shares held as capital asset while computing capital gains. However, with due respect, the author feels that such interest should be considered under the head business or other sources. In view of author: Making, holding, carrying, reshuffling etc. of investments involve adventure in nature of commerce. The investments are to be held and maintained to earn income. The investments are capital assets of such business. These activities are business - an adventure in nature of commerce (It is not necessarily to be adventure in nature of trade). The income need to be computed under different heads of income that is business, house property and / or other sources, and capital gains. Therefore, all expenses including interest ( even on capital borrowed to acquire capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al assets of such business), insurance, storage or holding charges (like DP charges), bank charges, administrative charges etc. incurred to maintain the activity should be regarded as allowable business expenses or expenses under head other sources as the situation may justify. - Reply By nilam maniya as = capital gains: INTEREST ON BORROWED CAPITAL ALLOWED AS COST OF ACQUISITION OF ASSET - recent decision in favor of assessee. However, with respect the author feels otherwise about post acquisition interest. Dated: 27-11-2015 - Scholarly articles for knowledge sharing authors experts professionals Tax Management India - taxmanagementindia - taxmanagement - taxmanagementindia.com - TMI - TaxTMI - TMITax ..... X X X X Extracts X X X X X X X X Extracts X X X X
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