Kalpesh Classes

"Interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (Including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized w.e.f. 1-4-2004, i.e., A.Y. 2004-05 a new provisio to section 36(1) (iii) has been added so as to provide that no deduction shall be allowed in respect of any amount of interest paid, in respect of capital borrowed for acquisition of an asset for extension of an existing business or profession (whether capitalized in the books of account or not) if such amount of interest is for the period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such an asset was first put to use.

In CIT v. Bazpur Co-operative SugarFactory Ltd. [1989] 177 ITR 469/44 Taxman 281 (SC) at page 139 while considering the meaning of the words "borrowed money", it was observed that the words should not be given a strained meaning and that it should be considered whether in ordinary commercial usage the relationship was that of a borrower and a lender and that the transactions were loan transactions.​​ 

The expression "for the purpose of business" was explained in CIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140 (SC) on page 150 as follows :

"The expression 'for the purpose of business' is wider in scope than expression 'for the purpose of earning profits'. Its range being wide expression may take in not only the day-to-day running of a business but also the rationalization of its administration and modernization of its machinery; it may include measures for the preservation of business and for the protection of its assets and property of expropriation, coercive process or assertion of hostile title; it may comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business."

It was laid down in CIT v. Sundaram Fasteners Ltd. [1984] 149 ITR 773/16 Taxman 217 (Mad.) by the Madras High Court that under section 36(1)(iii) of the Act, the following conditions have to be satisfied by the assessee before it can claim a deduction in respect of payment of interest on borrowed capital:

• There should have been a​​ borrowing of money (capital)​​ by the assessee;​​ 

• Such borrowing should have been for the​​ purpose of the business of the assessee;​​ 

• The assessee must have​​ paid interest on the said borrowing​​ and claimed it as a deduction;​​ 

Facts and circumstances of each case and also the law will help in justifying whether the particular borrowing is for the purpose of business or profession so as to allow the interest on such borrowing as deduction under section 36(1)(iii) if there is any dispute. If there is no dispute as such, the claim under section 36(1)(iii) will be allowed accordingly. It was observed by the Supreme Court in BadalRam Laxmi Narain v. CIT [1991] 191 ITR 296/57 Taxman 235 "that the amount of interest paid on the borrowed capital is an allowable deduction. It is not in dispute and indeed cannot be disputed that if the goodwill is purchased out of the borrowed capital the interest paid on the borrowed capital is an allowable deduction".

The language employed in section 36(1)(iii) is plain and simple. Many cases have been decided in reference to whether a particular borrowing is for the purpose of business or is not so as to allow/disallow a claim of​​ deduction of interest? With the help of some of the important decisions of the High Courts and the Supreme Court, the practical/general use/benefit (to take an example, in claim for set off and carry forward of losses under the head "business or profession") scope of the same is extended.

Claiming of deduction under section 36(1)(iii) even on income shown under another head of income​​ 

It has been held in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 (SC), that in case money is borrowed by a newly started company which is in the process of constructing and erecting its plant,​​ the interest incurred before the commencement of production on such borrowed money can be capitalized and added to the cost of fixed assets​​ which have been created as a result of such expenditure. This was a case of a new factory being set-up and not expansion of the existing business.​​ 

Deduction of interest as business expenditure when borrowing for the expansion of business.

In Prem Spg & Wvg. Mills Co. Ltd. v. CIT [1975] 98 ITR 20 (All.) the assessee was running a Spinning and Weaving Mill and had set up a strawboard manufacturing factory. For that purpose it took a loan from the Uttar Pradesh Financial Corporation. The assessee claimed deduction of the interest paid towards the loan under section 36(1)(iii) but the same was disallowed by the Tribunal holding that the strawboard factory was an altogether fresh undertaking with the help of surplus funds and borrowed funds and could not be identified with the existing business. The business for which capital was borrowed had not started production. It was held by the Allahabad High Court that the management trading organization, administration, funds and the place of business were identical. Hence, it could not be said that the setting up of the strawboard factory was initiation of a different business by the assessee. On that ground the expenditure could not be disallowed. The decisive test was held to be unity of control and not the nature of the two lines of business (see also Kanhiram Ramgopal v. CIT [1988] 170 ITR 41/38 Taxman 41 (MP.). Also in CIT v. Expanded Metal Manufacturers [1991] 189 ITR 317/55 Taxman 429 (All.), the Allahabad High Court again relied on Prem Spg. & Wvg. Mills case (supra), wherein it was held that assessment was not made unit-wise but assessee-wise, interest on borrowed capital was allowable as business expenditure irrespective of the fact that such borrowed capital was used in a business which was different from the existing one. Where the assessee-company had incurred expenditure for establishing a new glass manufacturing unit at Bangalore, while it was already manufacturing glass at Baroda and, had borrowed money for that purpose and the Interest paid on the said borrowings was claimed as business expenditure. Also the said new unit did not go into production during the two assessment years in question. The Income-tax Officer disallowed the company's claim on reference, it was held by the Gujarat High Court that the said interest was deductible as business expenditure. It was observed that where borrowing was for the purpose of business, the interest paid on such borrowings would become eligible for deduction contemplated by section 10(2)(iii) of the Indian Income-tax Act, 1922 or section 36(1)(iii) of the Act [CIT v. Alembic Glass Industries Ltd. [1976] 103 ITR 715 (Guj.)].

In case of Dy. CIT v. Core Health Care Ltd. [2001] 251 ITR 61 (Guj.), the assessee Co. installed three more machines in addition to existing ones by purchasing them from borrowed capital. Interest on such loan was held to be allowable deduction under section 36(1)(iii).​​ Also, in CIT v. Associated Fibre & Rubber Industries (P) Ltd. [1999] 149 Taxation 70 (SC), machinery was purchased with borrowed capital; interest on loan was held to be allowable deduction under section 36(1)(iii), even though such machinery was not actually used in the business of assessee-company during assessment year in question.

From A.Y. 2004-05 deduction under section 36(1)(iii) is not allowed in respect of interest on capital borrowed for acquisition of new asset for extension of existing business or profession, where such interest is for the period beginning on the date on which capital was borrowed for acquisition of the asset and till the date on which such an asset was first put to use.

Borrowed capital may be invested to acquire revenue or capital asset​​ 

When a borrowing is made for the purpose of business, interest paid on such borrowing becomes eligible for deduction contemplated by section 36(1)(iii) of the Act.​​ This would be so, whether the capital is invested in order to acquire a revenue asset or a capital asset, because the act of borrowing capital is distinct from the act of investment of the capital to acquire an asset​​ Dy. CIT v. Core Healthcare Ltd. [2008] 298 ITR 194/167 Taxman 206 (SC), (CIT v. Shah Theatres (P) Ltd. [1988] 169 ITR 499/36 Taxman 335 (Raj.); Calico Dyeing & Printing Works v.CIT [1958] 34 ITR 265 (Bom.): Ramkrishnan Oil Mills v. CIT [1965] 56 ITR 186 (MP). The Supreme Court in India Cements Ltd. v. CIT [1966] 60 ITR 52 did not agree with the principle that the nature of the expenditure incurred in raising a loan would depend upon the nature and purpose of the loan. It observed that loan may be intended to be used for the purchase of a raw material when it is negotiated but the company may after raising the loan, change its mind and spend it on securing capital assets. The reliance was placed by the Supreme Court referring to the decision of Nagpur Electric Light & Power Co. v. CIT [1931] 6 ITC 28 (JC) where it was held by the Nagpur Judicial Commissioner that the purpose for which the new loan was required was irrelevant to the consideration of the question whether the expenditure for obtaining the loan was revenue expenditure or capital expenditure.

Interest on money borrowed for the purpose of acquiring leasehold rights was allowable, even if capital borrowed was paid to spouse as a commercial expediency​​ 

In C.T. Desai v. CIT [1979] 120 ITR 240/[1980] 3 Taxman 57 (Kar.) the assessee was carrying on the business of film distribution on his own and also exhibition of films on percentage basis under agreements entered into by him with theatre owners. For the purpose of securing the lease of a fully equipped cinema theatre, he entered into an agreement with his wife and in accordance therewith the assessee paid to his wife certain sum which the assessee had borrowed on interest and the wife was to construct the cinema theatre and equip it fully for being used for the exhibition of films and to allow the assessee to use the theatre. During the assessment year in question he claimed the deduction of interest amount paid on the borrowed money. The Income-tax Officer disallowed the deduction claimed on the ground that the money borrowed and paid under the agreement for construction of theatre and its equipment was not for the business carried on by the assessee. On reference, it was held by the Karnataka High Court that the money was borrowed for purposes of acquiring leasehold right in a new theatre and, therefore, it was capital borrowed and invested during the relevant accounting year for purposes of business of the assessee. Also, when it was established that the capital borrowed and paid by the assessee to his wife was for the purpose of his business the mere fact that the lessor was the wife of the lessee was no ground to hold that the money paid was only on account of their relationship and not as a commercial expediency and to disallow the deduction to which the assessee was entitled to under section 36(1)(iii) of the Act.

Use of capital borrowed need not be remunerative, it is not necessary that the asset acquired be used during the accounting year in question​​ 

It was held by the Bombay High Court in Calico Dyeing & Printing Works v. CIT [1966] 59 ITR 221 that if the capital​​ borrowed is used in the year of account and the use is for the purpose of the business of the assessee, it is immaterial whether the user of the capital actually yielded profit or not.​​ It is not open to the Income-tax department to reject the claim of he assessee in respect of the interest paid on​​ that capital merely because the use of the capital is un-remunerative. The following observation of the Lord Thankerton in Hughes v. Bank of New Zealand [1938] 6 ITR 636 (HL) has been cited by the Supreme Court in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 at page 523 by relying on the same:​​ "Expenditure in course of the trade which is un-remunerative is nonetheless a proper deduction.​​ If wholly and exclusively made for the purpose of the trade, it does not require the presence of a receipt on the credit side to justify the deduction of an expense."​​ 

Interest under section 32 and 36(1)(iii)

If we read section 32 the condition for such deduction is use of an asset. On the other hand the condition for deduction under section 36(1)(iii) for interest is for the purpose of acquisition.​​ The state, condition and use of the asset are, therefore, insignificant in the matter of allowance of deduction of interest. It is only when the purchase of an asset is made for the purpose of extension of an existing business or profession and the same is not put to use the same can be disallowed.

In other words, replacement of an asset in the course of an existing business is not affected and any interest incurred to finance such a replacement would qualify for deduction upfront without any restriction.​​ 

Further, the term asset employed in the proviso to section 36(1)(iii) has a bearing to all those assets that are capable of being put to use. Land per se is not itself an asset of the type envisaged for being put to use. It is because of the reason that it always appreciates and never depreciates, so that the use thereof is irrelevant. The reference to the term 'asset' in sections 32, 36(1)(iii) and 43(1) and the Explanation (8) thereto is only viz-a-viz those assets that are capable of use and exploitation and those that depreciate with the efflux of time and use. Hence, as far as the question of allowance of interest cost incurred on acquisition of land in the course of extension of a business is concerned, there is a hiatus between the conditions for grant of depreciation and interest. Thus, any interest cost incurred on acquisition of land for the purpose of business is upfront admissible as deduction, as the user condition lacks application to such an instance.