Section 36(1)(iii)

Interest on borrowed capital

Relevant/Irrelevant factors

Any and every payment, in garb of interest in excess of what can be really termed as interest, is not allowable - As the essence of ‘interest’ is that it is a payment which becomes due because the creditor has not had his money at the due date, it may be regarded as either representing the profit he might have made if he had use of the money, or conversely, the loss he suffered because he had not had that use. The general idea is that he is entitled to compensation for the deprivation. It is only interest in the above sense which is deductible under section 36(1)(iii). If in the garb of interest something more is paid over and above ‘interest’, that something cannot be allowed as deduction under this section. The assessee is entitled to deduction only of that part of the amount paid by him for money borrowed which can genuinely be regarded as interest. Any and every payment in the garb of interest in excess of what can really be termed as ‘interest’ cannot be allowed as a deduction under this section - CIT v. Hindustan Conductors (P.) Ltd. [2000] 108 Taxman 258 (Bom.).

Deduction is not dependent on whether resulting profit is taxable or not - It would not be correct to say that if a part of profits of a business was not taxable, no expenditure incurred for the purpose of earning those profits could be allowed as a deduction. Thus, where a bank utilised part of the deposits mobilised by it on investment in tax-free securities interest paid on such deposits was deductible - CIT v. Indian Bank Ltd. [1965] 56 ITR 77 (SC).

Borrower and lender must be two different entities - Words ‘borrowed’ and ‘paid’ in section 36(1)(iii) clearly postulate two different entities, one which lends capital and the other which borrows and pays interest. The same entity cannot be its own lender and borrower nor interest can be paid to self. Therefore, interest paid by one unit of assessee to its another unit cannot be allowable because it is paid and received by the same person and not by one person to another. This would be so even where separate accounts were maintained for the two units - Malwa Mills Karamchari Parasper Sahakari Sanstha Ltd. v. CIT [1983] 140 ITR 379 (MP).

Borrowal on revenue account - Section 36(1)(iii) nowhere stipulates that borrowing has to be on revenue account - Dy. CIT v. Core Healthcare Ltd. [2001] 251 ITR 61 (Guj.).

Utilisation in particular branch of business is not a pre-requisite - It is not necessary to show for the purpose of deduction under clause (iii) that the money borrowed was utilised for a particular branch of his business - Birla Gwalior (P.) Ltd. v. CIT [1962] 44 ITR 847 (MP).

Necessity for borrowal need not be shown - It is not the requirement of the provision that the assessee must show that the borrowing of the capital was necessary for the business so that if at the time of borrowing the assessee had sufficient amount of its own, the deduction could not be allowed - CIT v. Bombay Samachar Ltd. [1969] 74 ITR 723 (Bom.)/Amna Bai Hajee Issa v. CIT [1964] 51 ITR 835 (Mad.).

Asset acquired out of borrowal need not have been used during relevant year - Where machinery was purchased out of borrowed amount for purpose of business and it was treated as business assets merely because such machinery had not been actually used in business at time when assessment was made, interest paid on amount borrowed could not be disallowed - CIT v. Associated Fibre & Rubber Industries (P.) Ltd. [1999] 102 Taxman 700 (SC)/CIT v. Insotex (P.) Ltd. [1984] 150 ITR 195 (Kar.)/Calico Dyeing & Printing Works v. CIT [1958] 34 ITR 265 (Bom.)/C.T. Desai v. CIT [1979] 120 ITR 240 (Kar.).

Decision about genuineness of credit taken in earlier year cannot be disturbed - Once the genuineness of credits had been accepted in an earlier year, there would be no question of disallowing the interest claimed in a subsequent year on the ground that the creditors to whom notices were issued did not respond to the notice and hence they should be treated as non-existent. Such a stand is not available to the Assessing Officer - CIT v. P.K. Narayanan [2000] 108 Taxman 424 (Ker.).

Relevance of steps for realisation of outstanding dues - Section 36(1)(iii) does not contemplate a situation where an assessee is required to take positive steps for realizing its outstanding dues in order to be eligible for the claim for the deduction of interest under the aforesaid provision. The claim cannot be disallowed on the ground that the assessee had wilfully and deliberately chosen not to collect its outstanding dues from its sister concern in order to accommodate the sister concern and had, on the other hand, borrowed capital from the market and paid interest thereon for which the deduction was claimed. It is also not correct to argue that, by not charging interest upon the failure of the sister concern to pay the dues, the assessee has forfeited his right to claim any deduction under section 36(1)(iii) - Caldern Pharmaceuticals Ltd. v. CIT [2004] 265 ITR 244/136 Taxman 531 (Cal.).

‘Capital’ - Meaning of

‘Capital’ means money and not any other asset - The expression ‘capital’ in the context in which it occurs means money and not any other asset, for interest is payable on capital borrowed and interest becomes payable on a loan of money and not on any other asset acquired under a contract - Bombay Steam Navigation Co. (1953) (P.) Ltd. v. CIT [1965] 56 ITR 52 (SC).

Capital borrowed

Interest on unpaid salaries is not deductible - Conceptually, for the purpose of section 36(1)(iii), ‘interest’ is relatable only to money borrowed and not to debt incurred. Therefore, salaries due to the directors but not paid to them and utilised for the purpose of business cannot constitute ‘capital borrowed’, and interest paid thereon is not allowable as a deduction - CIT v. Saraswati Chemicals & Allied Industries (P.) Ltd. [2001] 249 ITR 235 (Delhi).

Interest paid to charity account is deductible - Where the assessee maintained separate charity accounts, and the receipts to that account were treated by the department as capital receipts, interest paid on the balance in that account towards utilisation of the moneys for business purposes is allowable as deduction. Once the department accepted that the moneys lying to the credit of various accounts did not belong to the assessee but belonged to a third party, and if such funds were utilised for purposes of business by paying interest, such interest was a deductible item of expenditure - CIT v. Nanalal Mansukhram [2002] 253 ITR 50 (Guj.).

‘For the purpose of business’

Words ‘for the purpose of business’ are wider in scope than ‘for the purpose of earning income’ - The expression ‘for the purpose of business’ is wider in scope than the expression for the purpose of earning income, profits and gains - Madhav Prasad Jatia v. CIT [1979] 118 ITR 200 (SC)/L.M. Thapar v. CIT [1988] 173 ITR 577 (Cal.).

Deduction is limited to interest on that part of capital which is used for the purpose of business - Interest paid on borrowed capital will be allowed as a deduction only if the capital was borrowed and used for the purpose of business and that if it is used for a purpose other than that of business, then interest to the extent to which the capital was so used, will not be allowed - P.R.M.S. Ramanathan Chettiar v. CIT [1969] 72 ITR 534 (Mad.)/M.S.P. Raja v. CIT [1976] 105 ITR 295 (Mad.).

When income earned by utilising the borrowals is diverted for non-business purposes - Interest on borrowals is allowable as deduction only when the borrowals are used for the purpose of business, and continue as such. Where the assessee paid interest on borrowals for use in his business of executing contracts, but later out of the contract receipts advanced interest free loans to relatives, interest relatable to sums so advanced is not deductible - K. Somasundaram & Bros. v. CIT [1999] 238 ITR 939 (Mad.).

Interest on tax paid under VDIS is not deductible - Interest paid by the assessee on tax paid under the Voluntary Disclosure Scheme in instalments is not deductible as interest on borrowed capital - Bharat Commerce & Industries Ltd. v. CIT [1998] 230 ITR 733/98 Taxman 151 (SC).

Utilisation of borrowals

Borrowals can be for incurring capital expenditure - There is no bar in section 36(1)(iii) to allowance of interest paid in respect of capital borrowed which has been utilised for purchase of a capital asset - CIT v. Rajeeva Lochan Kanoria [1994] 208 ITR 616 (Cal.).

Interest on borrowals connected with setting up of business is not deductible - In order to be allowed as expenses, interest should be in respect of business which was carried on by the assessee and the profits of which are computed and assessed, and should be incurred after the business is set up. Accordingly, interest paid on borrowing in connection with the setting up or a new hotel which had not commenced business at the end of the relevant previous year, was not deductible - Ritz Continental Hotels Ltd. v. CIT [1978] 114 ITR 554 (Cal.).

Interest on borrowal for payment of income-tax is not eligible - Interest on money borrowed to pay income-tax is not deductible - Kishinchand Chellaram v. CIT [1978] 114 ITR 654 (Bom.)/Mannalal Ratanlal v. CIT [1965] 58 ITR 84 (Cal.)/M.M. Thapar v. CIT [1978] 114 ITR 331 (Cal.)/Waldies Ltd. v. CIT [1977] 110 ITR 577 (Cal.)/CIT v. Shree Changdeo Sugar Mills Ltd. [1983] 143 ITR 469 (Bom.).

Interest on borrowals for payment of dividend is deductible - Interest paid on moneys borrowed, which are utilised for payment of dividend to the shareholders of a company, is entitled to deduction under section 36(1)(iii) - Kesar Sugar Works Ltd. v. CIT [1997] 140 CTR (Bom.) 431.

Borrowals by firms

Interest paid by firm on borrowals diverted to partners for personal use is not deductible - Where money borrowed by the firm is lent to a partner for personal purposes without interest, the interest paid by the firm on the borrowed money cannot be allowed as a deduction - Marolia & Sons v. CIT [1981] 129 ITR 475 (All.).

Closed business

Concept of ‘same business’ will not apply - Test of ‘same business’ which is appropriate for set-off of carried forward losses, is not appropriate for purpose of claiming interest on borrowed capital where business in respect of which borrowing has been made, has been closed - Veecumsees v. CIT [1996] 86 Taxman 243/220 ITR 185 (SC).

Where one out of two lines of business run as composite business is closed, interest on borrowals used in closed business is allowable - Where assessee running jewellery business and also business of exhibition of cinematographic films, obtained loan for construction of cinema theatre and Tribunal’s finding was that business carried on by assessee as jewellers and business of running cinema theatre were composite, interest on such loan had to be allowed as a deduction under section 36(1)(iii) even after business of running theatre had been closed - Veecumsees v. CIT [1996] 86 Taxman 243/220 ITR 185 (SC).

Others

Dividend on preference shares - Dividend payable on preference shares cannot treated as interest paid on borrowed capital - Kirloskar Electric Co. Ltd. v. CIT [1997] 228 ITR 674 (Kar.).