TMI Blog2020 (3) TMI 1022X X X X Extracts X X X X X X X X Extracts X X X X ..... allowed as deduction under Section 36(1)(iii) or under Section 57(iii). At this stage, it is worthwhile to mention that the income by way of dividends on shares, whether held on investment portfolio or as stock-in-trade, is specifically assessable, under Section 56(2)(i), as the Income from other sources . Although the shares are held, on the investment portfolio, as an integral part of the business, yet the interest on such borrowings is allowable under Section 36(1)(iii). Thus, the qualifying factor in this case is to ascertain whether the borrowings for purchasing shares is an integral part of the business of the assessee. The appellant assessee had borrowed the capital to purchase the shares of the IHFC Ltd so as to have effective control of the IHFC Ltd in order to expand its real estate business. Thus, the investment in share was nothing but the expansion of business of the assessee. Therefore, all the conditions necessary for deduction under Section 36(1)(iii) were prima facie satisfied by the appellant assessee. The CIT(A) was, therefore, not justified to allow deduction under Section 57(iii) of the Act as the appellant assessee did not borrow the capital for earning d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... extent it was utilised for purchasing shares was deductible neither under Section 36(1)(iii) nor under Section 57(iii) of the Act? 4. For the sake of convenience, the Tax Appeal No.1626 of 2007 is treated as the lead appeal. 5. This Tax Appeal under Section 260A of the Income Tax Act, 1961 (for short, 'the Act, 1961'] is at the instance of the assessee and is directed against the order passed by the Income Tax Appellate Tribunal, Ahmedabad Bench 'A'', Ahmedabad dated 15th December 2006 in the ITA No.1549/Ahd/2000 for the A.Y. 1996-97. 6. The assessee is in the business of real estate. With the intention to expand the business of real estate, it created a housing arm in the name and style of International Housing Finance Corporation Limited [for short, 'IHFC']. The purpose to create such a housing finance company within the group was to make funds readily available when required for the development of a housing project or to fund any acquisition of real estate. The assessee subscribed 499950 equity shares constituting 99.99% in the total paid up capital of 500000 equity shares in the assessment year 1994-95. The IHFC Limited got registered wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nder 36(1)(iii) of the Act, but the same should be allowed under Section 57(iii) of the Act. We may quote the relevant observations made in the order passed by the CIT(A): 22 The contention of the appellant has been carefully considered. From the facts admitted by the appellant it is clear that he had maintained two separate accounts in its books for dealings with I.H.F.C. Ltd. It had paid interest of ₹ 16,49,090/on the current account @ 22%. The borrowings in the current account had been utilised for the purpose of appellant s regular business. One of the reasons for disallowing interest was that the funds borrowed had been invested in acquiring shares of the I.H.F.C. Ltd. Therefore, interest paid on such funds could not be allowed. Taking the above finding of the A.O. to its logical conclusion, the interest paid by the appellant upon the funds borrowed for its regular business will have to be allowed u/s.36(1)(iii) of the I.T. Act. Accordingly, interest of ₹ 16,49,090/is directed to be allowed as interest paid on borrowings utilised for the purpose of business u/s.36(1) (iii). 23 On the other account with I.H.F.C. Ltd, the appellant firm had paid interest of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would be considered against income from business. Balance of interest would be allowed as deduction to be set off against income from other sources. 9. The Revenue challenged the deletion of ₹ 54,92,068/by filing appeal before the ITAT (even though in the remand report, the Jt. CIT conceded that the deduction under Section 57(iii) of the Act, 1961 is applicable). In this regard, we may quote the observations of the CIT(A) as contained in para 14 of the order: 14. However, interest on borrowed capital used for purchase of share was allowable expenditure u/s 57(iii). The Supreme Court in the case of CIT vs. Rajendraprasad Mody (1978) 115 ITR 519 (SC) had held that irrespective of receipt of dividend or not, interest on borrowed capital used for purchase of shares was for the purpose of earning dividend. Therefore, interest on borrowed funds was to be allowed u/s 57(iii) against the income from other sources . In view of the above, the Jt.. C.I.T. S.R. 5, stated that the outright disallowance of interest as made in the assessment order was not correct. The A.O. should have computed the income of the appellant by disallowing interest on borrowed capital out of busin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid company so that contact of IHFCL with the same line, of business can be exploited. This contention also found part of the submission of assessee as recorded in the report under the head contention of the assessee . Thus it cannot be disputed the assessee that its intention to invest in the shares of IHFCL, was to have controlling interest in IHFCL. It has already been pointed out that it is not the business of assessee to keep controlling interest or management over companies. Thus the purpose of assessee in purchasing the shares of IHFCL was not for the purpose of assessee s business which is only sale and purchase of land Thus the money borrowed by assessee for purchasing the shares of IHFCL cannot be said to be for the purpose of business or profession of the assessee. It was only for the purpose of having control over the IHFCL. The main condition for allowability of interest under section 36(1)(1 ) is that interest should be paid in respect of capital borrowed for the purpose of business or profession of assessee. Thus the interest paid by assessee does not fulfill the condition laid down in section 36 (1)(iii). 20. Now coming to the question that whether or not suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was the rationale for borrowing and purchasing the shares of the IHFC Limited: 1 To retain the controlling interest in the company. Prior to the public issue of IHFC limited, the family of the firm owned all the issued shares of IHFC Ltd. They wanted to retain the controlling stake even after the public issue. After the public issue the shareholding became 49.87% from 100%. 2 It was also decided that the assessee firm and B. Nanji Construction P Ltd issues the shares of IHFC Ltd. Assessee came to hold 30 lakhs shares of IHFC Ltd. 3 The partners and family of the assessee firm were also the Directors in the company. 4 Assessee is a real estate developer and IHFC gives housing loans. Business activity of both the entities have synergy for mutual benefit. Prospective customers of the assessee could get credit facilities from IHFC on priority basis. 17. Mr. Soparkar, in support of his submissions, has placed reliance on the following decisions: [1] S.A. Builders Ltd vs. Commissioner of Income tax (Appeals) [2007] ITR 1 (SC) [2] Commissioner of Income tax vs. Tulip Star Hotels Ltd [338 ITR 482 (DEL)] [3] Bright Enterprises Pvt Ltd vs. Commiss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. Explanation : Recurring subscriptions paid periodically by shareholders or subscribers in Mutual Benefit Societies which fulfill such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause; 24. The subsection has three important words or phrases that are important for the purpose of understanding the provision viz. (i) Interest, (ii) Capital Borrowed and, (iii) For the purpose of business or profession. In the following paras we would elucidate the meaning of these with reference to this particular section. (i) Meaning of Interest The definition of the term interest in the Section 2(28A) means the interest payable in any manner in respect of any moneys borrowed or debt incurred . But for the purpose of Section 36(1)(iii), interest is restricted to that on the money ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer found that the assessee had advanced huge amounts as interest free loans out of its cash credit account in which there was a huge credit balance. The Assessing Officer disallowed the proportionate interest relating to the said amount out of the total interest paid to the bank, holding that the assessee had diverted its borrowed funds to its sister concern without charging any interest. On appeal, the Commissioner (Appeals) accepted the partial claim of the assessee on the ground that out of the total amount advanced by the assessee only certain sum had a clear nexus with borrowed funds, as the balance amount had been paid out of the receipts from other parties to whom no interest had been paid. However, on the cross appeals, the Tribunal allowed the revenue's appeal. On the assessee's appeal, the High Court held that the order of the Tribunal did not suffer from any factual or legal infirmity, as the amount in question had been advanced by the assessee to its sister concern out of the overdraft account in which there was already a huge debit balance. Thus, the question involved in S.A. Builder Ltd (supra) was one about the allowability of the interest on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the question of allowability of interest on the borrowed funds from the above angle. In other words, the High Court and other authorities should have enquired as to whether the interest free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed. 25. The expression commercial expediency is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency. 26. No doubt, as held in Madhav Prasad Jantia vs. CIT (supra), if the borrowed amount was donated for some sentimental or personal reasons and not on the ground of commercial expediency, the interest thereon could not have been allowed under Section 36(1)(iii) of the Act. In Madhav Prasad's case (supra), the borrowed amount was donated to a college with a view to commemorate the memory of the assessee's deceased husband after whom the college was to be named. It was held by this Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt was advanced to the subsidiary company as a measure of commercial expediency is the correct view, and the view taken by the Bombay High Court which set aside the aforesaid decision is not correct. 33. Similarly, the view taken by the Bombay High Court in Phaltan Sugar Works Ltd. vs. Commissioner of Wealth-Tax (1995) 215 ITR 582 , also does not appear to be correct. 34. We agree with the view taken by the Delhi High Court in CIT vs. Dalmia Cement (Bhart) Ltd. (2002) 254 ITR 377 , that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The Income Tax Authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman. As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ision of a businessman on the business expediency matters. The money borrowed even when advanced to a subsidiary for some business purpose would qualify for deduction of interest. However, if the money borrowed is utilised by the assessee for personal benefit and not for business purpose, the interest paid on that money would not satisfy the test of commercial expediency . [See ( 2018) 409 ITR 587 (Delhi )]. 27. In the context of the present case, the purpose for borrowing and purchasing shares of IHFC Ltd was as under: 1. To retain the controlling interest in the company. Prior to the public issue of IHFC limited, the family of the firm owned all the issued shares of IHFC Ltd. They wanted to retain the controlling stake even after the public issue. After the public issue the shareholding became 49.87% from 100%. 2. It was also decided that the assessee firm and B. Nanji Construction P Ltd issues the shares of IHFC Ltd. Assessee came to hold 30 lakhs shares of IHFC Ltd. 3. The partners and family of the assessee firm were also the Directors in the company. 4. Assessee is a real estate developer and IHFC gives housing loans. Business activity of both t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mmercial expediency or not. It is not necessary that the amount so advanced is earning profit or not but there must be some nexus between expenses and the purpose of business. 30. It is important to note that the Division Bench in arriving at its aforenoted conclusion followed the judgment of the Supreme Court in S.A. Builders Ltd. (supra). The Division Bench, in fact, after remanding the matter, expressly directed the Tribunal to consider the matter in the light of the principles laid down by the Supreme Court in S.A. Builders Ltd. (supra). 31. We shall now consider Section 57(iii) of the Act, 1961, which reads thus: Deductions 57. The income chargeable under the head Income from other sources shall be computed after making the following deductions, namely:*** (iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. 32. A bare perusal of the aforesaid provision would indicate that in order to grant deduction of interest paid by the assessee, it would be necessary to determine the dominant purpose for which the expenditure was incurred, m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpenditure must be examined. (2) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee; (3) the expenditure must have been laid out or expended wholly and exclusively for the purpose of making or earning income from other sources ; (4) the purpose of making or earning such income must be the sole purpose for which the expenditure must have been incurred, that is to say, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose; (5) the distinction between purpose and motive must always be borne in mind in this connection, for, what is relevant is the manifest and immediate purpose and not the motive or personal considerations weighing the mind of the assessee in incurring the expenditure; (6) if the assessee has no option except to incur the expenditure in order to make the earning of the income possible, such as when he has to incur legal expenses for preserving and maintaining the source of income, then undoubtedly, such expenditure would be an allowable deduction; however, where the assessee has an option and the option which he exercises has no conn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pecified in S. 14, Items A to E shall be chargeable to tax under the head 'Income From Other Sources' and subsec. (2) includes in such income various items, one of which is 'dividends'. Dividend on shares is thus income chargeable under the head 'Income From Other Sources'. Section 57 provides for certain deductions to be made in computing the income chargeable under the head Income From Other Sources and one of such deductions is that set out in Cl. (iii) which reads as follows : Any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. The expenditure to be deductible under S. 57 (iii) must be laid out or expended wholly and exclusively for the purpose of making or earning such income. The argument of the Revenue was that unless the expenditure sought to be deducted resulted in the making or earning of income, it could not be said to be laid out or expended for the purpose of making or earning such income. The making or earning of income, said the Revenue, was a sine qua non to the admissibility of the expenditure under S. 57 (iii) and, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Income-tax, 20 ITR 1 : (AIR 1951 SC 278) where interpreting the corresponding provision in S. 12 (2) of the Income-tax Act, 1922 which was ipsissima verba in the same terms as Section 57 (iii), Bose, J., speaking on behalf of the Court observed : It is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned . It is indeed difficult to see how, after this observation of the Court, there can be any scope for controversy in regard to the interpretation of S. 57 (iii). 4. It is also interesting to note that, according to the Revenue, the expenditure would disqualify for deduction only if no income results from such expenditure in a particular assessment year, but if there is some income, howsoever small or meagre, the expenditure would be eligible for deduction. This means that in a case where the expenditure is ₹ 1,000/, if there is income of even Re. 1/, the expenditure would be deductible and there would be resulting loss of ₹ 999/under the head 'Income From Other Sources'. But if there is no income, then, on the argument of the Revenue, the expenditure would have to be ignored as it would not be liable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the same view has been taken by the Madras High Court in Appa Rao v. Commr. of Income tax, (1962) 46 ITR 511 and Mohamed Ghouse v. Commr. of Income-tax, (1963) 49 ITR 127 the Bombay High Court in Ormerods (India) Private Ltd. v. Commr. of Income-tax, (1959) 36 ITR 329, the Allahabad High Court in Chhail Beharilal v. Commissioner of Income-tax, (1960) 39 ITR 696, the Madhya Pradesh High Court in Commissioner of Income-tax v. Dr. Fida Husain G. Abbasi, (1969) 71 ITR 314, the Kerala High Court in M. N. Ramaswamy Iyer v. Commr. of Income-tax, (1969) 71 ITR 218 and the Orissa High Court in Commissioner of Income-tax v. Gopal Chand Patnaik, 111 ITR 86 : (1976 Tax LR 443). This view is eminently correct as it is not only justified by the language of S. 57 (iii) but it also accords with the principles of commercial accounting. The contrary view taken by the Patna High Court in Kameshwar Singh v. Commr. of Income-tax, 32 ITR 377 : (AIR 1957 pat 400) and the Calcutta High Court in Madanlal Shohanlal v. Commissioner of Income-tax, (1963) 47 ITR 1 must in the circumstances be held to be incorrect. 35. Thus, it is evident from the plain and natural construction of the language ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... C Ltd so as to have effective control of the IHFC Ltd in order to expand its real estate business. Thus, the investment in share was nothing but the expansion of business of the assessee. Therefore, all the conditions necessary for deduction under Section 36(1)(iii) were prima facie satisfied by the appellant assessee. The CIT(A) was, therefore, not justified to allow deduction under Section 57(iii) of the Act as the appellant assessee did not borrow the capital for earning dividend or for making profit and gains. The dominant purpose of the appellant assessee to borrow the capital was to acquire the shares to have effective control over the IHFC Ltd so as to expand the business of the assessee. In that view of the matter, the CIT(A) was not justified in granting deduction of interest paid by the assessee under Section 57(iii) of the Act. But the assessee is entitled to deduction of interest paid on capital borrowed for investment in the shares of IHFC for the purpose of expansion for its business under Section 36(1)(iii) of the Act. 38. The Tribunal was, therefore, not justified in holding that the purpose of the assessee for purchase of shares of IHFC was not for the purpose o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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