Interest on borrowings of capital assets not put to use allowable deduction

NEW DELHI. The Apex Court vide a significant ruling dated 8th February 2008 AIT-2008-46-SC has ruled that  interest paid in respect of borrowings on capital assets not put to use in the concerned financial year can be permitted as allowable deduction under Section 36(1)(iii) of the Income-tax Act, 1961

T H E  F A C T S

                On 31.12.92 assessee filed its return of income for A.Y. 1992-93 declaring “nil” income.  Later on the assessee filed a revised return on 6.8.93 declaring a loss of Rs.1,11,68,543/-.  Assessee-company is engaged in the business of manufacturing and sale of intravenous solutions.  For the assessment year under consideration assessee claimed deduction towards expenses aggregating to Rs.2,12,05,459/- which included interest on borrowings of Rs.1,56,76,000/-. 

During the assessment year under consideration assessee had installed new machinery.  The A.O. vide assessment order dated 30.3.95 disallowed the amount of Rs.1,56,76,000/- placing reliance on the judgment of this Court in Challapalli Sugars Ltd. & Anr. v. Commissioner of Income-tax, A.P. and Anr. – (1975) 98 ITR 167, inter alia, on the ground that during the assessment year under consideration assessee had installed new machinery on which production had not started.  On appeal, vide order dated 15.11.96, CIT (A) confirmed the addition of interest amount on borrowings of Rs.1,56,76,000.  Therefore, both the authorities, namely, the A.O. and CIT (A) added the said amount of Rs.1,56,76,000/- to the income of the assessee.  The matter was carried in appeal by the assessee.  Vide order dated 6.6.2000 the Tribunal held that the Department was not justified in adding Rs.1,56,76,000/- to the income of the assessee.  In other words, the Tribunal held that the A.O. was not justified in making disallowance of Rs.1,56,76,000/- in respect of borrowings utilized for purchase of machinery.  This decision was confirmed by the High Court, hence these civil appeals are filed by the Department.

T H E   R U L I N G:

Interest on moneys borrowed for the purposes of business is a necessary item of expenditure in a business.  For allowance of a claim for deduction of interest under the said section, all that is necessary is that – firstly, the money, i.e. capital, must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business; and, thirdly, the assessee must have paid interest on the borrowed amount.  All that is  germane is : whether the borrowing was, or was not, for the purpose of business.  The expression “for the purpose of business” occurring in Section 36(1)(iii) indicates that once the test of “for the purpose of business” is satisfied in respect of the capital borrowed, the assessee would be entitled to deduction under Section 36(1)(iii) of the 1961 Act.  This provision makes no distinction between money borrowed to acquire a capital asset or a revenue asset.  All that the section requires is that the assessee must borrow capital and the purpose of the borrowing must be for business which is carried on by the assessee in the year of account.  What sub-section (iii) emphasizes is the user of the capital and not the user of the asset which comes into existence as a result of the borrowed capital unlike Section 37 which expressly excludes an expense of a capital nature.  The legislature has, therefore, made no distinction in Section 36(1)(iii) between “capital borrowed for a revenue purpose” and “capital borrowed for a capital purpose”.  An assessee is entitled to claim interest paid on borrowed capital provided that capital is used for business purpose irrespective of what may be the result of using the capital which the assessee has borrowed.  Further, the words “actual cost” do not find place in Section 36(1)(iii) of the 1961 Act which otherwise find place in Sections 32, 32A etc of the 1961 Act. The expression “actual cost” is defined in Section 43(1) of the 1961 Act which is essentially a definition section which is subject to the context to the contrary.

                Before concluding on this point we may state that in this batch of civil appeals we are concerned with the assessment years 1992-93, 1993-94, 1995-96 and 1997-98.  A proviso has since been inserted in Section 36(1)(iii) of the 1961 Act.  That proviso has been inserted by Finance Act, 2003 w.e.f. 1.4.2004.  Hence, the said proviso will not apply to the facts of the present case.  Further, in our view the said proviso would operate prospectively.  In this connection it may be noted that by the same Finance Act, 2003 insertions have been made by way of proviso in Section 36(1)(viia) by the same Finance Act which is also made with effect from 1.4.2004.  Same is the position with regard to insertion of a sub-section after Section 90(2) and before the Explanation.  This insertion also operates w.e.f. 1.4.04.  In short, the above amendments have been made by Finance Act, 2003 and all the said amendments have been made operational w.e.f. 1.4.04.  Therefore, the proviso inserted in Section 36(1)(iii) has to be read as prospectively and w.e.f. 1.4.04.  In this case, we are concerned with the law as it existed prior to 1.4.2004.  As stated above, we are not concerned with the interpretation or applicability of the said proviso to Section 36(1)(iii) w.e.f. 1.4.04 in the present case. 

Section 36(1)(iii) of the 1961 Act has to be read on its own terms.  It is a Code by itself.  Section 36(1)(iii) is attracted when the assessee borrows the capital for the purpose of his business.  It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because of that the section requires is that the assessee must borrow the capital for the purpose of his business.  This dichotomy between the borrowing of a loan and actual application thereof in the purchase of a capital asset, seems to proceed on the basis that a mere transaction of borrowing does not, by itself bring any new asset of enduring nature into existence, and that it is the transaction of investment of the borrowed capital in the purchase of a new asset which brings that asset into existence.  The transaction of borrowing is not the same as the transaction of investment.  If this dichotomy is kept in mind it becomes clear that the transaction of borrowing attracts the provisions of Section 36(1)(iii). 

A.O. was not justified in making disallowance of Rs. 1,56,76,000/- in respect of borrowings utilized for purchase of machines.

(Source: Allindiantaxes)

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: