2004 (7) TMI 39 - HC - Income Tax

Court allows deduction of interest paid on borrowed funds for share investments under Income-tax Act, emphasizing purpose over actual income.

Commissioner of Income-Tax Versus M. Ethurajan.

The court affirmed the Income-tax Appellate Tribunal's decision, allowing the deduction of interest paid on borrowed funds under section 57(iii) of the ... Interest on moneys borrowed for investment in shares which had not yielded any dividend - Tribunal holding that the investment made by the respondent/assessee, according to the directions of the BIFR with the view to sustain the control over the company and to protect the shares already existing in the company, is a reasonable expenditure and is wholly and exclusively made for the purpose of earning of income, and therefore, the residuary provision u/s 57(iii), is applicable to this case, as the same is not a capital expenditure, but an expenditure laid out or expended wholly and exclusively for making or earning such income. - What section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. The section does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction – assessee is entitle to deduction Issues:1. Interpretation of section 57(iii) of the Income-tax Act, 1961 regarding deduction of interest paid on borrowed funds.2. Whether interest paid on borrowings for investment in shares without receiving dividends is admissible as a deduction under section 57(iii) of the Act.Issue 1: Interpretation of section 57(iii) of the Income-tax Act, 1961The appellant, the Revenue, appealed against the order of the Income-tax Appellate Tribunal, Madras, which held that the investment made by the respondent/assessee as per BIFR directions to sustain control over a company is a reasonable expenditure under section 57(iii) of the Act. The Tribunal found that the expenditure was wholly and exclusively made for the purpose of earning income, not a capital expenditure. The appellant raised substantial questions of law questioning the treatment of interest-free loans given to a company and the deduction under section 57(iii) for interest paid on borrowed funds. The court referred to CIT v. Rajendra Prasad Moody [1978] 115 ITR 519, where it was held that interest on borrowed funds for shares without dividends is admissible under section 57(iii) of the Act. The court emphasized that the section requires expenditure to be laid out for making or earning income, not necessarily that income must have been earned. The court dismissed the appeal, affirming the Tribunal's decision.Issue 2: Deduction of interest paid on borrowings for shares without receiving dividendsThe respondent/assessee borrowed funds and invested in a sick company under BIFR directions to earn dividends. However, no dividends were received, leading to a claim for deduction of interest paid on the borrowings under section 57(iii) of the Act. The court analyzed the case in light of the precedent set in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519, which allowed deductions for interest on borrowed funds for shares without dividends. The court highlighted that section 57(iii) requires expenditure to be wholly and exclusively made for earning income, not contingent on actual income earned. Therefore, the court upheld the Tribunal's decision, dismissing the appeal by the Revenue against the allowance of the deduction under section 57(iii) for the interest paid on the borrowed funds.This judgment clarifies the interpretation of section 57(iii) of the Income-tax Act, 1961 regarding the deduction of interest paid on borrowed funds for investments, emphasizing that the expenditure must be laid out for the purpose of making or earning income, irrespective of actual income earned. The court's decision reaffirms the principle that deductions under section 57(iii) are permissible even if the investment does not yield income, as long as the expenditure was made with the intention of earning income.