2003 (1) TMI 93 - HC - Income Tax

Interest Paid on Borrowed Capital for Development Rights Deemed Fully Deductible Under Section 36(1)(iii)

The SC examined the tax treatment of interest on loans for acquiring development rights in a construction project. The court held that interest paid on ... Whether, the Tribunal was correct in law in holding that the interest claimed as revenue expenditure cannot be treated as capital expenditure and added to work-in-progress in spite of the fact that other expenses on project were being capitalised by the assessee itself and holding that the Commissioner of Income-tax was wrong in directing the Assessing Officer to disallow the said interest and treat the same as capital expenditure as a part of work-in-progress, thereby quashing the order under section 263 of the Act of the Commissioner of Income-tax? - HELD THAT:- Since the assessee had received loan for obtaining stock-in-trade (Kandivali project), the assessee was entitled to deduction under section 36(1)(iii) of the Act. That, while adjudicating the claim for deduction under section 36(1)(iii) of the Act, the nature of the expense--whether the expense was on capital account or revenue account--was irrelevant as the section itself says that interest paid by the assessee on the capital borrowed by the assessee was an item of deduction. That, the utilization of the capital was irrelevant for the purposes of adjudicating the claim for deduction under section 36(1)(iii) of the Act. In that judgment, it has been laid down that where an assessee claims deduction of interest paid on capital borrowed, all that the assessee had to show was that the capital which was borrowed was used for business purpose in the relevant year of account and it did not matter whether the capital was borrowed in order to acquire a revenue asset or a capital asset. The said judgment of the Bombay High Court applies to the facts of this case. We answer the above question in the affirmative, i.e., in favour of the assessee and against the Department. The appeal is accordingly disposed of. 1. ISSUES PRESENTED and CONSIDEREDThe core legal question considered by the Court was whether the interest paid by the assessee on loans borrowed for acquiring development rights for a construction project could be treated as revenue expenditure deductible under section 36(1)(iii) of the Income-tax Act, 1961, or whether it should be treated as capital expenditure and added to the cost of work-in-progress. Specifically, the Court examined the correctness of the Tribunal's decision to allow the interest deduction as revenue expenditure and whether the Commissioner of Income-tax was justified in invoking section 263 to disallow the interest deduction on the ground that the loan was for acquiring a capital asset.2. ISSUE-WISE DETAILED ANALYSISIssue: Treatment of interest on loan raised for acquiring development rights-Revenue or Capital ExpenditureRs.Relevant legal framework and precedents: The primary statutory provision under consideration was section 36(1)(iii) of the Income-tax Act, 1961, which allows deduction of interest paid on moneys borrowed for the purpose of the business. The Commissioner of Income-tax relied on section 263 to revise the assessment order, holding that the loan was for acquiring a capital asset and therefore the interest should be treated as capital expenditure and not deductible as revenue expenditure.The Court referred to the precedent set by the Supreme Court in India Cements Ltd. v. CIT, which clarified that the purpose for which the loan was obtained is irrelevant for the claim of deduction under the corresponding provision of the earlier Income-tax Act (section 10(2)(iii) of the 1922 Act, analogous to section 36(1)(iii) of the present Act). The Supreme Court held that if the borrowing is incidental to the carrying on of business, the loan itself is not an asset, and interest on such borrowing is deductible.Court's interpretation and reasoning: The Court analyzed the nature of the assessee's business and the transaction in question. The assessee was engaged in construction and sale of flats and followed a mercantile system of accounting with a modified project completion method. The development rights acquired from Bombay Gaw Rakshak Mandal for the Kandivali project formed part of the stock-in-trade rather than a fixed capital asset. The Court emphasized that the project itself constituted stock-in-trade and not a capital asset.The Court reasoned that since the loan was raised for acquiring stock-in-trade (development rights for the construction project), the interest paid on such borrowing fell within the ambit of deductible revenue expenditure under section 36(1)(iii). The Court rejected the Commissioner's view that the loan was for a capital asset and that interest should be capitalized, holding that the utilization of the borrowed capital-whether for acquiring a capital or revenue asset-was irrelevant for the purpose of the interest deduction claim under section 36(1)(iii).Key evidence and findings: The facts established that the assessee had paid Rs. 1.10 crores towards development rights and incurred other project-related expenses shown as work-in-progress. The loan of Rs. 1.15 crores was utilized for this purpose. No conveyance was executed by the end of the relevant accounting period, and no activity was carried out during the assessment year, resulting in work-in-progress being carried forward.Application of law to facts: Applying the principle from India Cements Ltd., the Court held that the loan was incidental to the business of construction and sale of flats, and the interest paid was therefore deductible as revenue expenditure. The fact that other project expenses were capitalized did not alter the nature of the interest expense under section 36(1)(iii).Treatment of competing arguments: The Department argued that the loan was for acquisition of a capital asset (development rights) and interest should be capitalized. The Court rejected this, holding that the project constituted stock-in-trade and the loan was for business purposes. The Commissioner's use of section 263 to revise the assessment order was found to be erroneous because the original assessment order allowing the deduction was legally sustainable.Conclusions: The Court concluded that the interest paid on the borrowed capital was deductible under section 36(1)(iii) as revenue expenditure. The Commissioner of Income-tax's order under section 263 disallowing the interest deduction was quashed. The Tribunal's decision restoring the assessment order allowing the deduction was upheld.3. SIGNIFICANT HOLDINGS'In cases where the act of borrowing was incidental to the carrying on of business, the loan obtained was not an asset. That, for the purposes of deciding the claim of deduction under section 10(2)(iii) of the Indian Income-tax Act, 1922 (section 36(1)(iii) of the present Income-tax Act), it was irrelevant to consider the purpose for which the loan was obtained.''The Kandivali project constituted the stock-in-trade of the assessee. That the project did not constitute a fixed asset of the assessee.''While adjudicating the claim for deduction under section 36(1)(iii) of the Act, the nature of the expense-whether the expense was on capital account or revenue account-was irrelevant as the section itself says that interest paid by the assessee on the capital borrowed by the assessee was an item of deduction.''Where an assessee claims deduction of interest paid on capital borrowed, all that the assessee had to show was that the capital which was borrowed was used for business purpose in the relevant year of account and it did not matter whether the capital was borrowed in order to acquire a revenue asset or a capital asset.'The Court's final determination was in favor of the assessee, holding that the interest on loan raised for acquiring development rights forming part of stock-in-trade was deductible under section 36(1)(iii) and the Commissioner's revision under section 263 was not justified. The appeal filed by the Department was accordingly dismissed.