Deduction of interest on genuine business borrowings cannot be cut down to a notional rate, even if linked to dividends.

Interest paid on genuine capital borrowed for business was deductible in full under section 10(2)(iii) of the Income-tax Act, 1922. The borrowing was held to be real and for business purposes, and the lenders were treated as creditors, not as shareholders receiving dividend in that capacity. Linking the contractual interest rate to the dividend declared did not change the character of the payment, because it remained interest on borrowed capital. The taxing authority could not substitute a notional reasonable rate or reduce the deduction on the ground that the agreed rate was commercially high. The full interest actually paid was therefore allowable.

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Issues: Whether interest paid on capital borrowed from shareholders, at a rate linked to the dividend declared and exceeding 6%, was deductible in full under section 10(2)(iii) of the Income-tax Act, 1922.

Analysis: The borrowing was found to be genuine and undertaken for business purposes. The lenders were creditors and not recipients of dividend in their character as shareholders; the right to interest arose from the loan and not from shareholding. The fact that the stipulated interest varied with the rate of dividend did not alter the character of the payment, because the payment remained interest on borrowed capital. Section 10(2)(iii) allowed the amount of interest actually paid on capital borrowed for the business and did not authorise the taxing authority to substitute a subjective reasonable rate. The arrangement was not treated as a device to distribute profits under the guise of interest.

Conclusion: The disallowance of interest in excess of 6% was not justified in law, and the assessee was entitled to deduction of the full interest paid.

Final Conclusion: Interest paid on genuine borrowings for business remained deductible even where the contractual rate was linked to dividends, and the deduction could not be curtailed to a notional reasonable rate.

Ratio Decidendi: Where a genuine borrowing for business purposes is established, the full contractual interest paid on the borrowed capital is deductible under section 10(2)(iii), and the deduction cannot be restricted on the ground that the agreed rate is commercially excessive or linked to profits or dividends.

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