Business expediency and interest on borrowed capital: deductibility depends on nexus, dominant purpose, and prudent businessman assessment.

The text addresses deductibility of interest on borrowed capital, clarifying that entitlement depends on the nexus between the advance/investment and business purpose assessed by the dominant purpose test; if the dominant purpose is not to earn income, deduction is not available. The plain language of the provision requires natural meaning, but tax authorities have jurisdiction to probe the substance, lift the veil and determine true legal character where devices conceal nature of transactions. The appropriate standard for assessment is whether a prudent person acting in the taxpayers business would have made the transaction, and enquiries must be fact-specific without becoming a roving probe.

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Issues: Whether the taxing authorities (Assessing Officer and appellate authorities) are entitled to examine the purpose and commercial/business expediency of transactions between group concerns, lift the veil to determine the true legal relation and deny deduction where the dominant purpose is not to earn income.

Analysis: Relevant provisions governing deduction and business expenditure (Sections 36(1)(iii), 37(1) and 57(iii) of the Income-tax Act, 1961) require that expenditure be wholly and exclusively for the purpose of making or earning income. Judicial authorities establish that tax planning is permissible but the tax authority may ascertain the true legal relation and dominant purpose of transactions; commercial expediency is to be assessed by applying the prudent businessman test. Authorities may lift the corporate veil where a device conceals the real character of the transaction, but such inquiry must not become a roving or deep probe and each case depends on its own facts.

Conclusion: The Assessing Officer and appellate authorities have jurisdiction to examine business/commercial expediency, determine the true legal relation between group entities and, where appropriate, disallow deductions if the dominant purpose is not to earn income; the inquiry must apply the prudent businessman/commercial expediency test and avoid a roving enquiry.

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