Interest on Capital Borrowed Deductible as Business Expense

The tribunal confirmed the CIT(A)'s order disallowing the disallowance of interest paid on a deposit made outside the books of account. The tribunal held that the interest paid on capital borrowed falls under section 36(1)(iii) of the Act and is not prohibited by law, making it deductible as expenditure for business purposes under section 37(1) of the Income-tax Act. The tribunal distinguished previous judgments and dismissed the revenue's appeal and the taxpayer's cross objection.

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Issues involved:
Disallowance of interest paid on deposit outside the books of account.

Analysis:
The appeal concerns the disallowance of interest paid on a deposit made outside the books of account. The appellant, represented by the ld. DR, argued that the taxpayer received a deposit outside the books of account and paid interest, violating the provisions of the Kerala Money Lenders' Act and RBI Act. The assessing officer disallowed the claim, citing that any expenditure incurred for an offense or prohibited by law shall not be deemed for business purposes. The ld. DR relied on judgments from the Karnataka High Court and Bombay High Court to support the disallowance.

In response, the ld. senior counsel for the taxpayer argued that the taxpayer operated a money lending business individually, not under the business name. The borrowed money was not shown in the business's books, and interest payments were personally managed. The ld. senior counsel contended that the interest paid on capital borrowed falls under section 36(1)(iii) of the Act and is not prohibited by law. The CIT(A) also found that interest on such deposits in personal capacity is not forbidden by law.

The tribunal analyzed section 37(1) of the Income-tax Act, which allows expenditure wholly and exclusively for business purposes. The Explanation to section 37(1) clarifies that any expenditure for an offense or prohibited by law shall not be considered for business purposes. The tribunal noted that the taxpayer borrowed funds for the money lending business's working capital, making interest payments deductible under section 36(1)(iii). The tribunal distinguished previous judgments where interest payments were disallowed due to different circumstances. As the interest in this case was allowable under section 36(1)(iii), the Explanation to section 37(1) was deemed inapplicable. Consequently, the tribunal confirmed the CIT(A)'s order.

Additionally, the cross objection filed by the taxpayer was dismissed as it only supported the CIT(A)'s order. Therefore, both the appeal of the revenue and the cross objection of the taxpayer were dismissed.

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