Interest nexus and exempt investment disallowance shape set-off, with disallowed interest treated as share acquisition cost.

Interest expenditure was treated as deductible only to the extent of a direct nexus with interest earned on term deposits, so the set-off was allowed only up to the income actually received. Interest attributable to exempt investments was disallowed under section 14A, and the Tribunal sustained the view that such disallowed interest could be capitalised as part of the cost of acquisition of the relevant shares for capital gains computation. The note thus applies nexus-based deduction principles and the treatment of disallowed investment-related interest in share cost determination.

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Issues: (i) Whether the assessee was entitled to deduction of interest expenditure under section 57(iii) against interest earned on term deposits to the extent of the interest income actually earned; (ii) whether the interest expenditure attributable to exempt investments was correctly disallowed under section 14A and whether such disallowance could be capitalised as part of the cost of acquisition of shares.

Issue (i): Whether the assessee was entitled to deduction of interest expenditure under section 57(iii) against interest earned on term deposits to the extent of the interest income actually earned.

Analysis: The deposits yielding interest were found to have arisen from liquidation of investments under the control of the Special Court, and the material on record showed a nexus between the borrowed funds on which interest was paid and the income from term deposits. The Tribunal accepted that the assessee should be allowed deduction to the extent of the interest income earned, especially since a similar set-off had been allowed in the assessee's own case in a later year.

Conclusion: The assessee was entitled to set off interest expenditure against the interest income earned from term deposits to the extent of such income.

Issue (ii): Whether the interest expenditure attributable to exempt investments was correctly disallowed under section 14A and whether such disallowance could be capitalised as part of the cost of acquisition of shares.

Analysis: The Tribunal followed the co-ordinate Bench decision that interest relatable to investment in shares, being disallowable under section 57, would form part of the cost of acquisition of shares for computing profit on sale. The Commissioner (Appeals) had also applied the Rule 8D methodology to segregate interest directly relatable to exempt investments.

Conclusion: The disallowance attributable to exempt investments was upheld, and capitalization of the disallowed interest as part of the cost of shares was sustained.

Final Conclusion: The assessee's appeals succeeded on the interest-set-off issue, while the Revenue's appeals failed on the capitalization issue, leaving the consolidated outcome in favour of the assessee.

Ratio Decidendi: Interest expenditure is deductible only to the extent it is shown to have a direct nexus with the income earned, and interest disallowed in relation to investments may be treated as part of the cost of acquisition of the relevant shares for capital gains computation.

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