Interest on borrowings used to pay tax liabilities was not deductible, while a disputed cash credit was deleted for lack of proof.

Interest on borrowed capital used to discharge income-tax and excess profits tax liabilities was held not deductible in computing business profits because section 10(2)(iii) requires the borrowing to be used for business purposes, and tax is an application of profits rather than expenditure incurred to earn them; the disallowance was upheld. The revenue also failed to prove that a credit of 77,000 represented undisclosed income, as the surrounding circumstances were equivocal and did not reliably establish income from undisclosed sources; the addition was deleted.

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Issues: (i) Whether interest paid on borrowed capital used to meet income-tax and excess profits tax liabilities was deductible in computing business profits; (ii) Whether the sum of Rs. 77,000 credited in the assessee's books could be treated as undisclosed income.

Issue (i): Whether interest paid on borrowed capital used to meet income-tax and excess profits tax liabilities was deductible in computing business profits.

Analysis: The allowance under section 10(2)(iii) of the Indian Income-tax Act, 1922, depends not merely on borrowing for business purposes but on the borrowed capital being used for the purposes of the business. Interest referable to money diverted for non-business purposes is not deductible. Tax liability arises after profits are earned and is an application of profits, not an expenditure incurred for earning them. Section 10(4) also negatives any deduction of tax paid on profits, and interest on money borrowed to pay such tax is equally not a legitimate business deduction.

Conclusion: The disallowance of interest attributable to borrowed funds used for payment of tax liabilities was upheld and this issue was decided against the assessee.

Issue (ii): Whether the sum of Rs. 77,000 credited in the assessee's books could be treated as undisclosed income.

Analysis: The material relied upon by the revenue consisted of equivocal circumstances such as absence of receipts, use of bearer cheques, and non-traceability of depositors. Those circumstances did not furnish reliable proof that the credits represented income from undisclosed sources, especially when the surrounding book entries and the short duration of the deposits did not support such an inference.

Conclusion: The addition of Rs. 77,000 as undisclosed income was set aside and this issue was decided in favour of the assessee.

Final Conclusion: The reference was disposed of with the disallowance of interest sustained, while the addition of Rs. 77,000 as undisclosed income was deleted.

Ratio Decidendi: For deduction of interest under section 10(2)(iii), the borrowed capital must be used for business purposes, and interest on borrowing used to discharge tax liabilities is not deductible because tax is an application of profits after they are earned.

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