2021 (7) TMI 113 - HC - Income Tax

High Court overturns ITAT's disallowance of interest on borrowed capital for advocate, clarifies Section 36(1)(iii) proviso

The High Court of Karnataka allowed the appeal filed by the assessee, an advocate, challenging the Income Tax Appellate Tribunal's order regarding the ... Disallowance of interest on capital as attributable to capital work-in-progress relying on the proviso to Section 36(1)(iii) - as argued when the said proviso was inapplicable to the case of the appellant and no part of the borrowed capital was utilized for investment in work in progress in any event? - HELD THAT:- As decided in assessee's own case [2021 (3) TMI 1030 - KARNATAKA HIGH COURT]. The word ‘expansion’ and ‘extension’ connote different meaning and legislature in its wisdom has used the terms differently under various provisions of the Act itself and therefore, the words cannot be used synonymously. In this connection reference may be made to Section 80- IC(2)(b) and Section 80-IE(2)(ii) where the expression ‘expansion’ is used and ‘substantial expansion’ is defined as increase in investment in plant and machinery by a specified percentage of book value of plant and machinery. In Section 35D(1)(ii) and proviso to Section 36(1)(iii) (prior to its amendment in the year 2015), the legislature has employed the expression ‘extension’. Therefore, prior to its amendment the extension of business was covered under Section 36(1)(iii) of the Act and not the expansion of business. In the instant case, the assesee has set up new coffee shops, which amounts to expansion of business and therefore, the bar under the proviso Section 36(1)(iii) is not applicable. It is only after the amendment of Section 36(1)(iii) with effect from 01.04.2016 the proviso can be attracted to the case of expansion of business which is not applicable to the facts of the case as the case of the assessee pertains to Assessment Year 2010-11. Decided in favour of the assessee Issues Involved:Challenge to order passed by Income Tax Appellate Tribunal regarding disallowance of interest on borrowed capital under Section 36(1)(iii) of the Income Tax Act, 1961 for assessment years 2013-14 and 2014-15.Analysis:1. Disallowance of Interest on Borrowed Capital:The appellant challenged the order of the Income Tax Appellate Tribunal (Tribunal) upholding the disallowance of a sum of Rs. 1,46,83,683/- under Section 36(1)(iii) of the Income Tax Act for the assessment years 2013-14 and 2014-15. The Assessing Officer disallowed the interest on borrowed capital utilized for work in progress. The Commissioner of Income Tax (Appeals) had initially set aside the disallowance, but the Tribunal reversed this decision based on a previous order related to the appellant's assessment for the year 2010-11. The substantial question of law was whether the disallowance was correct under the circumstances. The appellant cited a previous judgment by a Coordinate Bench of the Court to support their case, emphasizing the principle that investments made from interest-free funds should not be presumed to be from borrowed funds unless proven otherwise by the revenue. The Court agreed with the appellant's arguments, considering the nature of the investments and the availability of interest-free funds, and quashed the Tribunal's order, ruling in favor of the appellant.2. Interpretation of Proviso to Section 36(1)(iii):The Court delved into the interpretation of the proviso to Section 36(1)(iii) of the Income Tax Act, which was inserted in 2004 to restrict deductions for interest on borrowed capital related to the extension of existing businesses. The appellant's case involved setting up new coffee shops, constituting an expansion of the business rather than an extension. The Court highlighted the distinction between 'expansion' and 'extension' in legislative terms, noting that the proviso did not apply to cases of business expansion before the 2016 amendment. The Court referred to relevant legal precedents and legislative provisions to support its interpretation. The revenue did not contest the legal position established by a previous judgment of the Court, leading to the Court quashing the Tribunal's order and ruling in favor of the appellant.Conclusion:The High Court of Karnataka, in a judgment delivered by a Division Bench, allowed the appeal filed by the assessee, an advocate, challenging the Income Tax Appellate Tribunal's order regarding the disallowance of interest on borrowed capital for the assessment years 2013-14 and 2014-15. The Court found in favor of the appellant, holding that the disallowance was not justified given the nature of the investments and the availability of interest-free funds. The Court also clarified the applicability of the proviso to Section 36(1)(iii) in cases of business expansion, ultimately quashing the Tribunal's order.