2024 (4) TMI 1233 - HC - Income Tax

Interest deduction allowed under Section 36(1)(iii) for share purchase financing upheld despite Revenue's tax avoidance claims

Gujarat HC upheld Tribunal's decision allowing interest deduction u/s 36(1)(iii) for share purchase financing. Revenue challenged disallowance deletion, ... Disallowance of interest u/s. 36(1)(iii) - purchase of shares was mainly for acquiring controlling rights in another company. HELD THAT:- When both final fact finding authorities have arrived at the same concurrent findings of fact, no further investigation is required to be undertaken to inquire about circular trading entered into solely with the idea of evading tax by assessee acquiring the shares of AEC through finances arrange mainly from sister companies of the Torrent Group along with two other companies to enable the Torrent Group to acquire and take over the business of AEC. No substantial question of law can be said to have arisen from the impugned order passed by the Tribunal as both CIT (A) and Tribunal have rightly deleted the addition made by the AO u/s 36(1)(iii) after recording the above findings that assessee has made investment during the course of business for purchase and sale of the share which represented only 2.56% of the total share capital of AEC and therefore, there cannot be any intention of the respondent-assessee to become a tool to acquire the shares of AEC by Torrent Group. No substantial question of law. ISSUES PRESENTED and CONSIDEREDThe core legal question considered in this judgment is whether the appellate tribunal was correct in law and on facts in confirming the order passed by the CIT (A) that deleted the disallowance of interest made by the Assessing Officer under Section 36(1)(iii) of the Income Tax Act. The disallowance was based on the ground that the purchase of shares was primarily for acquiring controlling rights in another company, specifically Ahmedabad Electricity Company Ltd. (AEC).ISSUE-WISE DETAILED ANALYSISRelevant Legal Framework and PrecedentsThe legal framework revolves around Section 36(1)(iii) of the Income Tax Act, which allows for the deduction of interest paid on capital borrowed for the purposes of the business. The key question is whether the interest paid on borrowed funds used to purchase shares can be considered a business expenditure or a capital expenditure aimed at acquiring controlling interest in another company.Relevant precedents include the case of Ormerods (India) Pvt. Ltd. vs. CIT, where the Bombay High Court allowed interest on borrowed capital for the purchase of shares as a deductible expense. This decision was approved by the Supreme Court, reinforcing the principle that the purpose of the expenditure should be to earn income, even if the connection is indirect.Court's Interpretation and ReasoningThe Court, in its interpretation, relied on the reasoning previously established by the CIT (A) and the Tribunal. Both authorities found that the borrowed funds were used for business purposes, specifically for the purchase and sale of shares, which was within the main object of the assessee's business as per its Memorandum of Association. The CIT (A) and Tribunal concluded that the interest expenditure was a legitimate business expense under Section 36(1)(iii) because the shares represented only 2.56% of AEC's share capital, indicating no intention to acquire controlling rights.Key Evidence and FindingsThe CIT (A) and Tribunal considered several key pieces of evidence, including the assessee's Memorandum of Association, which outlined the business objective of acquiring, holding, and selling shares. The evidence also showed that the shares were sold in the subsequent year at a profit, reinforcing the business nature of the transaction. The Tribunal distinguished the facts of this case from the Sarabhai Sons Pvt. Ltd. case, where 100% control was acquired, unlike the minor percentage in the current case.Application of Law to FactsApplying the law to the facts, the Court found that the interest paid on the borrowed funds used to purchase shares was a deductible business expense. The Tribunal's decision to uphold the CIT (A)'s order was based on the consistent application of the principle that the acquisition and sale of shares were part of the assessee's business activities, and the interest incurred was for business purposes.Treatment of Competing ArgumentsThe Revenue argued that the interest should be disallowed as it was capital expenditure aimed at acquiring control over AEC. However, this argument was countered by the Tribunal's findings that the shares acquired were a minor percentage of AEC's total share capital and were sold at a profit, demonstrating a business transaction rather than an attempt to gain control.ConclusionsThe Court concluded that the Tribunal and CIT (A) rightly deleted the disallowance of interest, as the transaction was a business activity within the scope of the assessee's objectives. The acquisition of shares did not constitute an attempt to gain controlling interest, and the interest expense was a legitimate business deduction under Section 36(1)(iii).SIGNIFICANT HOLDINGSThe Court preserved the significant legal reasoning that interest on borrowed funds used for business activities, such as the purchase and sale of shares, is deductible under Section 36(1)(iii) of the Income Tax Act. The core principle established is that the purpose of the expenditure should be to earn income, and the connection between the expenditure and income need not be direct.The final determination was that no substantial question of law arose from the Tribunal's order, as the findings of fact by the CIT (A) and Tribunal were consistent and supported by evidence. The appeal was dismissed, affirming the Tribunal's decision to allow the interest deduction as a business expense.