Interest on strategic group company investments held deductible as business expenditure under S.36(1)(iii), revenue's appeal dismissed

ITAT Chennai dismissed the revenue's appeal, upholding the CIT(A)'s order allowing deduction of interest under S.36(1)(iii). The assessee had borrowed funds and invested in shares of a group company engaged in the same line of jewellery business. On facts, the investment was found to be strategic and driven by commercial expediency, conferring substantial business advantage. The Tribunal held that interest on borrowed capital used for such commercially expedient, strategic investments in group companies constitutes allowable business expenditure, and the AO's blanket disallowance of interest was unjustified.

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1. ISSUES PRESENTED AND CONSIDERED

(1) Whether interest on borrowed capital utilized for investment in shares of a group company engaged in the same line of business is deductible under section 36(1)(iii) on the ground of commercial expediency.

(2) Whether disallowance of interest under section 36(1)(iii) should be made with reference to section 14A where the assessee claims to have sufficient own funds for its investments.

2. ISSUE-WISE DETAILED ANALYSIS

(1) Deductibility of interest on borrowed capital used for investment in shares of group company under section 36(1)(iii)

Legal framework

(a) Section 36(1)(iii) allows deduction of "the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession".

(b) The proviso to section 36(1)(iii) restricts deduction of interest relatable to capital borrowed for acquisition of an asset up to the date the asset is first put to use.

(c) The judgment refers to and applies the principle laid down by the Supreme Court in S.A. Builders Ltd. that the expression "for the purposes of the business" is of wide import and that the allowability of interest depends on whether the advance/investment was made as a measure of "commercial expediency".

Interpretation and reasoning

(d) The Tribunal records that the assessee, a proprietor of a concern dealing in bullion, gold and diamond ornaments, primarily sells to one group flagship company, which runs multiple jewellery showrooms; the assessee "exists for this purpose only".

(e) The assessee had made substantial investment (Rs. 128.19 crores) in the shares of that flagship company, which is in the same line of business and is the principal buyer of the assessee's products.

(f) The assessee received substantial brand fee from the said company (Rs. 25.30 crores for AY 2020-21 and Rs. 30.36 crores for AY 2021-22), which was credited as professional income. The brand fee was considered as directly linked with the assessee's stake in and association with the said company.

(g) The Commissioner (Appeals) held that, given the business model, the nature of the relationship, and the predominant sales to this company, the investment in its shares was for business purposes and satisfied the test of commercial expediency laid down in S.A. Builders Ltd.; accordingly, interest attributable to such investment was allowable.

(h) The Tribunal noted that the Assessing Officer had disallowed the entire interest on the ground that borrowed funds were diverted to group companies as personal/non-business investments, without adequately appreciating the business nexus and strategic character of the shareholding in the flagship company.

(i) The Tribunal accepted the assessee's contention, as upheld by the Commissioner (Appeals), that the investment in shares of the flagship group company was a strategic business investment intended to secure substantial business advantages and control, and thus constituted application of borrowed capital "for the purposes of business".

(j) The Tribunal relied on the principle that, once a nexus between the expenditure (interest) and the purpose of the business (including commercial expediency in relation to group/associated entities or strategic investments) is established, the Revenue cannot step into the shoes of the businessman to re-evaluate business decisions or deny deduction merely because borrowed funds have been used for investments in group companies.

(k) In line with decisions cited and relied upon (including S.A. Builders Ltd. and various High Court/Tribunal rulings on interest for strategic investments in group concerns), the Tribunal treated the share investment in the flagship company as falling within the permissible ambit of section 36(1)(iii).

Conclusions

(l) Interest on borrowed funds to the extent relatable to investment in shares of the flagship group company engaged in the same business and providing substantial business/brand income to the assessee is allowable as a deduction under section 36(1)(iii), being incurred for purposes of business based on commercial expediency.

(m) The Assessing Officer's wholesale disallowance of interest under section 36(1)(iii) on the premise that such investment was non-business/personal was not sustainable.

(n) The order of the Commissioner (Appeals) allowing proportionate interest as deductible, to the extent attributable to investment in the flagship group company, was upheld and the Revenue's challenge was rejected.

(2) Applicability of section 14A vis-à-vis section 36(1)(iii) in the context of investments claimed to be out of own funds

Legal framework

(a) The assessee invoked section 14A to contend that, if at all any disallowance was warranted in relation to investments generating exempt income, it should be made under that provision and not under section 36(1)(iii), especially when segregation between borrowed and own funds was not feasible.

Interpretation and reasoning

(b) The Commissioner (Appeals) noted that the assessee's investments were not confined to share capital but included debt capital (loans) to various entities, and that the assessee itself was asserting "business expediency" for these investments.

(c) On that reasoning, the Commissioner (Appeals) held that the core question was whether there was business expediency in such investments, squarely attracting examination under section 36(1)(iii) rather than section 14A; section 14A was therefore considered inapplicable and the assessee's argument was rejected.

(d) The Commissioner (Appeals) also rejected the assessee's plea of having sufficient own funds, observing that if sufficient own funds were genuinely available, there would be no need to borrow and incur substantial interest cost; no specific cash-flow or one-to-one fund-tracking was furnished to show that own funds, and not borrowed funds, were utilized for the impugned investments.

(e) For investments other than in the flagship group jewellery company, the Commissioner (Appeals) found no established commercial/business nexus: many investee entities were in unrelated fields (real estate, renting service, motor vehicle body manufacture, insurance, media, software, etc.), and even where some were in jewellery, no business relationship similar to that with the flagship company was proved.

(f) On these facts, the Commissioner (Appeals) confirmed disallowance of proportionate interest under section 36(1)(iii) on the non-business investments, and specifically declined to apply section 14A.

(g) The Tribunal did not find any infirmity in this approach, and focused its adjudication on the Revenue's challenge to the relief granted for interest linked to the flagship company's shares, leaving undisturbed the disallowance retained by the Commissioner (Appeals) on other investments.

Conclusions

(h) Section 14A was held to have no application in the facts of the case, as the primary enquiry was the presence or absence of commercial expediency under section 36(1)(iii) in respect of various investments.

(i) The plea of sufficient own funds, unsupported by specific fund-flow evidence, was rejected; disallowance of proportionate interest under section 36(1)(iii) on non-business/non-strategic investments was sustained.

(j) Only the interest attributable to the investment in the flagship group jewellery company, found to be for commercial expediency and business purposes, was allowed, and the Revenue's appeals against such relief were dismissed.

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