2024 (7) TMI 1723 - AT - Income Tax

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 ... Disallowance of interest on borrowed capital - assessee has made investments in shares of the group companies - search and seizure operations U/s. 132 as conducted in the group cases - HELD THAT:- Provisions of U/s.36(1)(iii) of the Act, deals with deduction of Interest paid on borrowed capital. As per the said provision, if interest paid on borrowed capital is not utilized for the purpose of business, then same cannot be allowed as deduction. AO disallowed the entire interest paid on borrowed capital for the reason of diversion of interest bearing funds to group companies as his personal investment - Assessee before the AO explained that the investment made in group companies to derive substantial business advantage which is with commercial expediency and hence the question of disallowance of interest U/s. 36(1)(iii) of the Act, does not arise. Out of these investments, as rightly observed by the Ld. CIT(A), the assessee has made investment in Lalithaa Jewellery Mart Pvt ltd (LJMPL), which is involved in the similar kind of business that the assessee also carrying out. Based on the nature of business carried on by both the assessee and Lalithaa Jewellery Mart Pvt ltd (LJMPL) and other business transactions between them, we find that there is a business expediency in investment made by the assessee in acquiring the shares of the above company for strategic business purpose. CIT(A) has rightly allowed the portion of interest paid as eligible expenditure by properly analyzing the commercial expediency of the investment. We do not countenance the action of the AO in disallowing the entire interest paid, merely for the reason that the assessee had used interest bearing funds to make investment in acquiring shares of the Company as per the provisions of Section 36(1)(iii) of the Act. Interest paid on borrowed funds utilized for investment in group companies for strategic business purpose with commercial expediency cannot be disallowed U/s. 36(1)(iii) of the Act. CIT(A) has rightly allowed the interest paid on borrowed funds, which is utilized for the investment in the shares of the company LJMPL as an expenditure U/s.36(1)(iii) of the Act, and thus we dismiss the appeal of the revenue. 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.