Deductibility of debenture interest under income tax law upheld where borrowing served a commercial investment purpose.

Interest paid on debentures issued in a capital reduction transaction was held to be deductible only if the expenditure was incurred solely for the purpose of making or earning assessable income under Section 12(2) of the Income-tax Act, 1922. The Court applied the test that the outlay need not be capital in nature, but must be directed solely to earning income. It held that the commercial character of the arrangement, the absence of fraud, and the identity between the debenture holder and the share seller did not alter the nature of the borrowing. Interest on money borrowed for investment purposes remained allowable, and the deduction was permitted.

---

---

Issues: Whether interest paid on debentures issued in consideration of a capital reduction transaction was expenditure incurred solely for the purpose of making or earning assessable income under Section 12(2) of the Income-tax Act, 1922.

Analysis: The relevant test under Section 12(2) is whether the expenditure, though not capital in nature, was incurred for the purpose of earning income and whether it was incurred solely for that purpose. The fact that the transaction did not disturb the company's investments, reduced taxable income, or benefited the counterparty was not decisive in the absence of fraud. The transaction was entered into as a commercial arrangement to facilitate the carrying on of the company's business, and interest on money borrowed for investment purposes is deductible whether the borrowing takes the form of an overdraft, deposit, or debenture. The identity of the debenture holder with the share seller did not alter the legal character of the expenditure.

Conclusion: The interest on the debentures was an allowable deduction under Section 12(2) of the Income-tax Act, 1922, and the answer to the referred question was in the affirmative.

---