Appeals dismissed: interest on loans used to buy shares deductible when shares later classified as stock-in-trade

The HC dismissed the appeals and affirmed the Tribunal's allowance of interest deduction, holding that the object of the loan is irrelevant and interest attributable to funds used for acquiring shares must be allowed even though initially shown as investments, since subsequent balance-sheets classified the shares as stock-in-trade. The court found the Assessing Officer and CIT(A) erred in treating the amounts as remaining investments and thus interfering was unnecessary; the Tribunal's view permitting the deduction was upheld.

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Issues: (i) Whether interest on borrowed funds used to acquire shares is deductible under Section 36(1)(iii) of the Income-tax Act, 1961 where the shares were held partly as investment and partly as stock-in-trade; (ii) Whether the Tribunal was justified in restoring for verification the claim that shares shown as investment were converted into stock-in-trade and in directing consideration under Section 45(2) of the Income-tax Act, 1961.

Issue (i): Whether interest on borrowed capital used for acquiring shares (held as investment and as stock-in-trade) is allowable as deduction under Section 36(1)(iii) of the Income-tax Act, 1961.

Analysis: Precedent establishes that Section 36(1)(iii) allows deduction of interest on capital borrowed if the capital was borrowed for the purpose of the assessee's business, irrespective of whether the borrowed capital was used to acquire a revenue or a capital asset. Authorities applying the principle include India Cements Ltd. and decisions applying the test that the object of the loan is irrelevant; the Calcutta High Court in Rajeeva Lochan Kanoria similarly held that utilization for business purposes is decisive. The Tribunal applied these principles to find that an investment company borrowing funds for share acquisitions (whether held as investment, stock-in-trade, or for control) satisfies the business-purpose test and that interest is deductible under Section 36(1)(iii).

Conclusion: Interest on borrowed funds used to acquire the shares held partly as investment and partly as stock-in-trade is deductible under Section 36(1)(iii) of the Income-tax Act, 1961. This conclusion is in favour of the respondent.

Issue (ii): Whether the Tribunal was right to restore for verification the claim that shares originally shown as investment were converted into stock-in-trade and to direct consideration with reference to Section 45(2) of the Income-tax Act, 1961.

Analysis: The balance-sheets showed the shares as investment in one year and as stock-in-trade in subsequent years; factual verification of entries and of the alleged conversion was necessary to determine the correct tax treatment and valuation. The Tribunal found that the revenue authorities had not adequately examined these facts and directed reassessment of the conversion and valuation issue with reference to Section 45(2).

Conclusion: The Tribunal's direction to verify the claimed conversion of investment into stock-in-trade and to consider valuation under Section 45(2) is justified. This conclusion is in favour of the respondent.

Final Conclusion: The Tribunal's allowance of interest under Section 36(1)(iii) and its remand for factual verification on conversion and valuation were upheld; the revenue appeal challenging those conclusions was dismissed.

Ratio Decidendi: Where capital is borrowed for the purpose of the assessee's business, interest payable on such borrowed capital is deductible under Section 36(1)(iii) of the Income-tax Act, 1961, irrespective of whether the borrowed funds are used to acquire assets of a capital nature or revenue nature, and the objective for which the loan was taken is immaterial.

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