Borrowed-fund interest on commercial property purchase: not a business deduction, but allowed under s. 24(b); remanded.

Interest on borrowed funds for acquisition of a commercial property was disallowed as a business deduction under s. 36(1)(iii) because the assessee failed to demonstrate that the property was acquired and/or used for its business; the ITAT affirmed the disallowance. However, since the property was not occupied for business, its annual value was assessable under the head "Income from House Property" under s. 23, and interest paid on borrowings for acquiring the property was deductible from such annual value under s. 24(b). The matter was remanded to the AO to compute the property's annual value and allow the s. 24(b) interest deduction after granting opportunity of hearing.

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ISSUES PRESENTED AND CONSIDERED

1. Whether interest on borrowed capital used to acquire a commercial property was allowable as a deduction from business income under Section 36(1)(iii), when the assessee failed to establish that the property was put to use for business purposes during the relevant year.

2. Whether, in the alternative, the same interest was allowable under Section 24(b) while computing income under the head "Income from house property", and whether the matter required recomputation of annual value and consequential allowance of the deduction by the assessing authority.

ISSUE-WISE DETAILED ANALYSIS

Issue 1: Allowability of interest under Section 36(1)(iii) as business expenditure

Legal framework (as discussed by the Court): The Court proceeded on the accepted legal position that interest on capital borrowed for acquisition of a capital asset is not allowable under Section 36(1)(iii) prior to the asset being put to use for business purposes.

Interpretation and reasoning: It was a recorded finding that borrowed funds were utilized to acquire a commercial property. The assessee's claim depended on proving that the property was put to use in business during the relevant year. The assessee could not establish such user before the lower authorities or before the Court. A document relied upon to show business use was found to be of a later date than the relevant year and therefore did not prove business user during the year in question. The assessee conceded inability to dislodge the finding that business use was not proved.

Conclusions: Since the commercial property was not demonstrated to have been put to business use during the relevant year, the interest attributable to borrowing for acquiring that asset was not allowable as a business deduction under Section 36(1)(iii). The disallowance under Section 36(1)(iii) was upheld.

Issue 2: Alternative claim-allowability of interest under Section 24(b) under the head "Income from house property" and remand for computation

Legal framework (as discussed by the Court): The Court examined Section 24(b), which permits deduction of interest on borrowed capital used to acquire property while computing "Income from house property," and Section 22, under which annual value of property (other than portions occupied for business) is chargeable under that head. The Court also noted that annual value is to be determined under Section 23.

Interpretation and reasoning: It was a fact on record that the commercial property was not occupied for business purposes in the relevant year. Consequently, its annual value qualified for taxation under the head "Income from house property." Once so assessed, Section 24(b) permitted deduction of interest payable on borrowed capital used to acquire the property, but such deduction operates against the computed annual value. Therefore, the interest deduction could not be granted in isolation without first computing the annual value in accordance with law.

Conclusions: The assessee was held entitled in principle to deduction of interest under Section 24(b) against income from house property. The matter was restored to the assessing authority to compute the annual value as per law and then allow the interest deduction accordingly, after giving the assessee an opportunity of hearing.

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