Deduction for share-related interest and litigation costs fails when the income source has already ceased to exist.

Under section 12(2), deduction is confined to expenditure, other than capital expenditure, incurred solely for earning income from an existing source. Where a block of shares had already ceased to be held by the assessee, the related dividend source was no longer in existence, so interest on the unpaid purchase price was not deductible. On the same reasoning, legal expenditure incurred in defending litigation concerning that block of shares was too remote from the earning of income from an existing source and was also not deductible. The note therefore states the principle that the existence of the income source at the time the expense is incurred is essential to deduction.

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Issues: (i) Whether interest payable on the unpaid purchase price of shares, after the relevant block of shares had ceased to be held by the assessee, was deductible under section 12(2). (ii) Whether legal expenditure incurred in defending litigation relating to that block of shares, after the shares had ceased to be held by the assessee, was deductible under section 12.

Issue (i): Whether interest payable on the unpaid purchase price of shares, after the relevant block of shares had ceased to be held by the assessee, was deductible under section 12(2).

Analysis: Section 12(2) allows deduction only of expenditure not being capital expenditure and incurred solely for the purpose of making or earning income from a source then in existence. Dividend income is derived from shareholding, and a particular block of shares may constitute a distinct source of income if it is treated as a separate and identifiable holding. On the facts, the block of 19,250 shares was treated as a distinct group, but by the relevant previous years it was no longer owned by the assessee. Since the source of dividend income had ceased to exist in the assessee's hands when the interest liability arose, the expenditure could not be said to have been incurred for earning that dividend income.

Conclusion: The deduction of interest was not admissible and the issue was decided against the assessee.

Issue (ii): Whether legal expenditure incurred in defending litigation relating to that block of shares, after the shares had ceased to be held by the assessee, was deductible under section 12.

Analysis: The litigation related to the same block of shares that had already ceased to form part of the assessee's holdings. For the same reason that governed the interest claim, the expenditure was not incurred for the purpose of earning income from an existing source. Once the asset had gone out of the assessee's hands, the connection between the litigation expense and the earning of dividend income from that asset was too remote to satisfy section 12.

Conclusion: The legal expenditure was not deductible and the issue was decided against the assessee.

Final Conclusion: The reference was answered wholly in favour of the Revenue, and the assessee was denied the deductions claimed in respect of both interest and litigation .

Ratio Decidendi: Deduction under section 12(2) is allowable only for expenditure incurred while the source of income exists and solely for earning income from that source; where the relevant asset or source has ceased to be held, the related interest or litigation expense is not deductible.

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