Capitalization of Interest paid for Capital Gain purpose

[Ethirajan Parthasarathy]

Zuhari Investments Ltd., ITAT Delhi, Maithreyi Pai, Karnataka HC, Trishul Investments, Madras HC allowed capitalization of interest on borrowed funds for acquiring shares etc., while calculating capital gain provided such interest was not claimed as deduction elsewhere.

Can such interest incurred post-acquisition be claimed as deduction for calculating capital gain on Market Linked Debentures (MLDs) u/s 50AA which is specifically introduced to tax all capital gain on MLDs as “Short Term” as a measure to curb tax arbitrage

 

[Ryan Vaz]

Applicable Law / Case Law

1. Section 50AA, Income-tax Act, 1961 (inserted by FA 2023, w.e.f. AY 2024-25)
   • Deems any gain on transfer/redemption of MLDs as Short-Term Capital Gain (STCG), irrespective of holding period.
   • Computation mechanism refers back to section 48 (full value minus cost of acquisition & cost of improvement).
2. Section 48 (Computation of Capital Gains)
   • Allows deduction of:
     • Cost of acquisition
     • Cost of improvement
     • Transfer expenses
3. Judicial precedents on capitalization of interest
   • Zuhari Investments Ltd. - 2022 (1) TMI 240 - ITAT DELHI(ITAT Delhi)
   • CIT v. Maithreyi Pai - 1983 (11) TMI 43 - KARNATAKA HIGH COURT (Karnataka HC)
   • CIT v. Trishul Investments Ltd. - 2007 (7) TMI 252 - MADRAS HIGH COURT (Madras HC)

Ratio: Interest on borrowed funds used to acquire a capital asset can form part of cost of acquisition, provided it is not claimed as revenue deduction elsewhere.

4. CBDT Circular No. 2/2024 (Explanatory Memorandum to FA 2023)
   • Objective of s.50AA: Curtail tax arbitrage arising from LTCG treatment of MLDs.
   • No restriction placed on components of “cost” under section 48.

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Short Practical Answer

Yes — interest incurred post-acquisition of MLDs can be capitalised and deducted while computing STCG under section 50AA, provided:

• Borrowed funds were used to acquire the MLDs, and
• Such interest has not been claimed as deduction under any other head (e.g., s.36(1)(iii) or s.57).

Section 50AAchanges only the character of gain (always STCG); it does not override section 48 nor disallow capitalization of interest.

AI Summary

Capitalisation of interest on borrowed funds can form part of the cost for MLD capital gains, if not claimed elsewhere. Interest paid on borrowed funds used to acquire Market Linked Debentures can be capitalised and treated as part of the cost of acquisition for computing capital gain under section 50AA, because section 50AA only recharacterises gains as short term and does not displace section 48; this is permissible provided the interest was not claimed as a revenue deduction under any other head.