Deduction under s 36(1)(iii)

Interest paid by the assessee, on account of an investment in its sister concern from borrowed funds for the acquisition of shares in a subsidiary company in order to have control over that company, is eligible for a deduction under s 36(1)(iii), as held by MumHC in CIT v Phil Corporation Ltd & Anr — In favour of: The assessee; Tax Appeal No 57 of 2002.

CIT v Phil Corporation Ltd. & Anr.

High Court of Bombay

Tax Appeal No. 57 of 2002

S A Bobde and F M Reis, JJ

Decided on: 28 June 2011

Counsel appeared:

Ms. Asha Dessai, Adv. for the appellant

Mr. M S Sonak, Adv. for the respondent

Judgment

Per: S A Bobde, J:

This appeal was admitted on the following substantial questions of law:

“A. Whether on the facts and in the circumstances of the case, the ITAT was right in directing

the Assessing Officer to allow deduction under section 80-IA pertaining to Konica Film Unit

without deducting depreciation under section 32 of the Income Tax Act ?

B. Whether on the facts and in the circumstances of the case, the ITAT was right in deleting

the addition of Rs.19,73,333/- being interest attributable to the borrowings made for

investment of Rs.3,70,00,000/- in Phil Photo Ltd., as the interest paid to Bank was related to

the debit balance arising from diversion to its sister concern which is not allowable under

section 36(1)(iii)?

C. Whether on the facts and in the circumstances of the case, the ITAT was justified in

holding that as the appeal against disallowance of provision for doubtful debts is withdrawn

before the ITAT, the claim of assessee towards bad debts written off amounting to

Rs.94,00,000/- be allowed as bad debts, without verifying whether they fulfil the condition

laid down under section 36(1)(iii) read with Section 36(2)?"

2. It is a common ground that the only question (a) has been decided against the respondent no.1-

assessee by judgment dated 30.08.2010 in Tax Appeal No. 58 of 2002 by this Court and as far as

question (c) is concerned, by consent the matter is remanded on this point to the Assessing Officer for verifying whether the amount of Rs.94,00,000/- can be claimed as bad debts after verifying whether the alleged bad debts fulfil the condition laid down under section 36(1)(iii) read with section 36(2) of the Income Tax Act.

3. The parties agreed that in question (c) above, “section 36(1)(vii)” be read instead of “section

36(1)(iii)”. Thus the only question that needs to be decided is whether the Income Tax Appellate

Tribunal (ITAT) was right in deleting the addition of Rs.19,73,333/- being interest on the loan taken

by the assessee for the investment of Rs.3,70,00,000/- in Phil Photo Ltd.

4. The assessee took a loan from the bank for a sum of Rs.3,70,00,000/-. This amount was invested by the assessee into the sister concern called Phil Photo Ltd., undisputedly, as an investment though no dividend has been received by the assessee. It was not disputed that the amount was paid to Phil Photo Ltd., as an integral part of the business. The assessee claimed a deduction under section 36(1)(iii) of the Income Tax Act in respect of the interest payable by it to the bank. section 36 reads as follows:

“36. (1) The deductions provided for in the following clauses shall be allowed in respect of the

matters dealt with therein, in computing the income referred to in section 28-

(i) …..............................

[(ia) …............................

[(ib)...............................

(A) …..............................

(B) …..............................

(ii) …..............................

[***]

[***]

(iia) ….............................

(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :

[Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an

asset for extension of existing business or profession ( whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.]

Explanation.-Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual

Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital

borrowed within the meaning of this clause;..........”

5. The Assessing Officer held that since the investment of Rs.3,70,00,000/- is out of borrowed funds

for business, the proportionate interest is to be disallowed. The Assessing Officer further observed

that since the assessee is entitled to receive an amount of 20% from Phil Photo Ltd., on account of

I.C.D., an amount of Rs.19,73,333/- is disallowed and is added to the gross total income. At this stage, it may be noted that the learned Counsel for the appellant is not in a position to point out any basis on which the Assessing Officer has treated the amount as I.C.D., and not an investment in the shares.

6. The Commissioner's order appears to have confirmed the demand in the tenor of reasoning that

even after investing the amount by the assessee in the Phil Photo Corporation as an investment as

debit balance assessment in the OD account of the assessee and when this money was diverted by

debiting this account, it went to increase the debit balance on which the interest is charged by the bank which is included in the total amount of interest claimed.

7. The Commissioner's order further appears to have treated the amount as bad debts. Before us the

learned Counsel for the appellant was not in a position to justify how this amount is treated as bad

debts, particularly since the amount is shown by the assessee as an investment in its account as

contended by the learned Counsel for the respondents.

8. The Commissioner of Income Tax (Appeals ) thus confirmed the order of the Assessing Officer.

9. In appeal, however, the ITAT found that the assessee had invested the amount in question in

subsidiary company - Phil Photo Ltd., for the acquisition of its shares i.e. to have a control over

majority shares but not to earn dividend on interest. Before ITAT, it was not disputed that such an

investment is an integral part of the business. In these circumstances, ITAT, therefore, came to the

conclusion that the assessee is entitled to the amount as deduction under section 36(1)(iii) of the

Income Tax Act.

10. Ms. Dessai, learned Counsel for the appellant submitted that the amount made over by the

assessee to Phil Photo Corporation must be treated as loan given to Phil Photo Corporation and since the amount was drawn directly from the overdraft account and paid to Phil Photo Corporation, it is attributed a pledging of debt on which the assessee would be entitled to earn interest since the

assessee now seeks to claim addition as bad debts, the Commissioner rightly disallowed the claim. We see no foundation in this submission since the assessee has nowhere stated that the amount has been paid to Phil Photo Corporation as loan neither there is anything to support the contention that the assessee is now claiming that the amount be added as an interest receivable on bad debts.

11. Mr. Sonak, learned Counsel for the respondent no.1 submitted that the Tribunal has rightly relied

on the decision of Shree Digvijay Cement Co. Ltd. v CIT (1982) (138 ITR 45) of the Gujarat High

Court. He further relied on CIT v Jardine Herderson Ltd., (1994) (210 ITR 981, 986) of Calcutta High

Court, wherein it was held that the interest paid on borrowings utilized for the purchase of shares in

order to retain managing agency by the assessee company was held allowable as business expenditure.

We find that the reasoning of the ITAT that the overdraft was not operated only for investing in the

shares of subsidiary company and the fact that it was also used for investment in the shares of the

subsidiary company to have control over that company and, therefore, the element of interest paid on the overdraft was not susceptible of bifurcation and therefore, the respondent no.1 is entitled to the deduction under section 36(1)(iii) of the Income Tax Act is correct and deserves to be accepted.

12. In this result, we hold that ITAT was right in deleting the addition of Rs.19,73,333/- and thus the

question is answered against the Revenue and in favour of the assessee.

Order accordingly.