Interest on borrowed capital is deductible under Section 36(1)(iii) when utilised for business purposes viewed through commercial expediency, including transfers to subsidiaries or sister concerns for share acquisitions in composite businesses.

ORDER :

1. This appeal is at the instance of the assessee and is directed against the Judgment and Order passed by the High Court of Karnataka dated 1-3-2010 in Income Tax Appeal No. 175 of 2001 by which the appeal preferred by the Revenue against the Order passed by the Income Tax Appellate Tribunal came to be allowed.

2. The short point that falls for our consideration is whether the appellant - assessee is entitled to a deduction of Rs.21,74,234/-(Rupees Twenty One Lakh, Seventy Four Thousand, Two Hundred and Thirty Four only) being the interest paid by it in respect of the loan availed from the Corporation Bank under Section 36(1)(iii) of the Income Tax Act 1961 (for short, “the Act 1961”).

3. It appears from the materials on record that the assessee borrowed a sum of Rs.3,80,00,000/- (Rupees Three Crore and Eighty Lakh only) from the Corporation Bank to purchase shares of Shaw Wallace and Company Limited in pursuance of an Agreement dated 19-11-1987. Under the said Agreement, the Company had committed to sell 7.80 lakh shares for a total consideration of Rs.3,80,00,000/-.

4. The assessee filed its return of income for the year 1989-90 declaring total income of Rs.7,55,67,530/- (Rupees Seven Crore, Fifty Five Lakh, Sixty Seven Thousand Five Hundred and Thirty only). The return was processed under section 143(1)(a) of the Act and later Notice was issued under Section 143(2). While passing the Assessment Order way back in 1992, the Assessing Officer noted that the assessee had availed a loan of rupees Rs.3,80,00,000/- from the Corporation Bank and had paid interest of Rs.21,74,234/-. However, the AO further noted that the amount had been transferred to M/s Gayatri Holdings Private Limited, a group company, through purchase of its shares, who in turn transferred the amount to one Shri G. Venkateshwaran for the purchase of shares of M/s Shaw Wallace and Company Limited.

5. In such circumstances referred to above, the AO took the view that the assessee was not entitled to claim deduction under Section 36(1)(iii) of the Act and accordingly the interest paid on the loan was disallowed.

6. The assessee went in appeal before the CIT(A). The CIT(A) also disallowed the deduction. The matter went in appeal before the ITAT. The ITAT allowed the appeal preferred by the assessee holding as under:-

“13. Now coming to the second leg of issue i.e., whether or not the appellant is eligible for deduction of interest paid to the bank under Sec.36(1) (iii) of Income-tax Act. Section 36(1)(iii) is reproduced below:-

(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

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

A plain reading of said section reveals that three principles are relevant to establish the allowability or otherwise of the interest expenses. We may mention here that the Hon'ble Supreme Court in the case of Madhav Prasad Jatia Vs. CIT., reported at 118 ITR 200 while dealing with Sec.10(2)(iii) of 1922Act (which was akin to the present section 36(1)(iii) in Income-tax Act, 1961) laid down three pre-requisites to be complied with before allowing the deduction for interest expenses. The three pre-requisites which would enable the appellant to claim deduction in respect of the interest expenses under the aforesaid section can be illustrated a