The main legal principle established in the judgment is that the deduction of interest paid on capital borrowed for the purpose of acquiring a business asset is permissible under s. 36(1)(iii) of the Income Tax Act, and the income from all businesses of the assessee falls under the head 'Profits and gains of business', allowing for the deduction of interest paid on borrowed capital.

Rama Jois, J.—As directed by this court, by an order made under s. 256(2) of the I.T. Act, 1961 (hereinafter referred to as "the Act"), the Income Tax Appellate Tribunal, Bangalore Bench, has referred the following question of law for the opinion of this court :

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in disallowing the interest of Rs. 42,846 claimed by the assessee for the assessment year 1969-70 ?"

2. During the accounting year 1967-68, the assessee was carrying on the business of film distribution on his own and also exhibition of films on percentage basis under agreements entered into by him with theatre owners. For the purpose of securing a lease of a fully equipped cinema theatre, he entered into an agreement dated July 5, 1967, with his wife. According to the agreement, the assessee was to pay to his wife a sum of Rs. 3,50,000 and the wife was to construct the cinema theatre, to equip it fully, for being used for the exhibition of films and to allow the assessee to use the theatre on rental basis and the rent payable was required to be adjusted out of the deposit so made in the manner indicated in the agreement. In terms of the agreement the assessee paid the sum of Rs. 3,50,000 to his wife having borrowed the said amount on payment of interest. During the assessment year 1969-70, he claimed the deduction of interest of Rs. 42,846 paid on the borrowed money. The ITO disallowed the deduction of interest of Rs. 42,846 paid on the borrowed money. The ITO disallowed the deduction claimed on the ground that the money borrowed and paid under the agreement for construction of the theatre and its equipment was not for the purpose of business carried on by the assessee. The AAC, before whom the assessee preferred an appeal against the assessment order, confirmed the order holding that the cinema theatre came into existence only in February, 1969, and, therefore, the capital borrowed was not for the purposes of the appellant's business and the interest paid on such amount is not deductible under s. 36(1)(iii) of the Act. The Tribunal also held that the theatre called "Kino Theatre" secured by the assessee under the agreement was ready and commenced exhibition only on February 7, 1969, and, therefore during the relevant year it was not capital borrowed for his business. It further held that the amount was paid to his wife and not due to any commercial expediency.

3. Sri K. Srinivasan, learned counsel for the assessee, contended as follows :

(i) As the capital borrowed was invested by the assessee during the accounting year for the purpose of acquiring a business asset notwithstanding the fact that the asset was not available for use during that year; and

(ii) as the assessee was already carrying on film business, both distribution and exhibition on percentage basis, under agreements with the theatre owners, the capital borrowed for the purpose of securing a cinema theatre for doing the business of exhibition on his own, he was entitled to the deduction of the interest paid, under s. 36(1)(iii) of the Act. Sri Rajasekhara Murthy, learned counsel for the revenue, on the contrary contended as follows :

(i) As the exhibition of cinema commenced only on February 7, 1969, the assessee could not claim deduction for the earlier period, as the theatre was not in use before that date.

(ii) The assessee had no exhibition business during the period in question and up to February 9, 1969, and, therefore, as the money borrowed was for exhibition business, and not for distribution business, he was not entitled to the deduction of interest paid on such borrowed money.

4. Before adverting to the rival contentions, it is useful to refer to the relevant parts of s. 36 of the Act. It reads :

"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 sections 28 - ......

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