Interest paid on borrowed funds is not deductible under Section 57(iii) of the Income Tax Act, 1961, unless it is laid out or expended wholly and exclusively for the purpose of earning the income.

( 1 ) IDENTICAL question has been set forth before us for decision in this reference under Section 256 (2) of the Income-tax Act 1961, and the appeal under Section 260a thereof. Therefore, both these cases were taken up together and have been addressed by learned counsel for the respective parties simultaneously. The assessee being one and the same and it related to only two different assessment years consecutively, we have taken up the matter together and propose to dispose of the same by one common judgment.

( 2 ) THE questions that have been set forth in the reference are as follows :" (1) Whether, on the facts and in the circumstances of the case, the amount of interest paid is allowable as a deduction under Section 57 of the said Act while computing the interest income assessed as income from other sources under Section 56 of the Act ? (2) Whether, on the facts and in the circumstances of the case, the hon'ble Tribunal was justified in holding that there was no nexus between the interest expenditure incurred by the applicant and the interest income received by the applicant by investing the surplus amount out of borrowed fund when the said activity was clearly permissible under the memorandum and articles of association of the applicant ? (3) Whether the interest expenditure incurred by the appellant is allowable as a deduction under Section 57 of the Income-tax Act, 1961, while computing the interest income sought to be assessed as 'income from other sources' under Section 56 as expenditure incurred for earning the income ? (4) Whether having regard to the memorandum of association of the appellant and its certificates of incorporation and commencement of business, the transactions relating to borrowing and lending were business operations and the interest paid was allowable as an expenditure incurred for earning the interest income under Section 36 (1) (iii) of the said Act. "

( 3 ) THOUGH a little varied expressions have been used in the appeal, these grounds do not make any distinction to obscure the identity of the grounds, which are one and the same.

( 4 ) THE assessee-company was incorporated as a limited company on June 15, 1987, under the Companies Act, 1956, with the main object of carrying on the business of manufacturing acrylic fibre. The objects of the memorandum of the company included borrowing and lending, viz. , advancement of money and earning interest thereon. The assessee obtained a sum of Rs. 5. 92 crores towards share application money from the promoters, which was shown under the head "unsecured loans". It had also obtained a sum of Rs. 5 crores from financial institutions as "secured loan". The relevant assessment year in the reference is 1990-91. The assessment year 1991-92 is involved in the appeal. Admittedly, the assessee did not commence its business until these relevant assessment years and the project was under construction. There were certain surpluses in the hands of the assessee. These were kept in short-term deposit on which the assessee earned interest. It is on the interest on the short-term investment of the surplus funds that the question is being raised as to whether it would be an income from other sources or business income. The Assessing Officer, the Commissioner of Income-tax (Appeals) and the learned Tribunal held this income to be an income from other sources. Whether the income is eligible for deduction under Section 36 (1) or under Section 57 (iii) :

( 5 ) DR. Pal had argued that since the objects clause in the memorandum of association included borrowing and lending, viz. , advancement of money, therefore, the interest earned on advancement of money is also to be treated as business, entitling him to claim the benefit of the interest paid on the borrowed sum under Section 36 (1) as deduction. Alternatively, he claimed that if it cannot be a business income and if it is treated as income from other sources, then it would be eligible for deduction under Sec