Deduction of interest on borrowed funds invested in sister concern for acquiring controlling interest allowed

Assessee is entitled to claim deduction of interest on borrowed funds invested in sister concern for acquiring controlling interest – Supreme Court

In a recent judgment, Hon’ble Supreme Court allowed deduction of interest on borrowed funds u/s 36(1)(iii) of the Act which was utilized for investment in a subsidiary company for controlling the interest in the associate concern by purchase of shares for commercial expediency.

ABCAUS Case Law Citation:
4948 (2025) (12) abcaus.in SC

During the assessment proceedings for the relevant Assessment Year, the Assessing Officer noted the claim of the assessee regarding interest on investments made in subsidiary company as well as interest on borrowings for payment of interest-free loan to sister concern and its directors.

The Assessing Officer noted from the balance sheet of the assessee that it had invested a substantial amount in the shares of the subsidiary company. At the same time, he found that there were interest bearing borrowings and interest was debited to the profit and loss account.

The AO completed the assessment under section 143(2) disallowing claim of deduction of the assessee under Section 36(1)(iii) of the Act to the extent of interest paid on borrowings. According to the Assessing Officer, interest on money borrowed for investment could be allowed against income from investment. But if the shares were acquired, not as an investment for earning income but to acquire controlling interest in a company, it would not be entitled to deduction of interest on borrowing.

The first appellate authority i.e. CIT(A) agreed with the reasonings given by the Assessing Officer and disallowed the interest payment on borrowed fund claimed under Section 36(1)(iii) of the Act and upheld the order of assessment.

However, ITAT observed that since the investment was made for controlling interest in the sister concern, assessee was entitled to the claim of allowance of the interest. Investment was made in the shares of the sister company with a similar line of business and for commercial expediency.

Following the decision of the Hon’ble Supreme Court, Tribunal directed the Assessing Officer to allow the claim of the assessee in respect of interest on borrowed fund since the advances were made for the purposes of commercial expediency.

Revenue challenged the aforesaid decision of the ITAT before the Bombay High Court. Adverting to one of its previous decisions, High Court held that the assessee was entitled to deduction of interest under Section 36(1)(iii) of the Act when the investment was made by the assessee in a subsidiary company to have control over the said company.

The Hon’ble Supreme Court observed that this question was considered in an earlier judgment and it was held that what was relevant was whether the assessee had advanced such amount to its sister concern as a measure of commercial expediency. Once it is established that there was nexus between the expenditure and the purpose of the business, which need not necessarily be the business of the assesee itself, revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and then decide how much would be the reasonable expenditure.

Income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. We have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view of whether the amount was advanced for earning profits. No businessman can be compelled to maximize his profits.

However, the Hon’ble Supreme Court put in a caveat that it is not in every case interest on borrowed fund has to be allowed if the assessee advances it to a sister concern. It all depends upon the facts and circumstances of the case.

The Hon’ble Supreme Court expressed agreement with the finding recorded by the ITAT and affirmed by the High Court that assessee is entitled to claim allowance of interest on the funds invested in sister concern for acquiring of controlling interest. 

The Hon’ble Supreme Court opined that the purpose for which the advances were made to the sister concern and its directors would also be covered by the principle of commercial expediency.

Accordingly, the decision of the ITAT which was not interfered with by the High Court, was upheld. Consequently, the appeal filed by the revenue on this issue was dismissed.

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