For claiming deduction u/s 57(iii) a reasonable and intelligible nexus should be established between the expenditure incurred and the income sought to be earned.
In a recent judgment, ITAT has held that for claiming deduction u/s 57(iii) a reasonable and intelligible nexus should be established between the expenditure incurred and the income sought to be earned. The test is one of purpose and connection, and not of actual yield.
ABCAUS Case Law Citation:
5215 (2026) (08) abacus.in ITAT
Important Case Laws relied upon by Parties:
Saroj kumar Muzumdar Vs CIT SC
CIT (Central) Vs Smt Swapna Roy
The appellant assessee was a promoter director and major shareholder of three companies to which the assessee had advanced certain funds on interest out of his personal borrowing from banks/financial institutions.
During the relevant Assessment Year, the assessee had offered interest income after deducting interest expense on personal borrowings under the head “Income from other Sources”.
The case was selected for limited scrutiny to verify the correctness of the deduction claimed u/s 57 of the Income Tax Act, 1961 (the Act) Act.
During the course of assessment proceeding, the AO invoking the provisions of section 28(ii)(a) of the Act treated the interest received from said companies as ‘adventure in the nature of trade’ and assessed interest received to tax as Profits & Gains of Business and Profession. The AO further invoked the explanation 1 to section 37(1) of the Act and disallowed the interest paid to banks etc. claimed by the assessee as deduction u/s 57(iii) of the Act.
The Tribunal observed that as held by the Hon’ble Supreme Court, whether a transaction or set of transactions under examination is or is not in line of business of assessee, and is an isolated or a single instance of a transaction like that, burden lies on revenue to bring case within words of statute, namely, that it was an adventure in nature of trade.
The Tribunal opined that without there being any agency or management contract, the transaction of interest payment by companies to the appellant could hardly be considered as falling u/s 28(ii)(a) of the Act. As a result, the Tribunal held not to disturb the head “income from other sources” under which the interest income was offered for taxation by the appellant assessee.
Thus, the only issue left was deductibility of interest expenditure u/s 57(iii) of the Act.
The Tribunal observed that the settled legal position is that there must be a proximate and live nexus between the expenditure incurred and the income sought to be earned.
The Tribunal further observed that the lower authorities had not doubted the genuineness of the interest expenditure, nor had they recorded any finding that the interest income in question was earned from sources unconnected with the borrowings on which interest was paid.
The Tribunal observed that the expression ‘for the purpose of making or earning such income’ occurring in section 57(iii) of the Act has a wider connotation and does not postulate that the expenditure must necessarily and immediately result in the earning of income in the same previous year. The statutory requirement is not that the expenditure should generate income, but that it should be incurred with the dominant and proximate object of earning income chargeable under the head income from other sources.
The Tribunal observed that what is required to be established is a reasonable and intelligible nexus between the expenditure incurred and the income sought to be earned. The test is one of purpose and connection, and not of actual yield. Once it is demonstrated that the borrowed funds have been utilised for the purpose of advancing loans or making investments with an intent to earn or generate interest income, and such interest income is earned & offered to tax, the interest paid on such borrowings assumes the character of an expenditure incurred wholly and exclusively for the purpose of earning such interest income. The allowability of such expenditure cannot therefore be merely denied on any discrete ground. So long as the expenditure is not capital in nature and is shown to have been incurred with the object or intent of earning taxable income, the statutory condition laid in section 57(iii) of the Act stands satisfied, thus entitled for allowance.
The Tribunal observed that where the utilisation of borrowed funds for earning interest income is established on the basis of material on record and the corresponding interest income is duly offered to tax, the interest expenditure incurred on such borrowings is allowable as a deduction under section 57(iii) of the Act, being expenditure laid out wholly and exclusively for the purpose of and with intention of making or earning such income.
Accordingly, the disallowance sustained in first appeal was set aside for deletion.
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