Interest on borrowed funds utilized for investment in group companies allowed

Interest paid on borrowed funds utilized for investment in group companies for strategic business purpose with commercial expediency cannot be disallowed u/s 36(1)(iii) – ITAT

In a recent judgment, ITAT Chennai has held that interest paid on borrowed funds utilized for investment in group companies for strategic business purpose with commercial expediency cannot be disallowed u/s 36(1)(iii).

ABCAUS Case Law Citation:
ABCAUS 4173 (2024) (07) ITAT

In the instant case, the revenue had challenged the order passed by the CIT(A) in in deleting the disallowance of interest on borrowed capital u/s 36(1)(iii) of the Income Tax Act, 1961 (the Act).

A search and seizure operations u/s 132 of the Act was conducted in a business group and the residential premises of the respondent assessee. The assessee was a proprietor and promoter of private limited company.

The assessee had made investments in shares of the group companies. The provisions of section 36(1)(iii) of the Act, deals with deduction of Interest paid on borrowed capital. As per the said provision, if interest paid on borrowed capital is not utilized for the purpose of business, then same cannot be allowed as deduction.

The assessee in reply to show cause, explained that the investment made in group companies to derive substantial business advantage which is with commercial expediency and hence the question of disallowance of interest u/s 36(1)(iii) of the Act, does not arise.

However, the AO disallowed u/s 36(1)(iii) of the Act, the entire interest paid on borrowed capital for the reason of diversion of interest bearing funds to group companies as his personal investment as these group companies had no connection with the business activities of the assessee.

The CIT(A) observed that the Hon’ble Supreme Court has settled the issue of disallowance of interest paid us 36(1)(iii) based on commercial expediency for the purpose of business.

The CIT(A) further noted that Delhi High Court has held that the answer whether the particular expenditure has been commercially expended will depend on the facts and Circumstances of the case as well as the Act. What is to be seen is the purpose for which borrowed money is finally utilized. It the money is utilized in a way that makes commercial sense and helps in running the intended business of the assessee more efficiently, then it can be said that the interest paid in respect of borrowed money has been incurred for the purpose of commercial expediency.

The CIT(A) observed that the assessee had made investments in various group concerns as well as in private concerns. The assessee was into the business of purchase of bullion, gold and diamond ornaments and sells the same to the said private limited company. As per the sales registers, most of the sales were made to the said company and sales to other parties were very less comparatively. Hence the assessee was mainly doing business with the group company and therefore the assessee exists for this purpose only.

The CIT(A) further noted that the assessee was a brand ambassador of the group company and had earned brand fee which worked out to 19.88% of the total value of the stake. The brand fee had been credited into Profit and Loss account and affected as professional income of the appellant. The assessee and group company were in same line of business and majority of the sales of the assessee was to group company only.

In view of the above, the CIT(A) held that investments in the shares of group company satisfied the principle of commercial expediency. Therefore, the interest paid in respect of these investments was to be allowed.

The Tribunal noted that the CIT(A) rightly observed that the assessee had made investment in group which is involved in the similar kind of business that the assessee also carrying out.

The Tribunal opined that based on the nature of business carried on by both the assessee and group company and other business transactions between them, there is a business expediency in investment made by the assessee in acquiring the shares of the above company for strategic business purpose.

Therefore, the Tribunal opined that the CIT(A) has rightly allowed the portion of interest paid as eligible expenditure by properly analyzing the commercial expediency of the investment. The Tribunal rejected the action of the AO in disallowing the entire interest paid, merely for the

reason that the assessee had used interest bearing funds to make investment in acquiring shares of the Company as per the provisions of Section 36(1)(iii) of the Act. This view is supported by the decisions of various courts where the courts have held that, Interest paid on borrowed funds utilized for investment in group companies for strategic business purpose with

commercial expediency cannot be disallowed U/s.36(1)(iii) of the Act.

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