Interest on loan for declaring dividend allowable deduction u/s 36(1)(iii) – High Court

Interest on loan for declaring dividend allowable deduction u/s 36(1)(iii) even in absence of profits/reserves and the treatment of such dividend as loans in the books of the company – High Court

ABCAUS Case Law Citation:
ABCAUS 1066 (2016) (11) HC

Assessment Year: 2008-09
Date/Month of Judgment/Order: 07-11-2016

Important Case Laws cited:
CIT vs. Tingri Tea Company Ltd (79 ITR 294)
Commissioner of Income Tax vs. Changdeo Sugar Mills Ltd. (1982) (31 CTR (Bom) 114
Kesar Sugar Works Ltd. vs. Commissioner of Income Tax (1997) (140 CTR 431))
Kirloskar Electric Co. Ltd. vs. Commissioner of Income Tax (1997) (228 ITR 674)

Substantial question of Law:
Whether on the facts and circumstances of the case, the Tribunal was right in holding that the interest on the amount borrowed for declaring dividend was allowable as deduction u/s 36(1)(iii), even in the absence of profits/reserves and the treatment of such dividend as loans in the books of the assessee company?

Brief Facts of the Case:
The return of Income filed by the respondent assessee company was scrutinized and the order of assessment was made u/s 143(3) of the Income Tax Act, 1961. (‘the Act’). During the assessment proceedings, the question of applicability of Section 14A was considered by the Assessing Officer  (AO).

Subsequently, revision proceedings u/s 263 were initiated by the CIT by issue of show cause notice on the ground that the interest payable on borrowed capital utilized for payment of dividend to the preferential shareholders was not liable to have been allowed as a deduction under Section 36(1)(iii).

The Commissioner of Income Tax was primarily driven by the net deficit appearing in the profit and loss account of the company. Which, according to him, was indicative that dividend had been declared and paid from out of borrowed funds and the interest on such borrowings did not constitute allowable deduction in terms of Section 36(1)(iii).

The assessee pointed out that there had been adequate cash profits on the dates of declaration of dividend and in any event, the declaration of dividend was itself for the purpose of business. Thus, the expenditure incurred in connection therewith constituted an allowable deduction in terms of Section 36(1)(iii) of the Act. However, CIT not agreeing with the assessee’s submission and by placing reliance on the Karnataka High Court judgment in the case of Kirloskar Electric Co. Ltd. passed the order under Section 263.

The order u/s 263 passed by CIT was challenged in appeal before the Income tax Appellate Tribunal (ITAT) which allowed the appeal of the assessee.

The present appeal in High Court was filed by the Revenue against the order of the ITAT.

Observations made by the Tribunal:
The High Court observed that there was no dispute that as on the dates when the dividend was declared, there was a credit balance in the bank statement. The assesssee did have required resources internally to effect the declaration of dividend and did not have to resort to bank borrowings for the said purpose.

The High Court observed that in the case relied by the CIT, the High Court was concerned with the allowability of expenditure incurred as dividend perse. In the said case, the contention was that dividend paid to preference shareholders should be construed as interest paid in respect of capital borrowed ‘for the purposes of business’ within the meaning of section 36(1)1(ii) of the Act. This was negatived by the Karnataka High Court holding that the provisions of section 36(1)(iii) cannot be stretched to include dividend in so far as preference share capital is a contribution by subscribers to the capital of a company and cannot be equated to a borrowing subject to payment of interest. Thus, the Court held that the expenditure incurred by way of preference dividend did not constitute allowable deduction in terms of section 36(1)(iii).

The High Court opined that in the present appeal, the judgment relied upon by CIT  was on different facts and does not advance the case of the revenue.

Held:
The substantial question was answered against the Revenue and the appeal was dismissed.