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Interest deductions allowed only on loans used for business 

SUBHASH LAKHOTIA  
The counsel cited the case of CIT vs Coimbatore-Salem Transport (Pvt.) Ltd (1966) 61 ITR 480 to shore up his argument. In this case, the Tribunal had considered the figures before it of borrowings by the assessee in each accounting year, of the advances made to the directors without interest and the amounts due from the assessees to certain other concerns in which some of the directors had an interest and on which no interest was paid, and found that the diversion of the borrowed money for advancing to the directors should have taken place in the years before September 30, 1955.

Meanwhile, in the K Somasundaram & Bros case, the high court was told that the Tribunal, commissioner and assessing officer had established beyond the doubt the fact that funds had been diverted.

The assessee's counsel said that according to the assessee, the advance to the relatives had been made from a contract realisation. However, the assessee later said that he had borrowed sums of more than Rs 5 lakh from sundry debtors and the advance could well have come from that borrowed money.

But the court was convinced that the interest- free amount advanced to the relatives of the partners came out of the firm's business funds and that the advance was not for business purposes. The advance was made out of the contract of realisation, which certainly included the borrowed funds and the profits realised. The deduction permitted under Section 36(1) (iii) of the Income-Tax Act is on the amount of interest paid against capital borrowed "for the purposes of the business or profession". Therefore, capital borrowed, if diverted-even after the amount had been invested in the business-from funds realised from the performance of the contract, could not be termed as having been used in the business.

The Supreme Court's decision in CIT vs Malayalam Plantations Ltd (1964) 53 ITR 140 was referred to here. The apex court explained the scope of expression, "for the purpose of business", thus: "The expression `for the purpose of the business' is wider in scope than the expression `for the purpose of earning profits'. Its range is wide; it may take in not only the day-to-day running of a business, but also the rationalisation of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory of hostile title; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on of a business; it may comprehend many other acts incidental to the carrying on of the business".

Section 36 of the I-T Act contains a provision that relates to the computation of income earned under the head, `Profits and Gains of Business or Profession'. The deduction contemplated by the section is in relation to expenditure that can be regarded as legitimate for business purposes.

Expenditure incurred as commercial expediency for business purposes is allowable under this provision, but the expenditure must have a business nexus. If the expenditure incurred is ostensibly for business, but not so in reality, it is not allowable.

Section 36(1) (iii) of the I-T Act refers to "the amount of interest paid in respect of capital borrowed for the purposes of business or profession". The capital borrowed should be for the purpose of business. It is implicit in this provision that the borrowed capital should not only be invested in the business, but should continue to remain in the business. So long as the amount borrowed is used in the business, the interest paid on it is a deductible expenditure required to be deducted in the computation of business income. It is allowable under the provision only because the amount on which it is paid continues to be used in the business and its payment is therefore necessary for the purpose of running the business.

The high court judges stated clearly that the objective of the provision was not to enable an assessee to make a large borrowing and create a liability in the form of interest payment thereon, both in the year in which the borrowing was made and in subsequent years, keep the loan outstanding and divert the amount borrowed by giving it interest-free to relatives of the partners, continue to pay interest out of the business income and claim the interest amount as business expenditure. The payment of interest on an amount not used in business cannot be regarded as a business expenditure as the business does not derive any benefit from paying interest on a loan that is no longer being used for its growth.

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