Section 36(1)(iii)

Section 36(1)(iii) — the law in short

What the courts have decided on section 36(1)(iii), in one screen. Read this first; open an entry when you need the facts, the reasoning and the source.

• L.K. Trust v CIT Supreme CourtHelps taxpayer
  I borrowed from a bank to buy shares, but the money passed through a group company before the shares were bought. The department says the borrowing was not for my business. Can it disallow my interest under s.36(1)(iii)?
  No, not on the reasoning the High Court gave. The Supreme Court set aside a Karnataka High Court order that had disallowed interest because the borrowed money was ultimately used for the benefit of the assessee's subsidiary rather than for the assessee's own business, and held that the borrowed funds must be looked at from the point of view of commercial expediency. It declared the assessee entitled to deduct the interest paid on the capital of Rs 3,80,00,000 borrowed from the Corporation Bank, and agreed with the Tribunal's interpretation of s.36(1)(iii).
• CIT v Mahindra and Mahindra Ltd Supreme CourtHelps taxpayer
  The lender wrote off the principal of a loan I used to buy machinery. Is that taxable?
  No. Section 28(iv) reaches only a benefit in a form other than money, and a waiver puts cash in the debtor's hands. Section 41(1) needs an earlier allowance or deduction in respect of a trading liability; here only depreciation on the assets had been claimed, never a deduction for the loan.
• Hero Cycles (P) Ltd v CIT Supreme CourtHelps taxpayer
  The AO says my borrowings funded advances to a sister concern and my directors. Can he disallow the interest?
  No, not once a nexus between the expenditure and the purpose of the business is shown. The advance to the sister concern was imperative as a business expediency because of undertakings given to financial institutions about its working capital margin, and the advances to directors were covered by the company's own reserves, so nothing was left for the disallowance to bite on.
• Taparia Tools Ltd v JCIT Supreme CourtHelps taxpayer
  I paid the whole five years' interest upfront to my debenture holders but wrote it off over five years in my books — can I still claim the entire amount in the year I paid it?
  Yes. The Supreme Court held on 23 March 2015 that where revenue expenditure is incurred and paid in a year, the ordinary rule applies and the assessee is entitled to the deduction in that year; if he claims it then, the Department cannot refuse it. Spreading is an indulgence available only where the assessee himself asks for it and the matching concept is satisfied. Here the company had shown the upfront interest as deferred revenue expenditure in its books but claimed the whole of it in the returns, and that claim governed. Entries in the books are not determinative, and there is no estoppel against the statute.
• Munjal Sales Corporation v CIT Supreme CourtHelps taxpayerNo later treatment found
  My firm pays interest on partners' capital. Is the s.40(b)(iv) ceiling the only test the AO can apply?
  No — both tests apply, in that order. A firm must first bring the interest within s.36(1)(iii) and then keep within the ceiling in s.40(b)(iv), because ss.30 to 38 grant the deduction while s.40 operates as a limitation on them. Whether the partners' capital was in the nature of a loan makes no difference to that analysis.
• DCIT v Core Health Care Ltd Supreme CourtCuts both ways
  I borrowed to buy machinery for my existing factory and the machine was not commissioned by 31 March. Can I still claim the interest under section 36(1)(iii)?
  Yes, for years before 1 April 2004. The Supreme Court held that section 36(1)(iii) asks only three things: capital was borrowed, it was borrowed for the purpose of the business, and interest was paid on it. Whether the asset bought with the money was put to use in that year is irrelevant, and Explanation 8 to section 43(1) does not cut down the deduction because it belongs to the depreciation provisions. Interest of Rs 1.56 crore on borrowings used to install three new machines was allowed for assessment years 1992-93 onwards.
• S.A. Builders Ltd v CIT (Appeals) Supreme CourtCuts both ways
  I passed borrowed money to my sister concern interest-free. Can the AO disallow the interest I paid?
  Only if the advance fails the commercial expediency test. Interest on borrowed funds advanced interest-free to a sister concern is deductible under s.36(1)(iii) where the advance was made on grounds of commercial expediency, an expression of wide import covering what a prudent businessman spends for the purposes of business, with no need for a legal obligation.
• Madhav Prasad Jatia v CIT Supreme CourtHelps department
  I borrowed on overdraft to honour a personal donation rather than sell my shares. Can I deduct the interest as it protected my income-earning assets?
  No. The Supreme Court held that interest on money borrowed to meet a personal obligation is not deductible, either as interest on capital borrowed for the purpose of business or as business expenditure. The borrowing here was completely unrelated to the purpose of the business and was actually used for making charity. The argument that the overdraft was drawn on to avoid selling shares did not make the borrowing a business borrowing. The Court also refused a deduction for interest credited on the unpaid part of the donation, since no trust in favour of the college had come into existence. The appeals were dismissed with costs.
• Challapalli Sugars Ltd v CIT Supreme CourtHelps taxpayerSuperseded by amendment
  I borrowed to buy and install my plant and paid interest before production started — can I add that interest to the cost of the plant and claim depreciation on it?
  Yes. The Supreme Court held that interest paid on money borrowed to acquire and install plant and machinery, for the period before production commences, forms part of the actual cost of the asset. 'Actual cost' is not defined in the Act, so it must be read in the sense no commercial man would misunderstand — that is, by the accepted accountancy rule, which brings in all expenditure necessary to bring the asset into existence and put it in working condition. Depreciation and development rebate are therefore admissible on the capitalised interest.
• Bombay Steam Navigation Co (1953) Pvt Ltd v CIT Supreme CourtHelps taxpayer
  I bought the assets of my business and left part of the price outstanding on interest. Is that interest deductible as interest on borrowed capital?
  Not as interest on borrowed capital, but yes as business expenditure. The Supreme Court held that an agreement to pay the unpaid balance of the purchase price does not give rise to a loan: a loan produces a debt, but not every debt involves a loan, and capital borrowed in the interest clause means money lent. So the claim under section 10(2)(iii) of the 1922 Act failed. The Court then allowed the whole interest under section 10(2)(xv). Acquiring the assets was closely related to the commencement and carrying on of the business, so the interest was expenditure laid out wholly and exclusively for that business and was not capital expenditure.
• Cheminvest Ltd v CIT High CourtHelps taxpayerSuperseded by amendment
  I earned no exempt income at all this year. Can the AO still disallow under s.14A?
  No, for assessment years up to 2021-22. Section 14A speaks of expenditure in relation to income which does not form part of total income, which presupposes income actually received or receivable in that year; it cannot be applied to notional exempt income that may arise later.
• CIT v Y. Ramachandra Reddy High CourtHelps taxpayer
  The officer made a best judgment assessment and fixed my profit at a percentage of receipts. Does that wipe out my claim to depreciation and to interest?
  No. The High Court held that depreciation and interest, which are otherwise deductible in the ordinary course of assessment, keep the same legal character even where the profit is determined on a percentage basis. There was no reason to withhold from the assessee, merely because his profit had been estimated, a facility he would have had on a regular computation. The Revenue's appeal was dismissed. Note the boundary of this: the assessee's receipts were far above the s.44AD threshold, so s.44AD did not apply to him at all. Where income is actually returned under s.44AD, s.44AD(2) provides that deductions under ss.30 to 38 are deemed to have been given full effect, and depreciation under s.32 falls inside that range.
• CIT v Reliance Utilities and Power Ltd High CourtHelps taxpayer
  I have my own funds and borrowings. Can the AO assume the interest-free advance came out of the loan?
  Where an assessee has interest-free funds of its own that are sufficient to meet the investment, and has also borrowed, it can be presumed the investment came out of the interest-free funds. The sufficiency of the own funds is the condition of the presumption, and here it rested on concurrent findings of fact by the Commissioner (Appeals) and the Tribunal.
• DCIT, Central Circle 8(3), Mumbai v Sanjana Cryogenic Storages Ltd ITATHelps taxpayerNo later treatment found
  The Approving Panel held that my client's arrangement is NOT an impermissible avoidance arrangement, but the Assessing Officer has taxed the same transaction under another section anyway. Can he do that?
  The Mumbai Tribunal did not decide the wide question, but it held that the Assessing Officer could not, while giving effect to the statutory process under section 144BA, proceed on a factual premise diametrically opposed to the findings returned by the Approving Panel on the very arrangement referred to it. It then dismissed the Revenue's appeal on the narrower ground that a company buying back its own shares, which must then be extinguished, does not 'receive' property within section 56(2)(x) at all.
• Osho Forge Ltd v DCIT ITATCuts both waysNo later treatment found
  The Assessing Officer has disallowed interest on plant under erection at a flat 12 per cent. I say I funded it out of cash accruals. Who has to prove what?
  The assessee has to prove it. The Tribunal held that where the assessee says the asset was funded out of internal accruals beyond the identified borrowing, but has not supported that through its financials or documentation before any authority, the contention fails and the proviso to section 36(1)(iii) applies. It accepted, however, that where borrowed funds enter a common pool the disallowance must be computed at the average rate of interest on the assessee's borrowings, not at a rate picked by the Assessing Officer, and remanded on that footing.
• Ceebros Hotels P Ltd v DCIT ITATHelps taxpayer
  I am a developer. I borrowed to buy land for the next project and the Assessing Officer has capitalised the interest because the project has not started. Does the proviso to section 36(1)(iii) apply to land held as stock?
  On this reasoning it does not. The Tribunal held that the expression "put to use" in the proviso applies to a capital asset, an income earning apparatus that facilitates the business activity, in contradistinction to inventory; the purchase and holding of inventory is itself a business activity, so interest on a borrowing used to buy land held as stock in trade cannot be disallowed under the proviso.
• Statutory position — Rule 8D of the Income-tax Rules, 1962 was SUBSTITUTED with effect from 2 June 2016: the three-limb formula was replaced by a two-limb one, and the disallowance is now capped at the total expenditure claimed — which formula applies is a question of the year, and the answer is not the same for every year still open CBDT Circulars & InstructionsCuts both ways
  The Assessing Officer has computed a s.14A disallowance under Rule 8D. Which version of Rule 8D applies to my year, and is the disallowance capped?
  That depends entirely on the previous year, because Rule 8D was substituted. THE DATE IS THE FIRST QUESTION: the departmental page for Rule 8D carries footnote 78, "Substituted by the IT (Fourteenth Amdt.) Rules, 2016, w.e.f. 2-6-2016", and footnote 79, "Omitted by the IT (Fourteenth Amdt.) Rules, 2016, w.e.f. 2-6-2016". As substituted, sub-rule (1) provides that where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with (a) the correctness of the claim of expenditure made by the assessee, or (b) the claim made by the assessee that no expenditure has been incurred, in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with sub-rule (2). Sub-rule (2) as substituted has TWO limbs and a cap: the expenditure is the aggregate of (i) the amount of expenditure directly relating to income which does not form part of total income, and (ii) an amount equal to one per cent of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income, with a proviso that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee. The three-limb formula that preceded it, including the interest-apportionment limb and the percentage-of-average-investments limb, is STILL the applicable law for earlier previous years, and is still being applied in appeals for them. The pre-substitution text is now sourced, from the departmental page for the notification that inserted the rule: under the original rule 8D(2) the disallowance was the aggregate of (i) expenditure directly relating to exempt income, (ii) where interest expenditure was not directly attributable to any particular income or receipt, an amount computed as A x B / C, where A was that interest, B the average value of investments yielding exempt income on the first and last day of the previous year and C the average of total assets on the same two days, and (iii) "an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year". Sub-rule (3) defined "total assets" as total assets in the balance sheet excluding an increase on revaluation but including a decrease.

Listed strongest first: Supreme Court, then High Court, then Tribunal, then CBDT. Nothing here has yet been read in full by a chartered accountant — open an entry to see where it came from.