The officer has disallowed everything I claimed under s.57 against my interest income - the interest I paid, the assistant's salary, a principal I wrote off - saying there is no direct nexus and the income is passive. How much of that can I get back?
The client is an individual at Surat, retired from a textile trading business closed in 2019, with no business income now. For AY 2025-26 he returned interest of Rs 46,80,000 on unsecured loans advanced to three private companies at 13 and 13.5 per cent, bank deposit interest of Rs 8,40,000 and dividend of Rs 3,60,000, all under the head income from other sources. Against that he claimed Rs 40,50,000 under s.57: Rs 28,60,000 of interest paid, being Rs 19,40,000 to eight relatives at 11 per cent and Rs 9,20,000 on a bank overdraft taken against his own fixed deposits; Rs 2,40,000 of salary to an assistant who keeps the loan ledgers, with office expenses; Rs 6,50,000 written off as irrecoverable principal from a borrower who stopped paying in June 2023; Rs 1,80,000 of interest on money borrowed in April 2024 to pay a tax demand for AY 2021-22; and Rs 1,20,000 of interest on money borrowed to buy the shares that yielded the dividend. The order under s.143(3) dated 14 September 2026 disallows the whole Rs 40,50,000 in one paragraph, holding that s.57(iii) requires a direct nexus which has not been shown, that netting of interest is not permitted, and that the income is passive so no expenditure is allowable against it. The demand is Rs 14,90,000 and the appeal is due by 14 October 2026. The client holds the loan agreements, the bank statements and his ledgers.
Break the Rs 40,50,000 into its five heads on a single sheet before drafting a ground of appeal, and put against each the section it is claimed under, the money trail that supports it and an honest mark for whether it survives. Three of the five are lost on authority and one of those three is lost on the words of the section. The order looks strong only because it answers one composite claim; the appeal is won by making the officer answer five separate ones, and it is weakened if the two that cannot be defended are carried into it.
Section 57 is a list, not a general allowance. Clause (i) covers only a reasonable sum paid to a banker or other person for realising dividends or interest on securities, clause (ii) brings in repairs, insurance and depreciation for the letting cases, and clause (iii) is the residuary limb for any other expenditure laid out wholly and exclusively for the purpose of making or earning the income. Section 58 is headed amounts not deductible and opens with a non obstante clause overriding s.57: it bars personal expenses, expenditure of the kind in s.40A(12), interest payable outside India without deduction, and more. An officer who never reaches s.58 and refuses everything on nexus alone has disallowed items on the wrong footing, and each head has to be met on the clause it actually falls under.
The strongest head is the Rs 19,40,000 paid to relatives at 11 per cent against interest earned at 13 per cent from the three companies, and it is won or lost on the money trail. The Supreme Court has held that s.57(iii) looks to the purpose of the expenditure and not to its result: the expenditure must be laid out wholly and exclusively for the purpose of making or earning income, but nothing in the section requires that purpose to fructify, and interest on money borrowed to buy shares was allowed for a year in which the shares paid no dividend. Build a dated table: borrowing in, advance out, and the days between.
The Rs 9,20,000 was paid on an overdraft taken from the same bank against the client's own fixed deposits, and the claim as framed is netting. That is squarely covered against the client. The Supreme Court has held that interest received on a fixed deposit is income in the depositor's hands in full and can be reduced only if some provision of law allows it, that there is no such provision, and that it makes no difference in law that the loan came from the same bank in which the deposit was placed. The Supreme Court has separately held that s.57 sets out exhaustively what may be deducted, so interest earned on deposits cannot be adjusted against interest payable on borrowings. What can still be run is different: if the overdraft money went out as one of the three company advances, the interest on it is claimed against that interest income under clause (iii), on the trail and not on netting.
This one is decided. The Supreme Court has held that interest on money borrowed to discharge a personal liability such as income-tax and wealth-tax is not expenditure laid out wholly and exclusively for the purpose of making or earning the income, and it refused the deduction even though part of the borrowing went into an annuity deposit that did fetch interest. The reasoning is that preserving an income-earning asset by borrowing rather than selling it is not the same as spending to earn the income. The same line runs through the business cases: the Supreme Court has held that interest on money borrowed to meet a personal obligation is deductible neither as interest on capital borrowed for business nor as business expenditure.
Clause (iii) allows expenditure not being in the nature of capital expenditure, and money advanced as principal is capital in the lender's hands. A Tribunal Bench has held exactly that - the principal advanced is a capital outflow, s.57(iii) excludes capital expenditure, and a write-off of principal cannot be deducted from interest assessed under s.56 - and it also held that the bad debt route under s.36 was unavailable because there was no business. That order is marked in this library as unverified, which means the library could not confirm it, so do not rest on it. Rest on the exclusion in the clause itself, which says the same thing and is not open to argument.
Clause (i) is not the route. It reaches only a reasonable sum paid by way of commission or remuneration to a banker or any other person for realising dividends or interest on securities, and interest on unsecured loans to three private companies is neither - so reasonableness is not the test and this head belongs in the residuary clause. Under clause (iii) the question is whether the expenditure was laid out wholly and exclusively for the purpose of making or earning that income, and the Supreme Court's test is purpose and not result. An assistant who keeps the loan ledgers, follows up instalments and issues the demand notices is employed for exactly that purpose. The proposition that no expenditure is allowable because the income is passive has no support in the words of clause (iii). Produce the appointment letter, the tax deducted on the salary if any, and a description of what the assistant actually does.
Against the dividend of Rs 3,60,000 the only deduction available is interest expense, and not more than twenty per cent of the dividend income included in total income for the year computed without that deduction. The proviso was inserted with effect from 1 April 2021 and applies to this year, so the ceiling is Rs 72,000 and the claim of Rs 1,20,000 is excessive by Rs 48,000 on its face. Offer Rs 72,000 in the grounds, with the borrowing traced to the share purchase, rather than leaving the whole Rs 1,20,000 to be struck out. Nothing else - no collection charge, no proportionate salary - is allowable against dividend.
Eight relatives lending at 11 per cent is the kind of pattern that produces a second line of attack on the borrowings themselves. The library's position is that a disallowance of interest following an addition of the principal as an unexplained credit is consequential rather than automatic: there is no provision disallowing the interest merely because the principal has been added, and the disallowance is made on the separate footing that a borrowing which does not exist cannot carry a deductible interest cost - so in practice the two stand or fall together. Get the lenders' confirmations, their returns and the bank trail on the file with the appeal, before anyone asks. Then run the same five-head exercise across the two earlier years and the current one, because a disallowance settled for one year is the template for the rest.
The traced interest head is usually allowed in substantial part at the first appeal where the table is produced, and refused where it is not - the outcome tracks the documents almost exactly. The salary and office expenses under clause (iii) are usually allowed once the assistant's duties are described, though often at a figure the authority fixes rather than the figure claimed. The tax-borrowing interest, the principal write-off and the excess over the dividend ceiling are lost, and should be treated as lost from the start. Expect a first appeal to take eighteen months to two years. The risk that materialises most often on files of this shape is not the s.57 disallowance at all but a fresh enquiry into eight relative-lenders, which converts a Rs 14,90,000 demand into something much larger.
