The Tax Publishers2020 TaxPub(DT) 4823 (Guj-HC) : (2020) 425 ITR 0286 : (2020) 317 CTR 0203

INCOME TAX ACT, 1961

Section 36(1)(iii)

Assessee had borrowed capital to purchase shares of IHFC Ltd. so as to have effective control of IHFC Ltd. in order to expand its real estate business. Thus, investment in shares was nothing but expansion of business of assessee. Therefore, all the conditions necessary for deduction under section 36(1)(iii) were prima facie satisfied by assessee. CIT(A) was, therefore, not justified in allowing deduction under section 57(iii) as assessee did not borrow capital for earning dividend or for making profits and gains.

Business deduction under section 36(1)(iii) - Interest on borrowed capital - Loan taken to acquire effective control over promoted finance company to expand business - CIT(A) allowed deduction under section 57(iii)

Assessee engaged in real estate development created a housing arm in the name and style of 'IHFC' with intention to expand the business. The purpose to create such a housing finance company within the group was to make funds readily available when required for the development of a housing project or to fund any acquisition of real-estate. Assessee subscribed 4,99,950 equity shares constituting 99.99% in the total paid-up capital of 5,00,000 equity shares in the assessment year 1994-95. IHFC Limited got registered with National Housing Bank as an approved housing finance company. Representation of assessee on the Board of IHFC Limited was 100% through its partners who had been appointed as directors of the IHFC Limited. Minimum capital requirement to keep housing finance company registered with the National Housing Bank was increased to Rs. 2 crores, and thereafter to Rs. 5 crores. In such circumstances, it became necessary for IHFC Limited to expand its capital. As almost 100% of capital was with assessee, with the consent of the partners of the assessee, it was decided to tap the funds from public by way of public issue. As per the public issue guidelines issued by the SEBI, minimum of 40% of post public issue capital was required to be brought in by the promoters. Accordingly, to comply with the SEBI guidelines, it was decided that the assessee and its group company M/s. B. Nanji Construction (P) Ltd. would bring in the minimum share capital so as to reach 40% of the post issue share capital. With this object, assessee and M/s. B. Nanji Construction (P) Ltd. borrowed funds and then subscribed share capital of the IHFC Limited. AO disallowed deduction of interest claimed in respect of funds borrowed for the purpose of investment in shares of promoted company on the ground that transaction of obtaining loans, making investment in shares and public issue was outside the ambit of assesses business. CIT(A) took the view that interest could not be allowed to assessee under 36(1)(iii) but same should be allowed under section 57(iii). Tribunal upheld this. Held: Assessee had borrowed capital to purchase shares of IHFC Ltd. so as to have effective control of IHFC Ltd. in order to expand its real estate business. Thus, investment in shares was nothing but expansion of business of assessee. Therefore, all the conditions necessary for deduction under section 36(1)(iii) were prima facie satisfied by assessee. CIT(A) was, therefore, not justified in allowing deduction under section 57(iii) as assessee did not borrow capital for earning dividend or for making profits and gains.

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