Allowance of interest on borrowed capital- Section 36(1)((iii)
The amount of the interest paid in respect of capital borrowed for the purposes of the business or profession is allowed under section 36(1)(iii).
It is to be noted that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalised in the books of account or not) for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction. (Proviso)
|Amendment in Clause(iii) related to Interest on borrowed capital [w.e.f A.Y. 2016-17]
Words “for extension of existing business or profession” have been omitted from the proviso.
E Now, w.e.f AY 2016-17, interest on borrowed capital for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use shall not be allowed in both the cases whether it be for extension of existing business or profession or for existing business or profession.
As per Explanation 8 to section 43(1), interest paid or payable in the case of acquisition of an asset after the asset first put to use shall not be included in the actual cost of such asset.
But Explanation 8 does not provide for treatment of interest before asset put to use. Therefore, assessee had option to claim interest before put to use as revenue expenditure or add it to cost of acquisition.
Earlier Proviso to section 36(1)(iii), provides for non deduction of interest for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use for extension of existing business or profession only.
But now after omission of the words “for extension of existing business or profession” this proviso shall equally apply in case of existing business or profession also.
In nut shell, interest on assets upto first put to use shall be included in cost of acquisition of an asset otherwise no deduction or depreciation in respect of it.
Note Deduction of interest incurred on amount borrowed from any public financial institution or a State financial corporation or a State industrial investment corporation or scheduled bank is subject to section 43B.
Prerequisite for claiming deduction
In the case of Madhav Prasad Jatia v CIT  118 ITR 200 / 1 Taxman 477 (SC), the Supreme Court held that three conditions are required to be satisfied in order to enable the assessee to claim deductions in respect of the borrowed capital, namely, (a) that money (capital) must have been borrowed by the assessee, (b) that it must have been borrowed for the purposes of business, and (c) that the assessee must have paid interest on the said amount and claimed it as a deduction.
Owned fund no bar to claiming interest
Merely because assessee had its own ample resources at its disposal could not negate deduction in respect of interest paid on borrowed funds. CIT v Gautam Motors (2011) 334 ITR 326 (Delhi)
Borrowed fund advanced to a third party should be for commercial expediency if it sought to be allowed u/s 36(1)(iii). Where holding company, has a deep interest in its subsidiary, and the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the holding company would ordinarily be entitled to deduction of interest on its borrowed loans. S.A. Builders Ltd. v CIT (2007) 288 ITR 1 (SC)
Where assessee engaged in business of owning, running and managing hotels borrowed money and invested same in its subsidiary company with a view to acquire control of a new hotel it was to be held that interest paid on borrowed capital was allowable u/s 36 (1) (iii) as it would be for commercial expediency. CIT v Tulip Star Hotel Ltd. (2011) 338 ITR 482 (Delhi)
Interest paid on money borrowed for settling liability of retiring partners is not allowable as the borrowing is not for the purpose of business. Hotel Roopa v CIT (2015) 231 Taxman 425 (Karnataka)