Interest on loans used to invest in shares for business expansion

Interest on loans used to invest in shares for business expansion is deductible under Section 36(1)(iii).

Issue

Whether interest expenditure on borrowed funds utilized to invest in the shares of another company is allowable as a business deduction under Section 36(1)(iii) when the dominant purpose of the investment is business expansion rather than earning dividend income.

Facts

Assessee’s Business: The assessee-company is engaged in providing services related to multiplex entertainment complexes.
Transaction: During Assessment Year 2012-13, the assessee made investments in the shares of a company using interest-bearing loans taken from its holding company.
Deduction Claimed: The assessee claimed the interest expenditure paid on these borrowed funds as a deductible business expense under Section 36(1)(iii).
Disallowance by AO: The Assessing Officer disallowed the interest claim on the ground that the borrowed funds were utilized for share investments.
Commercial Expediency: The share investment was made not merely to gain controlling interest or earn dividend income, but out of commercial expediency to expand business activities and maximize resources.

Decision

In Favor of Assessee: The deduction for interest expenditure under Section 36(1)(iii) is allowable.
Dominant Purpose: Since the primary objective of acquiring the shares was strategic business expansion and resource maximization, the expenditure holds a direct nexus with the business operations of the assessee.

Key Takeaways

Commercial Expediency Over Dividends: If borrowed capital is invested in shares with the dominant purpose of furthering business activities rather than generating dividend yield, the interest paid qualifies as allowable business expenditure under Section 36(1)(iii).
Nexus Test: The test for allowability under Section 36(1)(iii) depends on whether the loan was borrowed for business purposes; strategic corporate expansion directly qualifies under business utility.

HIGH COURT OF GUJARAT

Principal Commissioner of Income-tax

Inox Leisure Ltd.

BHARGAV D. KARIA and Pranav Trivedi, JJ.

R/TAX APPEAL NO. 523 of 2022

AUGUST 14, 2026

Rutvij R. Patel for the Appellant.

JUDGMENT

Bhargav D. Karia, J.- Heard learned Senior Standing Counsel Mr. Rutvij Patel for the appellant.

2. Though served, none appeared for the respondent.

3. This appeal was admitted by order dated 19.09.2022 for consideration of the following substantial question of law:

“Whether in the facts and circumstances of the case, the Hon’ble ITAT has erred in law and on facts in holding that the assessee is eligible for deduction of the interest expenditure incurred for the purpose of investment in shares as business expenditure under the provisions of Section 36(1)(iii) of the Income Tax Act, 1961, without appreciating that the interest paid to holding company which was incurred on the funds borrowed for making investment in shares in another company cannot be said to be incurred for the purpose of the business of the assessee and as such the same is not allowable either under the provisions of section 36(1)(iii)/37(1) of the Income Tax Act or under the provisions of Section 57(iii) of the Income Tax Act?”

4. Brief facts of the case are that the respondent-assessee is a limited company engaged in the business operation of multiplex entertainment complex related services.

5. For the Assessment Year 2012-13, the assessee had shown investment in the equity shares of Rs. 17879.85 Lakhs (Rs. 8502.73 Lakhs of the opening balance) in M/s. Fame India Limited (‘FIL’ for short). The investment made by the assessee was out of interest-bearing loan from holding company M/s. Gujarat Flurochemicals Limited (‘GFL’ for short).

6. The assessee therefore, incurred interest expenses amounting to Rs. 8,60,16,920/- on borrowing from GFL.

7. The Assessing Officer made disallowance under Sections 14A of the Income Tax Act, 1961 [for short ‘the Act’] read with Rule 8D of the Income Tax Rules,1962, [for short ‘the Rules’] and under Section 115JB of the Act.

8. The assessee, being aggrieved by the order passed by the Assessing Officer, preferred an appeal before the CIT (Appeals) on the ground that there cannot be any disallowance under the provisions of Section 14A of the Act read with Rule 8D of the Rules in view of the decision of this Court in case of CIT v. Corretech Energy (P.) Limited [2015] 372 ITR 97 (Gujarat), as there was no dividend income earned by the assessee on such investment in the year under consideration.

9. However, the CIT (Appeals) was of view that such interest expense cannot be allowed under Section 36 (1)(iii) of the Act and accordingly, the CIT (Appeals) following the earlier years, held that the interest expenses cannot be allowed as deduction under Section 36 (1)(ii) or Section 57(i) of the Act and made addition of the interest paid to GFL of Rs. 8,60,16,920/- to the total income of the assessee.

10. Being aggrieved by the order of the CIT an (Appeals), the assessee preferred an appeal before the Tribunal, the Tribunal recorded the following undisputed facts:

” i. The assessee and FIL, both are engaged in the business of exhibition of cinematographic films in multiplex cinema and single screen cinema.

ii. The assessee company acquired 1,75,65,288 share of FIL during F.Y. 2009-10 and further acquired 1075 shares as on 6th January 2011. Accordingly, the assessees shareholding increased to 50.27% in the share capital of FIL. Thus, FIL became subsidiary of the assessee company w.e.f. 6th January 2011.

iii. The shareholding of the assessee company in FIL further increased to 69.54% in the year under consideration. Thereafter the FIL got merged with assessee company w.e.f. 1 April 2012 by virtue of order of Hon’ble Gujarat High court dated 20th March 2013 and Hon’ble Bombay High Court dated 10th May 2013.

iv. By virtue of amalgamation, the resources of assessee increased from 30 multiplex to 55, from 109 screen to 204 and seating capacity from.”

11. The Tribunal, considering such undisputed facts, concluded that, that the assessee did not merely acquire the shares of FIL to have the controlling interest, but the shares were also acquired to expand its business activities and the dominant purpose was not to make investment for the purpose of dividend, but to maximize the resources.

12. The Tribunal, after considering the decision of this Court in case of B. Nanji & Co. v. Dy. CIT (Gujarat) involving similar facts and circumstances, held in favor of the assessee by deleting the disallowance made by the CIT (Appeals).

13. In view of the above findings of fact arrived at by the Tribunal, the question raised in this appeal is no more res-integra in view of the decision of Apex Court in case of Sharp Business System v. CIT 484 ITR 509 (SC) wherein, the Hon’ble Apex Court, after considering the similar facts, has held as under:

“39. Adverting to the facts of this case, we find that the respondent assessee had claimed interest on borrowed funds under Section 36(1) (iii) of the Act which was utilized for investment in M/S Ceylon Glass Company Ltd., a subsidiary company of the assessee. The investment was made for controlling the interest in the associate concern by purchase of shares. Thus the investment was clearly for commercial expediency. We agree with the finding recorded by the ITAT and affirmed by the High Court that assessee is entitled to claim allowance of interest on the funds invested in sister concern for acquiring of controlling interest.

40. Following the decision of this Court in SA Builders Ltd. (supra) , we find that the purpose for which the advances were made to the sister concern and its directors would also be covered by the principle of commercial expediency.

41. Accordingly, the decision of the ITAT on this point, which was not interfered with by the High Court, is hereby affirmed. Consequently, the appeal filed by the revenue on this issue is dismissed. The question framed in paragraph 5.2 of this judgment is thus answered in favour of the assessee and against the revenue.”

14. In view of the above dictum of law, we answer the question in favor of the assessee and against the Revenue.

15. The Appeal is accordingly dismissed.