Law: Income Tax Act, 1961

Section: 36,36(1)(iii)

Income-tax---Business expenditure---Interest on borrowed capital---Condition precedent for deduction---Capital must be used in business---Borrowed capital invested in executing contracts---From contract receipts, sums advanced interest free to relatives of partners---Interest paid on borrowed capital to extent relatable to sums advanced to relatives not deductible---Indian Income Tax Act, 1961, S.36(1)(iii). Section 36(1)(iii) of the Income Tax Act, 1961, refers to "the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession". It is implicit in this provision that the capital so borrowed should not only be invested in the business, but that the amount borrowed should continue to remain in the business. So long as the amount borrowed is used in the business, the interest paid on such borrowing is an expenditure which is required to be deducted in the computation of the income from the business. The interest payable on the capital borrowed is a liability which continues till such time as the amount borrowed is repaid. Such interest is allowable under the provision only for the reason that the amount on which interest is paid continues to be used in the business and the payment of such interest is, therefore, necessary for the purpose of running the business. This provision cannot be construed as enabling an assessee to burden the business with interest even while taking the amount initially borrowed for the business, but subsequently taken out of the business by diverting it as interest-free loans to relatives of the partners. The assessee-firm was engaged in the business of construction. It had borrowed certain amounts for the purpose of its business and claimed deduction of interest paid on the borrowing for the assessment years 1978-79 and 1979-80. The Assessing Officer found that the assessee had been advancing monies to close relatives of the partners without charging any interest. The assessee claimed that the amounts so lent had not been lent out of the borrowed funds, but only at a time when the firm had sufficient funds at its disposal. According to the assessee, the advance was made when it received…

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