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[Section-36(1)(iii)] : Interest on Borrowed Capital

Interest on capital borrowed is allowed as deduction if the following conditions are satisfied —

  1. The assessee must have borrowed money.

  2. The money so borrowed must have been used for the purpose of business.

  3. Interest is paid or payable on such borrowing.
  • Assessee must have Borrowed Capital -

Interest in respect of capital borrowed for the purpose of business/ profession is a permissible deduction. Interest on own capital is not deductible. In other words, interest shall be paid to another person. Interest paid by one unit of the assessee to another unit is not deductible.

  • The following Propositions should also be kept in view –

  1. Deduction of interest on borrowed capital cannot be denied only because the borrowed capital produces nontaxable income.

  2. Guaranteed interest paid to shareholder on paid-up capital is not deductible.

  3. Interest paid to wife and daughters on money allotted to them on partition, is deductible.

  4. Interest paid by a firm to partners is deductible according to the provisions of section 40(b) [i.e., @ 12 per cent per annum simple interest]. However, interest paid by an association of persons to its members is not deductible.
  • Capital must be used for the Purpose of Business -

Capital should have been borrowed for the purpose of business or profession.

  • Interest on capital borrowed for acquiring a capital asset -

Interest liability pertaining to the period beginning from the date on which capital is borrowed by an existing concern for the acquisition of an asset till the date, when such asset is first put to use, should be capitalised and it cannot be claimed as deduction under section 36. Only interest on capital borrowed to purchase a capital asset for business purposes pertaining to the period after the asset is put to use, is deductible on year to year basis under section 36.

  • Other Points -

The following proposition taken from different judicial pronouncements should also be kept in view:

  1. If borrowed money is utilised in earning non-assessable income, no deduction is allowed for interest paid on such borrowing.

  2. It is not for the income-tax department to examine whether there was no need to borrow money because the assessee had ample fund of his own.

  3. A taxpayer who is engaged in the business of trading in paper can claim deduction in respect of interest on capital borrowed for the setting of a garment business (even if the new business generates negative income).

  4. It is not open to the Assessing Officer to reject the claim of the assessee in respect of the interest paid on that capital merely because the use of the capital is unremunerative.

  5. Interest on money originally borrowed for business purposes would be disallowable in a subsequent year in which the money is used for non-business purposes.

  6. Interest paid by the assessee on money borrowed for payment of dividends is an allowable deduction.

  7. Where the assessee-partner borrows money for investing as capital in partnership, interest paid by the assessee on borrowed money is allowable as deduction.

  8. Interest on money borrowed to pay income-tax is not allowable as deduction. Interest for late payment/nonpayment of income-tax/advance tax/tax deducted or collected at source or for late filing of return, is not allowable as deduction. Similarly, where interest is paid for meeting tax liability of partners, such interest is not deductible.

Topics...on ‘Profits and Gains of Business or Profession’

Define … ‘Profits and Gains of Business or Profession’ and its Computation (Section 28)
Method of Accounting for Computing Business Income (Section 145)
Principles for Allowing Business Deductions / Allowances from Profits and Gains of Business or Profession.
Expenses Allowed as Deductions against Profits and Gains of Business or Profession [Section-30-37]
[Section 37(1)] : General Or Allowable Deductions under Business or Professions
Business Losses Deductible under the head  'Profits and Gains of Business or Profession'.
Expenses Not Deductible under the head 'Profits and Gains of Business or Profession (Section 40, 40A, 43B)
DEEMED PROFITS Chargeable to Tax as Business Income Under Profits and Gains of Business or Professions [Section 41]
Taxation of Undisclosed Business Income/Investments from Undisclosed Sources
Deduction in respect of Expenditure incurred on setting up of a Specified Business [Section-35AD] :
When Maintenance of Books of Accounts becomes Compulsory (Section 44AA)
Compulsory Audit of Books of Accounts by Chartered Accountant (Section 44AB)
Computation of Income On Estimated Basis Under Sections 44AD, 44ADA and 44AE

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