Interest Paid = Deductible When Obligation Exists – ITAT Allows Claim on Capital Bond Arrangement

Hutchinson & Co. (India) Pvt. Ltd. Vs ITO (ITAT Bangalore)

Interest Paid = Deductible When Obligation Exists – ITAT Allows Claim on Capital Bond Arrangement

In Hutchinson & Co. (India) Pvt. Ltd., the Bangalore ITAT dealt with allowability of interest paid to Prestige Holiday Resorts Co. Ltd. under a capital bond arrangement, after the matter was remanded by the Karnataka High Court.

The Revenue had disallowed the claim on the ground that:

• There was no obligation to pay interest, and
• Hence, the payment was not incurred wholly and exclusively for business.

However, on detailed examination of the capital bond agreement, the ITAT found:

• Prestige had parked funds with the assessee for a specific business purpose.
• The agreement clearly provided that interest accruing on such funds must be paid to Prestige.
• Thus, a legal and enforceable obligation existed.

The Tribunal observed:

• The assessee had already offered interest income earned on deposits to tax.
• Correspondingly, the liability to pay interest to Prestige arises simultaneously.
• Therefore, the payment is not voluntary, but a business-linked obligation.

Accordingly, ITAT held:

• Interest paid is allowable deduction u/s 36(1)(iii) (and in substance also satisfies Section 37(1) principles).
• Disallowance by lower authorities was incorrect.

Where income and liability are two sides of the same transaction, taxation cannot be one-sided. If interest income is taxed, matching interest obligation must be allowed.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

1. All the 7 Appeals namely ITA Nos. 1512-1514/Del/2006 and ITA Nos. 908-911/Bang/2009 are pertaining to M/s. Hutchinson & Co., (India) Private Limited restored back to the Tribunal by the Hon’ble Karnataka High Court by its order dated 31.08.2020 in ITA No. 219/Bang/2012 to decide the issue whether the Assessee is entitled to deduction of interest paid to M/s. Prestige Holiday Resorts Company Limited in terms of terms and conditions of the Capital Bond agreement entered into by the Assessee.

2. The briefly stated facts of the case shows that the Assessee is engaged in providing services to Holiday Resort Company, for which the Assessee receives service charges besides the other income. Such income is offered for taxation by the Assessee.

3. The Assessee entered into an agreement with M/s. Prestige Holiday Resorts Company Pvt. Ltd., which is engaged in the business of property development and development of resorts. The prestige formed a club namely Royal Goan Bench Club, with the object to secure for its members exclusive right of occupation of certain apartments at various locations in India for a specified period in each year.

4. A trust deed was executed between the Assessee and M/s. Prestige Group on 04.1995 where the Assessee is a trustee. A capital bond agreement was also executed between the Assessee and Prestige wherein it is agreed that the Prestige is in the process of constructing the resorts was to provide funds for the Assessee to enable it to provide guarantee to the timeshare holders in respect of preconstructions of the unit of accommodation. The Prestige agreed to park the funds with the Assessee which were to be kept in deposit by way of capital bond and if any interest accrues on such capital bond they are to be paid by the Assessee to M/s. Prestige Holiday Resorts Company Limited.

5. In terms of above agreement, Assessee made deposits and offered the interest earned on this deposit as income derived from such deposits. Thus, the interest received from the bank etc., the Assessee offered the same as its own income.

6. The interest that is payable by the Assessee to Prestige was claimed as a deduction from the above sum of interest received on account of capital bond.

7. The Assessment got concluded wherein the interest earned on deposits by the Assessee was charged to tax in the hands of the Assessee but the interest payable to M/s. Prestige Holiday Resorts Company Ltd., was not allowed as a deduction from the above income. The reason being that the revenue authorities held that the Assessee had no obligation to make payment to M/s. Prestige Holiday Resorts Company Limited.

8. The Assessing Authority, the First Appellate Authority categorically held that there is no stipulation for payment of interest to Prestige in the agreement and there is no liability accrued by the Assessee for which deduction can be allowed. The matter reached the Coordinate Bench wherein the orders of the Ld. lower authorities were upheld.

9. Against this, the Assessee approached the Hon’ble Karnataka High Court wherein it is challenged that Tribunal failed to consider the terms and conditions of the agreement and therefore the matter may be remitted back to the ITAT for decision afresh. At that time, before the Hon’ble High Court, the counsel for the revenue also could not point out from the order of ITAT that the terms and conditions of the agreement havenot been considered by ITAT.

10. Therefore, the Hon’ble High Court was pleased to restore back all these 7 appeals to ITAT to decide the issue afresh on deductibility of interest payable to M/s. Prestige Holiday Resorts Company Limited.

11. The Ld. Authorized Representative furnished a paper book containing 20 documents for Assessment Year 1997-98 to 2003-04. The Assessee also submitted the paper book submitted on 03.01.2007 before the Tribunal.

12. We have heard Shri Tata Krishna, Advocate and Shri Prakash, Authorized Representative on behalf of the Assessee and Shri Shivanad Kalakeri, CIT-DR on behalf of the Ld. Assessing Officer.

13. With respect to the claim of interest expenditure, it is held by the Coordinate Bench at para no. 7of its order. The Coordinate Bench held that after perusing the agreements between the Assessee and M/s. Prestige Holiday Resorts Company Limited (PHRC) where there is nothing to mandate that interest earned out of fixed deposits representing capital bond account was to be paid by the Assessee to Prestige. It was further concluded that the agreement between the parties did not evidence that the creation of deposits or payment of interest to Prestige was warranted by any business arrangement or legal obligation between them. Therefore the Coordinate Bench did not accept the claim of the Assessee but agreed with the revewasthat the claim that the interest paid is out of interest earned is not acceptable as the Assessee did not have any liability or obligation to pay the same to Prestige nor could the latter legally enforces payment of the same by the Assessee and therefore the interest paid by the Assessee to Prestige were not incurred wholly and exclusively for the purposes of business u/s. 37(1) of the Act and therefore the claim of the Assessee was dismissed.

14. The Ld. Authorized Representative submitted that the capital bond agreement was entered into on 04.07.1997, which clearly speaks about the payment of interest to Prestige by the Assessee. It was further stated that Prestige has offered the above interest as its income for all these years and therefore the Assessee must be granted deduction of the same.

15. On careful perusal of the capital bond agreement dated 04.07.1997 placed at page no. 192 of the paper book it is apparently clear that Prestige is carrying on the business of building holiday resort and marketing of timeshare where the Assessee is a trust company for timeshare resorts in India. According to the agreement, as the prestige is in the process of constructing the resort and Assessee is not willing to provide any guarantee to each owner of a timeshare week to protect the rights of the owners, it was agreed between the parties, and the agreement was entered into.

16. According to the agreement, Assessee will open a bank account at ANZ Grindlays Bank, Bangalore. As agreed, after calculating the cost of construction and determining the net short fall after time sharing revenue, the prestige will transfer to the above account of capital bond a sufficient sum in the bank account which would be known as capital bond.

17. According to article 5 of the agreement, there is a definite clause that interest accruing on the capital bond shall be paid by the Assessee to Prestige. Thus, according to the agreement, it is apparent that interest accruing on the capital bond shall be paid by M/s. Hutchinson to the Prestige and it does not remain with the Assessee.

18. Though admittedly, the Assessee has offered the income in the hands of the Assessee but corresponding liability to pay interest by Assessee to Prestige also arises on the Assessee as soon as interest accrues on such capital bond.

19. Thus, on the careful perusal of the capital bond agreement, the interest income paid by the Assessee to Prestige is an expenditure incurred by the Assessee of interest which is paid by the Assessee to Prestige. There is no other purpose of the above interest income chargeable to tax arising on such capital bond in the hands of the Assessee. Thus, the interest income earned by the Assessee on capital bond account from ANZ Grindlays Bank which is chargeable to tax in the hands of the Assessee and subsequently the interest liability in favor of Prestige also arises on account of the Assessee which is eligible for deduction as expenditure from the above interest income. Thus, the expenditure of interest income by the Assessee is generated out of the funds received only from Prestige. Thus, the amount of capital operated by the Assessee to be put into the capital bond account was provided by the Prestige and amount of interest paid on such money lying with the bank is income of the Assessee and from that income u/s. 36(1)(iii) of the Act, amount of interest paid is deductible in the hands of the Assessee.

20. As this is the only dispute in all these 7appeals restored by the Honourable High court to that extent only , which is now decided in favor of the Assessee by directing the Ld. Lower Authorities to delete the disallowance of interest paid to Prestige of interest expenditure incurred by the Assessee on capital bond account funds provided by the Prestige in terms of clause 5 of capital bond agreement dated 04.07.1997.

21. In the result, all 7 Appeals are allowed in favor of the Assessee to the extent indicated above.

Order pronounced in the open court on 28^th April, 2026.