Interest on borrowing to pay earliest money deposits allowable as deduction u/s 36(1)(iii)

DCIT Vs M/s. Prestige Garden Estates Pvt. Ltd. (ITAT Bangalore)

Conclusion: Deduction was allowable under section 36(1)(iii) on interest on borrowing to pay earnest money deposits (EMD) to purchase properties being lands, flats, etc. as the same was for purpose of assessee’s business of acquiring properties.

Held: In the present case, assessee-company was engaged mainly in the business of purchase of lands and to construct, sell flats, apartments, dwelling-houses, shops, etc. In the course of its business, it participated in the bids invited for sale of properties by NGEF and HUDA during financial year 2005-06 and 2006-07 respectively. Accordingly, it had made earnest money deposit (EMD) of Rs 186 crores and Rs 107.60 crores with NGEF and HUDA respectively. In order to arrange the finance for making the deposits, assessee signed Memorandum of understanding (MOU) with various persons whereunder it received share application money from such persons. In addition, assessee also accepted Inter Corporate Deposits (ICDs) for financing the payment of EMD. During the year under consideration, assessee paid interest of Rs 16,68,11,932 in respect of share application monies received and the said interest expenditure was claimed as deduction while computing income under the head ‘income from business or profession’. AO rejected claim of the assessee and he held that interest expense had to be capitalised and could not be allowed as deduction. It was held the first condition for applicability of the proviso was that there should be acquisition of an asset. The second condition was that such acquisition should be for extension of existing business. In the present case, both the conditions were not satisfied. There was no acquisition of any asset by assessee from NGEF or HUDA and both the transactions did not ultimately fructify. Assessee had to abandon its idea of carrying out development on these properties and was already in the business of acquiring properties and constructing flats. In the ordinary course of its business, assessee sought to acquire properties from NGEF and HUDA. Therefore it could not be said that assessee indulged in any extension of existing business or profession. Thus, interest expenditure was for the purpose of business of assessee and an allowable deduction under section 36(1)(iii).

FULL TEXT OF THE ITAT JUDGEMENT

This is an appeal by the revenue against the order dated 27.07.2017 of the CIT(Appeals)-5, Bengaluru relating to assessment year 2008-09.

2. The grounds of appeal raised by the revenue reads as follows:-

“1. The order of the Commissioner of Income Tax(Appeals) – 5, Bangalore, is opposed to the law and not on the facts and circumstances of the case.

2. Whether the CIT(A) is justified in law by allowing relief to the assessee by erroneously observing that condition (c) of section 36(1)(iii) has not been satisfied”?

3. Whether the CIT(A) is justified in allowing capital expenditure as revenue expenditure simply because the acquisition of capital asset was aborted”?

4. The appellant craves leave to add, alter, amend or delete any other grounds on or before hearing of the appeal.”

3. The assessee is a Company. It is engaged mainly in the business of purchase of lands and to construct, sell flats, apartments, dwelling-houses, shops, etc. The assessee in the course of its business participated in the bids invited for sale of properties by (i) the official liquidator of New Government Electric Factory Ltd. (NGEF) and (ii) Hyderabad Urban Development Authority (HUDA) during financial year 2005-06 and 2006-07 respectively. The assessee accordingly had made earnest money deposit (EMD) of Rs 186 crores and Rs 107.60 crores with NGEF and HUDA respectively. In order to arrange the finance for making the deposits, the Assessee signed Memorandum of understanding (MOU) with various persons whereunder it received share application money from such persons. In addition, the assessee also accepted Inter Corporate Deposits (ICDs) for financing the payment of EMD.

4. During the year under consideration, the assessee paid interest of Rs 16,68,11,932 in respect of share application monies received. The said interest expenditure was claimed as deduction while computing income under the head ‘income from business or profession’.

5. The AO called upon the assessee to show cause as to why interest of Rs. 16,68,11,932 claimed as deduction be not disallowed as no income other than dividend income from mutual funds have been offered to tax during year under consideration.

6. In response, the assessee submitted that the interest payout was compensation to the parties who had advanced monies for financing the EMD’s made with NGEF and HUDA. The assessee submitted that interest paid on share application money/ICD was claimed as expenditure in accordance with generally accepted accounting principle as well as on prudence. The assessee also submitted that by paying EMD the Assessee became qualified to bid at the auction and did not acquire any interest in any immovable property and therefore the Assessee could not capitalize the interest paid as part of the cost of any asset. The assessee also submitted that any interest it might receive on the EMD would be offered to tax.

7. The AO however rejected the plea of the assessee and he held that interest expense has to be capitalized and cannot be allowed as deduction. According to the AO, the EMD was made with the purpose of acquiring an asset and therefore interest payout should have been capitalized or in the alternative shown as work-in-progress. The AO accordingly denied the claim of assessee and disallowed interest of Rs.16,68,11,932 holding the same as capital expenditure.

8. The details of interest paid and other relevant details are as under:-

9. Before the CIT(Appeals), the assessee pointed out that during 2005- 06, in response to the public notice inviting sealed tenders by the official liquidator of New Government Electric Factory Limited (NGEF), a Government of Karnataka undertaking, under liquidation before the Hon’ble High Court of Karnataka for sale of its movable and immovable assets, the assessee submitted its tender and accordingly remitted the Earnest Money Deposit (EMD) of Rs. 186 crores. On completion of the tendering process, the official liquidator reported to the Hon’ble High Court of Karnataka of the assessee’s tender being the highest bid. Subsequently, pursuant to an application filed by the Government of Karnataka seeking to revive and pleading not to proceed with the sale of NGEF assets, the Hon’ble High Court of Karnataka vide its order dated 22nd December 2005 terminated the sale proceedings and ordered refund of EMD along with interest upto 31st December 2005 to the bidders. The assessee being aggrieved by the said order refused to accept refund of the EMD and preferred an appeal before the division bench of the Hon’ble High Court on 30th December 2005. Based on the order of the division bench dated 28^th February 2006, the assessee filed before the Single Judge impleading application and also a petition to recall the order terminating of sale of NGEF assets. Subsequently, on 13^th September 2006, the learned single judge dismissed the assessee’s petition and the assessee preferred further appeals with the division bench of the Hon’ble High Court for relief on the matter. The division bench vide its order dated 30^th March 2007 allowed the assessee’s appeal recalling the earlier order dated 22nd December 2005 and temporarily kept the sale proceedings in abeyance.

10. Subsequently, divisional bench dismissed the Assessee’s appeal. The assessee preferred further appeal before the Hon’ble Supreme Court which was also dismissed vide its order dated 25th September 2008 directing the official liquidator to refund the EMD of Rs.186 crores along with interest. These facts are evident from the notes to accounts forming part of audited financial statements for the year ending 31^st March 2009.

11. Since the matter attained finality with dismissal of the appeal by the Supreme Court during the financial year 2008-09, the assessee recognized gross interest income amounting to Rs. 46,35,12,695/- (Interest received Rs. 35,84,80,718 + TDS on estimated basis Rs. 10,50,31,977) in the financial statements for the year ending 31st March 2009 and the same was offered for tax in the IT return for AY 2009-10. The relevant para from notes to account was as under:-

“”Hence, interest earned on the Earnest Money Deposit (EMD) is recognized during the year considering the amounts received Rs. 35,84,80,718/-, grossed up for taxes deducted at source by Rs. 10,50,31,977/-, on an estimated basis. Any change in the estimate of amount recognized as tax deducted at source will be recorded in the year in which such change is determined.”

12. From the aforesaid facts, it would be evident that entire EMD of Rs.186 crores was received back with interest. The interest paid on borrowings was for the purpose of business of the Assessee and the deduction u/s.36(1)(iii) of the Act ought to have been allowed by the AO. The Assessee submitted that since there was no asset acquired out of the entire transaction, the question of asset being first put to use under proviso to section 36(1)(iii) did not arise. In other words, proviso to section 36(1)(iii) was not at all applicable. The Assessee therefore submitted that the disallowance made by the AO should be deleted.

13. In respect of EMD and installments paid to HUDA, the submissions of the assessee was that during the year 2006-07, in response to the public notice inviting sealed tenders by the Hyderabad Urban Development Authority (HUDA) for sale of lands at Kokapet village, the assessee submitted its tender for 3 plots under auction and remitted the Earnest Money Deposit (EMD) of Rs. 6.00 crores on July 20 2006. On completion of the tendering process, the HUDA informed that the assessee has been awarded the bid. Accordingly the assessee paid first and second installments duly aggregating to Rs. 101.60 crores towards the said lands. Meanwhile, a writ petition was filed before the Hon’ble High Court of Andhra Pradesh in which the petitioner in the writ petition claimed title to the said lands as against HUDA and also made the assessee a party to the litigation pending between the HUDA and the petitioner. While the matter was pending with High Court, the assessee vide its letter dated November 27, 2006 to HUDA, informed its decision to terminate the land purchase agreements and sought for refund of the amounts paid so far aggregating to Rs. 107.60 crores together with interest @ 24% per annum and has also reserved its right to claim damages for breach of contract.

14. Subsequently, the Hon’ble High Court of Andhra Pradesh vide its order dated April 22, 2010, directed HUDA to refund the amount deposited by the Company within three months and in case of delay of refunding the amount beyond three months together with interest at 9% p.a from the date of deposit. HUDA filed a writ appeal against the above order and obtained stay order from Hon’ble High Court of Andhra Pradesh vide order dated June 28, 2010. The writ appeals were disposed by the High Court of AP by common order dated 27.12.2012 setting aside the orders of the Ld. Single Judge in the writ petitions. Against this order the assessee preferred SLP to Supreme Court and the matter is now pending for final adjudication before the Hon’ble Supreme Court.

15. The Assessee submitted that entire EMD and installments paid amounting to Rs. 107.60 crores did not result in acquisition of any asset. There was no asset acquired out of the entire transaction. Consequently, the question of asset being first put to use under proviso to section 36(1)(iii) did not arise. In other words, proviso to section 36(1)(iii) was not at all applicable.

16. On the above submissions, the CIT(Appeals) was of the view that deduction claimed by the assessee on account of payment of interest was allowable u/s. 36(1)(iii) of the Income-Tax Act, 1961 [“the Act”]. The CIT(Appeals) held as follows:-

(i) That the amounts borrowed were used for the purpose of making payment of EMD to NGEF and HUFDA for acquisition of asset. The assessee could not ultimately acquire the Assets and the assessee got back only refund of EMD together with interest for which the EMD was with NGEF. This interest income was offered to tax during the relevant assessment year and the interest expenditure incurred in borrowing monies for the purpose of making deposit of EMD was also claimed as an expenditure. The CIT(A) therefore held that payment of interest on borrowing for the purpose of making EMD was for the purpose of business of assessee.

(ii) The liability of deduction u/s. 36(1)(iii) of the Act is not conditional upon corresponding income being offered to during the same period. The fact that there were no business receipts during the previous year cannot be a ground for disallowing expenditure incurred in carrying on business.

The CIT(Appeals) thus directed the AO to allow claim of assessee for deduction on account of interest expenses.

17. Aggrieved by the order of CIT(Appeals), the revenue has preferred the present appeal before the Tribunal. The ld. DR reiterated the stand of the AO as contained in the order of assessment. According to him, the proviso to section 36(1)(iii) of the Act is applicable in the present case and therefore the interest expenses ought to have been capitalized in the books of account. The ld. counsel for the assessee, on the other hand, relied on the order of CIT(Appeals) and further submitted that proviso to section 36(1)(iii) of the Act is not applicable and that the interest expenses in the present case is admittedly incurred for the purpose of business of the assessee and irrespective of the fact whether the borrowing is for capital or revenue purposes, deduction has to be allowed. The ld. counsel for the assessee in this regard relies on the decision of the Hon’ble Supreme Court in the case of DCIT v. Core Health Care Ltd., 298 ITR 194 (SC).

18. We have given a careful consideration to the rival submissions. Section 36(1)(iii) and proviso thereto is as follows:

“Sec.36(1): The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—

(i) & (ii)………..

(ii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :

Provided 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 capitalized 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 was inserted by the Finance Act, 2003 w.e.f.1.4.2004. Before insertion of Proviso w.e.f. 01.04.204, it was settled law by various court decision that any interest paid on borrowing for business & profession can be claimed as a deduction irrespective of the fact whether the borrowing is for the purpose of meeting capital or revenue expenditure. So long as the borrowing is for the purpose of business, interest paid on such borrowing was to be allowed as deduction. In Dy. CIT v. Core Health Care Ltd. [2008] 167 Taxman 206 (SC), the Hon’ble Supreme Court held that Section 36(1)(iii) has to be read on its own terms. It is a code by itself. Section 36(1)(iii) is attracted when the assessee borrows the capital for the purpose of his business. It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the section requires is that the assessee must borrow the capital for the purpose of his business. There by meaning that the transaction of borrowing is not the same as the transaction of investment. The proviso however restricts the claim for deduction on account of interest on amount borrowed for acquisition of an asset for extension of existing business or profession.

The section does not define what is acquisition of an asset for extension or what is extension of existing business. The purpose of the amendment has been spelt out in the memorandum explaining the provisions which states that

“it is, therefore, proposed to provide that no deduction will be allowed in respect of interest paid, in respect of capital borrowed for acquisition of new asset for extension of existing business or profession (whether capitalised in the books of account or not) for the period beginning from the date on which the capital was borrowed for the acquisition of the asset till the date on which such asset was first put to use.”

The logic behind provision is only to ensure that wherever interest is capitalised for books of accounts, it remains capitalised for the purpose of income-tax. This interest cannot be claimed as a deduction under Section 36(1)(iii) of the Act.

19. The first condition for applicability of the proviso is that there should be acquisition of an asset. The second condition is that such acquisition should be for extension of existing business. In the present case both the conditions are not satisfied. There was no acquisition of any asset by the Assessee from NGEF or HUDA and both the transactions did not ultimately fructify. The Assessee had to abandon its idea of carrying out development on these properties. The Assessee was already in the business of acquiring properties and constructing flats. In the ordinary course of its business, the Assessee sought to acquire properties from NGEF and HUDA. Therefore it cannot be said that the Assessee indulged in any extension of existing business or profession.

20. From the facts of the case it is clear that at no point of time the Assessee was certain of acquiring the properties either from NGEF or HUDA. As far as the transaction with NGEF is concerned, the Division Bench dismissed the Assessee’s claim for acquiring the property much prior to the end of the relevant previous year. Though the Assessee preferred appeal before the Hon’ble Supreme Court against the order of the Division Bench of the Karnataka High Court, the same was ultimately dismissed on 25.9.2008 and the Assessee was to get back only the EMD paid by it to the Official Liquidator together with interest. The interest income was offered to tax by the Assessee in AY 2008-09 and the interest expenditure in connection with borrowing funds for paying the EMD was also claimed as deduction and revenue expenditure for the relevant previous year. The interest expenditure was therefore rightly held by the CIT(A) to be for the purpose of business of the Assessee and an allowable deduction u/s.36(1)(iii) of the Act. As far as the EMD paid to HUDA is concerned, the Assessee as early as 27.11.2006 has rescinded the agreement to acquire property from HUDA. Therefore the expenditure incurred in the form of interest on borrowings to pay the EMD to HUDA has to be considered as borrowing for the purpose of business of the Assessee allowable u/s.36(1)(iii) of the Act.

21. We find no grounds to interfere with the order of the CIT(A). Consequently, the appeal by the revenue is dismissed.

22. In the result, appeal by the Revenue is dismissed.