Expenses Against Interest Income U/s. 57 of Income Tax Act, 1961: A Judicial Analysis

A. Introduction

It is well knowledge that the Income Tax Act offers specific deductions from an individual’s taxable incomes to alleviate their income tax obligations. The Income Tax Act’s Section 57 specifically addresses deductions for incomes taxable under the “Income from other sources” income head. The expenses that can be subtracted from such income prior to determining the taxable amount are listed in this section

B. Overview of Section 57

The term “income from other sources” (IFOS) refers to any form of income that is not included in the other four categories of income, which are capital gains income, housing property income, company and profession earnings and gains, and salary. Dividends, lottery profits, interest income, family pensions, and other types of income earned by a taxpayer are all subject to IFOS.

While many of us are aware that firms can calculate their profit by subtracting business expenses from turnover, it is less well recognized that some deductions can only be taken under the heading of “income from other sources.” Many taxpayers are uncertain about deducting company-related expenses when it comes to income from other sources, despite the apparent logic that taxpayers with business revenue should be allowed to do so. To clear up this ambiguity, Section 57 of the Income Tax Act provides specific deductions for the different types of income that are included by “Income from other sources.”

Clauses (i), (ia), (ii), (iia), (iii), and (iv) of Section 57 outline the deductions that are intended to assist taxpayers in accurately calculating their taxable income while preventing them from paying more taxes than necessary on these sources of income.

C. Allowable deductions U/s. 57 of Income Tax Act, 1961

i. A deduction is permitted for any reasonable amount paid to a banker or other individual on commission or compensation in order to realize such dividend or interest on behalf of the assessee. Section 57(i) was modified by the Finance Act of 2020, and the changes took effect on April 1, 2021. Accordingly, an assessee who receives dividend income may deduct interest charges. Subject to a 20% limitation on dividends or income for mutual fund units, interest on funds borrowed for share investments may be deducted. A shareholder, however, is not allowed to deduct any additional expenses paid in order to receive dividend income.

ii. Section 57(ia): Employee Contributions to Welfare Schemes – Contributions made by an employer on behalf of an employee to welfare programs like the Provident Fund (PF), Employee State Insurance (ESI), or Superannuation Fund (SF) are deductible from taxes if they are credited on or before the deadline.

This guarantees that, as long as the payments are submitted by the deadlines specified, employee contributions to these social programs can be subtracted from their pay.

iii. Section 57(ii): Rental Income Expenses – Any costs required for the upkeep, repairs, or insurance of assets like machinery, furniture, or plant can be deducted from income received from the rental of these items. Depreciation, however, can only be claimed for a structure if the taxpayer is the real owner. The taxable income from rental operations is decreased in part by these deductions.

iv. Section 57(iia): Standard Deduction on Family Pension – A standard deduction of ₹15,000 or one-third of the entire pension, whichever is less, is permitted in the case of family pensions. For instance, if a family member receives a pension of ₹60,000, the taxable pension would be ₹45,000 after the permitted deduction of ₹15,000. The rightful heirs of departed employees receive financial comfort through this deduction.

v. Section 57: Other Expenses (iii) – Under the “Income from Other Sources” category, any further costs that are incurred expressly to generate money may also be written off. Nevertheless, capital or personal expenses paid from the business account will not be included in this.

Although international businesses are not eligible for this deduction, it is intended to offset significant expenses that directly contribute to generating revenue from non-business activities.

vi. Section 57(iv): Interest in Compensation or Enhanced Compensation – You are eligible to deduct 50% of the interest you earn from compensation or enhanced compensation (for instance, in land acquisition circumstances). This deduction, which lessens the tax burden on income from such compensations, is subject to specific requirements.

D. Expenses Not Allowed as Deduction U/s. 57 of Income Tax Act, 1961

There are some expenses that are specifically not deductible, even though Section 57 of the Income Tax Act lists deductions that taxpayers can claim against income from other sources.

These exclusions, which are mostly covered by Section 58, aid in maintaining adherence to tax regulations and preventing improper use of deductions. To avoid penalties and file proper tax returns, it is essential to comprehend these non-allowable deductions. The following are the main deductions that Section 57 prohibits:

i. Personal Expenses – Deductions are not permitted for personal expenses that are not related to business or that do not generate revenue. This covers any expenses that don’t directly go toward producing taxable revenue from other sources, such as personal travel or entertainment. Personal vacations are not included in the list of allowable deductions, for example.

ii. Interest Due Outside of India Without Tax Reduction – You can only claim a deduction for interest charges paid outside of India if the associated taxes have been paid at the source or withheld. When paying non-residents, this rule makes sure that taxpayers follow the tax withholding guidelines. The deduction for these interest payments will be denied if the necessary taxes have not been paid.

iii. Salary Payments Made Outside of India Without Tax – Payrolls to employees outside of India can only be deducted if the relevant taxes have been paid or withheld at the source, much like interest payments. The purpose of this rule is to stop taxpayers from avoiding paying taxes or deducting from payments they make to non-residents.

iv. Wealth Tax – Under Section 57, the taxpayer’s wealth tax is not deductible. Wealth tax cannot be subtracted to lower taxable income from other sources, despite being a distinct tax obligation unrelated to earned income. By making this distinction, wealth tax is guaranteed to remain a separate responsibility from the taxpayer’s ordinary income.

v. Costs Associated with Racing, Gambling, and Lotteries – gain from gambling, horse racing, and lotteries is completely taxable, and you are not allowed to write off any costs incurred in generating such gain. To put it another way, expenses like participation fees or ticket sales won’t lower the amount of taxable income.

E. Interaction between the Section 57 and Section 80M deductions

The Income Tax Act of 1961’s Chapter VI contains Section 80M. As a result, this deduction is permitted from the assessee company’s gross total income, which includes dividend income. Dividend income is unquestionably included in the assessee company’s total income when the deduction under section 80M is approved.

The maximum amount of interest expenses that can be deducted in a prior year is 20% of the dividend income included in the total income, according to proviso to section 57.

This raises the question of whether the interest expense deduction under section 57 will be permitted at 20% of net dividend income included in total income following the section 80M deduction or on gross dividend income.

The general reasoning is that interest expenditure deductions under Section 57 should be permitted based on gross dividend income rather than net dividend income.

The Act’s plan is to add together all of the income from each source to create “Gross Total Income,” from which deductions listed in Chapter VI A are taken to determine the “Total Income” for the prior year. To put it another way, head-wise income is calculated after deducting the amounts allowed by the corresponding heads of income. Standard deductions, for instance, are permitted when calculating income under the head salary. Following the standard deduction, the salary income is eligible to be included in gross total income.

However, section 57 explicitly stipulates that the deduction for interest expenses from dividend income in a prior year can only be 20% of the total income that was obtained after any deductions under section 80M were made. According to a literal reading of this clause, the net dividend income—that is, gross dividend income less the deduction under section 80M—should be subject to the 20% limit. Since a dividend income is only included in total income once it has been calculated in accordance with section 56 and section 57’s regulations, this argument is without merit.

Even though section 80AA is not currently included in the statute, the Hon’ble Supreme Court noted in the Distributors (Baroda) P. Ltd. case that the allowability of the deduction under section 80M with reference to gross dividend does not accurately reflect the legislature’s intent. As a result, the first step is to calculate the net dividend income in accordance with section 57’s provisions, after which the deduction under section 80M will be permitted. Therefore, without mentioning the deduction that will be permitted under section 80M, the interest expense deduction under section 57 will be permitted on the gross dividend income in the first stage.

F. Judicial Analysis

i. The honorable ITAT, Ahmedabad bench noted in the case of Shri Girishbhai Vadilal Shah vs. DCIT ITA No.429/Ahd/2018 that section 57(iii) stipulates that expenses must have been incurred to earn revenue in order to be entitled to claim them against that income.

ii. Commissioner Of Income-Tax v. Gannon Dunkerley And Co. (P.) Ltd., decided by the Madras High Court on December 22, 1997, deals with the crucial question of whether certain expenses paid by an assessee can be deducted from income that falls under the category of “Other Sources.” Future issues pertaining to the deductibility of expenses from income under the heading “Other Sources” would be significantly impacted by this ruling. It establishes a precedent that for expenses to be eligible for deductions, they must be clearly connected to the generation or preservation of revenue.

iii. Commissioner of Income-Tax v. Dwaraka Chit Funds Pvt. Ltd. ([1995] 216 ITR 115) is the case in which the deductibility of expenses directly associated with the operating operations that generate revenue was upheld in this case.

iv. United Provinces Electric Supply Co. Ltd. v. CIT ([1993] 204 ITR 794), In re ([1992] 195 ITR 244), and Wan door Jupiter Chits P. Ltd. (In Liquidation) all further supported the idea that expenses must be directly related to the production of income to be deductible.

v. According to the ruling in Sunil Bardia v. Income Tax Officer, ITAT Raipur, dated 10/10/2023, section 57(iii) deductions are non-conditional, and appropriate accounting standards are crucial. The ruling acts as a reminder that the objective of an expenditure determines its allowance, regardless of whether income is realized.

vi. The Supreme Court ruled in Sultana Begum v. Prem Chand Jain held that the Rule of Interpretation mandates that when interpreting two contradictory or blatantly objectionable provisions of an Act, the courts must attempt to interpret the provisions in a way that harmonizes them so that the Act’s goal can be fulfilled and both provisions can function without making either of them obsolete.

vii. The Supreme Court ruled in the Cloth Traders (P.) Ltd.’s case reported in (1979) 118 ITR 243 (SC) that the deduction under Section 80M might be applied to the entire number of dividends received by the assessee, rather than just the amount calculated in line with the Act’s requirements.

Conclusion

Expenses incurred in earning income other than salaries are deductible under Section 57 of the Income Tax Act. Taxpayers are eligible to deduct interest paid on loans taken out for investments as well as costs incurred to generate revenue.

The expenses that are claimed as a deduction must, however, be entirely and only incurred to earn revenue, and the borrowed funds must be invested in income-producing assets. To claim these deductions, taxpayers must also keep accurate records of the costs they spend and the interest they pay on loans.

To properly claim the deductions and prevent fines for making false claims, it is imperative to comprehend the terms of Section 57.