Interest on Commercial Property Loan Disallowed as Business Expense Due to Non-Use

Summary: In Rup Kumar Ramchandani Vs ITO, ITAT Jaipur examined whether interest on borrowed capital used to acquire a commercial property could be allowed either as business expenditure under Section 36(1)(iii) or alternatively as a deduction under Section 24(b). The assessee claimed interest as a business deduction, asserting that the property was used for business, but failed to produce evidence of such use during the relevant assessment year. The Tribunal held that interest under Section 36(1)(iii) is allowable only when the asset is actually put to use for business, and since business use was not established, the disallowance was upheld. However, the Tribunal clarified that once a property is not used for business, its annual value becomes chargeable under the head “Income from House Property,” and deduction of interest under Section 24(b) does not depend on actual rental income. The alternate claim under Section 24(b) was therefore accepted in principle and remanded to the Assessing Officer for computation of annual value and consequential deduction.

Key issue: 

Whether interest on borrowed capital used for acquisition of a commercial property is allowable:

1. As business expenditure under section 36(1)(iii) when the asset is allegedly put to use, and

2. Alternatively, as deduction under section 24(b) under the head “Income from House Property” where the property is not proved to be used for business purposes during the relevant year.

Brief Facts:-

The assessee is an individual carrying on business through a proprietary concern, M/s SHE.

During the relevant assessment year, the assessee claimed interest expenditure of ₹11,82,662 as a business deduction.

Out of the above, interest amounting to ₹6,71,628 pertained to loan utilized for acquisition of a commercial property situated at Miraz Mall, Ajmer.

The Assessing Officer disallowed the said interest on the ground that the property was a capital asset and was not demonstrated to have been used for business purposes during the year.

The assessee alternatively claimed that if the interest was not allowable as business expenditure, the same should be allowed as deduction under section 24(b) under the head “Income from House Property”.

Statutory Provisions Involved

Section 36(1)(iii) – Deduction of interest on borrowed capital used for purposes of business or profession

Section 22 – Chargeability of income under the head “Income from House Property”

Section 23 – Determination of annual value of house property

Section 24(b) – Deduction of interest on borrowed capital used for acquisition, construction, repair or reconstruction of property

Action of AO:

Held that the borrowed funds were used for acquisition of a capital asset.Observed that the assessee failed to establish that the commercial property was put to use for business purposes during the year.

Disallowed interest of ₹6,71,628 claimed under section 36(1)(iii).

Did not allow the alternate claim under section 24(b) on the ground that the assessee neither earned rental income nor demonstrated letting out of the property.

CIT(A) order:

Confirmed the disallowance of interest under section 36(1)(iii).Recorded a categorical finding that interest paid prior to the asset being put to use is not allowable as business expenditure.

Rejected the alternate claim under section 24(b) on the reasoning that no income from the property was shown by the assessee.

ITAT Findings: 

A. Claim under Section 36(1)(iii) – Business Expenditure

The Tribunal noted that:

It was undisputed that the borrowed funds were utilized for acquisition of a commercial property.

Interest on borrowed capital is allowable under section 36(1)(iii) only when the asset is put to use for business purposes.

The assessee relied on an UDYAM Registration Certificate to establish business use of the property.

The Tribunal found that:The UDYAM Registration was dated 27.04.2021, which was subsequent to the relevant assessment year.

No material was produced to establish user of the property for business purposes during A.Y. 2019-20.

The assessee conceded inability to establish business use.

Accordingly, the Tribunal upheld the disallowance under section 36(1)(iii).

B. Alternate Claim under Section 24(b) – Income from House Property

The Tribunal undertook a combined reading of sections 22, 23 and 24(b).It observed that:

Section 22 taxes annual value of property owned by the assessee, except where the property is occupied for business purposes.

In the present case, it stood established that the property was not used for business purposes during the year.Consequently:

• The annual value of the property was chargeable under the head “Income from House Property”.
• Section 24(b) permits deduction of interest on borrowed capital used for acquisition of such property, irrespective of whether actual rental income is earned.
• The Tribunal rejected the reasoning of the lower authorities that absence of rental income disentitles the assessee from claiming deduction under section 24(b).
• However, since deduction under section 24(b) is allowable against the annual value, the Tribunal held that:
• Computation of annual value under section 23 was necessary.
• The matter required verification and computation by the Assessing Officer.

ITAT Decision:

Disallowance of interest under section 36(1)(iii) was confirmed, as the assessee failed to establish that the commercial property was put to use for business purposes during the relevant year.

• The alternate claim of deduction under section 24(b) was accepted in principle.
• The matter was restored to the file of the Assessing Officer with direction to:
• Compute the annual value of the property in accordance with section 23, and
• Allow deduction of interest under section 24(b) after granting due opportunity of hearing to the assessee.