The Taxpayer incurred interest expenditure on the funds borrowed for investing in shares of a company, with a view to acquire controlling interest. The ITAT held that the interest expenditure incurred is not allowable under Section 57(iii)(Section) of the Indian Tax Law (ITL), since it is not incurred ‘wholly and exclusively’ for the purpose of earning dividend income.
Background and facts of the case
- The Section provides for deduction of revenue expenditure, laid out or expended ‘wholly and exclusively’, for the purpose of making or earning income assessable under the head ‘Income from other sources’.
- The Taxpayer is a Tata Group company, engaged in the business of investment and finance.
- The Taxpayer was used as a Special Purpose Vehicle (SPV) by the Tata Group for the acquisition of 45% equity share capital of VSNL (a telecom company owned by Government of India) under a divestment program. By this acquisition, the Tata Group acquired management control over VSNL.
For financing the acquisition, the Taxpayer used its share capital, as also borrowed funds raised by way of unsecured loan and private placement of bonds and debentures.
- The Taxpayer claimed interest paid on the borrowed funds as a deduction under the Section from the dividend income received from VSNL.
- The Tax Authority and the first appellate authority disallowed the deduction, by holding that the borrowed funds were used for acquisition of controlling interest in VSNL and not with the object of earning income. The Taxpayer appealed further to the ITAT.
Contentions of the Taxpayer
- The funds were borrowed for acquiring the shares of VSNL for strategic investment purpose and not with the intention of trading in such shares. The terms of the share purchase agreement with the Government precluded the Taxpayer from selling the shares for a period of 3 years. The terms permitted the Taxpayer to appoint 8 out of 12 directors on VSNL’s board of directors. The investment was, therefore, a capital investment in order to earn dividend income.
- As long as one of the purposes of the investment was to earn dividend income, the deduction cannot be disallowed merely because the purchase of the shares also had a ‘concurrent purpose’ of acquiring controlling interest.
- In any case, there need not be a direct nexus between the incurrence of expenditure and the earning of income in order to qualify for a deduction under the Section.
- The Taxpayer placed reliance on the decision of the Bombay High Court (HC) in the case of Ormerods (India) Pvt. Ltd. vs. CIT [36 ITR 329] (Ormerods ruling)where the HC allowed the deduction under similar facts.
- The case of CIT vs. Amritaben R. Shah [238 ITR 777] (Amritaben ruling) relied upon by the Tax Authority is distinguishable since the ITAT, in that case, recorded a factual finding that the acquisition of shares was for the purpose of acquiring controlling interest in the investee company and not for earning dividend.
Contentions of the Tax Authority
- The Taxpayer acquired the shares of VSNL with a view to enable the Tata Group to have control over VSNL. The acquisition was, therefore, only for the Tata Group’s convenience and not for the Taxpayer’s own benefit.
- The Section requires the expenditure to be incurred ‘wholly and exclusively’ for the purpose of making or earning income to be allowed as deduction. The Taxpayer acquired the shares neither with a view to have controlling interest for itself nor with a view to earn dividend income.
- The Ormerods ruling, relied on by the Taxpayer, is distinguishable since the facts were peculiar and there was an element of acquiescence on the Tax Authority’s part since it did not challenge the ITAT’s deletion of identical disallowance for some years.
- The HC, in that case, proceeded on the basis that the shares acquired did not comprise stock-in-trade of the taxpayer. In the same case, the ITAT did not give any finding that the shares were not purchased solely with the intention to earn dividend income. The ITAT ruled in the taxpayer’s favor for 5 years but the Tax Authority appealed to the HC for the first 2 years only, conceding that the deduction is allowable for the balance 3 years.
Ruling of the ITAT
- The Taxpayer acquired controlling interest in VSNL only to serve its holding company’s interest, by acting as an SPV, and not with the dominant objective to earn income, either directly or indirectly. The intention of making investment in VSNL was only in its capacity as a subsidiary of the Tata Group and in order to enable the Tata Group to have control of VSNL. The Ormerods ruling relied upon by the Taxpayer is not applicable in the present case since, as noted by the HC itself, the facts in that case were very peculiar.
- As against that, Amritaben’s ruling is squarely applicable to the Taxpayer’s facts. As held by the HC in that case, in order to qualify for deduction, the expenditure should be incurred ‘wholly and exclusively’ for earning dividend income. If the investment is made for acquiring controlling interest, then the expenditure cannot be regarded as ‘wholly and exclusively’ incurred for earning dividend income.
- In the present case, since the main object behind the investment was to acquire controlling interest and not to earn dividend income, the interest expenditure on borrowed funds was not deductible under the Section.
Comments:-This ruling provides guidance that deduction for expenditure is available under the Section only if it is incurred ‘wholly and exclusively’ for the purpose of making or earning income assessable under the head ‘Income from other sources’.