The Kerala High Court (Ernakulam Bench) has held that deduction under Section 36(1)(iii) of the Income Tax Act is available only in respect of interest paid on capital borrowed for the purpose of the assessee’s own business or profession. However, if an individual borrows money and invests it as capital in a partnership firm, in which she is a partner, and it is the Firm that carries on the business, then the individual assessee cannot claim the deduction under Section 36(1)(iii) in respect of interest paid on such borrowing. The right to claim such deduction, if at all available, would vest in the Firm and not in the individual partner.

The Division Bench comprising Justice Devan Ramachandran and Justice Basant Balaji observed that the appellant’s own conceded case was that she had borrowed money from others and invested it as her capital in the Firm, and that it was the Firm, not the appellant herself, that was running the business. The appellant did not raise even a whisper of a contention that she was running any business on her own, or that she had borrowed for the purpose of capital for such a business.

The Bench further observed that under Section 36(1)(iii) of the Act, only the amount paid as interest in respect of capital borrowed for the purpose of business or profession is eligible for deduction. Since the appellant had borrowed to invest as capital in the Firm, and it was the Firm that was conducting the business, the Bench held that only the Firm could have made any such claim, even if it were assumed to be eligible.

Briefly, the appellant, a partner in a Firm, has borrowed money from the open market and invested the same as her capital contribution in the Firm. The Firm, in turn, paid her interest on such capital investment, which she used to repay the persons from whom she had originally borrowed.

Now, while filing her return, the appellant claimed a deduction under Section 36(1)(iii) of the Income Tax Act in respect of the interest paid on the borrowed amounts, contending that the interest received from the Firm on her capital investment was eligible for such deduction. The Assessing Officer however, passed an assessment order holding that the provisions of Section 37(1) of the Act stood against her, which was confirmed by the ITAT as well.

Appearances:

For Appellant:Advocate G. Chitra

For Respondent: Advocate Jose Joseph, for Respondent