INTEREST ON BORROWED CAPITAL--SECTION 36(1)(iii)

This query is : Resolved

AJAY BANSAL (Querist)
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18 April 2011 There is an amendment in Section 36(1)(iii) by Finance Act, 2003, w.e.f. 01.04.2004 that is w.e.f. Assessment year 2004-05. A provisio was inserted in the said section---Any amount of interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession(whether capitalised in the books of account or not; for any period beginning from the date on which the capital was borrowed for acquisition of asset till the date on which such asset was first put to use, shall not be allowed as deduction.

One of my clients case was assessed and finalised for the assessment year 2007-08 u/s 143(3).My client had borrowed capital for expansion of his existing business but the assets so acquired were not put to use during that assessment year. Now based upon the audit objection, whether the department can raise any tax demand upon my client by disallowing the interest on borrowed capital for the expansion of existing business viewing the newly inserted provisio to section 36(1)(iii). Please clarity and also quote any case law which can be argued in my client's favour.
Please reply taking into account the Assessment Year 2007-08.
Thanks.

Yours,

(CA.Ajay Bansal)Cell: 9855652696

Pankaj Gandhi Jaiswal

Pankaj Gandhi Jaiswal (Expert)
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22 January 2012 Major Factor will be extention of business or addition of machinery in existing busienss

AJAY BANSAL

AJAY BANSAL (Querist)
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22 January 2012 SIR,

I DID NOT GET WHAT YOU MEAN. PLEASE CLARIFY FURTHER WHETHER INTEREST CLAIMED IN P & L A/C IN THE SITUATION CAN BE DISALLOWED AS PER PROVISO INSERTED W.E.F.01.04.2004? ALSO PLEASE CONSIDER THE ACCOUNTING STANDARD, IF ANY, APPLICABLE TO THIS SITUATION (BORROWING COST).
YOURS,

(CA. AJAY BANSAL)
9855652696

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Pankaj Gandhi Jaiswal

Pankaj Gandhi Jaiswal (Expert)
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22 January 2012
Analysis of Proviso of Section 36(1)(iii)

(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—

(iii) 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.]

Explanation.—Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause;

Analysis of Sections inserted w.e.f. 01.04.2004

1. Interest Paid
2. In respect of Capital Borrowed
3. Capital Borrowed For the Purposes of Business & Profession
4. Proviso-
a. Interest Paid
b. In respect of capital borrowed
c. Capital borrowed for acquisition of an asset
d. For Extension
e. Extension of Existing Business or Profession
f. Asset may be capitalized or not
g. for any period beginning from the date on which the capital was borrowed for acquisition of the asset
h. till the date on which such asset was first put to use
i. shall not be allowed as deduction

Before 01.04.2004 and after decision of the case XXXXXX it was clear that interest paid for business and profession will be allowable expenditure. But after addition of Proviso w.e.f. 01.04.2004 the section gives more clarity with respect to earlier.

As learned officer disallow the interest amount of Rs. keeping in mind the above proviso, so we want to give more light on this section and meaning arise after the insertion of this w.e.f. 01.04.2004.

This Proviso Say Following Line

Capital borrowed for acquisition of an asset

Proviso says amount borrowed for acquisition of an asset for extension of existing business or profession means it deals exclusively for acquisition of an asset for extension of existing business or profession and not deal with amount borrowed for business & profession generally.

Asset
Section say capital borrowed for acquisition of an asset. But Asset is not defined in the Act itself neither in this section. This asset is Fixed Asset or Current Asset it is not defined elsewhere. However in section 2(11) Block of Asset is defined and in Section 2(14) “Capital Asset” defined but nowhere defined only “Asset”.
As 16 deals with Borrowing cost and it describe the qualifying asset and not only use asset. So here using the word asset means in general term all asset including current assets, investment & fixed assets.

Acquisition of an asset for extension

Again section describe that this acquisition is for extension. This extension also is not defined in Income Tax Act. However in dictionary this word came from the word “Extend” and meaning of extend is-
• to stretch out; draw out to the full length
• to stretch, draw, or arrange in a given direction, or so as toreach a particular point, as a cord, wall, or line of troops.
• to stretch forth or hold out, as the arm or hand
• to place at full length, especially horizontally, as the body orlimbs.
• to increase the length or duration of; lengthen; prolong

As per dictionary meaning it come out that something stretch to be made to current position is called as a extension.

Extension of Existing

Also in proviso the word used “of” means there should be extension and this extension should be of existing. Means this proviso does not deal

• on interest paid on capital borrowed for commence of a newly startup.

• or this proviso does not deal with interest paid on capital borrowed for existing business.
What is Existing

Again existing used in this section is not defined in the ACT so we have to go to the general commercial or dictionary meaning of the word “Exist”.
Exist Means
• to have real being whether material or spiritual
• to have being in a specified place or with respect to understood limitations or conditions
• to have life or the functions of vitality
Origin of EXIST
Latin exsistere to come into being, exist, from ex- + sistereto stand, stop; akin to Latin stare to stand — more at STAND

Here word used in commercial term exist means something physically present at particular point of time. And extension of existing means some thing added to this physically present business asset at particular point of time.

• Means some asset to be added to existing business
• and capital borrowed for this something new addition of existing business.

Or you may say for disallowance of interest paid on capital borrowed,

• an existing business is required
• and the capital borrowed is only for extension of this existing business
• and not capital borrowed for other than existing business
• like capital borrowed 1st time when no existing business was there
• or capital borrowed for existing business only and not for its extensions.

Section Silent

Section is silent about capital borrowed first time for startup where more than one integrated plant was planned to be installed and only one part of plant is running and rest were not started just because of some more capital requirement. The all asset were bought at starting and thereafter neither new asset was added nor any new further extension was made and also nor any further capital was borrowed.

CA Pankaj Jaiswal
pankaj@anpllp.com