Interest on Borrowed Funds for Shares in Appellant’s Companies Ineligible for Deduction: Bombay High Court

Interest on Borrowed Funds for Shares in Appellant’s Companies Ineligible for Deduction: Bombay High Court

The Bombay High Court has ruled that interest paid on borrowed funds for investing in shares of two companies was impacted by Section 14A of the Act, given that dividends received from those shares did not contribute to the total income. The Division Bench, consisting of Justices K.R. Shriram and Dr. Neela Gokhale, emphasized that the dividends from these companies were not taxable. Consequently, any expenditure incurred on interest paid for funds borrowed in relation to the investment in shares of these companies fell under the purview of Section 14A, as the dividends did not form part of the total income.

The appellant, a former chartered accountant turned stockbroker, borrowed money and primarily invested it in shares of his own two companies: MKM Shares and Stock Brokers Ltd. and MKM Finance and Investment Pvt. Ltd. He claimed a deduction for the interest paid on these borrowings, amounting to Rs.36,88,866/-.

The Income Tax Department disallowed the interest deduction, citing Section 14A, which prohibits deductions for expenses related to income not included in the total income. Since dividends from these companies were exempt under Section 10(33), any related expenses couldn’t be deducted. Additionally, the shares were held as investments, not stock-in-trade, disqualifying them for a deduction under Section 36(1)(iii).

The Bench noted that the circumstances of the current case mirrored those addressed in the ruling of the Supreme Court in Maxopp Investment Ltd. v. Commissioner of Income Tax, New Delhi. In that case, the Supreme Court deliberated on whether expenses, including interest paid on borrowed funds, relating to investments in shares of operating companies to secure and maintain a controlling interest, were affected by Section 14A, given that dividends received from such shares did not contribute to the total income.

As per the Bench’s addition, the Supreme Court, in its interpretation of Section 14A, emphasized that the provision, particularly the phrase "in relation to the income" not forming part of the total income, doesn’t necessitate a dominant purpose test for which the investment into shares is made by an assessee. It clarified that even though dividend income is non-taxable, any expenditure incurred to earn such dividend income must be disallowed to the extent attributable to the dividend income. Therefore, such expenditures cannot be treated as business expenditures.

Relying on the Supreme Court’s judgment, the High Court upheld the disallowance of the interest deduction.