Introduction
The deductibility of interest on borrowed capital under the Income-tax Act, 1961 depends on the purpose and head of income under which it is claimed. Section 36(1)(iii) allows interest deduction for capital borrowed for the purposes of business or profession. In contrast, Section 57(iii) permits deduction of expenditure (including interest) incurred wholly and exclusively for earning income under the head "Income from Other Sources".
While both provisions operate independently, judicial scrutiny under Section 57(iii) is significantly stricter—especially when interest is claimed on borrowed capital that is lent onwards to related parties at concessional rates. The recent ruling of ITAT Mumbai in Jackie Mahesh Vora v. ACIT is a timely reaffirmation of this principle and draws a clear boundary on what qualifies as permissible deduction under Section 57(iii).
Section 57(iii) — Statutory Language and Interpretation
Section 57(iii) provides:
“Any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income” shall be allowed as a deduction.
Key Conditions for Allowability:
-
Wholly and exclusively incurred for the purpose of earning income;
-
Not capital in nature;
-
Direct nexus between expenditure and income;
-
No element of personal motive or non-commercial purpose.
This provision is narrower than it appears. Courts have repeatedly emphasised that even though income need not actually arise, the dominant intent of incurring expenditure must be income generation.
Judicial Evolution — From Rajendra Prasad Moody to Jackie Mahesh Vora
In CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 (SC), the Supreme Court held:
Expenditure under Section 57(iii) is allowable even if no income results, as long as the intent is to earn income.
However, this principle has been interpreted conservatively in later rulings. Courts have clarified that where the transaction lacks commercial justification or involves a benefit to a related entity, deduction may be disallowed in part or whole.
This judicial limitation culminates in the ITAT’s latest decision in Jackie Mahesh Vora v. ACIT [2025] 176 taxmann.com 279 (Mumbai).
Key Ruling: Jackie Mahesh Vora v. ACIT
Facts:
-
The assessee borrowed funds and paid interest exceeding ₹1 crore.
-
He earned interest income by lending to both related and unrelated parties.
-
He charged 8.5% to related parties and 12% to others.
Issue:
Was full deduction of interest paid on borrowed capital allowable under Section 57(iii), despite charging lower rates to related parties?
Findings of the Tribunal:
-
Disallowed a portion of the interest under Section 57(iii).
-
Held that lending to related concerns at concessional rates failed the exclusivity test.
-
Cited the presumption of non-commercial intent when differential rates are applied.
-
Distinguished the Moody ruling, clarifying that:
“The benefit of Moody cannot be extended where the assessee departs from a commercially reasonable approach in related party dealings.”
Comparison with Section 36(1)(iii)
| Particulars | Section 36(1)(iii) | Section 57(iii) |
|---|---|---|
| Applicable Head of Income | Profits and Gains of Business or Profession | Income from Other Sources |
| Nature of Allowance | Interest on capital borrowed for business | Any revenue expenditure to earn other income |
| Condition for Deduction | Capital must be used for business purposes | Expenditure must be wholly for earning income |
| Need for Income Result | Not necessary if funds used for business | Not necessary, but intent must be proven |
| Related Party Concessional Lending | Permissible with commercial nexus | Disallowed if exclusivity is compromised |
| Documentation Required | Books of account and audit trail | Strong evidence of intent and commercial purpose |
| Common Pitfall | Capital used for non-business purpose | Lending to relatives at concessional rates |
Key Takeaways for Taxpayers and Professionals
-
Uniform Lending Rates are Critical
Any differential in interest rates between related and unrelated parties may invite scrutiny and disallowance unless commercially justified. -
Maintain Documentation of Commercial Intent
Board resolutions, loan agreements, and fund flow statements must support the argument that funds were advanced solely to earn taxable income. -
Avoid Transactions Appearing as Accommodation Entries
Loans to relatives or group concerns without clear benefit to the lender may fail the deductibility test under Section 57(iii). -
Burden of Proof is on the Assessee
The Revenue is not required to prove personal benefit; it is for the taxpayer to establish the dominant income-earning purpose. -
Scrutiny Risk in Related Party Loans is Higher
Interest claims under Section 57(iii) involving related parties often attract detailed investigation or disallowance.
Conclusion
Section 57(iii) is not a fallback for every interest deduction claim outside business income. It demands that the expenditure be wholly and exclusively for earning income assessable under "Other Sources". Lending to related parties at concessional rates, without robust justification, falls afoul of this test.
The ruling in Jackie Mahesh Vora has restated the law: commercial rationale must override familial or group considerations. Otherwise, the interest claim will be disallowed to the extent it fails the exclusivity test.
Professionals advising on inter-entity lending or personal investments involving borrowed capital must evaluate whether their strategy would withstand scrutiny under Section 57(iii) — where intent, documentation, and commercial objectivity must align.
