Introduction
A recurring issue in tax assessments concerns the deductibility of interest on borrowed funds when those funds are temporarily parked in mutual funds or fixed deposits before being used for the intended business purpose. The Mumbai ITAT has addressed this issue in a comprehensive ruling in the case of Incline Realty Private Limited, reaffirming that such interest is allowable under section 36(1)(iii) of the Income tax Act, 1961, provided the business nexus is clear and uninterrupted.
Legal Provision under Section 36(1)(iii)
Section 36(1)(iii) provides for deduction of interest paid in respect of capital borrowed for the purposes of business or profession. The section does not impose any restriction on interim use or temporary deployment of funds, as long as the purpose of borrowing remains wholly and exclusively for the business.
Key Conditions to Claim the Deduction
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Existence of a capital borrowing
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Payment of interest on the borrowed capital
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The borrowing must be for the purpose of the business or profession
There is no requirement in law that the borrowed funds must be used immediately or without any temporary investment.
Facts of the Case
Incline Realty Private Limited, a real estate company, raised funds by issuing secured debentures to acquire land from Tata Steel Limited. Due to the terms of the agreement, the payment for land acquisition was scheduled after a certain period. During the intervening period, the borrowed funds were temporarily invested in growth mutual funds and fixed deposits. Subsequently, the funds were withdrawn and used for the stated business purpose. The company claimed the interest cost incurred during the interim period as a deduction under section 36(1)(iii).
The Assessing Officer disallowed the claim, stating that since the funds were invested in financial instruments, the interest was not incurred for business purposes. The Commissioner of Income-tax Appeals confirmed the disallowance. The matter was taken up before the Income Tax Appellate Tribunal Mumbai Bench.
Tribunal's Ruling
The Tribunal reversed the disallowance and held that the interest was fully allowable under section 36(1)(iii). The following key points were considered:
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The funds were raised specifically for the purchase of land which was to be used for a real estate development project. The purpose of borrowing was never in dispute.
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The temporary parking of funds in mutual funds and deposits was done out of commercial prudence to reduce the cost of borrowing during the idle period. The funds remained earmarked for the land purchase.
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The assessee had no intention to divert the funds for any non business purpose. The end use remained the same.
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Income earned from the interim investments was offered to tax. The act of earning interim income does not nullify the business purpose of the borrowing.
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The Tribunal reiterated that commercial expediency and business intent are paramount in evaluating such deductions.
Judicial Precedents Supporting the View
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CIT vs Bombay Samachar Limited 1969 74 ITR 723 SC
Held that temporary deposits of borrowed funds do not break the nexus if the final use is business related -
DCIT vs Core Healthcare Limited 2008 298 ITR 194 SC
Interest on borrowed capital is deductible even when the asset is under construction -
CIT vs Tata Chemicals Limited 2002 256 ITR 395 Bombay HC
Temporary investment of borrowed funds does not disentitle deduction under section 36(1)(iii) -
S A Builders Limited vs CIT 2007 288 ITR 1 SC
If the borrowing is made on grounds of commercial expediency, deduction cannot be disallowed
Tax Treatment and Practical Implications
Interest on borrowed funds remains deductible under section 36(1)(iii) even if the funds are temporarily parked in investments, provided:
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There is clear documentation showing the original business intent
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The temporary investment is safe, liquid and intended to reduce interest cost
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The final application of funds is for business use
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Income from temporary investments is reported under the head Income from Other Sources
Compliance Checklist
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Maintain board resolutions and debenture issuance terms specifying purpose
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Ensure the investment instruments are short term and easily redeemable
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Keep records of redemption and application of funds towards the stated project
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Disclose interest income and interest expense accurately in the books
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Ensure consistency between financial statements and tax returns
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Report interest under the appropriate clauses in Form 3CD of the tax audit report
When Deduction May Be Denied
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If borrowed funds are used for unrelated investments or diverted to group entities without commercial justification
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If there is no evidence of subsequent business use
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If the investments are speculative or long term in nature
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If the interim investment becomes a permanent arrangement
Conclusion
The Mumbai ITAT in Incline Realty Private Limited has reinforced the principle that temporary investment of borrowed funds does not break the business nexus required under section 36(1)(iii), provided the end use is for business and the investment is made out of commercial prudence. This decision is consistent with long standing judicial principles and provides clear guidance to taxpayers operating in capital intensive industries.
Proper documentation, transparency in fund flow, and commercial rationale are essential to sustain such claims during assessments. Taxpayers should ensure alignment of intent, accounting treatment, and legal compliance while handling interim deployment of borrowed capital.
