Interest paid for capital borrowed for business purpose is deductible u/s 36 of Income Tax Act

In an order rendered on 8^th April 2022 rendered in MMR Social Housing Pvt. Ltd. V. Dy. Commissioner of Income Tax, the ITAT Bench held that any amount of the interest paid in respect of capital borrowed for the business purposes constitutes an allowable deduction u/s 36(1) of the Income Tax Act (“Act”) irrespective of the method of accounting of recognizing the income followed by the assessee. In case it is not evident from the record that the interest claim and related capital borrowed were not utilized by the assessee for business purposes of the assessee the deduction has to be allowed.

In this case, the assessee was a private limited company and was engaged in the business of real estate construction and development. During the year under consideration, the assessee e-filed its return of income on 29 November 2014 declaring an income of Rs. NIL. During the year under consideration, the assessee was developing a residential project named as “Casa Royale” at Thane. The assessee being the company was following the mercantile system of accounting and for the purposes of recognizing the revenue from the above project, it was following the percentage completion method of accounting. For the purpose of construction, the assessee had borrowed interest-bearing funds from the group concern and financial institutions. On the said funds, the assessee had paid the interest of Rs. 16.96 crores and after reducing the interest income of Rs. 5.58 crores net interest expenses of Rs. 11.38 crores was shown as expense. Out of the total interest expenses of Rs. 11.38 crores, the assessee had capitalized interest of Rs. 5.02 crores to work in progress. Out of the said interest of Rs. 5.02 crores, capitalized in the books of accounts, the interest of Rs. 4.35 crores was claimed as a deduction in the return of income.

Accordingly, during the course of assessment proceedings, the assessee was asked to explain why the interest expenses claimed in the return of income should not be disallowed. In reply, the assessee submitted that the interest expenses have been claimed as a deduction in the year of incurrence thereof for the reason that the interest is a periodic cost; hence, the claim in the year for which it belongs to.

The Assessing Officer rejected the submissions of the Assessee and held that (i) the assessee had not followed the correct method of accounting in respect of the expenses towards the project being developed by the assessee, and (ii) as per guidance note on accounting for real estate transaction issued by the Institute of Chartered Accountants of India, all expenses directly related to the project have to be carried over and debited to the cost of the project. Such expenses can be claimed as deductions in the year in which the corresponding income of the project is credited in the books of accounts and offered to tax.

The appeal of the Assessee before the CIT(A) was dismissed.

ITAT in its order dated 8^th April 2022 set aside the order of CIT and allowed the deduction to the assessee. It relied on an order dated 5^th April 2021 passed by a coordinate bench in CIT v/s National Standard Private Limited in ITA No.3048/Mum and allowed the deduction. The reasoning is given in National Standard (supra) relied on by ITAT is as follows:

“6. Proceeding further, it is undisputed fact that the assessee was engaged in real estate construction and had borrowed capital for business purposes. No other diversion of income has been alleged by Ld. AO. As noted by Ld. CIT(A), the interest was paid to debenture holders, financial institutions as well as unsecured loan creditors and the loan was utilized for business purposes. The funds were borrowed for the purpose of construction and have gone into the projects of the assessee which constitute assessee’s stock-in-trade and not capital asset. In view of these clear cut findings, the adjudication of Ld. CIT(A) could not be faulted with. Another important fact is that the assessee has followed consistent accounting treatment to charge interest expenditure in the accounts. Therefore, the ground thus raised by the revenue stand dismissed.”

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