In Absence Of Business Nexus, No Interest Deduction Allowed U/s 36(1)(iii) For Leveraged Acquisition

BACKGROUND

• The Assessee¹ is engaged in the business of manufacturing and sale of inorganic chemicals, fertilizers, and bio-fuels.
• The Assessee raised funds through External Commercial Borrowings (‘ECBs') and Non-Convertible Debentures (‘NCDs') and deployed the proceeds towards investment in the share capital of its overseas subsidiary companies.
• The Assessee debited interest expenditure of INR 146 crores pertaining to the ECBs and NCDs to the Profit and Loss Account for Financial Year 2014–15.
• The case was selected for complete scrutiny, and statutory notices under the Income-tax Act, 1961 were issued by the Assessing Officer (‘AO').

REVENUE'S ARGUMENTS

• Treatment in books of accounts - The investments in the overseas subsidiaries were recorded as capital investments in the Assessee's books and not as stock-in-trade. Any income arising from the subsidiaries to be assessable under the head “Income from Other Sources” (‘IFOS').

• Purpose of borrowing - The borrowed funds were utilized to acquire and maintain controlling interest in the overseas subsidiaries. The borrowings were not for carrying on the Assessee's business operations.
• Head of income - Any income arising from the overseas subsidiaries is assessable under the head IFOS and not as business income of the Assessee.
• Deductions follow the head of income - It is a settled principle that the taxability of a receipt under a particular head requires that allowable deductions be confined to that head.
• Assessee not in investment business - The Assessee is not engaged in the business of investments. The acquisitions represent capital investments in the share capital and subsidiary is a distinct legal entity, which conduct their own businesses and pay taxes in their respective jurisdictions.
• No claim under section 36(1)(iii) - The Assessee has not offered any income from these investments under Profit and gains from Business or Profession (‘PGBP'). Consequently, interest deduction under Section 36(1)(iii) of the Act shall not be allowed.
• Section 57(iii) not satisfied - Where income is chargeable under IFOS, any deduction must satisfy Section 57(iii) of the Act, i.e., the expenditure must be laid out wholly and exclusively for the purpose of making or earning such income. The purpose of the borrowings here was to acquire and retain controlling interest in the subsidiaries, not to earn dividend income. Therefore, the deduction under section 57(iii) of the Act shall not be allowed.
• Deduction under section 115BBD not allowed - No deduction shall be allowed from dividend income under section 115BBD of the Act if any dividend is received from the foreign subsidiary in which the Assessee holds 26% or more.
• Reliance is placed on decisions of the Hon'ble High Court² holding that interest on borrowings for acquiring controlling interest in subsidiaries is not allowable under Section 57(iii) of the Act when the primary objective is acquiring control.
• AO rejected the contentions of Assessee and held against the Assessee.
• Dispute Resolution Panel (‘DRP') endorsed AO's findings pursuant to which, Assessee contested the final order before the Appellate Tribunal.

ASSESSEE'S ARGUMENTS

• The Assessee raised borrowings in FY 2008–09 for the acquisition of General Industrial Products Inc. (GCIP), USA, a significant player in the global soda ash market, for an aggregate consideration of INR 4,036 crores.
• The overseas subsidiary operates in the same line of business as the Assessee. The investment was undertaken as a measure of commercial expediency and for the furtherance of the Assessee's own business interest.
• The interest on borrowed capital is deductible under Section 36(1)(iii) of the Act as it was incurred for the purposes of the Assessee's business.
• Reliance is placed on the decisions of the Hon'ble Supreme Court³ recognizing that Section 36(1)(iii) of the Act does not distinguish between capital borrowed for revenue purposes and capital borrowed for capital purposes, so long as the borrowing is for business purposes.
• Any dividend from such overseas subsidiary is merely incidental or ancillary to the principal business objective. Therefore, the allowability of interest under section 36(1)(iii) of the Act could not be denied.
• Alternatively, the Assessee submits that, to the extent the borrowed funds were utilized for investment in shares yielding dividend income chargeable to tax, the corresponding interest expenditure is allowable under Section 57(iii) of the Act as it was laid out wholly and exclusively for the purpose of earning such income.

TRIBUNAL OBSERVATIONS

• The deduction allowed under Section 36(1)(iii) of the Act is for computing income chargeable under the head PGBP. Consequently, such deduction can be allowed only against income assessable under the PGBP head.
• Permitting deduction of interest expenditure against business income, when the corresponding investment yields income assessable under entirely different head, would be contrary to the fundamental scheme and principles governing computation of income under the Act.
• The borrowed capital did not result in the acquisition of any business asset employed in the Assessee's business operations. Funds borrowed has merely facilitated acquisition of controlling interest in subsidiary companies. Consequently, the nexus required for allowance of deduction under section 36(1)(iii) of the Act is absent.
• In view of the above, Tribunal holds that the interest expenditure claimed under Section 36(1)(iii) of the Act is not allowable.
• Placing reliance on judicial precedent, Tribunal holds that interest incurred on borrowed funds utilized for acquiring controlling interest in a company is not deductible under section 57(iii) of the Act as the expenditure is not incurred wholly and exclusively for the purpose of earning dividend income.

AURTUS COMMENTS

• Acquisition through the borrowed funds has always remained a subject matter in the Indian judicial forums. This is another ruling for the leveraged strategic acquisition of target having the similar line of business, wherein it is held that interest for leveraged acquisition is not deductible under the Act.
• Interestingly, there are also contrary judicial precedents wherein appellate forums have taken a purposive and business-centric approach that if the leveraged acquisition served for expansion of the business, interest expense should be deductible under the provisions of the Act.

Footnotes

1. Tata chemicals Ltd. Vs DCIT vs DCIT (ITA No. 7912/MUM/2019)

2. CIT v. R. Amritben Shah (238 ITR 777) (Bombay HC)

3. Core Health Care Ltd. 298 ITR 194 (SC)(2008

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