Mumbai Tribunal Upholds Interest Deduction on Borrowings for Overseas Acquisition

 Mumbai Tribunal has deleted the interest disallowance in respect of borrowed funds deployed for the acquisition of an overseas company through step-down wholly owned subsidiaries, holding that the interest expenditure claimed as a deduction under Section 36(1)(iii) of the Income-tax Act, 1961 (‘the Act’)was incurred wholly and exclusively for the purposes of business and was therefore fully allowable.

The Assessee identified a European steel producer for acquisition through a combination of own funds and borrowings. Funds were contributed into a wholly owned special purpose vehicle, which in turn invested into a UK-incorporated step-down subsidiary that ultimately acquired the target company. Interest payable on these borrowings was claimed as a business deduction under Section 36(1)(iii) of the Act. Revenue disallowed the claim on the ground that it was a capital expenditure, and the investment was made solely to acquire controlling interest and not out of any business consideration, and that the shares were classified as 'investments' in the Assessee's books.

The Tribunal in order to evaluate whether the interest expense was for "the purpose of the business or profession" examined the factual matrix in depth and placed significant reliance on board meeting minutes and presentations which demonstrated that the Assessee had evaluated strategic synergies arising from the acquisition including operational integration, savings and entry into mature overseas markets. It also noted that loan agreements entered with lenders mentioned the use of borrowings for acquisition purposes.

Considering the factual matrix, the Tribunal relied on the Bombay High Court's ruling in PCIT v. Concentrix Services (P) Ltd., which held that a company has three broad options for overseas business expansion i.e., establishing a branch, incorporating a new entity or acquiring an existing similar business and that the choice among these is a pure business decision. Since the Assessee had chosen the acquisition route and the target was in the same line of business, the interest on borrowed funds was allowable under Section 36(1)(iii) of the Act. The Tribunal also relied on a recent Supreme Court ruling in the case of Sharp Business Systems vs. CIT, wherein it was held that the investment was clearly for commercial expediency since it was for acquiring controlling interest in a subsidiary. The Tribunal further distinguished the Revenue's reliance on the Tata Sons precedent, noting that the said entity is an investment company whose sole objective is acquiring shares for investment, whereas the assessee is a manufacturing enterprise making a strategic business acquisition, a fundamentally different factual position. Additionally, the Tribunal also noted that since the interest deduction was allowed under Section 36(1)(iii) of the Act, the alternate claim under Section 57(iii) of the Act did not survive.

This ruling provides significant affirmation of the deductibility of interest on borrowings made for inorganic overseas expansion through the acquisition route. It also underscores the importance of robust documentation. Accordingly, companies undertaking such acquisitions should carefully document the business rationale through board presentations, financing recitals, synergy assessments, and integration records.