Supreme Court Allows Interest Deduction on Funds Advanced to Sister Concern – Reaffirms ‘Commercial Expediency’ Test

 Summary

The Supreme Court (SC) has recently ruled in the case of L. K. Trust v. CIT on the deductibility of interest expenditure incurred on borrowed funds that were advanced to a sister concern. The key issue was whether such interest qualifies as a deduction under Section 36(1)(iii) of the Income Tax Act, 1961 (ITA 1961) – specifically, when the borrowed funds are used by the sister concern to acquire shares in another company.

Facts of the Case

The taxpayer (L. K. Trust) had advanced borrowed funds to its sister concern for the purpose of acquiring shares in a company. However, the proposed acquisition did not materialise fully, and a portion of the funds remained with the sister concern.

Key Legal Issue

Whether the interest expenditure on such borrowed funds could be allowed as a business deduction under Section 36(1)(iii), even though the funds were not used directly in the taxpayer’s own business but were advanced to a sister concern.

Supreme Court Ruling

Relying on its earlier precedents, the Supreme Court held as follows:

1. Wider scope of “for the purpose of business”: The expression “for the purpose of business” under Section 36(1)(iii) is wider in scope than the phrase “for the purpose of making or earning income” used in Section 57(iii) of the ITA 1961.

2. Test of commercial expediency: The use of borrowed funds for a business purpose must be examined from the perspective of commercial expediency, and not merely from whether the advance was made for earning immediate profits.

3. Application of precedent: In earlier rulings, the Court had held that commercial expediency is satisfied in situations such as:

   • A holding company advancing interest-free funds to its subsidiary (in which it has a deep interest) for use in the subsidiary’s own business; or

   • Borrowed funds used for investment in a subsidiary to acquire controlling interest.

Applying the same ratio to the present case, the Court concluded that the test of commercial expediency was met – even though the borrowed funds were utilised by the sister concern for its own business, and even though part of the proposed share acquisition did not fructify.

Outcome

The Supreme Court ruled in favour of the taxpayer, permitting the deduction of interest expenditure under Section 36(1)(iii).

Significance

The decision reaffirms that interest on borrowed funds advanced to a sister concern can qualify as a business deduction if the advancement is driven by commercial expediency – such as maintaining control, supporting group operations, or facilitating business arrangements – rather than being judged solely by whether the funds directly generated income for the lender.

---

Note:
[1] L. K. Trust v. CIT (Supreme Court)
[2] Corresponding provisions under the Income Tax Act, 1961 (as applicable)