The High Court ruled that if installments of loans taken by subsidiary company were repaid by guarantor for protecting its business then, assessee shall be entitled to deduction of interest on such payments.   

Facts:

The assessee is a public limited company engaged in the manufacture and sale of synthetic yarn and cement. It has a subsidiary company. This subsidiary company availed of credit facilities, term loans as well as working capital from various financial institutions. The subsidiary company incurred heavy losses as a result, it became a defaulter in paying its debts. The assessee, also a guarantor to the loans taken by the subsidiary company, repaid the installments of loan for protecting its own business interest. The amount paid was debited to their account. After making the payments, a debit balance of Rs. 61 lakhs stood in the name of the subsidiary company in the books of the account of the appellant. The debit balance was covered by the retained profits of the assessee during the period 1978-81.

According to the assessee, such repayment of the loan installment on behalf of the subsidiary company became necessary in order to protect the assessee’s own business interest.

In the assessment proceedings, the AO made a disallowance of interest and also disallowed the expenses claimed towards guarantee commission.

The Assessing Officer found that out of Rs. 61 lakhs only Rs. 8 lakhs was paid by the company to the financial institution and, therefore, was eligible for deduction of interest on the amount of Rs. 8 lakhs under section 36(1)(iii) of the Income-tax Act, 1961. The Assessing Officer held that the balance amount of Rs. 53 lakhs did not qualify for deduction of interest.

On appeal, CIT(A) accepted the plea of the assessee.

Aggrieved by the order, Revenue appealed to the Tribunal. The Tribunal set aside the order of the CIT(A) and upheld the order of the AO.

On this, appeal was made to the High Court.

Held:

The Court viewed that the assessee had deep business interest in the existence of its subsidiary company. It discharge its legal obligation by repaying the installments of loan to the financial institutions. Such loans were given for the purpose of business.

The Court also noted that the retained profits of the company were to the tune of Rs. 1,362 lakhs till the accounting year 1983-84 which covered the amount advanced to the subsidiary company and, therefore, found that interest on the said loan was to be given the necessary deduction under section 36(1)(iii) of the Act. The appellate authority found that any expenditure incurred by the assessee in an earning concern on deferred payment of the assets acquired is a revenue expenditure and, therefore, necessary deductions have to be allowed.

The provision of sec. 28 deals with the deduction on the profit of interest paid in respect of capital borrowed for the purposes of business or profession. It would be found from clause (iii) of sub-section (1) of section 36 of the Act that the three conditions must be established by an assessee for getting the benefit under the aforesaid clause, namely :

1. Interest should have been payable
2. There should be borrowing
3. Capital must have been borrowed or taken for business purposes.

Thus, in the light of aforesaid, the Court held that where guarantor repays loan of its subsidiary for benefits of its business then such expense shall be allowed.

Hence, the assessee was entitled to deduction of interest amounting to Rs. 9,54,000 on the loan given to its subsidiary company.

Case: J. K. Synthetics Ltd. vs. Commissioner of Income tax

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