(2007) 288 ITR 1 (SC)
Other specified deductions allowable — interest on borrowed capital
Yes, if the advance was made as a measure of commercial expediency. The test is whether the funds were advanced for the assessee's own business purposes, not whether the assessee earned a direct return.
Where a company borrows at interest and advances funds interest-free to its subsidiary, is the interest on the borrowing deductible?
The assessee had borrowed money on which it paid interest, and in the same period advanced sums to its subsidiary company without charging interest. The Assessing Officer disallowed a proportion of the interest on the borrowings, reasoning that to the extent borrowed funds had been diverted to an interest-free advance, the interest could not be said to have been incurred for the purposes of the assessee's business. The assessee maintained that the subsidiary's operations were closely connected with its own and that supporting it served its business interests.
The disallowance was sustained by the appellate authorities and the High Court, which considered that an interest-free advance could not be for the purposes of the lender's business. The assessee appealed to the Supreme Court.
For the assessee
The expression 'for the purposes of business' is wider than earning income directly from the sum advanced. Assistance to a subsidiary whose activities support or complement the assessee's own business is a legitimate business purpose, and it is for the businessman to judge what his interests require.
For the Revenue
Interest is deductible where capital is borrowed for the purposes of business. Money lent on without charge produces nothing for the lender, so the borrowing to that extent cannot be said to serve the business, and the interest must be apportioned and disallowed.
The Court held that the correct question is not whether the assessee earned a return on the amount advanced, but whether the advance was made as a measure of commercial expediency — an expression covering expenditure a prudent businessman incurs for the purposes of the business, even though not under legal compulsion and even though no immediate return results. Where a holding company advances funds to a subsidiary for the subsidiary's business, and there is a nexus between that assistance and the holding company's own business interests, the interest on borrowings deployed for that purpose is deductible. The Court cautioned that the mere existence of a subsidiary relationship is not enough: the Revenue and the appellate authorities must examine whether the advance genuinely served the assessee's business, and an advance made for the personal benefit of directors or for purposes unconnected with the business would stand on a different footing. It remitted the matter for that enquiry to be made on the facts.
Applied under Section 32 of the IT Act 2025. The leading authority on interest-free advances within groups, and the standard answer to proportionate interest disallowances. It should be read with South Indian Bank, which supplies the complementary presumption that investments are made from own funds where those exceed the advances — together they cover most interest disallowance disputes.