The Income Tax Appellate Tribunal, Mumbai, has clarified a critical principle in corporate tax law: interest on borrowings used to acquire a controlling stake in a foreign subsidiary operating in the same line of business qualifies as a deductible business expense under Section 36(1)(iii) of the Income-tax Act, even if the primary return is dividend income.
Background & Facts
The Dispute
The dispute centers on the disallowance of ₹146.73 crore in interest expenditure incurred by Tata Chemicals Ltd. on External Commercial Borrowings (ECB) and Non-Convertible Debentures (NCDs). These funds were utilised to acquire a 100% controlling interest in General Chemical Industrial Products Inc. (GCIP), USA, a global player in the soda ash market. The Assessing Officer treated this interest as capital expenditure, arguing that the investment was not part of the assessee’s core business and that the returns (dividend income) were taxable under "Income from Other Sources".
Procedural History
- Assessment Year 2015-16: The Assessing Officer disallowed the entire interest amount of ₹146,72,85,057/- under Section 36(1)(iii), classifying it as capital expenditure.
- Dispute Resolution Panel (DRP): The DRP upheld the disallowance, citing the need to maintain consistency with its own earlier view, despite having previously accepted the assessee’s position in assessment years 2009-10 to 2011-12.
- Appeal to Tribunal: The assessee filed an appeal before the ITAT Mumbai, challenging the disallowance on grounds of legal precedent and commercial rationale.
Relief Sought
The assessee sought deletion of the disallowance, contending that the interest was incurred wholly and exclusively for the purposes of its business, in line with the Supreme Court’s ruling in Core Health Care Ltd. and the principle that the nature of the asset acquired is irrelevant under Section 36(1)(iii). In the alternative, it claimed the interest should be allowed under Section 57(iii) as expenditure for earning dividend income.
The Legal Issue
The central question was whether interest on borrowings used to acquire a controlling stake in a foreign subsidiary engaged in the same line of business qualifies as a deductible business expense under Section 36(1)(iii) of the Income-tax Act, even when the returns are dividend income taxable under "Income from Other Sources".
Arguments Presented
For the Appellant/Petitioner
The assessee relied on the Supreme Court’s decision in Core Health Care Ltd. (298 ITR 194), which held that interest is allowable under Section 36(1)(iii) if the borrowing is for business purposes, irrespective of whether the funds are used for capital or revenue assets. It argued that the acquisition of GCIP was a strategic business move to consolidate its global position in soda ash production, expand market reach, and gain cost advantages. The classification of shares as "investment" in the books was irrelevant; what mattered was the business purpose behind the borrowing. The assessee also cited its own prior successful claim in AY 2017-18, where the Tribunal had allowed the deduction, and emphasized that Section 36(1)(iii) does not require the expenditure to be for earning immediate profits, only for the purposes of business.
For the Respondent/State
The Revenue contended that the interest could not be allowed under Section 36(1)(iii) because the assessee did not earn any income from the investment under the head "Profits and Gains of Business or Profession". It argued that dividend income from foreign subsidiaries is taxable under "Income from Other Sources", and therefore, any related expenditure must be examined under Section 57(iii). Relying on CIT v. R. Amritaben Shah (238 ITR 777), the Revenue asserted that the dominant purpose of the investment was to acquire controlling interest, not to earn dividends, making the interest non-deductible under Section 57(iii). It further invoked Section 115BBD(2), arguing that since the foreign subsidiary was capable of yielding dividend income, no deduction of interest was permissible against such income.
The Court's Analysis
The Tribunal examined the statutory language of Section 36(1)(iii), which permits deduction of interest on capital borrowed "for the purposes of the business". It noted that the Supreme Court in Core Health Care Ltd. had explicitly rejected the distinction between capital and revenue purposes for this provision. The Tribunal held that the term "for the purposes of the business" is broad and encompasses acts incidental to the carrying on of business, including strategic acquisitions that enhance competitive position, secure supply chains, or expand market presence.
"The decisive test is whether the capital is borrowed 'for the purposes of business'. Once this condition is satisfied, the nature of the asset acquired - whether capital or revenue - and the form in which it is held, namely as investment or otherwise, are wholly irrelevant."
The Tribunal rejected the Revenue’s reliance on Amritaben Shah, observing that this case applied to Section 57(iii), which imposes a narrower test - expenditure must be incurred "wholly and exclusively" for earning income from other sources. Section 36(1)(iii) has no such restrictive condition. The acquisition of GCIP was not a passive investment but a deliberate business strategy to integrate vertically and horizontally in the global soda ash industry, directly advancing the assessee’s operational objectives.
The Tribunal also dismissed the Revenue’s invocation of Section 115BBD(2), noting that this provision bars deductions against dividend income only when the dividend is actually received and taxed under Section 115BBD. Since the dividend income was not offered for taxation in the year under consideration, Section 115BBD(2) was inapplicable. The mere potential to earn dividend does not trigger its bar.
The Tribunal further noted that the assessee’s prior claim in AY 2017-18 had been upheld by a coordinate bench, and the principle of consistency in tax administration required the same treatment. The DRP’s attempt to reverse its earlier view without any material change in facts or law was found to be arbitrary.
The Verdict
The assessee won. The Tribunal held that interest expenditure of ₹146.73 crore incurred on borrowings used to acquire a controlling interest in a foreign subsidiary engaged in the same business qualifies as a deductible business expense under Section 36(1)(iii). The disallowance was deleted, and the appeal was allowed.
What This Means For Similar Cases
Business Purpose Trumps Asset Classification
- Practitioners must argue that strategic acquisitions - whether of subsidiaries, joint ventures, or overseas assets - are valid business purposes under Section 36(1)(iii), regardless of whether the asset is classified as investment in the books.
- The mere fact that returns are dividends taxable under "Income from Other Sources" does not disqualify the interest deduction.
- Maintain clear documentation linking the borrowing to the strategic business rationale, including board resolutions, feasibility studies, and market expansion plans.
Section 57(iii) Is Not a Substitute for Section 36(1)(iii)
- The Revenue’s attempt to shift the ground to Section 57(iii) is legally flawed. Section 57(iii) requires the expenditure to be incurred exclusively for earning income from other sources, which is rarely the case in corporate acquisitions.
- If the primary purpose is business expansion, Section 36(1)(iii) applies; Section 57(iii) is irrelevant.
- Do not concede to the Revenue’s argument that interest must be claimed under the head where income is reported.
Section 115BBD(2) Does Not Automatically Bar Deductions
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Section 115BBD(2) only denies deductions when dividend income is actually received and taxed under Section 115BBD.
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If the dividend is not declared or not offered for tax, the bar does not apply.
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In cases where foreign dividends are not taxed in India due to DTAA or non-distribution, Section 115BBD(2) cannot be invoked to disallow interest.
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The Tribunal’s reliance on Core Health Care Ltd. reaffirms that the purpose of borrowing, not the nature of the asset, governs deductibility under Section 36(1)(iii).
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This judgment reinforces the principle that corporate restructuring and strategic acquisitions are integral to business operations and deserve tax neutrality.
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Practitioners should proactively raise this precedent in cases involving cross-border acquisitions, especially in sectors like chemicals, pharmaceuticals, and manufacturing where vertical integration is common.
