Can interest expenses be deducted under Section 57(iii) if the assessee is not in the business of lending?

Yes. The ITAT held that the nature of the assessee’s primary business is irrelevant. Deduction is allowed if the expenditure is incurred wholly and exclusively for earning income from other sources, as established in Vodafone South Ltd. v. CIT.

Can an assessee partially capitalize interest and partially claim it as revenue expenditure?

Yes. The ITAT accepted that where borrowed funds are used for both capital (e.g., land purchase) and revenue (e.g., FDRs, loans) purposes, the assessee may capitalize interest attributable to capital assets and deduct interest attributable to income-generating investments, provided the allocation is reasonable and documented.

Section 57(iii) interest deduction ITAT Delhi

Q: Is the Tuticorin Alkali Chemicals case applicable to disallow interest expense deductions under Section 57(iii)?

No. The ITAT clarified that Tuticorin dealt with the taxability of interest income earned on borrowed funds, not the deductibility of interest expense. It does not bar deduction under Section 57(iii) where a direct nexus exists.

The Income Tax Appellate Tribunal, Delhi, has clarified that interest expenses incurred by a real estate company can be deducted against interest income under Section 57(iii) of the Income Tax Act, 1961, provided a direct nexus exists between the borrowed funds and the income earned - regardless of whether the entity is in a pre-operative stage. This ruling reinforces commercial expediency as a valid basis for expenditure allowance and limits the scope of blanket disallowances based on business nature alone.

Background & Facts

The Dispute

The assessee, Nadish Real Estate Pvt. Ltd., engaged in real estate development, borrowed funds from M/s India Bulls Financial Services Ltd. during the financial year 2017-18 (Assessment Year 2018-19). A portion of these borrowed funds was used to purchase land, while another portion was invested in Fixed Deposit Receipts (FDRs) or advanced as interest-bearing loans to third parties. The company earned interest income from these investments and claimed a deduction of Rs. 2,38,71,670/- under Section 57(iii) against such income. The Assessing Officer (AO) disallowed this deduction, arguing that the interest expense was not incurred wholly and exclusively for earning interest income, as the borrowed funds were also used for capital purposes. The AO further directed capitalization of the entire interest expenditure of Rs. 5,67,80,588/-.

Key Facts

The assessee borrowed a total of Rs. 56,95,74,077/- during the year.
Rs. 32,98,27,810/- was utilized for purchase of land (capital purpose).
Rs. 23,97,46,267/- was deployed in FDRs and interest-bearing loans (revenue purpose).
Total interest expense incurred: Rs. 5,67,80,588/-.
Of this, Rs. 3,29,08,918/- was capitalized against land inventory.
Rs. 2,38,71,670/- was charged to revenue and claimed as deduction under Section 57(iii).
Total interest income earned: Rs. 3,58,05,065/- (Rs. 3,57,39,987/- from loans + Rs. 65,078/- from FDRs).
Net interest income offered to tax: Rs. 1,19,33,395/- (after netting claimed deduction).
The assessee submitted detailed ledgers, PAN details of borrowers, and a weighted average computation of interest capitalization.

Procedural History

25.09.2018: Assessee filed return of income for AY 2018-19 under ITR-6, disclosing total income of Rs. 1,15,71,030/- under normal provisions and Rs. 1,15,71,033/- under Section 115JB.
15.02.2021: AO issued notice under Section 142(1) seeking explanation on capitalization of interest and utilization of loan proceeds.
13.04.2021: Assessee replied, submitting evidence of fund deployment and claiming deduction under Section 57(iii).
16.04.2021: AO passed assessment order disallowing Rs. 2,38,71,670/- under Section 57(iii) and directing capitalization of entire interest expenditure.
05.05.2025: Commissioner of Income Tax (Appeals) [NFAC] allowed the appeal, deleting the disallowance and relying on Vodafone South Ltd. v. CIT.
22.04.2026: ITAT Delhi heard the Revenue’s appeal and upheld the CIT(A)’s order.

The Parties' Positions

For the Revenue (AO):

Argued that since the assessee was in pre-operative stage (no business activity), all interest expenditure must be capitalized.
Contended that the funds were not used exclusively for earning interest income, as part was used for land acquisition.
Relied on Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT (227 ITR 172) to assert that interest earned on borrowed funds is taxable, but corresponding interest expense is not deductible.

For the Assessee:

Maintained that the Rs. 2,38,71,670/- expenditure was directly linked to earning Rs. 3,58,05,065/- interest income.
Emphasized that the sanction letter from India Bulls permitted onward lending and FDR investment.
Relied on Vodafone South Ltd. v. CIT [2015] 61 taxmann.com 415 (Delhi) to establish that commercial expediency and direct nexus, not business nature, determine deductibility.
Clarified that Tuticorin dealt with taxability of interest income, not deductibility of expenses.

Relief Sought

The Revenue sought to restore the AO’s disallowance of Rs. 2,38,71,670/- and uphold the capitalization of entire interest expenditure. The assessee sought confirmation of the CIT(A)’s order allowing the deduction.

The Legal Issue

Can interest expenses claimed under Section 57(iii) of the Income Tax Act be allowed against interest income earned from borrowed funds, even if the assessee is in a pre-operative stage and part of the loan was used for capital purposes, provided there is a direct nexus between the expenditure and the income?

Arguments Presented

For the Appellant (Revenue)

The Revenue contended that the assessee was in a pre-operative phase with no active business, and therefore, all interest expenditure must be capitalized under the principle of matching expenses with future revenue. It argued that since part of the borrowed funds was used for land acquisition - a capital purpose - the interest expense could not be said to have been incurred wholly and exclusively for earning interest income. The Revenue relied on Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT (227 ITR 172), asserting that interest earned on temporarily parked funds is taxable, and the corresponding interest cost is not deductible. It further argued that the assessee’s selective capitalization of only Rs. 3,29,08,918/- and deduction of Rs. 2,38,71,670/- amounted to cherry-picking, violating the principle of uniform accounting treatment.

For the Respondent (Assessee)

The assessee countered that Section 57(iii) does not require the expenditure to be incurred in the course of the assessee’s primary business, but only that it be laid out wholly and exclusively for earning income from other sources. It emphasized that the sanction letter from India Bulls permitted onward lending and FDR investment, making the deployment of funds a commercial decision. The assessee relied on Vodafone South Ltd. v. CIT, where the Delhi High Court held that even if the assessee is not in the business of money-lending, if the interest expense has a direct nexus with the interest income earned, the deduction is allowable. It clarified that Tuticorin was inapplicable as it concerned the taxability of interest income, not the deductibility of interest expense under Section 57(iii).

The Court's Analysis

The Tribunal undertook a detailed examination of the factual matrix and the legal principles under Section 57(iii). It noted that the provision permits deduction of expenditure incurred wholly and exclusively for the purpose of earning income from other sources, irrespective of whether the assessee is engaged in the business of lending. The Tribunal emphasized that the test is not whether the transaction was prudent or whether it resulted in ultimate gain, but whether it was entered into as part of a legitimate commercial undertaking.

"The expenditure may not have been incurred under any legal obligation, yet it is allowable as business expenditure if it was incurred on grounds of commercial expediency. In other words, if it is such expenditure as a prudent businessman would incur for the purpose of business."

The Tribunal found that the assessee had established a clear and direct nexus between the Rs. 2,38,71,670/- interest expense and the Rs. 3,58,05,065/- interest income earned from FDRs and loans. The funds deployed for earning interest income were traceable, documented, and aligned with the terms of the loan sanction. The Tribunal distinguished Tuticorin on the ground that it dealt with the taxability of interest income earned on borrowed funds, not the deductibility of interest expense under Section 57(iii). It affirmed the Delhi High Court’s reasoning in Vodafone South Ltd., which held that the nature of the assessee’s primary business is irrelevant if the expenditure has a direct connection to the income earned.

The Tribunal also rejected the Revenue’s argument that the assessee was in a pre-operative stage and therefore all interest must be capitalized. It held that capitalization and revenue deduction are not mutually exclusive; the assessee was entitled to capitalize interest attributable to land acquisition and deduct interest attributable to income-generating investments. The weighted average computation submitted by the assessee was accepted as reasonable and supported by evidence.

The Verdict

The Revenue’s appeal was dismissed. The Tribunal upheld the order of the CIT(A) dated 05.05.2025, allowing the deduction of Rs. 2,38,71,670/- under Section 57(iii) of the Income Tax Act against interest income earned from FDRs and loans. The Tribunal confirmed that the interest expenditure was incurred wholly and exclusively for earning income from other sources, and the direct nexus was established. No further adjustments were directed, and the assessment was to be completed accordingly.

What This Means For Similar Cases

Direct Nexus Overrides Business Nature

Practitioners can now argue that Section 57(iii) allows deduction even if the assessee is not in the business of lending, provided the interest expense has a direct, traceable link to interest income.
The nature of the assessee’s primary business (e.g., real estate, manufacturing) is irrelevant under Section 57(iii); only the purpose of the expenditure matters.
Documentation of fund flow, sanction letters, and ledger entries is critical to establish nexus.

Capitalization and Revenue Deduction Are Not Mutually Exclusive

Assessees may capitalize interest attributable to capital assets while deducting interest attributable to income-generating investments.
A weighted average method of allocation, if properly documented, is acceptable under the law.
The Tribunal’s acceptance of partial capitalization sets a precedent for entities with mixed fund usage.

Tuticorin Does Not Bar Deduction - It Addresses Taxability

The Tuticorin judgment is not a bar to claiming interest expense deductions under Section 57(iii); it only confirms that interest income from borrowed funds is taxable.
Practitioners must distinguish between taxability of income and deductibility of expenditure when citing precedents.
Relying on Vodafone South Ltd. and similar decisions strengthens arguments for netting interest income and expense.
Always prepare a fund flow statement linking borrowed funds to specific income-generating activities.
Retain sanction letters permitting onward use of funds as key evidence.
Avoid blanket capitalization claims where part of the loan is clearly used for revenue purposes.