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Tax query: How is the interest paid on borrowings taxed?

Dilip Lakhani, Senior Chartered Accountant, answers queries from our readers on income tax and other levies.

Last Updated: Oct 11, 2019, 11.49 AM IST
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The said interest will not qualify as part of cost of acquisition in respect of listed shares purchased on the stock exchange.
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I am in the business of manufacturing readymade garments. I also regularly invest in IPOs as well as in listed securities. My source of funds include own funds, borrowing from commercial banks, NBFCs and private parties. The funds borrowed are used for making investment which earn dividend income and capital gains. The borrowed funds are also used for the purpose of business. Is the interest paid on borrowings will be allowed as deduction in computing taxable business income and capital gains? -Satish Shah

You can claim deduction of interest payment on borrowings as per u/s 36(1)(iii) of I.T. Act 1961 while computing business income provided you prove that the borrowing is used for the purpose of business. The interest paid on borrowing which is used for making direct investments in IPO or purchase of listed shares on stock exchange will not be allowed as deduction against capital gains u/s 36(1)(iii) of I.T. Act 1961. In computing capital gains the deduction of cost of acquisition and expenditure incurred on transfer of assets is allowed u/s 48 of I.T. Act 1961.

Interest paid will not qualify under any of the above two items. Section 36(1)(iii) permits deduction only when loans are used for the purpose of business and profession and not while computing capital gains.

Dividend income will be exempt u/s 10 of the I.T. Act 1961. Section 14A of the I.T. Act 1961, provides that no deduction shall be allowed for any expenditure incurred for earning income that is not chargeable to tax. On this ground, interest paid on borrowing will also not be allowed as deduction. In case of mixed source of funds, depending upon the fact of the case, the interest paid on apportioned portion of borrowing will not be allowed as deduction against dividend income and capital gains.

The issue as to whether the interest paid on borrowing can be capitalised to the cost of acquisition of listed shares purchased on the exchange.

The said interest will not qualify as part of cost of acquisition in respect of listed shares purchased on the stock exchange as the shares are in existence and the borrowing are used to acquire existing shares.

As regards investment made in IPO there is a gap between date of borrowing and making application and date of allotment. Shares come into existence only on the date of allotment and during intervening period shares are not in existence, from the investor point of view.

It is possible to argue that the interest paid from the date of making application till the date of allotment is to bring the asset into existence and may be allowed to be added to the cost of acquisition. This view is not free from doubt as provision of Section 36(1)(iii) are not applicable to investment activity. There is a difference between cost of acquisition and acquisition cost. If the interest is capitalised and treated as cost of acquisition it will result into litigation with tax department.

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