Interest on borrowed funds invested in a subsidiary for controlling interest is deductible under Section 36(1)(iii).

The respondent-assessee, engaged in operating multiplex entertainment complexes, invested in the equity shares of Fame India Limited (“FIL”), another company engaged in the exhibition of cinematographic films.

The investment, amounting to ₹17,879.85 lakhs, was funded from an interest-bearing loan obtained from the assessee’s holding company, Gujarat Fluorochemicals Limited (“GFL”), on which the assessee incurred interest expenditure of ₹8,60,16,920.

The Assessing Officer made a disallowance under Section 14A of the Income-tax Act, 1961, read with Rule 8D of the Income-tax Rules, and also under Section 115JB.

Although the assessee contended that no disallowance under Section 14A was warranted because no dividend income had been earned during the relevant year, the Commissioner (Appeals) held that the interest expenditure was not allowable under Section 36(1)(iii) or Section 57 and added the entire interest amount to the assessee’s income.

The Income Tax Appellate Tribunal (“ITAT”) found that the assessee and FIL were engaged in the same business; that the assessee acquired a controlling shareholding in FIL, which increased to 69.54%; and that FIL subsequently amalgamated with the assessee.

The amalgamation expanded the assessee’s multiplexes from 30 to 55 and its screens from 109 to 204.

The ITAT therefore deleted the disallowance, holding that the investment was made for business expansion and commercial purposes, rather than merely for earning dividends.

Whether the interest expenditure incurred on funds borrowed for acquiring shares in a subsidiary or associate company, with the object of acquiring controlling interest and expanding the assessee’s business, is allowable as business expenditure under Section 36(1)(iii) of the Income-tax Act, 1961?

Whether such interest expenditure is disallowable under Sections 36(1)(iii), 37(1), or 57(iii) of the Act on the ground that the borrowed funds were used for investment in shares?

Section 36(1)(iii) permits deduction of interest paid on capital borrowed for the purposes of the assessee’s business, which includes borrowing undertaken for a commercially expedient acquisition of controlling interest in a subsidiary or associate company.

The doctrine of commercial expediency, recognised in S.A. Builders Ltd. v. CIT, permits deduction where the expenditure is incurred for the purposes of the assessee’s business, even if the immediate benefit accrues to a related or sister concern.

The Court relied on B. Nanji & Co. v. DCIT, 124 ITR 357, concerning similar facts.

The Court relied on the Supreme Court’s decision in Sharp Business System v. Commissioner of Income Tax, (2026) 484 ITR 509 (SC), which held that interest on borrowed funds used to acquire shares in a subsidiary for obtaining controlling interest was allowable because the investment was made for commercial expediency.

Section 14A and Rule 8D govern disallowance of expenditure incurred in relation to income not forming part of total income; however, the Court relied on the principle stated in CIT v. Corretech Energy Pvt. Ltd., (2014) 45 taxmann.com 116 (Guj.), regarding the absence of a Section 14A disallowance where no exempt dividend income was earned during the relevant year.

The Court accepted the ITAT’s factual findings that the investment in FIL was not a passive investment made solely to earn dividend income.

The assessee and FIL operated in the same multiplex and cinema-exhibition business; the assessee acquired a controlling shareholding in FIL; and the subsequent amalgamation materially expanded the assessee’s business infrastructure and capacity.

These facts demonstrated a direct commercial purpose and business nexus for the borrowing.

Applying the principle of commercial expediency recognised in S.A. Builders and reaffirmed in Sharp Business System, the Court held that acquisition of controlling interest in a subsidiary for business expansion falls within the purposes of the assessee’s business under Section 36(1)(iii).

The Revenue therefore could not disallow the interest merely because the borrowed funds had been used to acquire shares.

The Court also noted that the ITAT’s findings were findings of fact and that the legal issue was covered by the Supreme Court’s decision.

It upheld the ITAT’s deletion of the disallowance of ₹8,60,16,920, holding that the interest paid on funds borrowed for acquiring controlling interest in FIL and expanding the assessee’s business was allowable under Section 36(1)(iii).

The tax appeal filed by the Revenue was accordingly dismissed.