Deductibility of interest on funds borrowed for acquiring controlling interest

This article summarizes a recent ruling of the Mumbai Income Tax Appellate Tribunal (ITAT) in the case of Panatone Finvest Ltd.(Taxpayer) [2009-TIOL-717-ITAT-MUM].  The Taxpayer incurred interest expenditure on the funds borrowed for investing in shares of a company, with a view to acquire controlling interest. The ITAT held that the interest expenditure incurred is not allowable under Section 57(iii) (Section) of the Indian Tax Law (ITL), since it is not incurred ‘wholly and exclusively’ for the purpose of earning dividend income.

Background and facts of the case

1. The Section provides for deduction of revenue expenditure laid out or expended ‘wholly and exclusively’, for the purpose of making or earning income assessable under the head ‘Income from other sources’.
2. The Taxpayer is a Tata Group company, engaged in the business of investment and finance.
3. The Taxpayer was used as a Special Purpose Vehicle (SPV) by the Tata Group for the acquisition of 45% equity share capital of VSNL (a telecom company owned by  Government of India) under a divestment program. By this acquisition, the Tata Group acquired management control over VSNL.
4. For financing the acquisition, the Taxpayer used its share capital, as also borrowed funds raised by way of unsecured loan and private placement of bonds and debentures.
5. The Taxpayer claimed interest paid on the borrowed funds as a deduction under the Section from the dividend income received from VSNL.
6. The Tax Authority and the first appellate authority disallowed the deduction, by holding that the borrowed funds were used for acquisition of controlling interest in VSNL and not with the object of earning income. The Taxpayer appealed further to the ITAT.

Contentions of the Taxpayer