Borrowed Funds Used for Subsidiary Still Eligible for Interest Deduction U/s 36(1)(iii): Supreme Court

The Supreme Court has held that borrowed funds used for subsidiaries are still eligible for interest deduction under Section 36(1)(iii) of the Income Tax Act, 1961. The bench of Justice J.B. Pardiwala and Justice Ujjal Bhuyan has set aside the Karnataka High Court judgment and restored the Income Tax Appellate Tribunal’s (ITAT) decision allowing deduction of ₹21.74 lakh towards interest expenditure. The dispute revolved around whether L.K. Trust was entitled to claim deduction of ₹21,74,234 paid as interest on a bank loan of ₹3.80 crore obtained from Corporation Bank. The funds had originally been borrowed to purchase shares of Shaw Wallace and Company Limited under an agreement executed in 1987. For Assessment Year 1989–90, the assessee filed its income tax return declaring an income exceeding ₹7.55 crore. During assessment proceedings, the Assessing Officer noted that although the trust had borrowed ₹3.80 crore and paid interest on the loan, the amount had eventually moved through a group entity, M/s Gayatri Holdings Pvt. Ltd., which in turn transferred the funds to another person for purchase of shares of Shaw Wallace. Based on this movement of funds, the Assessing Officer denied the deduction claim under Section 36(1)(iii). The Commissioner of Income Tax (Appeals) also upheld the disallowance. However, the ITAT reversed the lower authorities and held that the assessee satisfied all the conditions necessary under Section 36(1)(iii). It found that the loan had indeed been borrowed by the assessee, had been used for business purposes, and the interest amount had actually been paid. The Tribunal further observed that the trust carried on multiple business activities including money-lending, speculation, film distribution and share investment, with a common pool of funds and integrated management structure, making it a composite business operation. The department challenged the ITAT decision before the Karnataka High Court. The High Court partly accepted the Revenue's arguments and concluded that interest relating to the amount transferred through Gayatri Holdings could not be allowed because such funds were ultimately utilised for another entity. It held that the Assessing Officer was justified in disallowing that portion of interest expenditure. The Supreme Court, however, disagreed with the High Court’s approach and undertook a detailed analysis of Section 36(1)(iii). The Court noted that the provision contains three important elements: there must be interest, there must be borrowed capital, and such borrowing must be for the purpose of business or profession. The Bench explained that the phrase “for the purpose of business” is broad in scope and wider than expressions used in certain other deduction provisions. It reiterated that courts should assess the matter from the perspective of commercial expediency rather than narrowly examining whether the expenditure generated direct profits. The Supreme Court also referred to its recent decision in Sharp Business System v. CIT, where it had held that interest on borrowed funds invested in sister concerns may still qualify as a business expenditure if such investment is guided by commercial expediency. The Court emphasized that the correct test is not whether the amount was advanced for immediate profit generation, but whether the transfer of funds had a business nexus. The Court observed that it had incorrectly treated the involvement of a subsidiary or related concern as breaking the connection with the assessee’s own business activity. According to the Court, the High Court erred in disregarding the commercial realities and business structure involved in the transaction. The Supreme Court declared that the Trust was entitled to claim deduction of interest paid on the borrowed capital of ₹3.80 crore and restored the benefit granted by the ITAT. Case Details Case Title: L.K. Trust Versus Commissioner Of Income Tax & Anr. Citation: JURISHOUR-1330-SC-2026 Case No.: Civil Appeal No.527/2012 Date: 07/05/2026 Click Here To Read Order Read More: JURISHOUR | TAX LAW DAILY BULLETIN : 21 May, 2026

Borrowed Funds Used for Subsidiary Still Eligible for Interest Deduction U/s 36(1)(iii): Supreme Court

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