Interest deductible is on the borrowed capital, which postulates the existence of a borrower and a lender. The relationship of a borrower and a lender must come into existence before it can be said that any money is borrowed by one person from another. The transaction should be real.

An interesting point on this subject arose before the Punjab and Haryana High Court where a tax payer took over the assets and liabilities of a dissolved firm and interest became payable to the erstwhile partners. In CIT v Four Fields P Ltd (231 ITR 262), the assessee-company took over as on June 30, 1975, all the assets and liabilities of the old firm, which included immovable property worth Rs2,16,973 and also comprised other properties including plant and machinery. The value of assets acquired was Rs 3,09,521.

After excluding the credit balance of Rs 1,24,785.02, a sum of Rs 1,82,037 remained as liability payable to the outgoing partners. According to the assessee, incurring this liability could not be considered as capital borrowed for acquiring, constructing, repairing, renewing or reconstructing the building under reference.

The Income-tax officer did not accept this plea of the assessee and turned down its request for allowing deduction of interest from the income derived from the property. The order of the Income-tax officer was upheld by the Commissioner of Income-tax (Appeals).

The Tribunal, after considering the facts and relying upon the decision in CIT v ND Radha Kishan and Co (140 ITR 860), accepted the appeal and allowed the claim of the assessee for deducting interest from the income derived from the property.

On a reference, the High Court held that section 28 deals withprofits and gains of business or profession. Section 29 provides that income referred to in section 28 would be computed in accordance with the provisions contained in sections 30 to 43-A. Various revenue expenses are mentioned from section 30 onwards. Section 36(1) 9iii) provides that the amount of the interest paid in respect of capital borrowed for the purposes of business or profession is deductible while computing the income referred to in section 28.

Section 37 provides that any expenditure, not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession would be allowed in computing the income chargeable under the head `Profits and gains of business or profession'.

Relying upon ND Radha Kishan & Co's case, the interest in the present case was allowed by the Tribunal under section 37, which was upheld by the high courttreating it as expenditure laid out for the purposes of business and not as interest on borrowed capital under section 36(1) (iii).

Payment of interest is an expenditure for the purposes of business or profession under section 37, but it is different from deduction of interest paid in respect of capital borrowed for the purposes of a business or profession under section 36(1) (iii).

The court, therefore, held that ND Radha Kishan & Co's case was of no assistance to the assessee. The Tribunal had erred in placing reliance on the above said case to hold that the assessee was entitled to deduction under section 24(1) (vi) of the Act. The judgment in ND Radha Kishan & Co's case was rendered on a totally different set of facts, which were not related to the facts of the present case.

Section 24(1) (vi) is in tune with section 36 (1) (iii). It permits the deduction of any interest on borrowed capital for the acquisition, construction, repair or reconstruction of the building in question. What is necessaryfor the purpose of claiming deduction of interest is that the borrowing should have a nexus with the acquisition, construction, etc of the property.

In the present case, there was no borrowing by the assessee from the outgoing partners. As per the deed of dissolution, on the amount payable to the erstwhile four partners, no interest was payable up to December 31, 1976, by which date the entire amount had to be paid to them.

It was agreed that in case the amount was not paid by December 31, 1976, then, with effect from January 1, 1977, the assessee would pay interest at the rate of 15 per cent per annum on the amount due from it. This did not establish that interest was paid for the purpose of borrowing capital used to acquire the immovable asset, ie the building, worth Rs 2,16,973.

No relationship of borrower and lender came into existence, in the absence of which it could not be said that the interest paid was on the borrowed capital. At the most, the assessee became liable to pay interest on the sumof Rs 1,82,037 due from it to the outgoing partners. Under the circumstances, the court concluded that the question of allowing any deduction under section 24 (1) (vi) did not arise. It could not be held that the assessee acquired the immovable property with the aid of borrowed capital.

In taking this view, the Punjab and Haryana high court referred to CIT v Rajkot Seeds, oil and Bullion Merchants Association Ltd (101 ITR 748 (Guj); CIT v Visakhapatnam Port Trust (144 ITR 146 )AP); CIT v Lucas TVS Ltd (153 ITR 239 (Mad); Rekhchand Gopaldas Mohta Spinning and Weaving Mills Ltd v VIT (60 ITR 699 (Bom); and CIT v Orient Trading Co (208 ITR 216 (Guj)) in which it was held that the relationship of borrower and lender must come into existence before it can be said that any amount, capital or any other money, is borrowed by one person from another to bring it within the ambit and scope of borrowed capital.

Therefore, the disallowance of the interest under section 24 (1) (vi) was upheld.

While the aforesaiddecision turns on the peculiar facts of the case, the principle which has been highlighted in these judgments is that the borrowing must be a genuine transaction where the creditor has lent money for the acquisition, construction, repairs or renovation of the immovable property.