Income from other sources, the ‘residuary’ head of income
Of the five ‘heads’ of income under the Income Tax Act 1961 (the Act), ‘Income from other sources’ is oft described as the ‘residuary’ head i.e. income that cannot satisfy the necessary criteria to be classified under the other heads but is subject to and taxable (not to be excluded from the total income) under the Act, can be classified under the said residuary head of income. The Act also expressly ‘deems’ and lists certain types of income (eg. dividends) as chargeable to tax under the said residuary head.
Deductions under section 57
The Act under section 57, allows certain deductions from income otherwise chargeable to tax under the above said head residuary of income. Expressly under section 57(iii), expenditure (not being in the nature of a capital expenditure) which is laid out or expended wholly and exclusively for the purpose of making or earning such said income is so allowed as a deduction.
(Private) Equity investment and scope of deductions under section 57(iii)
In a very recent matter^ before the Hon’ble Punjab and Haryana High Court, the appellant was denied a deduction for interest expenses incurred with respect to borrowings (the loan), used for acquiring equity (share capital) of a ‘closely held’ private Company (the Acquisition Company).
- The said loan was taken from an Hindu Unidivided Family (HUF) entity of which the said appellant was a member and her husband the ‘Karta’.
- The appellant, along with her husband, the HUF and a second Company of which the appellant was a Director, together held all the share capital of the said Acquisition Company.
- During assessment proceedings, the concerned Assessing Officer (AO) had denied 50 percent of the said interest expenses, which in appeal was denied completely by the Commissioner of Income Tax (Appeals) i.e. CIT(A) and further confirmed by the Income Tax Appellate Tribunal (ITAT) in further appeal.
- The CIT(A) made a finding that the entire borrowed funds had been used by the said appellant for acquiring shares of the relevant said Company for the purpose of acquiring ‘control’ therein and not as an investment for earning dividend income, taxable under the head, ‘Income from other sources’ and subject to the above said deductions under the Act.
- The ITAT had later held that the appellant had not clarified whether she had been in the business of dealing in shares, and that unless proved that she had been dealing in shares as a business, it was difficult to accept the contention that that the said shares were purchased for the purpose of making or earning (business and/or dividend and/or capital gains) income.
Hon’ble Punjab and Haryana High Court’s adjudication^ in favour of the Appellant (edited and paraphrased) –
- The deduction under section 57(iii) is not available only to persons who deal in shares as a business, and even other investors are entitled to its benefits.
- The observation, that unless and until the appellant proves that she has been dealing in shares as a business, the said deduction would not be available is not well- founded.
- There is no presumption that such a person (not in share business) purchases them for a purpose other than making or earning income from such shares and there is certainly no presumption that such persons purchase shares for the purpose of gaining control of the Company.
- A Company in which the shares are purchased that does not declare dividend even for a few years is not determinative of the purpose for which the shares are purchased and that the receipt of dividend is not the only criteria for such purposes.
- It is the purpose of the expenditure that is relevant in determining the applicability of said section 57(iii) i.e. it must be for making or earning of income and it is not necessary that the expenditure laid out or expended actually results in making or earning such income.
- If the expenditure is so laid out or expended for the purpose of making or earning such income, the assessee is entitled to the benefit of section 57(iii), irrespective of the motive for doing so.
- However, once it is established that the purpose of acquisition of shares is to control a Company and not to make or earn income, the deduction would be denied irrespective of the nature or the extent of the control.
- ‘Control’ itself is of different types and to a varying extent, and it is presumed that what is meant by control of a Company is the ability to control its management and affairs by virtue of the exercise of rights as a shareholder.
- In a given case and depending upon the spread of the equity capital, a person may well be in a position to control the company with much less than 51 percent of the equity shares.
- The control need not necessarily be on account of the shares being held by a single shareholder. If more than one person holds the controlling interest ‘in concert’ with others, i.e., with the common purpose of acquiring or maintaining control, each of them would be said to have acquired the shares for the purpose of acquiring or maintaining control.
- Merely because the acquisition of shares results in a person or a group of persons acquiring control of whatever nature and to whatever extent, it would not necessarily follow that the purpose of the acquisition was to gain control and that would depend upon the facts of the case.
- If the expenditure is laid out or expended wholly and exclusively for the purpose of earning dividends, the fact that the assessee incidentally also acquires control of a company for himself and/or for others would make no difference and in such a case, gaining control of a company would be purely incidental.
LL.B (CLC Faculty of Law Delhi University), JD (UNSW)
Taxation & Criminal Law Advocate
^Refer Smt. Satish Bala Malhotra v Commissioner of Income Tax, Jalandhar in ITA No.438 of 2006 (O&M) as decided by the Hon’ble Punjab and Haryana High Court on on 3 October 2016