Interest on Loan Routed via Group Company Deductible Under Section 36(1)(iii), Commercial Expediency Test: Supreme Court in L.K. Trust v. CIT [2026 INSC 474]

In L.K. Trust v. Commissioner of Income Tax & Anr. (2026 INSC 474), the Supreme Court held that the High Court erred in taking the view that the borrowed amount was used for the benefit of the assessee's subsidiary and not for the assessee's own business (paras 17–18). Relying on Sharp Business System v. CIT and S.A. Builders v. CIT, the Court reiterated that the transfer of borrowed funds must be examined from the point of view of commercial expediency, and not whether the amount was advanced for earning profits (paras 19–21). A Bench of Justice J.B. Pardiwala and Justice Ujjal Bhuyan agreed with the ITAT's interpretation of Section 36(1)(iii) and allowed the assessee's appeal (paras 22–25).

Status: Karnataka High Court judgment dated 1-3-2010 in Income Tax Appeal No. 175 of 2001 set aside; assessee declared entitled to deduction of interest on capital borrowed to the tune of Rs. 3,80,00,000; Civil Appeal allowed (paras 1, 23–25).

Headnote: Interest on Borrowed Capital Routed Through a Group Company

Income Tax Act, 1961 – Section 36(1)(iii) – Section 2(28A) – Section 37(1) – Section 57(iii) – Deduction of interest on capital borrowed for the purposes of business – Borrowed funds transferred to group company for purchase of shares – Commercial expediency – Composite business.

Held: (i) Section 36(1)(iii) has three important elements: interest, borrowed, and for the purpose of business or profession (para 13).

(ii) For Section 36(1)(iii), "interest" is restricted to interest on money borrowed and not on debt incurred; the clause concerns capital borrowed, and capital here means money and not any other asset purchased on credit (paras 14–15).

(iii) As held in Madhav Prasad Jatia v. CIT, the expression "for the purpose of business" in Section 36(1)(iii) is wider in scope than "for the purpose of making or earning income" in Section 57(iii) (para 16).

(iv) The High Court erred in holding that, because the borrowed amount was ultimately used for the benefit of a subsidiary, it was not used for the assessee's business (paras 17–18).

(v) Following Sharp Business System v. CIT and S.A. Builders v. CIT, the transfer of borrowed funds must be examined from the point of view of commercial expediency, and interest on borrowed funds invested in a sister concern to acquire a controlling interest is allowable (paras 19–21).

(vi) The ITAT's interpretation of Section 36(1)(iii) was correct, and the assessee is entitled to deduction of the interest paid on capital of Rs. 3,80,00,000 borrowed for the purposes of business (paras 22, 25).

(paras 13–25)

Case Details: L.K. Trust v. Commissioner of Income Tax (2026 INSC 474)

Final Outcome: Civil Appeal allowed; High Court judgment set aside; assessee held entitled to deduction under Section 36(1)(iii) of the interest paid on the borrowed capital of Rs. 3,80,00,000.

Case: L.K. Trust v. Commissioner of Income Tax and Another

Neutral Citation: 2026 INSC 474

Case No.: Civil Appeal No. 527 of 2012

Court: Supreme Court of India (Civil Appellate Jurisdiction) – Reportable

Date of Decision: 7 May 2026

Bench: Justice J.B. Pardiwala and Justice Ujjal Bhuyan (Order; no individual author named)

Relevant Acts & Sections: Income Tax Act, 1961 – Sections 2(28A), 36(1)(iii), 37(1), 57(iii), 143(1)(a) and 143(2)

Impugned Order: Judgment and Order dated 1-3-2010 of the High Court of Karnataka in Income Tax Appeal No. 175 of 2001, allowing the Revenue's appeal against the ITAT's order (para 1)

Source: Supreme Court of India

Key Holdings of the Supreme Court

• The three elements of Section 36(1)(iii) are interest, borrowing, and use for the purpose of business or profession (para 13).
• Interest under Section 36(1)(iii) is limited to interest on money borrowed, and capital means money, not assets bought on credit (paras 14–15).
• "For the purpose of business" in Section 36(1)(iii) is wider than the expression in Section 57(iii) (para 16).
• Use of borrowed funds through a subsidiary or sister concern does not by itself take the interest outside Section 36(1)(iii); commercial expediency is the test (paras 17–21).
• The ITAT's view allowing the deduction was correct and is restored (paras 22–25).

Brief Facts of the Case

The assessee, L.K. Trust, borrowed Rs. 3,80,00,000 from the Corporation Bank to purchase shares of Shaw Wallace and Company Limited under an agreement dated 19-11-1987, under which 7.80 lakh shares were to be sold for that consideration (para 3).

In its return for the year 1989-90, the assessee claimed deduction of Rs. 21,74,234 as interest paid on the loan. The Assessing Officer noted that the amount had been transferred to M/s Gayatri Holdings Private Limited, a group company, through purchase of its shares, which in turn transferred it to an individual for purchase of the Shaw Wallace shares, and disallowed the deduction under Section 36(1)(iii). The CIT(A) also disallowed it (paras 2, 4–6).

The ITAT allowed the assessee's appeal, holding that the borrowed money was raised and used for purposes integral to the assessee's composite business, which included money-lending, speculation, film distribution and investment in shares, with one common set of books (para 6).

The High Court admitted the Revenue's appeal on two substantial questions of law, including whether the arrangement was a colourable device, and answered both in favour of the Revenue, upholding the disallowance of interest on the amount lying with the group company. The assessee appealed (paras 7–10).

Issues Before the Supreme Court

1. Whether the assessee is entitled to deduction of Rs. 21,74,234, being interest paid on the loan from the Corporation Bank, under Section 36(1)(iii) of the Income Tax Act, 1961 (para 2).
2. Whether the High Court committed any error in passing the impugned order (para 11).

Court's Findings and Reasoning

Scope of Section 36(1)(iii) (paras 12–13): The Court set out the provision and identified its three important words or phrases: interest, borrowed, and for the purpose of business or profession.

Meaning of interest and capital (paras 14–15): Though Section 2(28A) defines interest to include interest on debt incurred, for Section 36(1)(iii) it is restricted to interest on money borrowed. Relying on Bombay Steam Navigation Co. v. CIT, the Court noted that every debt does not involve a loan, and capital here means money and not any asset purchased on credit.

Wider expression (para 16): Citing Madhav Prasad Jatia v. CIT, the Court held that "for the purpose of business" in Section 36(1)(iii) is wider than "for the purpose of making or earning income" in Section 57(iii), so the scope for deduction under Section 36(1)(iii) is much wider.

High Court's error (paras 17–18): The High Court held that the business of the subsidiary could not be treated as the business of the assessee, rejected the ITAT's finding based on commercial expediency, and treated the loan as used for the subsidiary's benefit. The Supreme Court held that the High Court fell in error in taking this view.

Commercial expediency (paras 19–21): In Sharp Business System v. CIT, the Court, referring to S.A. Builders v. CIT, held that transfer of borrowed funds must be examined from the point of view of commercial expediency and not whether the amount was advanced for earning profits, and allowed interest on borrowed funds invested in a sister concern to acquire a controlling interest.

ITAT's view endorsed (para 22): The Court stated that it was in complete agreement with the ITAT's line of reasoning on the interpretation of Section 36(1)(iii).

Final Outcome and Directions

• The appeal succeeds and is allowed (para 23).
• The impugned Judgment and Order of the High Court is set aside (para 24).
• The assessee is declared entitled to seek deduction of the interest paid in respect of the capital borrowed to the tune of Rs. 3,80,00,000 for the purposes of the business (para 25).
• Pending applications, if any, disposed of (para 26).

Legal Principle Laid Down

Under Section 36(1)(iii) of the Income Tax Act, 1961, interest on money borrowed for the purposes of business is deductible, and the expression "for the purpose of business" is wider than the corresponding expression in Section 57(iii). Where borrowed funds are transferred to a subsidiary, sister concern or group company, the question is to be examined from the point of view of commercial expediency, and the deduction cannot be denied merely because the funds were ultimately used for the benefit of the subsidiary (paras 16–22).

Precedents Relied Upon

• Bombay Steam Navigation Co. Pr. Ltd. v. CIT, 56 ITR 52 (SC) – Relied upon – capital borrowed means money, not an asset purchased on credit. Discussed at para 15.
• Madhav Prasad Jatia v. CIT, 118 ITR 200 (SC) – Relied upon – "for the purpose of business" in Section 36(1)(iii) is wider than the expression in Section 57(iii). Discussed at para 16.
• Sharp Business System v. CIT, 2025 SCC OnLine SC 2892 – Relied upon – interest on borrowed funds invested in a sister concern for acquiring controlling interest allowable. Discussed at paras 19–21.
• S.A. Builders v. CIT, 288 ITR 1 – Relied upon – transfer of borrowed funds to be examined from the point of view of commercial expediency. Discussed at para 20.

Important Paragraphs of the Judgment

Verbatim extracts from the judgment. For the full text, refer to the judgment PDF below.

Para 13: "The sub section has three important words or phrases, i.e., (i) Interest, (ii) Borrowed and, (iii) For the purpose of business or profession."

Para 15: "The legislature has, under this clause, permitted as an allowance interest paid on capital borrowed for the purposes of the business; and the capital, in this context, means money and not any other asset purchased on credit"

Para 16: "The Court held that the expression occurring in Section 36(1)(iii) is wider in scope than the expression occurring in Section 57(iii)."

Para 18: "We are afraid that the High Court fell in error in taking the aforesaid view."

Para 20: "it has been opined that the court should examine the transfer of borrowed funds from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits."

Para 25: "It is declared that the assessee is entitled to seek deduction of the amount of the interest paid in respect of the capital borrowed to the tune of Rs.3,80,00,000/- for the purposes of the business."

Practical Impact of the Ruling

• For assessees: Interest on loans whose proceeds are routed through group or subsidiary companies for business purposes, such as acquiring shares, can be claimed under Section 36(1)(iii) if commercial expediency is shown (paras 19–22).
• For the Revenue: A disallowance cannot rest only on the fact that the funds ultimately benefited a subsidiary (paras 17–18).
• For tribunals and High Courts: Claims under Section 36(1)(iii) are to be tested on the wider expression "for the purpose of business", not the narrower test in Section 57(iii) (para 16).

FAQs on Interest Deduction Under Section 36(1)(iii)

1. What did the Supreme Court decide in L.K. Trust v. Commissioner of Income Tax?

It set aside the Karnataka High Court judgment and held that the assessee is entitled to deduct interest paid on Rs. 3,80,00,000 borrowed from the Corporation Bank for its business (paras 23–25).

2. Why had the deduction been disallowed?

The Assessing Officer found that the loan amount had been transferred to a group company, which in turn used it to purchase shares of Shaw Wallace and Company Limited (paras 4–5).

3. What test applies when borrowed funds are given to a sister concern?

The transfer is examined from the point of view of commercial expediency, not whether the amount was advanced for earning profits, as held in Sharp Business System and S.A. Builders (paras 19–20).

4. Does "interest" under Section 36(1)(iii) include interest on any debt?

No. For this clause, interest is restricted to interest on money borrowed, and capital means money, not assets bought on credit (paras 14–15).

5. Is Section 36(1)(iii) narrower than Section 57(iii)?

No. Following Madhav Prasad Jatia, the expression "for the purpose of business" in Section 36(1)(iii) is wider than "for the purpose of making or earning income" in Section 57(iii) (para 16).

Keywords: 2026 INSC 474, L.K. Trust v. Commissioner of Income Tax, Section 36(1)(iii) Income Tax Act, interest on borrowed capital, commercial expediency, borrowed funds to sister concern, group company shares, Madhav Prasad Jatia, Sharp Business System, S.A. Builders, Bombay Steam Navigation, Section 57(iii), Justice J.B. Pardiwala, Justice Ujjal Bhuyan, Supreme Court judgment

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Download Judgment PDF – L.K. Trust v. Commissioner of Income Tax

Judgment PDF: 2026 INSC 474 – L.K. Trust v. Commissioner of Income Tax & Anr. (Civil Appeal No. 527 of 2012) – Download Judgment PDF

Source: Supreme Court of India (official website).