L K Trustv.Commissioner of Income Tax & Anr 2026 INSC474

Legal Analysis: L.K. Trust vs. Commissioner of Income Tax & Anr

Citation: 2026 INSC 474
Court: Supreme Court of India
Bench: Justice J.B. Pardiwala and Justice Ujjal Bhuyan (Division Bench)
Date of Decision: May 7, 2026
Nature of Judgment: Civil Appeal under Article 136 of the Constitution of India against the judgment of the Karnataka High Court in an Income Tax Appeal.

Synopsis of the Judgment

The assessee (L.K. Trust) borrowed ₹3.80 crores from a bank to purchase shares of Shaw Wallace and Company Limited. The borrowed amount was transferred to a subsidiary company (Gayatri Holdings Pvt. Ltd.), which in turn advanced it to another individual for purchasing the shares. The Assessing Officer disallowed the interest paid on the loan (₹21.74 lakhs) under Section 36(1)(iii) of the Income Tax Act, 1961, holding that the funds were not used for the assessee’s own business. The ITAT allowed the deduction, applying the principle of commercial expediency and composite nature of business. The High Court reversed. The Supreme Court restored the ITAT’s order, holding that interest on borrowed capital is allowable if the borrowing is for the purpose of business, even if the funds are routed through a subsidiary or sister concern, as long as the transaction is borne out of commercial expediency. The Court relied on S.A. Builders Ltd. v. CIT and Sharp Business System v. CIT.

1. Basic Information of the Judgment

• Case Title: L.K. Trust vs. Commissioner of Income Tax & Anr.

• Civil Appeal No.: 527 of 2012

• Bench: Justice J.B. Pardiwala and Justice Ujjal Bhuyan (Division Bench)

• Date of Decision: May 7, 2026

• Citation: Not specified in the extract (the judgment is from 2026)

• Appeal From: Judgment and order dated 01.03.2010 of the Karnataka High Court in Income Tax Appeal No. 175 of 2001

2. Legal Framework

Laws and Provisions Involved

• Income Tax Act, 1961: Section 36(1)(iii) (deduction for interest on capital borrowed for business purposes), Section 2(28A) (definition of interest), Section 37(1) (general business expenditure), Section 57(iii) (expenditure for earning income from other sources)

• Income Tax Act, 1922: Section 10(2)(iii) (predecessor provision) – referred to in Madhav Prasad Jatia.

Key Precedents Cited

1. Madhav Prasad Jatia v. CIT (118 ITR 200) (SC) – Explained the three prerequisites for deduction under Section 36(1)(iii): (i) money must be borrowed by the assessee; (ii) borrowed for the purpose of the assessee’s business; (iii) interest must be paid. Also held that the expression in Section 36(1)(iii) is wider than in Section 57(iii).

2. CIT v. Associated Fibre and Rubber Industries (P) Ltd. (1999) 236 ITR 471 (SC) – Interest on borrowings used to purchase assets that are treated as business assets is allowable.

3. Vecumsees v. CIT (220 ITR 185) (SC) – Loans obtained for business purposes remain deductible even if the particular branch of business for which the loan was taken is later closed or transferred; test of “same business” for carry forward of losses is not applicable.

4. S.A. Builders Ltd. v. CIT (288 ITR 1) (SC) – Interest on borrowed funds invested in a sister concern (for acquiring controlling interest) is allowable as business expenditure if it is for commercial expediency, even if no immediate profit is earned.

5. Sharp Business System v. CIT (2025 SCC OnLine SC 2892) – Reaffirmed the principle of commercial expediency; interest on borrowed funds invested in a sister concern or directors is allowable business expenditure.

What the Judgment is About

The judgment interprets Section 36(1)(iii) of the Income Tax Act, 1961. It clarifies that for interest on borrowed capital to be deductible, the borrowing must be “for the purposes of the business” of the assessee. This condition is satisfied even if the borrowed funds are routed through a subsidiary or sister concern, as long as the transaction is for commercial expediency and the funds are ultimately used for the assessee’s business (e.g., acquiring controlling interest in a company whose shares are part of the assessee’s business assets). The Court disapproved the High Court’s restrictive view that the funds must be directly used by the assessee itself.

3. Relevant Facts

• Assessee: L.K. Trust, which was engaged in multiple businesses: money lending, speculation, film distribution, and investment in shares. It maintained a common set of books for all these activities.

• Loan: The assessee borrowed ₹3,80,00,000 from Corporation Bank to purchase shares of Shaw Wallace and Company Limited under an agreement dated 19.11.1987.

• Routing of funds: The borrowed amount was transferred to M/s Gayatri Holdings Private Limited (a group company/subsidiary), which in turn advanced it to one Shri G. Venkateshwaran for purchasing the shares. Some shares were eventually transferred to the name of the assessee.

• Interest paid: ₹21,74,234.

• Return for AY 1989-90: Assessee declared total income of ₹7,55,67,530. The return was processed under Section 143(1)(a), and later scrutiny notice was issued.

• Assessing Officer’s order (1992): Disallowed the interest deduction, holding that the funds were not used for the assessee’s own business but routed through a group company.

• CIT(A): Affirmed the disallowance.

• ITAT: Allowed the deduction, holding that the business of the assessee was composite, that the borrowings were for business purposes, and that the interest was paid. The ITAT relied on Vecumsees and Associated Fibre and Rubber Industries.

• High Court (Karnataka; 01.03.2010): Reversed the ITAT, answering two substantial questions of law in favour of the Revenue. The High Court held that the business of a subsidiary cannot be treated as the business of the assessee, and that the arrangement was a colourable device.

• Supreme Court: Allowed the appeal, set aside the High Court’s judgment, and restored the ITAT’s order.

4. Issues

1. Whether the assessee is entitled to deduction under Section 36(1)(iii) of the Income Tax Act, 1961 for interest paid on a loan borrowed from a bank, when the borrowed funds were routed through a subsidiary company to purchase shares, and some shares were ultimately held in the assessee’s name.

2. Whether the High Court erred in holding that the interest was not allowable because the funds were used for the benefit of a subsidiary and not directly for the assessee’s business.

5. Ratio Decidendi

A. Three prerequisites for deduction under Section 36(1)(iii) (Para 12-13, citing Madhav Prasad Jatia):
The Court reiterated the three conditions: (i) the money must be borrowed by the assessee; (ii) it must be borrowed for the purpose of the assessee’s business; (iii) the assessee must have paid interest on the loan. In this case, all three were satisfied – the loan was taken by the Trust, the funds were used for acquiring shares (which were business assets), and interest was paid.

B. “For the purposes of business” – wider interpretation (Para 16-17):
The expression in Section 36(1)(iii) is wider than in Section 57(iii) (which applies to income from other sources). The test is whether the borrowing was for commercial expediency and for the purpose of the assessee’s business, not whether the funds were directly deployed by the assessee itself.

C. Routing through subsidiary does not disqualify deduction (Paras 18-22):
The Court relied on S.A. Builders Ltd. v. CIT and Sharp Business System v. CIT, where it was held that interest on borrowed funds invested in a sister concern for acquiring controlling interest is allowable as business expenditure. The Court noted that the subsidiary company was a group company, and the transaction was for commercial expediency – the shares were ultimately held as business assets of the Trust. The fact that the funds passed through an intermediary does not break the nexus with the assessee’s business.

D. Composite nature of business (Para 15-17, from ITAT order quoted by SC):
The assessee was carrying on multiple businesses (money lending, speculation, film distribution, investment in shares) under a common management with interlocking funds. The business was composite. Following Vecumsees, even if a particular branch of business for which funds were taken is later closed or transferred, the interest deduction continues to be allowable because the borrowing was for business purposes at the time it was made.

E. High Court’s error (Paras 18, 23):
The High Court incorrectly held that the business of the subsidiary cannot be considered the business of the assessee. The Supreme Court held that the correct test is whether the investment in the subsidiary was for commercial expediency and for the purposes of the assessee’s business. Since the shares were business assets of the Trust, the interest was allowable.

F. Conclusion (Paras 23-25):
The appeal was allowed; the High Court’s judgment was set aside; and it was declared that the assessee is entitled to deduction of the interest paid (₹21,74,234) under Section 36(1)(iii).

6. New Legal Principles Established / Reiterated

• Reiteration of the “commercial expediency” test: Even when borrowed funds are routed through a subsidiary or a sister concern, the interest deduction under Section 36(1)(iii) is allowable if the transaction is for commercial expediency and the ultimate use of the funds is for the assessee’s business (e.g., acquiring shares that become business assets).

• The business of a subsidiary can be treated as the business of the parent assessee for the purpose of Section 36(1)(iii) when the investment is made to acquire controlling interest or to hold shares as business assets. This follows from S.A. Builders and Sharp Business System.

• The High Court’s view that the “purpose of business” requires direct deployment of funds by the assessee itself is incorrect. The test is one of commercial expediency, not direct physical deployment.

7. Court’s Analysis and Examination of Concepts

The Court began by setting out the statutory provision and the three prerequisites. It noted that the first and third requirements (borrowing and payment of interest) were undisputed; the controversy was on the second – “for the purpose of business”.

The Court examined the facts: the assessee was a Trust engaged in multiple businesses, including investment in shares. It borrowed money to purchase shares of Shaw Wallace. The funds were transferred to a subsidiary (Gayatri Holdings) and then to an individual for purchase, but ultimately shares were acquired and held by the assessee. The AO and High Court focused on the routing through the subsidiary to deny the deduction.

The Court then traced the evolution of the law. It cited Madhav Prasad Jatia for the proposition that Section 36(1)(iii) is wider than Section 57(iii). It then cited Vecumsees where the Supreme Court held that interest on loans taken for a theatre business remained deductible even after the theatre was transferred, because the loans were taken for business purposes. Similarly, in Associated Fibre and Rubber Industries, interest on borrowings for purchase of assets that were treated as business assets was allowable.

The Court then applied the principle of commercial expediency from S.A. Builders. In that case, the assessee advanced borrowed funds to its sister concern to enable it to purchase machinery – the Court held that the interest was allowable because it was for commercial expediency. The same principle was reaffirmed in Sharp Business System.

Applying these principles, the Court held that the routing of funds through Gayatri Holdings did not alter the fact that the borrowing was for the business of the Trust. The shares were business assets of the Trust, and the transaction was commercially expedient. The High Court’s distinction that “the business of the subsidiary cannot be the business of the assessee” was rejected because the issue was not whether the subsidiary’s business was the assessee’s business, but whether the investment in the subsidiary was for the purpose of the assessee’s business.

The Court also approved the ITAT’s finding that the Trust had a composite business, and the funds were interlocked. Therefore, the deduction was allowable.

8. Critical Analysis

Strengths: The judgment reaffirms a tax‑payer friendly interpretation of Section 36(1)(iii). It prevents the Revenue from disallowing interest deductions merely because funds are routed through a subsidiary or a sister concern. By adopting the “commercial expediency” test, it aligns with modern business realities where holding companies and group structures are common. The judgment also clarifies that the presence of multiple business activities (composite business) and interlocking of funds should not be used to disallow legitimate deductions.

Potential concerns: The judgment does not explicitly address the situation where the subsidiary is not a wholly owned subsidiary or where the funds are not ultimately used for the assessee’s business (e.g., if the shares were never transferred to the assessee). However, on the facts, the shares were eventually held by the assessee. Also, the Court did not discuss the proviso to Section 36(1)(iii) regarding capitalisation of interest – but that was not relevant.

Practical impact: This judgment will be cited extensively in tax disputes where an assessee borrows funds and lends or transfers them to a subsidiary or associated enterprise. It will be used to argue that as long as the transaction is for commercial expediency and the funds are ultimately used for the assessee’s business (or for acquiring business assets), interest is deductible. Tax authorities will need to examine the commercial expediency and not merely the routing of funds.

9. Final Outcome

• Civil Appeal allowed.

• The impugned judgment and order of the Karnataka High Court dated 01.03.2010 in Income Tax Appeal No. 175 of 2001 is set aside.

• The order of the Income Tax Appellate Tribunal is restored.

• It is declared that the assessee (L.K. Trust) is entitled to deduction of the interest amount of ₹21,74,234 (Rupees Twenty One Lakh Seventy Four Thousand Two Hundred Thirty Four only) under Section 36(1)(iii) of the Income Tax Act, 1961 in respect of the capital borrowed of ₹3,80,00,000.

• No order as to costs.

• Pending applications disposed of.

10. Practical Application (Use in Court)

• For assessees (taxpayers): If you have borrowed funds and lent them to a subsidiary or sister concern, and you claim interest deduction under Section 36(1)(iii), you must demonstrate that the transaction was for “commercial expediency” – i.e., it was necessary for your business (e.g., to acquire controlling interest, to secure business advantage). Also, ensure that the borrowed funds ultimately result in an asset that is part of your business (e.g., shares held as stock‑in‑trade or investment). This judgment can be cited to counter the Revenue’s argument that routing through a group company disallows the deduction.

• For tax authorities (Revenue): When scrutinising such claims, examine whether the assessee had any business purpose in lending to the subsidiary. If the funds are used for non‑business purposes (e.g., personal loans to directors or for unrelated business), the deduction may be disallowed. However, mere routing through a subsidiary without proof of diversion for non‑business purposes will not be sufficient after this judgment.

• For courts and tribunals: Follow the “commercial expediency” test. Do not disallow interest deduction solely because the borrowed funds were transferred to a sister concern. Instead, examine: (i) whether the assessee had a genuine business purpose for the transaction; (ii) whether the funds were ultimately used for the assessee’s business or for acquiring business assets; (iii) whether there was any colourable device.

11.  Court Lines

“The expression ‘for the purpose of business’ occurring in Section 36(1)(iii) is wider in scope than the expression occurring in Section 57(iii). Thus, meaning thereby that the scope for allowing a deduction under Section 36(1)(iii) would be much wider than the one available under Section 57(iii).” (Para 16)

“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 20, quoting Sharp Business System)

“The fact that the particular part of the business for which the loans had been obtained had been transferred or closed down did not alter the fact that the loans had, when obtained, been for the purpose of the assessee’s business. The test of ‘same business’ appropriate for set-off of carry forward losses is not applicable here.” (Para 16, quoting Vecumsees)

“The High Court fell in error in taking the view that the business of the subsidiary company cannot be considered in law as the business of the assessee.” (Para 18)

12. Legal Strategy Insight

• For the assessee (taxpayer): When claiming interest deduction under Section 36(1)(iii) for funds routed through a subsidiary, prepare a detailed note on commercial expediency – explain why the investment in the subsidiary was necessary for your business (e.g., to ensure control, to secure supply chain, to maintain business relationships). Also maintain documentary evidence that the shares or assets ultimately belong to your business. If the Revenue disallows, cite S.A. Builders, Sharp Business System, and this judgment.

• For the Revenue (tax department): To disallow such interest, you must show that the transaction was a “colourable device” i.e., there was no business purpose and the funds were diverted for non‑business purposes. Mere routing through a subsidiary is not enough. Also, examine if the proviso to Section 36(1)(iii) applies (interest capitalised during construction period). If the shares are held as capital assets (not business assets), you may argue that the purpose is not “business” – but the assessee can rely on SA Builders where investment in shares of a subsidiary was held to be for business purposes.

• For tax tribunals (ITAT, High Courts): Follow the two‑step test: (i) Was the borrowing for a business purpose at the time it was made? (ii) Even if the funds were routed through an intermediary, was the ultimate use for the assessee’s business? If yes, allow the deduction. Do not apply the “same business” test for set‑off of losses, as that is a distinct concept.