Taxation Law

Commissioner of Income Tax v. Rajendra Prasad Moody

[1978] 115 ITR 519 (SC); (1979) 1 SCC 250

Facts

The case concerned two brothers who had borrowed money.
Each brother used the borrowed funds to purchase shares in certain companies.
During assessment year 1965–66:
they paid interest on the borrowed money;
the shares did not produce any dividend.
Each assessee claimed the interest payment as a deduction under section 57(iii).
The Income Tax Officer and Appellate Assistant Commissioner disallowed the claim.
They reasoned that:
no dividend income had been earned;
the expenditure had not produced taxable income;
it could therefore not have been incurred for earning income.
The Tribunal allowed the deduction.
Because different High Courts had taken conflicting views, the Tribunal referred the legal question directly to the Supreme Court under section 257.

Whether expenditure is deductible under section 57(iii) when it is incurred for earning income but produces no actual income during the relevant year.
Specifically, whether interest on money borrowed to purchase shares remains deductible when no dividend is received.

Section 57(iii) allows non-capital expenditure laid out or expended wholly and exclusively for the purpose of making or earning income taxable under “Income from other sources.”
The provision focuses on the purpose of the expenditure.
It does not require proof that:
the expenditure successfully produced income;
income was actually received in that year;
the transaction was profitable.
A distinction exists between:
expenditure incurred with the genuine objective of earning taxable income; and
expenditure lacking a sufficient connection with any income-producing source.
Commercial success is not a statutory condition for deductibility.

The borrowed money was used to purchase shares.
Shares were capable of producing dividend income taxable under “Income from other sources” under the law then applicable.
The interest payment therefore had a direct connection with the income-producing investment.
The Revenue argued that the wording “for the purpose of making or earning such income” was narrower than the business-expense language in section 37.
According to the Revenue, deduction required actual receipt of income in the same year.
The Court rejected this interpretation.
The statutory words referred to the taxpayer’s objective in incurring the expense, not to the success of that objective.
Parliament did not say:
expenditure is deductible only where income is made; or
the amount of deduction must be restricted to income actually earned.
An investment may fail to yield income because:
the company makes no profit;
no dividend is declared;
commercial expectations are not fulfilled.
These events do not retrospectively change the purpose for which the money was borrowed.
Denying the deduction would make tax treatment depend on the investment’s success rather than the nature and purpose of the expense.
The Court also relied on the established proposition that an expenditure need not be profitable to be deductible.
The genuine nexus with the intended income source was sufficient.

The Supreme Court decided in favour of the assessees.
It held that interest on money borrowed for investment in shares was deductible under section 57(iii), even though the shares produced no dividend in the relevant year.
Actual earning of income was not a condition precedent to deduction.
What mattered was that the expenditure was genuinely and exclusively incurred for the purpose of making or earning taxable income.
The case does not mean that every unsuccessful expense is deductible.
The assessee must still establish:
a real income-earning purpose;
a sufficient nexus between the expenditure and the intended income source;
that the expense is not capital or personal.