One of the most significant & practical provisions under the Income Tax Act, 1961 is Section 36(1)(iii). If you are a business owner, entrepreneur, or investor, understanding this section is crucial. It specifically allows deduction of the amount of interest paid in respect of capital borrowed for the purpose of business or profession. In simpler terms, if you have taken a loan for business purposes, the interest on borrowed capital can be claimed as a deductible expense under this section.
Let’s break it down for better understanding & explore how Section 36(1)(iii) of the Income Tax Act works in real-life scenarios.
What is Section 36(1)(iii) of the Income Tax Act?
Section 36(1)(iii) comes under the broader Section 36, which lists down various expenses that are allowed as a deduction while computing business income. Clause (iii) focuses exclusively on interest payments made on capital borrowed.
Whether you borrow from a bank, NBFC, or even private sources, if the interest paid on loans borrowed for business purposes is genuine & the capital is deployed in the business, you are eligible for deduction under this clause.
This applies to both running businesses & businesses under setup. That means, even if the business has not commenced operations, but the funds were used to set it up, the interest expense still qualifies.
Applicability of Section 36(1)(iii) in the Real World
Let's say you’ve taken a term loan to purchase machinery or working capital finance to pay suppliers. The interest on borrowed capital in both these cases would be deductible. This also includes loans taken for the acquisition of fixed assets, provided they are for business use."
But there’s a catch: if the capital is used for personal purposes or investment (not related to business), Section 36(1)(iii) benefits won’t apply. The Income Tax Department has been clear about this distinction, especially after judicial interpretations of this section.
Proviso to Section 36(1)(iii): Capital Asset Clause
One must also keep in mind the proviso to Section 36(1)(iii) inserted in the Finance Act, 2003. It disallows interest from being claimed as a deduction for the period during which a capital asset is under construction. In simple terms, the interest paid before the asset is put to use must be capitalised with the asset & not deducted immediately.
Once the asset is operational, the interest paid becomes deductible under Section 36(1)(iii).
Conditions for Claiming Deduction under Section 36(1)(iii)
To claim deduction under Section 36(1)(iii), here are the important conditions:
- The capital must be borrowed.
- The borrowing must be for business or a profession.
- The interest should be paid or payable.
- The capital should be utilised for business (not for personal use).
If these conditions are met, the entire interest amount can be claimed, whether the loan was for fixed assets, working capital, or operational expenses."
Judicial Viewpoints
The courts have consistently supported taxpayers where the borrowing & its usage were genuine & connected to business operations. However, deductions were denied where the usage was for personal benefit or speculative transactions.
For example, in the case of CIT vs. Tata Chemicals Ltd, it was clarified that even interest paid on borrowed capital for investment in subsidiaries can be claimed, provided the investment aligns with business objectives.
Impact on Tax Planning
For small businesses & startups, Section 36(1)(iii) is a highly beneficial tool. It encourages growth by easing the tax burden through interest deductions. If structured smartly, even large corporations use this section as part of their tax planning arsenal.
Common Mistakes to Avoid
- Not maintaining proper documentation: Loan agreements, bank statements, & fund utilisation proof are critical.
- Claiming interest for personal loans: If funds are diverted for personal use, deduction is not allowed.
- Claiming deduction for pre-construction interest: As discussed, such interest must be capitalised.
Final Thoughts
To summarise, Section 36(1)(iii) of the Income Tax Act is a simple yet powerful provision. It enables businesses to claim tax relief on interest payments, provided they are for valid business purposes. With the right planning & documentation, it can significantly reduce your taxable income.
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