Section 36(1)(ii) of the Income Tax Act, 1961 is an important provision that deals with the deduction of interest on borrowed capital. The section provides for the deduction of interest paid or payable on any capital borrowed for the purpose of business or profession. In this blog, we will discuss the provisions of section 36(1)(ii) in detail.
Meaning of Section 36(1)(ii)
Section 36(1)(ii) allows for the deduction of interest on borrowed capital, which is used for the purpose of business or profession. This deduction is allowed to be claimed as an expense in the year in which it is paid or accrued. The section also specifies that the interest deduction can be claimed only if the capital is borrowed for the purpose of business or profession and not for any other purpose.
The term “capital borrowed” includes any loan, debenture, bond or other financial instrument that results in the borrowing of money. The term “business or profession” is defined to include any trade, commerce, manufacture, or adventure or concern in the nature of trade, commerce, or manufacture.
Conditions for claiming deduction under Section 36(1)(ii)
To claim a deduction under Section 36(1)(ii), the following conditions must be satisfied:
- The capital must be borrowed: The deduction is allowed only for interest paid or payable on borrowed capital. Interest paid on self-generated funds, such as reserves, is not eligible for a deduction under this section.
- The capital must be used for business or profession: The borrowed capital must be used for the purpose of business or profession. Interest paid on loans taken for personal purposes, such as the purchase of a house or a car, is not eligible for deduction under this section.
- The interest must be paid or payable: The deduction is allowed only for interest paid or payable in the previous year. Interest accrued but not paid is not eligible for a deduction.
- The interest must be incidental to the business or profession: The interest paid or payable must be incidental to the business or profession. Interest paid on overdue income tax, penalties, or interest is not eligible for a deduction under this section.
- The interest must not be in the nature of capital expenditure: Interest paid on capital borrowed for the acquisition of capital assets, such as land, building, machinery, etc., is not eligible for deduction under this section. Such interest is added to the cost of the asset and allowed as a deduction under the head “Depreciation”.
The deduction under this section is allowed to both individuals and businesses, including sole proprietorships, partnerships, and companies. It is worth noting that the section only allows for a deduction of the interest component of the loan and not the principal amount.
One important aspect to consider when claiming a deduction under this section is the nature of the borrowing. It is essential to distinguish between revenue and capital expenditure to determine if the interest paid is eligible for a deduction. Interest paid on loans taken for revenue purposes, such as to finance day-to-day business operations, is eligible for a deduction. However, interest paid on loans taken for capital purposes, such as to purchase a building or machinery, is not eligible for a deduction under this section.
Another aspect to consider is the timing of the deduction. The interest can be claimed as an expense in the year in which it is paid or accrued, whichever is earlier. This means that if interest is paid in advance for future years, it can only be claimed in the year in which it is due.
In case the borrowed capital is used for both business and personal purposes, only the proportion of interest attributable to the business portion is eligible for a deduction. The proportion can be calculated based on the actual usage of the borrowed capital.
It is also worth noting that there are specific conditions and restrictions for interest paid to related parties. If the borrower and the lender are related parties, the interest rate charged should be at arm’s length and should not exceed the rate that would have been charged by an unrelated party for a similar loan.
In conclusion
Section 36(1)(ii) of the Income Tax Act, 1961 is a crucial provision that allows for the deduction of interest on borrowed capital used for the purpose of business or profession. However, it is essential to ensure that the conditions and restrictions mentioned above are met to claim a deduction under this section. As with any tax-related matter, it is advisable to seek the guidance of a tax expert to ensure compliance with the provisions of the Income Tax Act.
Read more useful content:
- section 234e of income tax act
- section 286 of income tax act
- section 90a of income tax act
- section 40a(7) of income tax act
- section 226(3) of income tax act
- section 24 of income tax act
Frequently Asked Questions (FAQs)
Q: What is Section 36(1)(ii) of the Income Tax Act?
A: Section 36(1)(ii) of the Income Tax Act provides for the deduction of interest on borrowed capital used for the purpose of business or profession.
Q: Who can claim a deduction under Section 36(1)(ii)?
A: Both individuals and businesses, including sole proprietorships, partnerships, and companies, can claim a deduction under this section.
Q: What is the meaning of “capital borrowed” under Section 36(1)(ii)?
A: The term “capital borrowed” includes any loan, debenture, bond or other financial instrument that results in the borrowing of money.
Q: What is the meaning of “business or profession” under Section 36(1)(ii)?
A: The term “business or profession” is defined to include any trade, commerce, manufacture, or adventure or concern in the nature of trade, commerce, or manufacture.
Q: What are the conditions for claiming a deduction under Section 36(1)(ii)?
A: The following conditions must be satisfied to claim a deduction under Section 36(1)(ii):
The capital must be borrowed.
The capital must be used for business or profession.
The interest must be paid or payable.
The interest must be incidental to the business or profession.
The interest must not be in the nature of capital expenditure.
Q: What is the timing of the deduction under Section 36(1)(ii)?
A: The interest can be claimed as an expense in the year in which it is paid or accrued, whichever is earlier.
Q: Can interest paid to related parties be claimed as a deduction under Section 36(1)(ii)?
A: Yes, interest paid to related parties can be claimed as a deduction under this section, subject to certain conditions and restrictions.
Q: Can interest paid on loans taken for personal purposes be claimed as a deduction under Section 36(1)(ii)?
A: No, interest paid on loans taken for personal purposes, such as the purchase of a house or a car, is not eligible for a deduction under this section.
Q: What is the impact of Section 36(1)(ii) on taxable income?
A: The deduction allowed under Section 36(1)(ii) reduces the taxable income of the taxpayer, which in turn reduces the tax liability.
