ITAT Bangalore: Interest Disallowance on Subsidiary Investments Deleted Where Shareholders' Funds Surpass Investment Amount — Kirloskar Electric Company Ltd. vs DCIT

Background and Overview

The Income Tax Appellate Tribunal, Bangalore Bench, recently delivered a significant ruling in the case of Kirloskar Electric Company Ltd. Vs DCIT (ITAT Bangalore), addressing a recurring and commercially important question — whether interest expenditure can be capitalised or disallowed on the presumption that borrowed funds were used for making investments in a subsidiary, even when the assessee possesses adequate interest-free own funds that comfortably exceed the investment amount.

The Tribunal's ruling, covering Assessment Years 2010-11, 2011-12, and 2012-13, consolidates well-established judicial thinking on the subject and offers meaningful clarity for assessees who maintain both equity-based funds and loan facilities simultaneously.

Profile of the Assessee and Return Filing

The assessee, Kirloskar Electric Company Ltd., is engaged in the manufacture and trading of a range of electrical products including Electric Motors, Alternators, Traction equipment, Transformers, DG sets, Circuit Breakers, Starters, and Contractors. For Assessment Year 2010-11, the assessee filed its return of income declaring Nil income under the normal provisions of the Income-tax Act, 1961, while reporting a book profit of Rs. 50,59,46,016 under Section 115JB.

The return was initially processed under Section 143(1) and subsequently flagged for scrutiny assessment. Notices under Section 143(2) and Section 142(1) were duly issued and served upon the assessee. The Authorised Representative appeared at various stages and furnished all information and documentation sought by the Assessing Officer. Upon completion of scrutiny, the Assessing Officer passed an order under Section 143(3), incorporating the following additions and disallowances:

  • Disallowance under Section 14A — Rs. 12,83,690
  • Disallowance of interest — Rs. 86,29,243
  • Capitalisation of interest — Rs. 9,69,40,630

The most contested of these additions was the capitalisation of interest, which formed the crux of the disputes carried forward across all three assessment years.

Procedural Journey

The assessee challenged the Assessing Officer's order before the Commissioner of Income Tax (Appeals), who partly allowed the appeal. Dissatisfied with the limited relief granted, the assessee appealed to the Tribunal. The Tribunal, upon its first consideration of the matter, remanded the case back to the CIT(A) for a fresh and more thorough examination of the issues involved.

The CIT(A), upon reconsideration and examination of the assessee's fresh submissions, remained unconvinced and dismissed the assessee's appeal. The assessee once again approached the ITAT Bangalore. Since Assessment Years 2011-12 and 2012-13 involved substantially identical facts and legal issues, the Tribunal decided to hear all three appeals together and designate ITA No. 1316/Bang/2024 (AY 2010-11) as the lead case.

The central issue before the Tribunal was straightforward but consequential: