The connection between the expenditure and the earning of income need not be direct - it may be indirect. The expenditure must be incurred for the purpose of earning the income, the motive behind the expenditure being irrelevant. It is not further necessary that "the purpose" should have been fruitful and income should in fact have been earned in the accounting year as a result of that expenditure. Interest on moneys borrowed to purchase shares should be allowed as a deduction even if the shares have yielded no dividendin the relevant accounting year, and even if there is no income at all under the head "other sources" (CIT vs Rajendra Prasad Moody (115 ITR 519 (SC)); Ormerods (India) Ltd vs CIT (36 ITR 329); Chhail Beharilal vs CIT (39 ITR 696); Apparao vs CIT (46 ITR 511); Mohammed Ghouse vs CIT (49 ITR 127)).

The position would now be different as in the case of dividends which are exempt from tax under Section 10(33) of the Income-tax Act, because such income enjoys complete exemption and does not enter into the computation of income under Section 56. In such an event, the question of claiming deduction under Section 57 (iii) would not arise.

In Eastern Investments Ltd vs CIT (20 ITR 1) the assessee, an investment company, under an agreement with its principal shareholder, reduced its share capital and issued debentures carrying interest to that shareholder. The transaction was effected by the company voluntarily on the ground of commercial expediency and in order indirectly to facilitate the carrying on of thecompany's activities. The transaction was not challenged on the ground of fraud. The Supreme Court held that the interest paid by the company on its debentures was allowable as expenditure incurred solely for the purpose of earning the company's income, the fact that the transaction resulted in considerable benefit to the principal shareholder being irrelevant.

It was further held that in the absence of fraud, the questions whether a transaction had the effect of diminishing the assessee's taxable income, whether it was a prudent or wise transaction and whether it was necessary for the assessee to enter into that transaction, were irrelevant in determining whether expenditure relating to that transaction should be allowed.

No deduction can be allowed under Section 57 from income earned on deposits or other assets, in respect of interest paid on money borrowed to pay personal expenses or income-tax, even though without such borrowing the assessee would have to withdraw the deposits or dispose of the otherassets in order to pay the expenses or tax. However, the position is different where an assessee comes into possession of an asset subject to a liability which attaches to the asset.

Recently, the Bombay high court held that where the dominant objective of borrowing funds was to acquire controlling interest in the company, the interest paid on the monies borrowed could not be claimed as a deduction. In CIT vs Amritaben R Shah (238 ITR 777), the assessee had purchased shares in Raval Tiles and Marbles Pvt Ltd, for Rs 2.07 lakh at par after January, 1972. Her husband also purchased shares in the said company during the same period at par of face value of Rs 1,77,500 and her father-in-law, Korshi Hirji Shah, purchased shares during the same period of Rs 34,500. Thus, the entire shareholding of Rs 4.19 lakh in the said company was purchased by the assessee, her husband and her father-in-law in a couple of months after January, 1972.

In her return for the assessment years 1976-77, 1977-78 and 1978-79, theassessee claimed deduction under Section 57 (iii) of the Income-tax Act, 1961, of the interest paid by her on the loan obtained for acquiring the shares in the above company. The assessing officer disallowed the claim of the assessee as, according to him, the loan taken by the assessee for the purchase of shares was for the purpose of acquiring controlling interest in the company. He was, therefore, of the opinion that, in such a situation, the interest on moneys borrowed for purchasing shares was not allowable as a deduction under Section 57 (iii) of the Act. On a reference, the high court held that in order to get deduction, the expenditure should be incurred wholly and exclusively for the purpose of making or earning the income from other sources and that it should not be in the nature of capital expenditure. Section 58(1) (a) further provides that no deduction would be allowed in case the expenditure is in the nature of personal expenses of the assessee.

The question which arose in this case waswhether the expenditure incurred for borrowing money for purchasing shares for acquiring controlling interest in the company could be held to be expenditure incurred wholly or exclusively for earning income from dividend. There was no dispute in this case that the shares in question were purchased by the assessee for the purpose of acquiring controlling interest in the company and not for earning dividend.

That being so, the expenditure incurred by way of interest on the loan taken by the assessee for the said purpose could not be held to be expenditure incurred wholly and exclusively for the purpose of earning income by way of dividends but was for the purpose of acquiring controlling interest in the company and, therefore, it was not allowable as a deduction under Section 57 (iii) of the Act.

A similar view was taken by the Gujarat high court in the case of Sarabhai Sons (P) Ltd vs CIT (201 ITR 464). In that case, it was held that if the dominant purpose for which the expenditure was incurred was not toearn income, the expenditure incurred in that behalf would fall outside the purview of Section 57(iii) of the Act. The Bombay high court was also of the same view in Chinai & Co Pvt Ltd vs CIT (206 ITR 616). In that case, there was a dispute in regard to deduction of expenditure under Section 37 of the Act. The expenditure was incurred by the assessee in fighting another group of shareholders to protect the investment in the erstwhile managed company. The court held that such an expenditure was not a business expenditure.

It may be pertinent to mention the distinction in the language used by the legislature in Sections 37(1) and 57 (iii) of the Act. Section 37 provides for deduction of expenditure incurred wholly and exclusively "for the purpose of business", whereas Section 57(iii) provides for deduction only of expenditure incurred wholly and exclusively "for the purpose of making or earning such income". "Such income" refers to "income from other sources". The expression "for the purpose of business" isnarrower than the expression "for the purpose of making or earning such income".

In order that an expenditure may be admissible under Section 57(iii), it is necessary that the primary motive of incurring it is directly to earn income falling under the head "income from other sources". That is not so under Section 37 which allows deduction of expenditure "incurred wholly and exclusively for the purposes of the business". Under Section 57(iii), deduction will not be allowed if the expenditure is not incurred for the purpose of earning income falling under the head "income from other sources".

Before concluding, it will be relevant to point out that expenditure on maintaining or preserving the source of income is allowable as revenue expenditure incurred for making or earning the income arising from that source. Expenses incurred by a director of a company in defending a suit brought for a declaration that his election to the directorship was invalid, or in bringing acts of mismanagement to the notice ofthe shareholders, were held allowable. However, where an assessee derived income in the form of director's fees and dividends form a company which he had promoted, and made a gift of Rs 3 lakh to the company at a time when the company was in financial difficulty, the sum was disallowed, for it was not expenditure incurred for the purpose of earning the fees as director.

The author is a Supreme Court advocate