Deduction of Interest on Borrowed Capital- Section 32(1)(b) of Income Tax Bill, 2025

Section 32(1)(b) of the Income Tax Bill, 2025 deals with the provision regarding deduction of interest on borrowed capital. This deduction is very important for every business entity as loans in the form of term loans & working capital loans are necessary for funding business activities. Finance cost i.e. interest on borrowed loans forms a major part of the expenditures of any business organization. In this blog, we will discuss whether the business entities are eligible for deduction towards interest on borrowed capital under section 32(1)(b) while calculating its taxable income for the purpose of ITR filing.

Meaning of Borrowed Capital

Borrowed Capital includes any loan, debentures, bond, deposits or any other financial instrument which bears an interest obligation for any entity. Business entity may borrow funds from banks, financial institutions or any other entity or person. It has to pay interest on such borrowed funds at the rate agreed with the lender.

Meaning of Interest

Section 2(5) defines “Interest” as interest payable in any manner for moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes service fee or any other charges for the moneys borrowed or debt incurred or for any credit facility that has not been utilized.

On the basis of perusal of the definition of “Interest”, it can be interpreted that the interest includes:

• Interest on term loan or working capital loans
• Processing fees
• Renewal Fees
• Foreclosure Charges (Premature closure of loan facility)
• Commitment Charges

However, any penal charges paid due to non-payment of installment or any other reason, will not be considered as “Interest”.

Conditions for claiming deduction for interest on borrowed capital

Section 32(1)(b) states that deduction towards interest paid in respect of capital borrowed shall be allowed while computing income of business or profession. But following conditions need to be satisfied for making a legitimate claim towards interest on capital borrowed:

• Capital must be borrowed: Deduction towards interest is allowed only when interest is paid towards borrowed capital. In other words, interest deduction is not allowed towards share capital introduced by shareholders or reserves. Only exception is partnership firm where partnership firm can claim deduction of interest on capital up to 12% p.a. as provided by the partnership deed.

• Borrowed funds must be used for purpose of business or profession: Deduction towards interest shall be allowed when such funds are utilized for the purposes of business or profession. If borrowed funds are utilized towards personal purposes, deduction can not be made while computing taxable income.

• Interest must be paid or payable: If the business entity is following accrual system of accounting, deduction towards interest can be claimed on accrual basis. It means that for making claim towards interest deduction, it must be actually paid or payable during the tax year. Further, It should be noted that if any interest is payable to bank or financial institutions at the year end, it must have been paid on or before the due date of filing ITR for claiming an interest deduction. Further, if the interest is paid in advance for future years, it will be allowed as deduction in the year in which it becomes due.

• Interest must not be in the nature of capital expenditure: No deduction shall be allowed in respect of any amount of interest paid, in respect of capital borrowed for acquisition of new asset like building, machinery (whether capitalized in the books of accounts or not) if the interest is for the period beginning from the date on which the capital was borrowed for acquiring the asset till the date such asset was first put to use.

Note:

• Interest for the period from the date of borrowing till the asset is first put to use, shall be added to the cost of the asset and thus will be eligible to depreciation over the useful life of the asset. Therefore, it is important to segregate revenue and capital element of interest expenditure in respect of a capital asset on the basis of the date on which the asset is first put to use.
• If borrowed capital is utilized partly for business purposes & partly for personal purposes, the deduction towards interest shall be allowed in a proportionate manner towards the capital utilized in the business.
• Further, where funds are borrowed from related parties, it must be ensured that the rate of interest should not be unreasonable.

Discount on issue of Zero Coupon Bonds

Any discount on issue of Zero Coupon Bonds shall be allowed on a pro-rata basis having regard to the period of life of such bond calculated in a manner, as may be prescribed.

• Meaning of Discount: Discount means the difference between the amount received or receivable at the time of issuing the bond and the amount payable on maturity or redemption of such bond;
• Meaning of period of life of bond: Period of life of bond means the period commencing from the date of issue of the bond and ending on the date of maturity or redemption of such bond.

Disclaimer: The above information is meant for educational purposes only. Readers are requested to act diligently and under consultation with any professional before applying the information contained in this article. For any support mail at: support@taxwink.com