Interest paid on funds borrowed for acquiring controlling stake in a company will not be exempt from tax. The Income Tax Appellate Tribunal (ITAT) has ruled that such expenditure for investing in shares of a company cannot be exempted, since it has not been incurred wholly and exclusively for the purpose of earning dividend income.

The ruling was given in the case of Panatone Finvest Ltd, a special purpose company formed by Tata Group for acquiring 45 per cent stake in VSNL under the governments disinvestment programme.

By this acquisition, the Tata Group got management control over VSNL, which was earlier owned by the government.

For financing the acquisition, Panatone Finvest used its share capital and borrowed funds raised through unsecured loan and private placement of bonds and debentures. It claimed deduction on interest paid on the borrowed funds under dividend income head.

Section 57 of the Income Tax Act provides for deduction of revenue expenditure, laid out or expanded wholly and exclusively, for the purpose of earning income assessable under income from other sources.

ITAT said Panatone Finvest acquired a controlling stake in VSNL only to serve its holding companys interest by acting as an SPV, and not with the objective to earn income, directly or indirectly.

Panatone Finvest, on its part, had argued that funds were borrowed for strategic investment in VSNL and not with the intention of trading in such shares. The government had barred Panatone Finvest from selling its shares in VSNL for three years. The company, thus, said this investment qualified as capital investment to earn dividend income.