Interest on Fixed Deposits from unutilized funds of Power Plant Taxable – income from other source

By | May 18, 2017
(Last Updated On: May 18, 2017)

Held

The Hon’ble jurisdictional High Court in the case of CIT v. Rasi Cement Ltd. [1998] 232 ITR 554 (AP) has answered similar questions involved in favour of the Revenue. The question before the Hon’ble High Court was whether the interest earned on surplus funds deposited in the banks during the installation of the company, the status of the company before commencement of the business. The Hon’ble High Court has held that such interest has to be separately treated as income from other sources and cannot be taken as part of the capital structure following the decision of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd.  It was categorically held that interest earned on surplus funds deposited in banks during installation of company, prior to commencement of business, has to be brought to tax as ‘income from other sources’ u/s. 57. Respectfully following the jurisdictional High Court decision also, the contentions of assessee that this amount has to be adjusted towards capital account cannot be accepted

IN THE ITAT HYDERABAD BENCH ‘A’

Thermal Powertech Corporation India Ltd.

v.

Deputy Commissioner of Income-tax, Central Circle 2(4), Hyderabad*

B. RAMAKOTAIAH, ACCOUNTANT MEMBER
AND G. PAVAN KUMAR, JUDICIAL MEMBER

IT APPEAL NO. 1534/HYD/2016
[ASSESSMENT YEAR 2012-13]

APRIL  26, 2017

S. Raghunathan for the Appellant. P. Chandra Sekhar, CIT DR for the Respondent.

ORDER

B. Ramakotaiah, Accountant Member – This is an appeal filed by Assessee against the order of CIT(A)-12, Hyderabad dated 29-07-2016. The main issue which arises for consideration is with reference to charging of tax on the interest received from the temporary fixed deposits from the escrow account out of the barrowed funds committed for project implementation. Assessee has raised various grounds on the issue running to 14 in number on the following 5 points.

(a) Whether the interest earned is capital receipt.
(b) Whether the interest income can be set off to Interest paid.
(c) Whether the interest income was taxable as income from business.
(d) Whether the nature/character of interest can be different from the related interest expenses.
(e) Whether business loss carried forward can be set Off to the interest income.

2. Briefly stated, Assessee is closely held Public Limited Company, incorporated under the companies Act, as a joint venture between Hyderabad based Gayathri Energy Venture Pvt., Ltd., and Singapore based Semb Corp Utilities, to build, own and operate a 1320 Megawatt Coal Fired Power Plant. During the impugned year the construction of the Power Plant was in advance stage and Assessee did not have any operational income. Due to delay in scheduled work Assessee parked unutilized/not immediately required funds (stated as committed funds) during the interim period in short term fixed deposits which yielded interest, in accordance with the terms laid down under the common loan agreement (CLA) read with the trust retention account (TRA) agreement. Assessee adjusted the said interest income to an extent of Rs. 22,35,48,281/- against the capital work in progress, on the reason that interest income earned from barrowed funds were linked to funds borrowed for setting up of the power plant. For the year under consideration, Assessee e-filed its return of income declaring Nil income under the normal provisions and the book loss of Rs.1,07,06,579/- u/s 115JB of the IT Act. Assessee also claimed business loss of amounting to Rs. 98,53,998/- during the year to be carried forward to subsequent years under the normal provisions of the Act. In the course of assessment proceedings the A.O considered the interest income received from short term fixed deposits as revenue receipts and taxed the same as income from other sources. The A.O relied on the decision of Hon’ble Apex court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172 and CIT v. Auto kast Ltd. [2001] 248 ITR 110  (SC). A.O also did not allow the alternate plea of Assessee to allow the corresponding interest expenditure incurred with respect to the amount borrowed. A.O also disallowed the claim of revenue expenditure of Rs. 98,53,996/- on the reason that Assessee has not commenced the business during the impugned year and therefore the loss cannot be allowed.

3. Aggrieved by the order of Ld. A.O, Assessee preferred an appeal before CIT(A) and vide impugned order Ld. CIT(A) has held against Assessee and hence the present appeal.

4. Ld. Counsel submitted that Assessee has commenced construction of a power plant with a project cost of Rs. 2,400 crores out of which one-fourth is by the promoters and three-fourths are financed by financial institutional investors. Since, there was a delay in scheduled work by the EPC contractor Assessee parked the committed funds in short-term fixed deposits and approved investments out of the escrow account. It was submitted that Assessee has to submit a periodical requirement of funds and the notice of drawl is from the Trust and Retention Account (TRA) which is generally managed by Punjab National Bank (PNB) being one of the ten lenders. As per the TRA agreement the company is required to instruct the account balance the parked committed funds in permitted investments in order to optimize the overall project cost. It was the submission that the interest income received in respect of short-term fixed deposits shall again be deposited in TRA and will reduce the interest out flow on the borrowed funds. Coming to the order of A.O and CIT(A), it was submitted that the issue in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) was with reference to treatment of income on surplus funds whereas there is a distinction between the term ‘surplus funds’ and ‘committed funds’. It was submitted that even though the A.O and CIT(A) relied on the judgments of Apex count in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), Auto Kast Ltd. (supra) they have failed to notice the judgment of the Hon’ble Supreme Court in the case of CIT v. Bokaro Steel Ltd. [1993] 236 ITR 315 wherein Hon’be Supreme Court held the receipts which are inextricably linked with the setting up of the business would be capital in nature and be reduced from the cost of construction/project. It was submitted that the facts of Assessee case were squarely covered by the above decision. It was further submitted that the Hon’ble Supreme Court in the case of CIT v. Karnataka Power Corpn. [2001] 247 ITR 268  has held that interest earned out of money kept in deposits with banks during the course of construction/preconstruction stage shall be set off against the expenses. The same principles were followed in the case of CIT v. Karnal Co-operative Sugar Mills Ltd. [2000] 243 ITR 2 (SC) While admitting that the coordinate Bench in the case of Kakinada SEZ (P.) Ltd [IT Appeal No. 1215/Hyd/2010] has followed the judgment of the Hon’ble Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), it was submitted that the Hon’ble Delhi High Court in the case of Indian Oil Panipat Power Consortium Ltd. v. ITO [2009] 181 Taxman 249 has held that interest earned on money received as share capital by Assessee which were temporarily put in a fixed deposit are capital receipts which can be set off to the preoperative expenses. While adjudicating, the Hon’ble Delhi High Court explained the principles laid down in the case of Hon’ble Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) and Bokaro Steel Ltd. (supra). It was further submitted that the same principles were followed by the Hon’ble Delhi High Court in the case of Pr. CIT v. Facor Power Ltd. [2016]  237 Taxman 613 (Delhi) and in the case of Pr. CIT v. Petronet LNG Ltd. [2011] 10 taxmann.com 257 (Delhi) and NTPC SAIL Power Co. (P). Ltd. v. CIT [2012 ] 210 Taxman 358 (Delhi). Ld. Counsel also relied on the decision of CIT v. Sasan Power Ltd. [2012] 205 Taxman 56 (Delhi) and the decision of Hon’ble Madras High Court in the case of CIT v. VGR Foundations [2008] 298 ITR 132 Ld. Counsel also relied on the following cases.

1. CIT v. Tehri Hydro Development Corpn. [2009] 183 Taxman 246 (Uttarakhand).
2. Adani Power Ltd. v. Asstt. CIT [2015] 155 ITD 239 (Ahd. – Trib.)
3. ACIT v. NTPC Tamil Nadu Energy Co. Ltd. [IT Appeal No. 6016/Delhi /2013, dated 15-2-2016].
4. Rail Vikas Nigam Ltd. v. Dy. CIT [IT Appeal No. 6165/Delhi/2012, dated 2-8-2013].

5. Ld. Counsel further relied on the decision of the coordinate Bench at Hyderabad in the case of Hyderabad Hitech Textile Park v. ITO [IT Appeal No. 587/Hyd/2016 dated 21-12-2016] wherein the ITAT relied on the rulings of the Hon’ble Delhi High Court in the case of Sasan Power Ltd. (supra) and Indian Oil Panipat Power Consortium Ltd. (supra).

6. In summary, it was argued that no prudent business man would borrow money from bank with higher rate to park in term deposits to earn a low interest and therefore, there is a clear nexus between the source of funds and source of investments, the amounts which was parked in short term deposits with the bank were committed funds and not surplus funds and the investment was with the sole object of reducing the overall interest cost, to optimize the project cost and not with the objective of earning interest income.

7. With reference to the ground Nos. 9 & 10 that only net interest income was liable to tax, without prejudice the earlier arguments, it was submitted that A.O had erred in taxing the gross interest income instead of net interest income. It was submitted that Assessee paid interest and finance charges totaling to Rs. 127,84,98,794/- on the term loans taken from the PF lenders and this amount has to be set off to the interest income earned and he relied on the decision of the Hon’ble Gujarat High Court in the case of Sardar Sarovar Narmada Nigam Ltd. v. ACIT 96 CCH 30. Ld. Counsel also placed reliance in the case of coordinate Bench decision of Chennai in the case of Dy. CIT v. Chennai Network Infrastructure Pvt. Ltd. following the judgment of the jurisdictional High Court in the case of M/s VJR Foundations. It was the contention that if interest income is to be considered taxable under head income from other sources, corresponding expenditure in Sec. 57 of the IT Act should be allowed.

8. Coming to the ground Nos. 11 & 12 regarding the contention that interest income to be taxed under head profit and gains of business, it was the submission that the funds are obtained for a distinct activity for a setting up of power project and interest earned thereon is only with the sole objective of reducing the project cost. Following principles laid down by the Hon’ble Bombay High Court in the case of CIT v. Indo Swiss Jewels Ltd. [2006] 284 ITR 389, it was submitted that the interest earned on short term deposits are to be tread as business income and not income from other sources. It was submitted that the same principle was upheld in the case of CIT v. Green Infra Ltd. [2017] 78 taxmann.com 340 by the Hon’ble Bombay High Court.

9. Coming to ground No. 14 with reference set off and carry forward of business loss, it was submitted that Assessee was in the advance stage of construction of the power plant and it has under taken many activities like acquiring lands, commencing civil works and investment in substantial project work by recruiting employees etc. Since Assessee has already in the stage 5 of the work of the power project, it was submitted that Assessee has commenced business and therefore the expenditure claimed should be allowed as revenue expenditure and should be set off to the income from other sources. Ld. Counsel placed reliance on the following judgments/decisions.

1. CIT v. Hughes Escorts Communications [2009] 311 ITR 253  (Delhi).
2. CIT v. Builders and Development Ltd. [IT Appeal Nos. 528 & 529 (Delhi) of 2012].
3. Sardar Sarovar Narmada Nigam Ltd. v. Asstt. CIT [2012]  138 ITD 203 (Ahd.) (SB).
4. Reliance Gems and Jewels Ltd. v. Dy. CIT [IT Appeal No. 3855/Mum./2013, dated 28-10-2015].
5. Omniglobe Information Tech India (P )Ltd., v. CIT [2014] 369 ITR 1 (Delhi).
6. CIT v. Whirlpool of India Ltd. [2009] 185 Taxman 387 (Delhi).

10. It was submitted that the principle of law emerging from the judgments of various High Courts and Tribunals is that the business is continuous course of activities and business can be said to be set up from the date when one of the essential categories of its business activities has started and it is not necessary that all categories of business activities must start either simultaneously or that the last stage must start before it can be said that the business was set up.

11. Alternately it was submitted that the preoperative expenses towards audit fee, salaries, legal proceeding charges financial and bank charges are allowable as revenue expenditure following the coordinate Bench decision in the case of ACIT v. LS Cable India (P )Ltd. [IT Appeal No. 1257/Delhi/2012]. Based on the principles laid down in various cases it was submitted that Assessee has commenced the business and accordingly the expenditure claim should be allowed as revenue expenditure and be allowed to be carried forward to the extent not set off to any income there under.

12. Ld. CIT DR in reply reiterated the stand of the Revenue. It was submitted that the principles were laid down by the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), which is a three Judge Bench, wherein the Hon’ble Supreme Court has clearly pronounced that interest on borrowed funds is taxable as interest from other sources and cannot be set off against the interest payable for the project cost. It was submitted that even though Ld. Counsel relied on the decision of the Hon’ble Supreme Court in the case of Bokaro Steel Ltd. (supra) it was stated that issue of interest on borrowed funds is not considered in the said decision of the Hon’ble Supreme Court in the case of Bokaro Steel Ltd. (supra) as Assessee has not contested the same as can be seen from para 4 of the judgment.

12.1 Then Ld. DR referred to para 4 of the said judgment to submit that the Hon’ble Supreme Court has clearly held that ‘this question is now concluded by the decision of this Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). Hence, we are not called upon to examine that issue’. It was submitted that the principle stressed by the Ld. Counsel that the funds are inextricable linked to the borrowed funds has been examined by the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) itself which was reiterated in the case of AutoKast Ltd, (supra) which was relied on by A.O. It was submitted that the decision of the Hon’ble Supreme Court in the case of Autokast Ltd. (supra) was rendered on 21-11-2000 and the principles laid down in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) has not been disturbed by the decision of the Bokaro Steel Ltd. (supra) and was followed up in the decision of Autokast Ltd. (supra). It was submitted that the reliance on various other decisions relied on by the Ld. Counsel cannot be accepted in view of the authentic pronouncement of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), principle of which has not been disturbed in any of the orders of the Hon’ble Supreme Court.

13. Ld. CIT DR has taken up various paras of the decision of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), to reiterate that all the issues being agitated by the Ld. Counsel has been answered in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). He then referred to the decision of the coordinate Bench in the case of Kakinada SEZ (P.) Ltd. (supra), wherein on similar facts the coordinate Bench at Hyderabad has upheld the taxability of interest income on borrowed funds and assessment under the head ‘other sources’. It was also further submitted that the same principle was reiterated by the Hon’ble Supreme Court in the case of Bongaigaon Refinery & Petrochemicals Ltd. v. CIT [2001] 251 ITR 329  (SC), Totgars Cooperative Sale Society Ltd. v. ITO [2010] 322 ITR 283 (SC). Relying on principles laid down by the above judgments, it was the submission of the Ld. CIT DR that Assessee is not eligible to the claims-

I. Set off of interest against the preoperative expenses.
II. Set off of interest income against interest expenditure on borrowed funds.
III. Set off of business loss against the interest income.
IV. Carried forward of business loss to subsequent years.

14. With reference to the argument that Assessee has commenced the business, Ld. CIT DR submitted that Assessee has not commenced its business during the financial year under reference and this fact was admitted by Assessee as ‘Assessee was in the advance stage of construction of power plant’ and business has been set up but did not commence its operations. It is also evident from the audited financial statements that Assessee has not commenced the business. With reference to the issue of ‘set up of the business’ and ‘commencement of business’, it was submitted that as per provisions of Sec. 3 of the IT Act all Assessees who are engaged in business or profession are required to file their first return of income, in the year in which the business was set up, ie. year of setting up of the business. The provisions of Sec. 3 of the IT Act applies only in regard to requirements of Assessee to file its first return of income, who is engaged in business or profession. However, it was submitted that the question of allowing any expenditure or computing income under head ‘profits and gains of business or profession’ would come into picture only from the year in which actual business/profession of Assessee yielding income has commenced or the first year of carrying on business or profession after completing the setup of the business. Ld. DR refer to provisions of Sec. 28, Sec. 36(1)(iii), Sec. 35A, Sec. 35AD, 35ABA/35ABB, Sec. 35D of the IT act to submit that there is difference between business ‘setup’ and business ‘commencement’. It was submitted that till the business has commenced the entire preoperative expenditure was allowed to be capitalized to the assets and Assessee was eligible for depreciation on the value of assets. Therefore in the given facts of the case, Assessee has only setup the business but has not commenced the business, therefore, the claim of revenue expenditure is not allowable as the provisions of Sec. 28 of the IT Act does not apply. Ld. CIT DR relied on the following cases:

i. CIT v. Omer Khayyam Wineries (P) Ltd. [1979] 120 ITR 859 (AP): In this case, it was held by Hon’ble High court of AP that expenditure incurred up to the date of commencement of the production is of capital in nature and thereafter it is of revenue nature and therefore, any expenditure incurred up to the date of commencement of the production cannot be allowed.
ii. K. Sampath Kumar v. CIT [1986] 158 ITR 25 (Mad.): In this case, it is held by Hon’ble Madras High Court that business commences only when production commences and mere purchase and erection of plant and machinery cannot amount to commencement of business. Accordingly, it was ruled that interest paid on capital borrowed for purchase of plant and machinery would not form part of actual cost of plant and machinery and not allowable as business expenditure prior to commencement of the business.
iii. CIT v. Industrial Solvents & Chemicals (P.) Ltd. [1979] 119 ITR 608 (Bom.): In this case, Hon’ble Bombay High Court held that expenditure incurred preparatory to commencement of the business is capital expenditure and business can said to have been set up when reasonable quantity of end product is obtained. It is further observed that mere installation of machinery is not sufficient to come to a decision that business of the assessee has commenced.
iv. CIT v. Sponge Iron India Ltd. [1993] 201 ITR 770  (AP): In this case, the Hon’ble Andhra Pradesh High Court held that in case of business of production of sponge iron, exploration of iron ore cannot be constituted as commencement of business of the assessee.
v. CWT v. Ramaraju Surgical Cotton Mills Ltd. [1967] 63 ITR 478 (SC): In this case, it is held by the Hon’ble Supreme Court that in the case of a manufacturing concern, the business cannot be set up unless the equipments are installed and the plant is ready for production beyond the experimental stage, whether there is any actual production or not.

14.1 It was submitted that the said principle of law with regard to the difference between setup of the business and commencement of the business have once again reiterated in the following decisions:

(a) Travancor-Cochin Chemicals (P.) Ltd. v. CWT [1967] 65 ITR 651 (SC)
(b) CIT v. Electron India [2000] 241 ITR 166  (Mad.)

14.2 It was submitted that the expenditure claimed by Assessee amounting to Rs. 98,53,986/- incurred during the year, but prior to commencing the business, cannot be allowed as revenue loss and therefore the same cannot be adjusted against the income computed under the head other sources. Since there is no issue of quantification of loss, it cannot be carried forward to subsequent assessment years also. Assess is free to claim capitalization of same in the ratio of the cost of the various assets falling under fixes asset schedule and claim depreciation from the year of commencement of the business.

15. The Bench has raised a query whether similar interest in the earlier year was offered to tax or not. Ld. CIT DR submitted that Assessee has offered the interest as income and subsequently filed an appeal before the CIT(A), which was dismissed on some technical grounds, therefore the issue was crystalized in favour of Revenue by order of CIT(A). Whereas, Assessee Counsel submitted that the subsequently Assessee filed before Ld. CIT(A,) by way of revised set of appeal documents on 08-08-2016, wherein Assessee took a ground that the interest income earned by Assesssee ought to have been set off against the capital work in progress.

16. We have considered the rival submissions and also perused the material available on record. Admittedly the assessee is in the process of setting up of power project. For the purpose of setting up of the project the assessee has availed funds from banks. Admittedly, the assessee invested a part of the borrowed funds from banks, which was not immediately required in short term deposits with an intention to earn interest ostensibly to reduce the interest liability. The question arises for consideration is whether the interest income of Rs. 22,35,48,281/- received by the assessee on temporary deposit of funds in with banks is assessable as income of the assessee or it would go to reduce the cost of borrowings? In other words, whether the interest amount of Rs. 22,35,48,281/-received by the assessee would be set off against the interest payment of Rs. 127,84,98,794/- on the borrowed funds. As rightly submitted by the learned CIT DR, the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) had examined an identical situation. The question which was referred to the Supreme Court is as follows:

“Whether, on the facts and in the circumstances of the case, interest derived by the assessee from borrowed funds which were invested in short term deposits with banks would be chargeable to tax under the head ‘Income from other sources’ or would go to reduce the interest payable by the assessee on the term loan secured by the assessee from financial institutions which would be capitalised after commencement of commercial production?”

17. In the case before the Apex Court, the assessee for the purpose of setting up of a factory has taken term loans from various banks and financial institutions. A part of the borrowed fund which was not immediately required by the assessee was kept invested in short term deposits with banks. The assessee claimed before the Assessing Officer that the interest of Rs.2,92,440 received on the term deposit with banks would go to reduce the pre-production expenses such as interest and financial charges which would ultimately be capitalised. Accordingly the assessee claimed that the interest of Rs.2,92,440 was not exigible to tax. However, the ITO rejected the claim of the assessee. The CIT(A) as well as the Tribunal confirmed the order of the Assessing Officer. However, the Tribunal found that there were conflicting judgments of the Madras High Court in CIT v. Seshasayee Paper & Boards Ltd. [1985] 156 ITR 542 and A.P. High Court in CIT v. Nagarjuna Steels Ltd. [1988] 171 ITR 663 Accordingly a reference was made to the Apex Court. The Apex Court after examining the facts of the case and the judgment of the Madras High Court in Seshasayee Paper & Boards Ltd. (supra) and Andhra Pradesh High Court in Nagarjuna Steels Ltd. (supra) confirmed the judgment of the Madras High Court.

The Apex Court has specifically observed as follows at pages 180 and 181 of the Report:

“It is true that the company will have to pay interest on the money borrowed by it. But that cannot be a ground for exemption of interest earned by the company by utilizing the borrowed funds as its income. It was rightly pointed out in the case of Kedar Narain Singh v. CIT [1938] 6 ITR 157 (All) that “anything which can properly be described as income is taxable under the Act unless expressly exempted “. The interest earned by the assessee is clearly its income and unless it can be shown that any provision like section 10 has exempted it from tax, it will be taxable. The fact that the source of income was borrowed money does not detract from the revenue character of the receipt. The question of adjustment of interest payable by the company against the interest earned by it will depend upon the provisions of the Act. The expenditure would have been deductible as incurred for the purpose of business if the assessee’s business had commenced. But that is not the case here. The assessee may be entitled to capitalise the interest payable by it. But what the assessee cannot claim is adjustment of this expenditure against interest assessable under section 56. Section 57 of the Act sets out in its clauses (i) to (iii) the expenditures which are allowable as deduction from income assessable under section 56. It is not the case of the assessee that the interest payable by it on term loans is allowable as deduction under section 57 of the Act.

If that be so, under which other provision of law can the assessee claim deduction or set-off of his income from other sources against interest payable on the borrowed funds?

There are specific provisions in the Income-tax Act for setting off loss from one source against income from another source under the same head of income (section 70), as well as setting off loss from one head against income from another (section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head. Similarly, any income from a non-business source cannot be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee.”

18. No doubt, the Apex Court found that it is not the case of the assessee that the interest payable by it on term loan is allowable as deduction u/s. 57 of the Act. The Apex Court after referring to the judgment of the Orissa High Court in CIT v. Electrochem Orissa Ltd. [1995] 211 ITR 552  and the judgment of the Madras High Court in Seshasayee Paper & Boards Ltd. (supra) disapproved the reading of the judgment of the Madras High Court in Seshasayee Paper & Boards Ltd. (supra) by the Orissa High Court. In fact, the Apex Court has observed as follows:

‘Our attention was drawn to two other decisions where the view of the Andhra Pradesh High Court was followed. In the case of CIT v. Electrochem Orissa Ltd. [1995] 211 ITR 552, the Orissa High Court preferred the view expressed by the High Court of Andhra Pradesh to the view expressed by the Madras High Court in Seshasayee Paper and Boards Ltd.’s case [1985] 156 ITR 542 on the ground that the Madras case was based on a finding of fact that there was no direct connection between the interest paid and the interest received. In our view, it will not be right to read the judgment in Seshasayee Paper and Boards Ltd.’s case [1985] 156 ITR 542 (Mad) in that way. The court’s finding in Seshasayee Paper and Boards Ltd.s case [1985] 156 ITR 542 (Mad) was that the interest earned by the assessee from the bank deposits had to be assessed under the head ” Other sources “. Consequently, the interest paid on the borrowings for the purpose of purchase of plant and machinery could not be allowed or adjusted against this income under section 57(iii) nor were such adjustments permissible under section 70 or 71 of the Act because the business of the assessee had not commenced. The Madras High Court (see [1985] 156 ITR 542) categorically held:

“In this case, admittedly, the borrowing has not been made exclusively and solely for the purpose of earning interest in which case alone it should be taken as an income which should be deducted from the interest receipts.”

An assessee-company may have raised its capital by issue of shares or debentures or by borrowing. But when that capital or a portion of it was utilised for whatever reason, even for a short period, to earn interest, that interest must be treated as revenue receipt and will have to be taxed accordingly. Any set off or deduction of any expenditure can only be made in accordance with the provisions of the Act.’

In view of the observation of the Apex Court, it is obvious that the Apex Court is conscious of the provision of section 57(iii) and it was held that when the assessee borrowed the funds for business, the interest earned on short term deposit of such funds cannot be allowed as deduction.

19. We have carefully gone through the judgment of the Madras High Court in Seshasayee Paper Boards Ltd. (supra). The assessee company invested its paid-up share capital and loans obtained from banks and received interest income. The interest income received by the assessee was adjusted towards the interest payable on its loan. Accordingly the interest received by the assessee was not offered as income for taxation. The claim of the assessee that the interest income received by the assessee would go to reduce the interest payment on borrowed funds was rejected by the Income-tax authorities. However, the Tribunal allowed the claim of the assessee. On a reference to the Madras High Court, after referring to the judgment of the Apex Court in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 and various other judgments of the High Courts, found that the borrowing has not been exclusively and solely for the purpose of earning interest in which case alone it should be taken as income which should be deducted from the interest receipt. This judgment of the Madras High Court in Seshasayee Paper and Boards Ltd. (supra) was specifically taken note of by the Apex Court and it was observed that interest paid on borrowings for the purpose of purchase of plant and machinery could not be allowed or adjusted against the income u/s. 57(iii) of the Act. The Apex Court finally concluded that the view expressed by the Madras High Court in Seshasayee Paper and Boards Ltd. is correct and the views expressed in other cases are erroneous. From the above it is obvious that even though the Apex Court found that the assessee in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) has not specifically made any claim u/s. 57 of the Act for setting off of the interest received on the FD with interest payment on borrowed fund, the Apex Court after referring to the judgment in the case of Seshasayee Paper and Boards Ltd. (supra) of the Madras High Court found that the claim of the assessee cannot be allowed even u/s. 57(iii) of the Act. In our opinion, the judgment of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) on identical set of facts has answered a similar question against the assessee. Therefore, the interest received by the assessee on temporary deposit of funds which are not required immediately has to be assessed as ‘Income from other sources’ and it cannot be set off against the interest payable by the assessee on borrowed funds.

20. Admittedly deposit of funds in the bank is not the business of the assessee. The assessee borrowed the funds for the purpose of establishing the Power project. So long as the assessee uses the funds in the process of setting up of the project, we can say that the assessee has utilised the funds for the purpose of business. In this case the assessee has deposited the funds in FD for a temporary period, since the same was not required immediately. As observed by the Madras High Court in the case of Seshasayee Paper and Boards Ltd. (supra) which was approved and confirmed by the Apex Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) the interest earned by the assessee by investing the borrowed fund which was not required immediately in fixed deposit has nothing to do with the actual borrowing. The payment of interest has no connection with the receipt of interest. Admittedly the borrowing has not been made for the purpose of earning interest income in which case alone the interest received by the assessee can be deducted from the interest payable. In view of the judgment of the Madras High Court in the case of Seshasayee Paper and Boards Ltd. (supra) and the judgment of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), we are unable to uphold the contention of the assessee. The distinction sought to be made by categorising the funds as committed funds and surplus funds, in our view, cannot be accepted as in both the events the nature of fund is the they are not required immediately for the project.

21. In this regard, it is interesting to note that in all the mentioned decisions by assessee, reliance has been placed on the decision of the Hon’ble Supreme Court in the case of Bokara Steel Ltd. (supra). Further, in all such cases, various judicial authorities have tried to differentiate the decision of Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) with the decision of Hon’ble Supreme Court in the case of Bokara Steel Ltd. (supra) However, in reality, the proposition of law laid down by Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) has not been overruled or distinguished by Hon’ble Supreme Court in its own decision in the case of Bokara Steel Ltd. (supra). On the other hand, in the case of Bokara Steel Ltd. (supra) the Hon’ble Supreme Court has once again reiterated and supported its decision in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) with regard to the issue of treatment of interest earned on short term deposits made out of borrowed funds during the period prior to the commencement of the business of the assessee. in the case of Bokara Steel Ltd. (supra), that company received certain income from the contractor who was assigned the job of constructing the factory. During the course of construction activities carried on by the contractor, the contractor had availed certain facilities and services from the company and paid certain consideration to the company. The nature of the services and consideration/income received by the company from the contractor are noted as below :—

i. Let out of its dwelling units to the contractor which were used for the purpose of housing the workers/labourers and staff for construction work;
ii. Hire charges received by the company from the contractor in connection with hiring of the plant and machinery owned by the company to the contractor which were used by the contractor in the construction work
iii. Interest received by the company from the contractor on account of advances made to the contractor which were used for the purpose of construction work of the factory by the contractor; and
iv. Royalty received by the company from the contractor in connection with permitting the contractor to excavate/mine the stones from the land owned by; the company which were used in the construction activity of the company.

In this connection, the Hon’ble Supreme Court held that the income received by the company ie. from the contractor under various sources mentioned above is inextricably linked with the setting up of the factory building/capital structure of the company and, therefore, such income has to be treated as capital receipt going to reduce the cost of construction of the assessee company.

22. However, in the same case of Bokara Steel Ltd. (supra), there was an issue with regard to treatment of interest income received by the company on short term deposits made with banks out of the amounts borrowed by it for the construction work which were not immediately required. On this issue, the AO treated the interest received as income of the assessee from “other sources” and brought to tax accordingly. However, as observed by the Hon’ble Supreme Court, the assessee had accepted the same and not filed any appeal against such finding and decision of lower authorities before Supreme Court. In view of this, Hon’ble Supreme Court made a mention in its judgement at Para No.4 stating that “we were not called upon to examine this issue” and further made a reference that in any” case, this question now concluded by the decision of Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). The relevant portion of the decision at Para No.4 is as under::

“During these assessment years, the respondent-assessee had invested the amounts borrowed by it or the construction work which were not immediately required, in short-term deposits and earned interest. It has been held in these proceedings that the receipt of interest amounts to income of the assessee from other sources. The assessee has not filed any appeal (rom this finding which is given against it. In any case, this question is now concluded by a decision of this court inTuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172(sq. Hence, we are not called upon to examine that issue.” (Emphasis supplied)

This issue of difference between the treatment of income received from contractor and the interest income received from the banks on account of short term deposits is once again highlighted by Hon’ble Supreme court in the case of Bokara Steel Ltd. (supra) at Para No.7. The relevant portion of the same is reproduced below:

“The appellant, however, relied upon the decision of this court in Tuticorin Alkali Chemicals & Fertilizers Ltd. case (supra). That case dealt with the question whether the investment of borrowed funds prior to commencement of business, resulting in earning of interest by the assessee, would amount to the assessee earning any income. This court held that if a person borrows money for business purposes, but utilises that money to earn interest, however, temporarily, the interest so generated will be his income. This income can be utilised by the assessee whichever way he likes. Merely because he utilised it to repay the interest on the loan taken will not make the interest income as a capital receipt. The department relied upon the observations made in that judgment (at page 179) to the effect that if the company, even before it commences business, invests surplus funds in its hands for purchase of land or house property and later sells it at profit, the gain made by the company will be assessable under the head ‘Capital gains’. Similarly, if a company purchases rented house and gets rent, such rent will be assessable to tax under section 22 as income from house property. Likewise, the company may have income from other sources. The company may also, as in that case, keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under section 56 of the Act. This court also emphasized the fact that the company was not bound to utilise the interest so earned to adjust it against the interest paid on borrowed capital. The company was free to use this income in any manner it liked. However, while interest earned by investing borrowed capital in short-term deposits is an independent Source of income not connected with the construction activities or business activities of the assessee the same cannot be said in the resent case where the utilisation of various assets of the company and the payments received for such utilisation are directly linked with the activity of setting up the steel plant of the assessee. These receipts are inextricably linked with the setting up of the capital structure of the assessee-company. They must, therefore, be viewed as capital receipts going to reduce the cost of construction. In the case of Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 (SC), this court examined the question whether interest paid before the commencement of production by a company on amounts borrowed for the acquisition and installation of plant and machinery would form a part of the actual cost of the asset to the assessee within the meaning of that expression in section 10(5) of the Indian Income Tax Act, 1922 and whether the assessee will be entitled to depreciation allowances and development rebate with reference to such interest also. The court held that the accepted accountancy rule for determining cost of fixed assets is to include all expenditure necessary to bring such assets into existence and to put them in working condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets. These are receipts of a capital nature and cannot be taxed as income.” (Emphasis supplied)

23. Under the facts and circumstances, it cannot be construed that the interest earned on account of parking the un utilized borrowed funds is inextricably linked with the setting up of the capital structure of the assessee company, inasmuch as such interest income is not received from the contractor to whom the assessee has assigned the construction work of its power project. In view of this, the ratio laid down by Hon’ble Supreme Court in the case of Bokara Steel Ltd. (supra)is not applicable to the facts of the assessee’s case. As such, in view of the similar set of facts and circumstances involved in the case of the assessee as well as in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), the proposition of law laid down by the Hon’ble Supreme court in that case is squarely applicable without any deviation.

24. Further, a clear-cut differentiation between treatment of interest income from short term deposits made out of borrowed funds and other categories of income received during the period prior to the commencement of business, more so, income received from the contractor undertaking the work of set up of the business of the assessee, has once again been made out by the Hon’ble Supreme Court in its later decision in the case of Bongaigaon Refinery and Petrochemicals Ltd. (supra). In this judgment, the Hon’ble Supreme Court has reiterated the law that excluding interest derived by the assessee during the period prior to the commencement of business, other items of income such as hire charges for it equipment and recoveries from contractors on account of water and electricity charges shall be adjusted against the project cost or the business of oil refinery and petro chemicals. As such, in regard to interest income earned prior to commencement of the business, it is once again reiterated by the Hon’ble Supreme Court as income under “other sources” by reiterating the law laid down in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). The relevant portion of – the said decision of Hon’ble Supreme Court is reproduced below:

“The High Court has already held that the interest income derived by the assessee during its formative period was taxable income. What remains for consideration is the income which the assessee derived from house property, its guest house, charges for equipment and recoveries from the contractors on account of water and electricity supply. These items are covered by the decision in Bokaro Steel Ltd.s case (supra). To the extent that it relates to these items, i.e., items excluding interest, the question must be answered in the affirmative and in favour of the assessee. The order under challenge will stand modified to that extent”.

25. Also, it is pertinent to note that in the case of Totgars Cooperative Sale Society Ltd. (supra), the Hon’ble Supreme Court has once again held that interest earned on investment of surplus funds on hand not immediately required in short term deposits and securities would not fall under business income but income from other sources.

26. We have also carefully gone through the judgment of the Delhi High Court in Indian Oil Panipat Power Consortium Ltd. (supra). The Hon’ble Delhi High Court distinguished the judgment of Apex Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) on the ground that the funds in the form of share capital were infused for a specific purpose of acquiring land and development of infrastructure. Therefore, the interest earned on funds primarily brought for infusion in the business could not have been classified as ‘Income from other sources’. After referring to the judgment of Apex Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), the Hon’ble Delhi High Court found that the interest on surplus funds would have to be treated as ‘Income from other sources’. We find that the Madras High Court on another occasion, in South India Shipping Corpn. v. CIT [1999] 105 Taxman 660, considered an identical situation and after referring to the Apex Court judgment in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) observed s follows at page 31 of the Report:

“Coming now to the questions that have been referred to us at the instance of the Revenue, these questions are required to be answered in favour of the Revenue and against the assessee, in view of the decision of the Supreme Court in the case of Tuticorin Alkali Chemicals an Fertilizers Ltd. [1997] 227 ITR 172, wherein the apex court, inter alia, held that in view of section 57(iii) of the Income-tax Act, interest paid on overdraft obtained for the purpose of business could not be deducted from the interest earned on monies kept in fixed deposits as such income derived by way of interest on fixed deposits was to be taxed under the head ‘Income from other sources.

We, however, make it clear that though the assessee may not be entitled to have interest paid by it on overdraft to the bank, deducted from the interest received by it on the short-term fixed deposits, the assessee is entitled to deduction of the same from its business income.”

27. In view of this judgment of the Madras High Court and the judgment of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra), and other judgments of Hon’ble Supreme court, in our opinion, the judgment of the Delhi High Court in the case of Indian Oil Panipat Power Consortium Ltd. (supra) and other case reloed on by Ld. Counsel in his arguments may not be applicable to the facts of this case. In view of the above discussion, we do not find any infirmity in the order of the lower authority. Accordingly, the same is confirmed.

28. Now the issue whether the assessee business has been set up or commenced. This issue was also decided by the Hon’ble Supreme court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). In the facts and circumstances of that case the Hon’ble Supreme Court held that the company cannot claim set off of income under the head “other sources” against the pre-operative/pre-production expenses to be capitalized in future under the head “profits and gains of business or profession” inasmuch as in the year under consideration, the business of the assessee had not started and there could not be any computation of business income’ or loss incurred by the assessee in the relevant accounting year. It is further held by the Hon’ble Supreme Court that the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head. Similarly, any income from a non-business source cannot be set-off against liability to pay interest on funds borrowed for the purpose of establishing the business including purchase of plant and machinery even before commencement of the business of the assessee.

29. While deciding the core issue of taxability of interest earned on short term deposits made out of borrowed funds during the period prior to the commencement of the business, the Hon’ble Supreme Court has also laid down proposition of law that no income under the head “profits and gains of the business or profession” could be computed during the accounting year prior to commencement of the business of the asessee. Further, the Hon’ble Supreme Court gave a finding of fact that the assessee had not commenced/started its business and accordingly ruled that there could not be any computation of business income or loss of the assessee in the relevant accounting year. The relevant portion at Para No. 17 of the order is as under:

“There are specific provisions in the Income-tax Act for setting off loss from one source against income from another source under the same head of income (section 70), as well as setting off loss from one head against income from another (section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under anyother head. Similarly, any income from a non-business source cannot be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee.” (Emphasis supplied)

The Hon’ble Supreme Court reiterated the same fact of non-commencement of business and its decision that until and unless the company commences its business, there cannot be any question of assessment of income of the assessee under “profits and gains of business or profession”. However, the Hon’ble Supreme Court laid down the law that any income earned which would fall under the other heads of income such as “capital gains”, “house property”, “income from other sources” etc. are subject to tax under respective heads even before the assessee commences its business activities. The relevant portion of the same at Para No. 12 of the order:

“The basic proposition that has to be borne in mind in this case is that it is possible for a company to have six different sources of income, each one of which will be chargeable to income-tax. Profits and gains of business or profession is only one of the heads under which the companys income is liable to be assessed to tax. If a company has not commenced business there cannot be any question of assessment of its profit and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. If the company, even before it commences business, invests the surplus funds in its hands for purchase of land or house property and later sells it at profit, the gain made by the company will be assessable under the head “Capital gains”. Similarly, if a company purchases a rented house and gets rent, such rent will be assessable to tax under section 22 as income from house property. Likewise, a company may have income from other sources. It may buy shares and get dividends. Such dividends will be taxable under section 56 of the Act. The company may also, as in this case, keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under section 56 of the Act.” (Emphasis supplied)

After having held that no business income could be computed prior to the commencement of the business, the Hon’ble Supreme Court has adjudicated the matter with regard to assessment of interest income under the head “other sources” and non-adjustment of interest paid on borrowed capital against such income. The relevant portion of the decision at Para No. 18 & 19 is as under::

“It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capital. Having regard to the identity of the fund on which interest is earned and interest is payable, the company should be allowed to set off its income against interest payable by it on the same fund. We are of the view that no adjustment can be allowed except in accordance with the provisions of the Income-tax Act. However desirable it may be from the point of view of equity. this adjustment cannot be made unless the law specifically permits such adjustment.

Next, it has been argued that according to well-established accountancy practice the interest earned by the company even before the commencement of business from investing borrowed capital will have to be set off against interest payable by the company on that borrowed capital. The argument based on accountancy practice has little merit, if such practice cannot be justified by any provision of the statute or is contrary to it.” (Emphasis supplied)

30. Further, the distinction between set up and commencement was also explained by Ld. CIT Dr in his arguments. We agree with the same. The following case law relied also support the Revenue stand.

i. Omer Khayyam Wineries (P) Ltd. (supra)
ii. K. Sampath Kumar (supra)
iii. Industrial Solvents & chemicals (P.) Ltd. (supra)
iv. Sponge Iron India Ltd. (supra)
v. Ramaraju Surgical Cotton Mills Ltd. (supra)
vi. Travancor – Cochin Chemicals (P.) Ltd. (supra)
vii. Electron India (supra)

31. Respectfully following the principles laid down as discussed above, we are of the opinion that the preoperative expenditure was to be capitalized to the assets and Assessee was eligible for depreciation on the value of assets. Therefore in the given facts of the case, we hold that Assessee has only setup the business but has not commenced the business, therefore, the claim of revenue expenditure is not allowable as the provisions of Sec. 28 of the IT Act does not apply.

32. Since the principles laid down by the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) a three judge bench decision is followed other cases relied on by assessee do not apply to the facts of the case. We reiterate that the decision of coordinate Bench of Hyderabad in the case of Kakinada SEZ Pvt Ltd (supra) has to be followed as the same relied on the principles laid down by the judgment of the Hon’ble Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra).

33. As seen from the above, the Hon’ble Supreme Court has clearly laid down the law that-

i. Before the commencement of the business of the assessee, income earned in the form of interest on deposits made with banks out of the funds borrowed from banks and financial institutions which was not immediately required for the purpose of setting up of the business should be assessed to tax under the head “other sources”.
ii. Similarly, no expenditure can be claimed under the head “Profits and Gains of business or profession” during the period prior to the commencement of the business; and
iii. Any expenditure incurred including the interest on funds borrowed for the purpose of setting up of the business/purchase of plant and machinery etc., cannot be set-off against the interest income under the head “other sources”.

34. The Hon’ble jurisdictional High Court in the case of CIT v. Rasi Cement Ltd. [1998] 232 ITR 554 (AP) has answered similar questions involved in favour of the Revenue. The question before the Hon’ble High Court was whether the interest earned on surplus funds deposited in the banks during the installation of the company, the status of the company before commencement of the business. The Hon’ble High Court has held that such interest has to be separately treated as income from other sources and cannot be taken as part of the capital structure following the decision of the Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra). It was categorically held that interest earned on surplus funds deposited in banks during installation of company, prior to commencement of business, has to be brought to tax as ‘income from other sources’ u/s. 57. Respectfully following the jurisdictional High Court decision also, the contentions of assessee that this amount has to be adjusted towards capital account cannot be accepted.

35. In view of the above, we hold that there is no merit in assessee contentions on all the grounds raised and accordingly they are rejected. The orders of AO and CIT(A) are accordingly confirmed.

36. In the result, assessee appeal is dismissed.

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