S. 40(b) Interest on deposits for availing bank guarantee is business income

S. 40(b) Interest on deposits for availing bank guarantee is business income includible in ‘book profit’  

It is the purpose or the proximity to the purpose, which would determine the character of the asset and, thus, that of the income arising there-from and, consequently, its assessability under the Act, going on to hold that where the amount was deposited in the bank to obtain a letter of credit for purchase of a capital asset (machinery), the interest thereon would only be a capital receipt, which shall go to reduce the cost of the relevant capital asset. The said decisions, in our view, full govern the present case, and the Revenue has misapplied the decisions by the hon’ble jurisdictional high court.

We, accordingly, hold the impugned interest income of Rs. 471612/- as liable to be assessed as business income under Chapter IV-D of the Act. Accordingly, it would be entitled to deduction qua remuneration allowed to working partner/s by considering the said income as part of the `book profit’ under Explanation 3 to s. 40(b)(v). We decide accordingly.

INCOME TAX APPELLATE TRIBUNAL, COCHIN  

I.T.A. No. 109/Coch/2010 – Assessment Year:2002-03

Solvents and Chemicals Vs. The Assistant Commissioner of Income-tax

 Date of Decision – Dated: 29th July, 2011

O R D E R

Per Sanjay Arora, AM:

This is an Appeal by the Assessee, arising out of the Order by the Commissioner of Income-tax (Appeals)-II, Kochi (‘CIT(A)’ for short) dated 30.11.2009; the assessee having contested its assessment u/s. 143(3) read with s. 147 of the Income-tax Act, 1961 (‘the Act’ hereinafter) dated 19.9.2007 for the assessment year (A.Y.) 2002-03. Though the appeal raises several grounds, it, in effect, raises principally two issues, each of which we shall take up in seriatim.

2. The first issue agitated by the assessee, per Grounds 2(a) to (c), is the challenge to the re-opening of its assessment, subsequent to the assessment under section 143(3) of the Act dated 27.12.2004. The basis of the challenge is that the same is occasioned only by a change of opinion by the Assessing Officer (AO); the assessment having been completed in the first instance u/s. 143(3) of the Act by examining all the relevant aspects; the `profit and loss account’ as well as the `tax audit report’ u/s. 44AB of the  Act, filed along with the return of income, duly disclosing both the interest received from the bank as well as the quantum of remuneration allowed to the partners, i.e., the two facts which constitute the basis of the re-opening of the assessment.

3. We have heard the parties, and perused the material on record. We find no substance in the assessee’s claim. There is no whisper either of the interest income, which is on bank deposits, credited to the profit and loss account of the assessee-firm for the year at ~4,71,612/-, or the head of income under which it is liable to be assessed under the Act, in the original assessment order (copy on record). The same has clearly escaped the attention of the AO while making the assessment, so that there has been no expression of any opinion in the matter, for the assessee to contend of a change of opinion. Even as observed by the Bench during the hearing, the assessment stands re-opened within four years of the commencement of the relevant assessment year, so that the assessee’s insistence on proper disclosure would not be of any relevance. The decision in the case of S.P. Equipments & Services v. CIT (Asstt.), 128 TTJ (Jp) 68, relied upon by the assessee (with regard to the issue arising on merits), upholding the reopening under like circumstances, is also fully applicable to the assessee’s case. Secondly, we find that there is another ground for reopening of the assessment, which stands stated at para 2 of the impugned assessment order, and has led to a disallowance u/s. 36(1)(iii) at ~20,545/-, i.e., at the same amount as stated in the reason. The said disallowance has not been agitated by the assessee either before the first appellate authority or before us, i.e., stands accepted. As such, its challenging the re-opening is without merit. The assessee fails on its Ground No. 2.

4. The second and the principal issue, projected per Ground Nos. 3(a) to 3(e), 4 & 5 (of the grounds of appeal) relates to the disallowance of Rs. 1,88,644/- in respect of excess remuneration to the working partners, effected u/s. 40(b)(v) of the Act. The said disallowance has been worked out by limiting the allowance in its respect w.r.t. the `book profit’, in terms of Explanation 3 to s. 40(b)(v), reckoned by excluding the income by way interest on bank deposits, on the ground that the same is assessable under the head  ‘income from other sources’ and, thus, not liable to be included as a profit of the business, on which the quantum of deduction qua remuneration to the working partner/s is to be based. While the AO has relied on the decision in the case of CIT vs. South India Shipping Corporation Ltd. (1999) 240 ITR 24 (Mad.), the ld. CIT(A) has further relied on the decisions by the jurisdictional high court in the case of CIT vs. Jose Thomas, 253 ITR 553 (Ker.) and Collis Lines Pvt. Ltd. vs. CIT, 135 ITR 390 (Ker.), stating of the same as representing the consistent view by the said court. The assessee’s stand is that what is relevant is the manner in which the income is derived and not the fact that the assessee is engaged in business or profession. Aggrieved, the assessee is in appeal.

5. We have heard the parties, and perused the material on record, including the hearing notes as well as the case law cited by the assessee per its grounds of appeal as also per its separate paper-book.

5.1 Though the assessee has raised alternative contentions as well, we shall proceed by examining the principal issue first. The primary facts are relevant and bear mention. The assessee is a wholesale dealer in solvents and chemicals, availing a loan of ~1.20 crores from its bank for the purpose during the relevant year. The bank deposits, on which the impugned interest stands earned, are only toward margin money for the issue of bank guarantee/s in favour of its principal suppliers, i.e., the Hindustan Oil Corporation Ltd. (HOCL) and Kochi Refineries Ltd. (KRL), by its banker, State Bank of India; the total amount of bank guarantees, issued and outstanding during the year, being to the tune of ~1.95 crores. The suppliers, as explained by the assessee, extend credit (for one month) only on the condition of being guaranteed the payment on the expiry of the defined period, toward which the funds are placed in bank deposits by way of margin money @ 25% of the bank guarantee/s. These fact are not disputed, so that we shall take them as given for the purpose of our deliberation.

5.2 With regard to the law in the matter, we may refer to, among others, the decision by the apex court in the case of CIT vs. Govinda Choudhury & Sons (1994) 203 ITR 881  (SC), since affirmed by the said court in the case of CIT v. B.N. Aggarwala & Co. (2003) 259 ITR 754 (SC). In the facts of the said case, there arose a dispute between the assessee, a government contractor, and the State Government with regard to the payments under the contract, and which were referred to arbitration. The assessee received certain amounts under arbitration award, and which included interest for the delay in the payment due to it. The question of the head of income under which the said interest was liable to be assessed, i.e., as `business income’ or `income from other sources’, arose for consideration. The apex court clarified that there was no rule that the interest had to be assessed only under the residuary head ‘income from other sources’, and which would be so only where it could not be brought within one of the several specific heads of charge. That is, the question of its assessability under one or the other heads of income is to be determined on the basis of the specific facts attending each case, and no omnibus or standard rule could be said to operate. It was further held that the interest payable to the respondent partook the same character as the receipt for payment of which it was otherwise entitled under the contract, and which payment had been delayed as a result of the dispute between the parties. The interest awarded could not be separated from the other amounts granted to the respondent under the award, and treated as `income from other sources’. The subsequent decisions by the apex court in the case of CIT vs. Bokaro Steel Ltd. (1999) 236 ITR 315 (SC) and CIT vs. Karnal Cooperative Sugar Mill Ltd. (2000) 243 ITR 2 (SC), inter alia, further confirm this view. In both the cases, the interest income was found as directly connected and incidental to the construction of the plant and, thus, considered as a credit toward acquisition or the setting up of the plant and machinery (or other capital asset) and, accordingly, only a capital receipt, which would go to reduce the cost of the relevant asset. In fact, the facts in the case of CIT vs. South India Shipping Corporation Ltd. (supra), relied upon by the Revenue, would also bear out the same in-as-much as the same follows the application of the decision by the apex court itself in the case of Tuticorin Alkalis Chemicals and Fertilizers Ltd. vs. CIT (1997) 227 ITR 172 (SC). In the subsequent decision cited supra, i.e., CIT vs. Bokaro Steel Ltd and CIT vs. Karnal Cooperative Sugar Mill Ltd, the overdraft facility was availed on the security of short term bank deposits, and which funds were used for business purposes. It  was under these circumstances that it was held that the interest on the bank deposits would not be assessable as business income but only as income from other sources, while the assessee would get full deduction u/s. 36(1)(iii) on the interest on the overdraft account. The bank deposits, it may be appreciated, were nowhere connected with the assessee’s business, and only represented parking of funds, deemed surplus for the time being, on a short term basis. That these constituted the security for availing of overdraft facility from the bank, availed and utilised for business purposes, was, as also pointed out by the hon’ble court, a different matter altogether. It was on this basis that the interest on overdraft was disallowed for being set off against the bank interest income, having not been incurred for earning the same. The said interest would, however, being on a borrowing of the business, stand to be allowed as business deduction u/s. 36(1)(iii). The bank deposits formed the security for the availment of borrowing from the bank, and thus by itself do not form part of the business or trade. The same premises informed the decision by the hon’ble jurisdictional high court in the case of CIT vs. Jose Thomas (supra), which was also in the context of the bank deposits held as collateral security for bank borrowing; it reversing the decision by the tribunal in the matter, holding that if agricultural land stood offered as a collateral security, going by the tribunal’s logic, the agricultural income there-from would be assessable as business income! Again, the decision in the case of Collis Lines Pvt. Ltd. vs. CIT (supra) is with reference to the bank deposits representing investment of surplus funds, lying idle and thus kept in the form of deposits with the bank.

5.3 The bank deposits, in the facts of present case, to the contrary, were necessitated only for the availment of credit from the supplier’s, who refused to extend trade credit and thus assume any credit risk against supplies to the assessee, except where the same stood mitigated by the issue of bank guarantee/s in their favour. The said bank deposits, being only in compliance of the terms of the availment of bank guarantee – a business arrangement – thus, constitute a business asset as any other. The same makes business sense, as also sought to be explained by the ld. AR during hearing, as a deposit of Rs. 25/- (say) enables the assessee to avail a credit of Rs. 100/- from its suppliers on a continuous basis, while earning it a reasonable return (by way of interest) on a risk-free or near risk-free basis. The assessee rather than being possessed with surplus funds, is in deficit, availing of a loan of ~120 lakhs during the relevant year. The facts of the instant case are, thus, completely distinguishable from that of the cases relied upon by the Revenue. The bank deposit(s), on which interest stands earned in the present case, thus, are only the business assets of the assessee’s trade, and income there-from rightly assessable as business income. The assessee’s case, rather than being covered against it, is, covered in its favour by the decisions, as in the case of CIT v. B.N. Aggarwala & Co. (supra); Tuticorin Alkalis Chemicals and Fertilizers Ltd. vs. CIT (supra); CIT vs. Bokaro Steel Ltd (supra); CIT vs. Karnal Cooperative Sugar Mill Ltd. (supra), where the apex court has time and again confirmed that it is the purpose or the proximity to the purpose, which would determine the character of the asset and, thus, that of the income arising there-from and, consequently, its assessability under the Act, going on to hold that where the amount was deposited in the bank to obtain a letter of credit for purchase of a capital asset (machinery), the interest thereon would only be a capital receipt, which shall go to reduce the cost of the relevant capital asset. The said decisions, in our view, full govern the present case, and the Revenue has misapplied the decisions by the hon’ble jurisdictional high court. We, accordingly, hold the impugned interest income of Rs. 471612/- as liable to be assessed as business income under Chapter IV-D of the Act. Accordingly, it would be entitled to deduction qua remuneration allowed to working partner/s by considering the said income as part of the `book profit’ under Explanation 3 to s. 40(b)(v). We decide accordingly.

5.4 Continuing further, Ground No. 4 represents the alternative plea raised by the assessee, relying on the decision by the tribunal in the case of S.P. Equipments & Services v. CIT (Asstt.), (supra) and CIT (Asstt.) v. Seth Brothers, 99 TTJ (Rajkot) 189, to the effect that even if the said interest was to be considered as assessable under Chapter IV-F of the Act, i.e., as income from other sources, the same would still qualify to be  considered as a part of the `book profit’, being with reference to the books of accounts, which the AO cannot disturb, so that remuneration to the partners would stand to be allowed on its basis. The moot question, however, that would arise in this regard, and only as a direct corollary to the foregoing discussion, is whether a deduction in respect of business expenditure, as remuneration allowed by a firm to its working partner/s, which is allowable only u/s. 37(1) of the Act, could be allowed against income that is admittedly not assessable under Chapter IV-D, but under any other head of income instead, as (say) `income from other sources’ [Chapter IV-F]. This would arise in direct consequence of the argument advanced that the term `book profit’ under Explanation 3 to s. 40(b)(v) could include income which may not be assessable u/c. IV-D; the only qualification for the same being that it must find inclusion in the firm’s `profit and loss account’ for the relevant year. As would be apparent, the same would go against the scheme of the Act, and the answer to the question posed, arising consequentially, could only be in the negative. The case law in the matter is legion, and the decisions referred to in the foregoing analysis would also support the same, apart from being subject to the specific provision of sec. 29 of the Act, which specifically mandates that the income assessable u/s. 28 is to computed by allowing deductions as exigible u/ss. 30 to 43D. What is the meaning of and purpose in classifying the income under defined heads of income, it may be asked, if any expenditure could be allowed against any income; the entire income could well be brought to tax under a single head? Any deduction, it may be appreciated, is only toward determining the income assessable under a particular head of income. It is only once the assessability of a particular income under a particular head of income is determined, that the further question of the permissible deduction/s there-against, in computing the quantum thereof, would arise. The relevant and the proper question to be asked, therefore, in determining the issue at large, is not whether the term `book profit’ would include only income assessable u/c. IV-D or could possibly include other income/s as well, but whether the impugned interest income is assessable u/c. IV-D, i.e., as business income, or as income from other sources, and the question posed, or the contention raised per the relevant grounds, is misconceived, and amounts to putting the cart before the horse.  The deduction qua the partner’s remuneration is being claimed and, therefore, would stand to be allowed only in determining the income assessable u/c. IV-D, in which case it would automatically fall to be included in the `book profit’, and the assessee allowed its claim for remuneration allowed to the working partner/s with reference thereto – at the claimed/exigible amount, else not. The condition with reference to `book profit’, it may be appreciated, does not lay down any qualitative test, but only a quantitative one, so that the deduction, being in respect of expenditure to persons constituting the firm itself, is sought to be regulated by the Act. The question as to whether `book profit’ would include income assessable under head of income other than that assessable Chapter IV-D, thus, does not arise for consideration, and the assessee’s alternate ground ( 4) is misconceived and misdirected. Ground No. 5 raises another alternate contention, i.e., of the impugned expenditure on remuneration to working partners, being not hit by s. 58, as allowable u/s. 57(iii), so that it would be stand to be allowed as a deduction even if the interest income is assessable u/s. IV-F, i.e., as `income from other sources’. The said ground was not argued before us nor raised before and, consequently, adjudicated by, the authorities below, so that consideration of the same raises the issue of its maintainability. We have in any case, already answered the relevant question, i.e., that the impugned interest income is assessable u/c. IV-D, so that the issue stands decided in favour of the stand taken by the assessee. We decide accordingly, dismissing the assessee’s alternate claim/s.

6. In the result, the assessee’s appeal is allowed.