Elgen (India) Pvt. Ltd. Vs. ITO (ITAT Hyderabad)
In case the share capital is brought for specific purpose for the implementation of the particular project, and interest is earned by temporarily depositing in the bank, such income can be treated as capital receipt. In the given case, assessee has brought the share capital only for the implementation/ commencement of the power project. Since, it could not proceed with the implementation, under constraint, it kept the unutilized funds in the bank; in that process it has earned interest; By following the ratios of Hon’ble Supreme Court, the funds kept in bank under constraint and the funds are inextricably linked to the project, such income can be treated as capital receipt. At the same time, the findings of Delhi High court in the similar circumstances as in the case under consideration are fully applicable to the case in hand. Therefore, in our considered view, the assessee is eligible to treat the interest as capital receipt. Whether the assessee can utilize this receipt to set off the other pre- implementation expenses, in our view, we have already treated the interest receipts as capital in nature and the pre- commencement expenses are also capital expenditure, the assessee can set off such expenses.
Full Text of the ITAT Order is as follows:-
Both these appeals filed by the assessee are directed against a common order of the learned Commissioner of Income-tax(A)- 5, Hyderabad, dated 29-07-2016 for AYs 2012-13 & 2013-14. As the issue is identical in both the appeals, the same were clubbed and heard together and, therefore, a common order is passed for the sake of convenience.
2. Briefly the facts of the case, as taken from AY 2012-13, are that the assessee, is a company, yet to start commercial operations, filed its return of income for the AY 2012-13 on 28/09/2012 admitting therein loss of Rs. 3,71,359/-. The said return was selected for scrutiny under ‘CASS’ category, therefore, a notice u/s 143(2) was issued on 07/08/2013. In response to the said notice, the AR of the assessee appeared and furnished the information called for. After considering the information furnished, the AO determined the income of the assessee as under:
2.1 The assessee company M/s Elgen (India) Ltd., was established for the purpose of power generation. It has taken up a 700MW (350 x 2) gas based power project in Karimnagar. It received huge amount of share capital nearly 50 crores including share premium. Most of the share capital was contributed by the friends and relatives who are NRIs. Since the assessee could not get approvals from various govt. departments during the year under consideration, the funds received in the form of share capital and share premium was kept in fixed deposits in the bank. During the year under consideration, the assessee earned an amount of Rs. 2,16,68,124/- as interest on deposits and the said interest had been set off against the capital expenditure of Rs. 2,17,39,457/- and the balance amount of Rs. 71 ,333/- was shown as expenditure to be set off in future and accordingly, this amount was shown on the assets side of Balance Sheet.
2.2 The AO noted that during the previous year relevant to AY 2010-11 also the assessee company earned an amount of Rs. 17,43,212/- as interest on FDRs and the said interest was offered to tax even though it had incurred capital expenditure of Rs. 51,76,387/- (1,02,06,485 – 50,30,098) during the said FY. The AO opined that when the interest income earned out of the fixed deposits was offered by the assessee itself for first year and immediately following year, it has changed the treatment of interest receipt and reduced the capital expenditure. Hence, the AO asked the assessee to explain the same. The Assessee submitted that during the year under consideration, it obtained legal opinion about the taxability of the interest and according to the legal opinion, it need not offer the interest as ‘income from other sources’ and the same can be set off against the capital expenditure incurred by the assessee. Therefore, the company had set off the interest earned on fixed deposits against the capital expenditure and did not offer any income out of interest earned.
2.3 After considering the assessee’s submissions and analyzing the issue in the light of various case law including the case of M/s Tutikorin Alkali Chemicals & Fertilizers Ltd. (227 ITR 172), the AO held that the assessee had made deposits only out of the share capital received which otherwise should have been kept idle. Therefore, principles laid down by the Hon’ble Supreme Court in the case of Tutikorin Alkali Chemicals & Fertilizers Ltd. (supra) are clearly applicable to the case of assessee and accordingly, he brought the interest amount of Rs. 2,16,68,124/- to tax under the head ‘income from other sources’.
3. Aggrieved by the order of the AO, the assessee preferred an appeal before the CIT(A) wherein it was contended that the amount received towards the equity share capital and allotment of shares in the company were inextricably linked to the setting up of the project such as acquiring land, development of infrastructure, getting the DPR prepared, the promoters’ financial capacity, financial soundness and readiness to undertake the project, etc. Assessee’s further arguments and case law relied upon were extracted by the CIT(A) in his order at pages 4 to 19.
5. The CIT(A), after considering the submissions of the assessee, examined the issue elaborately in light of various case law including the case law relied upon by the assessee, observed that in the instant case there could be no doubt that the expenditure incurred by the assessee can by no stretch be said to have been incurred with the object or for the purpose or earning the interest income. Further, he observed that it could not be said that the expenditure incurred was to preserve the asset or could it be said that the expenses were incurred for the purpose of maintenance of the source. He also observed that the interest income was derived from the fixed deposits and accounts etc., the assessee could not be said to have carried on any business to bring the interest income within the meaning of section 28 of the Act and, therefore, the interest income was liable to be assessed only under the ‘income from other sources’. In view of the above observations, the CIT(A) held that the AO was right in holding that the expenses claimed were not related to the interest income and was not a deductible expenditure.
6. Aggrieved by the order of the CIT(A), the assessee is in appeal before us raising the following grounds of appeal, which are common in both the appeals except the amount of addition:
“1. The order of the Learned Commissioner of Income tax (Appeals) is against law, weight of evidence and probabilities of the case.
2. The learned Commissioner of Income tax (Appeals) erred in confirming the order of the Assessing Officer and holding that the interest amount of Rs.2, 16,68, 124/- is asses sable as income from other sources.
3. The learned Commissioner of Income Tax (Appeals), had erred in holding that the assessee company was not entitled to set off of interest on bank deposits of Rs. 2,16,68,124/ – earned during the pre- operative period against the expenditure incurred during the said period.
4. The learned Commissioner of Income Tax (Appeals) erred in merely relying on the assessment order of learned AO, which order failed to consider the detailed submissions made in this behalf by the appellant.
7. Ld. AR of the assessee filed written submissions before us wherein he relied on various case law to submit that if the amounts were meant for the purpose of setting up of the plant and interest earned on account of temporary deployment of these funds but due to land disputes or government decisions not to allot gas, coal, water linkages, which led to temporary deployment of these funds in fixed deposits and earned interest, which has to be treated as capital receipts, these should not be brought to tax net.
7.1 He submitted that if more than one view is possible on the same set of facts, the ld. CIT(A) ought to have adopted the view which is most favorable to the assessee. For this proposition he relied on the decision of Hon’ble Supreme Court in the case of CIT Vs. Vegetable Products,  88 ITR 192 (SC). Further, he submitted that seen from any angle, it would be more logical, legal, rational and equitable that interest derived during the project implementation stage be allowed to be set off from the cost of project rather than taxing an otherwise capital receipt. He also submitted that the method followed by the assessee is revenue neutral. Therefore, there will be no loss of revenue as ultimately the cost of assets, after the set off of interest income against capitalized cost of various indirect expenses will be lower, thus, leading to a lower claim of depreciation by the company over the life of assets.
8. Ld. DR, on the other hand relied on the orders of revenue authorities and also relied on the decision of the Hon’ble Supreme Court in the case of Bongaigaon Refinery & Petrochemical Ltd.,  251 ITR 329 (SC) wherein the Apex Court held that “income derived from house property, guest house, charges for equipment and recoveries from the contractors on account of water and electricity supply during the formation period of the business is not chargeable to tax but had to be adjusted against the project cost; interest income is however taxable.”
9. Considered the rival submissions and perused the material facts on record. The assessee has brought share capital for the sole purpose of establishing power generation unit, mainly, a gas based project of 700MW. This share capital along with share premium, was contributed by the friends and relatives, who are NRI’s, of the director. The assessee has commenced the initial activities for securing the various permissions/approvals for the project from the state/ central government agencies, land acquisition and project feasibility etc. Due to change in the government policies and unforeseen development, it makes the project difficult to implement. In the given case, it was discovered that shortfall in allocable supply of natural gas in Krishna Basin would not meet the demand of power units in the state of AP/ Telengana. Accordingly, Power Ministry has issued an advisory to Power developing units not to plan projects until 2015-16 vide circular dated 14/03/2012. The above development brought the project implementation process to halt. The assessee still expects to get favorable sanction from the Power Ministry for Gas linkages considering the fact that there is still huge demand for power. In order to achieve the above object of establishing gas based power plant, assessee has retained the share capital and also this capital could not be returned to the shareholders as the same was already allotted. Such share capital was deposited in the banks and earned interest income. Can the interest be chargeable to tax under the head ‘income from other sources’. We have analyzed the above query in the light of various judicial pronouncements of Hon’ble Supreme Court, High Courts and coordinate benches. The major decisions of Hon’ble Supreme Court in this subject are as under:
1. Tuticorin Alkali Chemicals and Fertilizers Ltd., Vs CIT,  227 ITR 172 (SC): If funds have been borrowed for setting up of a plant and the funds are ‘surplus’, then by virtue of that circumstances they are invested in fixed deposits, the income earned in the form of interest will be taxable under head ‘income from other sources’.
2. CIT Vs. Bokaro Steel Ltd.  236 ITR 315 (SC): If income is earned, whether by way of interest or in any other manner on funds, which are otherwise ‘inextricably linked’ to the setting up of the plant, such income is required to be capitalized to be set off against preoperative expenses.
9.1 From the above ratios, it is clear that if the surplus funds are invested in fixed deposits, the interest income earned is chargeable to tax. Whereas in the Bokaro Steel case, funds which are otherwise inextricably linked to the setting up of the plant, such income required to be capitalized. Later in the case of Bongaigoan Refinery,  251 ITR 329 (SC), the Hon’ble Supreme Court has reiterated the findings of Bokaro Steel, for the other income and, with regard to interest income, it reiterated the ratio of Tuticorin Alkali case. Hon’ble Supreme Court has laid down the principle that the surplus funds invested and income generated are taxable under the head ‘income from other sources’ and at the same time, if it is inextricably linked to project, it can only be capitalized. Subsequently, the Hon’ble Delhi High Court in the case of Indian Oil Panipat Power Consortium Ltd. Vs. ITO, 181 Taxman 249 (Del.) has held as under:
“The funds in the form of share capital were infused for a specific purpose of acquiring land and the 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’. Since the income was earned in a period prior to commencement of business, it was in the nature of capital receipt and hence, was required to be set off against preoperative expenses.”
In the case of Pr. CIT Vs. Facor Power Ltd., 66 Taxmann.com 178 (Delhi),
“there is a finding of fact that the money placed in the fixed deposits was inextricably linked with the setting up of the power plant. Thus, the revenue generated on account of interest on Fixed Deposit would be in the nature of a capital receipt and not revenue. This case has been decided on the basis of this principle and not on the basis that the source of the funds was through raising of share capital and not through borrowings.”
9.2 In the above two decisions, it is clear that in case the share capital is brought for specific purpose for the implementation of the particular project, and interest is earned by temporarily depositing in the bank, such income can be treated as capital receipt. In the given case, assessee has brought the share capital only for the implementation/ commencement of the power project. Since, it could not proceed with the implementation, under constraint, it kept the unutilized funds in the bank; in that process it has earned interest; By following the ratios of Hon’ble Supreme Court, the funds kept in bank under constraint and the funds are inextricably linked to the project, such income can be treated as capital receipt. At the same time, the findings of Delhi High court in the similar circumstances as in the case under consideration are fully applicable to the case in hand. Therefore, in our considered view, the assessee is eligible to treat the interest as capital receipt. Whether the assessee can utilize this receipt to set off the other pre- implementation expenses, in our view, we have already treated the interest receipts as capital in nature and the pre- commencement expenses are also capital expenditure, the assessee can set off such expenses.
9.5 Ld. DR has submitted jurisdictional High Court decision in the case of Derco Cooling Coils Ltd.,  198 ITR 375 (AP) wherein the Court has laid down the following ratio:
“The receipt in question arose out of share capital money deposited with the bank which might or might not be utilized or meant to be utilized for the purpose of setting up of the plant. This again emphasized that the interest received might not stand on the same footing as the interest incurred during pre- production period, so that one could be set off against the other.”
In the above case, the issue was, can the assessee set off the interest income earned by depositing the share capital money against the interest expenses incurred during pre- production period. This ratio cannot be applied to the case of the assessee under consideration.
9.6 Considering the above discussion, in our considered view, the interest income earned by assessee by depositing the share capital in Fixed Deposits under constraint are eligible to treat the income as capital in nature and allowed to set off against the pre- commencement expenses during the year. Accordingly, grounds raised by the assessee are allowed.
10. As the issue in AY 2013-14 is identical to that AY 2012-13, following the conclusions drawn therein, we allow the appeal in AY 2013-14 also.
11. In the result, both the appeals under consideration are allowed.
Pronounced in the open court on 29th November, 2017.