ITAT HYDERABAD BENCH ‘B’
Kakinada SEZ (P.) Ltd.
Assistant Commissioner of Income-tax, Circle 2 (2), Hyderabad
IT Appeal No. 213 (Hyd.) of 2012
[ASSESSMENT YEAR 2008-09]
Date of Pronouncement– 18.01.2013
Smt. Asha Vijayaraghavan, Judicial Member
This appeal preferred by the assessee is directed against the order of CIT(A)-III, Hyderabad dated 25/11/2011 for the assessment year 2008-09.
2. The assessee is a company and it was implementing a multi product special economic zone. For the year under consideration, it had filed its return of income on 27/09/2008, showing income at NIL. After processing of the said return u/s 143(1) of the Act, the same was selected for scrutiny for scrutiny assessment. During the course of assessment proceedings, the Assessing Officer noticed that during the previous year the assessee had obtained large amount of secured loan of Rs. 375 crores, out of which it had invested an amount of Rs. 95.48 crores in fixed deposits in banks, from which it had earned interest of Rs. 6,09,35,544/- during the FY 2007-08. Since the assessee had not commenced business operation, the AO was of the view that the said amount of interest earned on that FDS in banks, is taxable in the hands of the assessee as income under the head ‘income from other sources’ for the AY 2008-09. As the assessee had not offered the said interest amount for taxation during the course of assessment proceedings, the AO vide his letter dated 18/10/2010, had asked the assessee to explain as to why the said interest earned on fixed deposits in banks should not be taxed, treating as income from other sources. In reply, the assessee submitted that it had obtained secured loan of Rs. 375.04 crores from banks for a multi product special economic zone project. The said loan could not be deployed immediately and was kept in fixed deposits with the banks, so as to earn interest which in effect reduced the actual interest outgo. He further submitted that during the year the company earned interest income of Rs. 6,09,35,544/- on such fixed deposits and it paid interest of Rs. 37,24,56,856/- on the said secured loan. It was further stated that the said amount of interest earned was netted off and the netted amount was shown as preoperative expenses pending allocation. It was further submitted that since borrowed funds were for the purpose of multi product special economic zone project, the interest expenses and income earned on the said fixed deposits were netted off and the net sum was treated as preoperative expenditure. It was further stated that the same is in accordance with the scheme of the Act. In this regard, referring to the decision in CIT v. Bokaro Steel Ltd.  236 ITR 315 and in Indian Oil Panipat Power Consortium Ltd. v. ITO  315 ITR 255, the assessee submitted that interest income should not be treated as income from other sources.
3. The assessee further submitted that unutilized borrowed money was used to make deposits for earning interest income and as the rate of interest on such borrowing was higher than the rate of interest earned on said deposits, the income from other sources would be “NIL”. It was further stated that from interest income proportionate interest costs be reduced for arriving the interest income to be taxed under the head ‘income from other sources’. The assessee relied on the decisions in Continental Construction Ltd. v. CIT  195 ITR 81 in H.K. (Investment) Co. (P.) Ltd. v. CIT  211 ITR 511, in India Cement Ltd., v. CIT  60 ITR 52 (SC), in CIT v. Sri Ram Honda Power Equipment  289 ITR 475 and the decision of ITAT, Mumbai, in J.F. Laboratories Ltd. v. ITO  96 ITD 448.
4. However AO did not accept the contentions of the Assessee and taxed the interest income of Rs.6,09,35,544/- as income from other sources. On appeal the CIT(A) confirmed the action of the AO following the decision of the ITAT in Assessee’s own case for the immediately preceding AY 2007-08 in ITA No 1218/H/2010 dated 29.12.2010.
5. Aggrieved the Assessee is in appeal before us.
6. We have heard the arguments of both the parties and perused the record as well as gone through the orders of the authorities below. The Assessee mainly relied on the two decisions of the Delhi High Court in the cases of Indian Oil Panipet Power Consortium Ltd. (supra) and NTPC SAIL Co. (P.) Ltd. v. CIT [IT Appeal No. 1238 of 2011, dated 17-7-2012]. In both the cases the Delhi high Court had held that as the funds infused by way of borrowing were inextricably linked with the setting up of the project following the decisions of the Apex Court in the cases of Bokaro Steel Ltd. (supra), CIT v. Karnataka Power Corpn.  247 I.T.R. 268 and Bongaigaon Refinery and Petro Chemical Co. Ltd. v. CIT  251 I.T.R. 329. The Delhi High Court distinguished the decision of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT  227 ITR 172.
7. In the cases of Indian Oil Panipet Power Consortium Ltd. (supra) the Delhi High Court observed:
“the funds in the form of share capital were infused for the 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 be 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 a capital receipt and was required to be set off against pre- operative expenses.”
8. The test, therefore, is whether the activity which is taken up for setting up of the business and the funds which are garnered are inextricably connected to the setting up of the plant. The clue is perhaps available in section 3 of the Act which states that for newly set up business the previous year shall be the period beginning with the date of setting up of the business. Therefore, as per the provision of section 4 of the Act which is the charging section income which arises to an assessee from the date of setting of the business but prior to commencement is chargeable to tax depending on whether it is of a revenue nature or capital receipt. The income of a newly set up business, post the date of its setting up can be taxed if it is of a revenue nature under any of the heads provided under section 14 in Chapter IV of the Act. For an income to be classified as income under the head “Profits and gains of business or profession” it would have to be an activity which is in some manner or form connected with business. The word ” business” is of wide import which would also include all such activities which coalesce into setting up of the business. Cf Mazagaon Dock Ltd. v. CIT/Excess Profits Tax  34 ITR 368 (SC) and Narain Swadeshi Weaving Mills v. Commissioner of Excess Profits Tax  26 ITR 765 (SC). Once it is held that the assessee’s income is an income connected with business, that the monies which were inducted into the company were primarily infused to purchase land and to develop infrastructure then it cannot be held that the income derived by parking the funds temporarily will result in the character of the funds being changed, inasmuch as, the interest earned from the bank would have a hue different than that of business and be brought to tax under the head ” Income from other sources” . It is well settled that an income received by the assessee can be taxed under the head ” Income from other sources” only if it does not fall under any other head of income as provided in section 14 of the Act. The head ” Income from other sources” is a residuary head of income. See S. G. Mercantile Corpn. (P.) Ltd. v. CIT  83 ITR 700 (SC) and CIT v. Govinda Choudhury & Sons  203 ITR 88.
9. Thus the Delhi High Court held that the funds in the form of loans 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 pre- operative expenses. The Delhi High Court found that in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) it was found by the authorities that the funds available with the assessee in that case were ” surplus” and, therefore, the Supreme Court held that the interest earned on surplus funds would have to be treated as ” income from other sources” . On the other hand in Bokaro Steel Ltd. (supra) where the assessee had earned interest on advance paid to contractors during pre- commencement period was found to be “inextricably linked” to the setting up of the plant of the assessee and hence was held to be a capital receipt which was permitted to be set off against pre- operative expenses.
10. The Court was of the view that situation in the case before them is quite similar to the circumstances considered by the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT  98 ITR 167, except here instead of paying interest on funds brought in for specific purpose interest is earned on funds brought in by way of loans share capital for a specific purpose. Could it be said that in the former situation interest could have been capitalized and in the latter situation it cannot be capitalized. To test the principle we could extend the example, that is, would our answer be any different had assessee passed on the interest to the respective shareholders. If not, then, in the court’s view, the only conclusion possible is that interest earned in the present circumstances ought to be capitalized.
11. The Court upheld the claim of the Assessee that interest earned on deposits made out of funds obtained for specific purpose is not taxable holding as under:
“In view of the discussion above, in our opinion, the Tribunal misdirected itself in applying the decision of the Supreme Court in Tuticorin Alkali Chemicals  227 ITR 172 in the facts of the present case. In our opinion, on account of the finding of fact returned by the Commissioner of Income-tax (Appeals) that the funds infused in the assessee by the joint venture partner were inextricably linked with the setting up of the plant, the interest earned by the assessee could not be treated as income from other sources. In the result we answer the question as framed in favour of the assessee and against the Revenue. These appeals are allowed and the impugned judgment is set aside.”
12. The next case relied on by the Assessee was the decision of the Delhi High Court in the case of NTPC SAIL Co. (P.) Ltd. (supra). In that case also the Court held that the interest receipts from FDs placed with borrowed funds, which were temporarily deposited, is inextricably linked to setting up of the project and hence will go to reduce the cost of the project. It held as under:
“9. This Court, in Indian Oil Panipat Power Consortium Ltd. v. ITO  315 ITR 255 (Del.) = (2009-TIOL-108-HC-DEL-IT) held that where interest on money received as share capital is temporarily placed in fixed deposit awaiting acquisition of land, a claim that such interest is a capital receipt entitled to be set off against pre- operative expenses, is admissible, as the funds received by the assessee company by the joint venture partners are “inextricably linked” with the setting up of the plant and such interest earned cannot be treated as income from other sources. The reasoning in Indian Oil is in line with Bokaro Steel Ltd. Similarly, the Supreme Court in CIT v. Karnataka Power Corporation,247 I.T.R. 268 (SC) and Bongaigaon v. Refinery and Petro Chemical Co. Ltd. v. Commissioner Income Tax251 I.T.R. 329 (SC) held that such receipts are not income.”
10. It is no doubt correct that the proviso to section 36(1)(iii) of the Income Tax Act enacts that any amount of the interest paid towards (“in respect of”) capital borrowed for acquisition of an asset or for extension of existing business regardless of its capitalization in the books or otherwise, “for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use” would not qualify as deduction. However, in all these cases, when the interest was received by the assessee towards interest paid for fixed deposits when the borrowed funds could not be immediately put to use for the purpose for which they were taken, this Court, and indeed the Supreme Court held that if the receipt is “inextricably linked” to the setting up of the project, it would be capital receipt not liable to tax but ultimately be used to reduce the cost of the project. By the same logic, in this case too, the funds invested by the assessee company and the interest earned were inextricably linked with the setting up of the power plant. It may be added that the Tribunal has not found that the deposits made as margin monies were not limited to the construction activity connected to the expansion of the business by way of setting up of a new power generation plant.
11. As a result of the above discussion, it is held that the Tribunal and the lower authorities fell into error in holding that the interest earned on fixed deposit of amounts borrowed, which is the subject matter of the present appeal, would have to be treated as revenue receipt. The answer is given in favour of the assessee; the appeal is consequently allowed.”
13. The above two decisions of the Delhi High Court was based on the ratio of the decisions of the Apex Court in the cases of Bokaro Steel Ltd. (supra), Karnataka Power Corpn. (supra) and Bongaigaon Refinery and Petro Chemical Co. Ltd. (supra). The Delhi High Court in the two cases distinguished the decision of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd (supra).
14. However, we find that a similar issue in the case of the Assessee came up for consideration before the ITAT for the immediately preceding AY 2007-08. The ITAT in their decision in ITA No1218/H/10 dated 29.12.2010 dismissed the appeal of the Assessee holding as under:
“15. 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), in our opinion, the judgment of the Delhi High Court in the case of Indian Oil Panipat Power Consortium Ltd. (supra) may not be applicable to the facts of this case. Moreover, the contention of the assessee that only the pro- rata interest relatable to borrowed funds alone to be taxed has no merit at all in view of the judgment of the Apex Court in Tuticorin Alakli Chemicals & Fertilizers Ltd. (supra). In view of the above discussion, we do not find any infirmity in the order of the lower authority. Accordingly, the same is confirmed.”
15. In view of the decision of the ITAT in Assessee’s own case for the earlier year, respectfully following the same, we hold that the interest income of Rs. 6,09,35,544/- earned during the year by the assessee, from the Fixed Deposits made out of borrowed funds was rightly taxed by the AO under the head ” Income from Other Sources’. The ITAT in their decision for the earlier year, supra, has found that the interest payable on borrowed funds has no connection with the receipt of interest. Following the decision of the coordinate bench, we hold that the interest payable on the loans out which the Fixed deposits were made is not allowable as deduction u/s 57(iii).
16. In the result the appeal of the Assessee is dismissed.