[1996] 220 ITR 476 (MAD.)

HIGH COURT OF MADRAS

Commissioner of Income-tax

v.

Arasan Aluminium Industries Pvt. Ltd.

THANIKKACHALAM AND JAYARAMA CHOUTA, JJ.

TAX CASE NO. 454 OF 1983

SEPTEMBER 12, 1995

 

JUDGMENT

Thanikkachalam, J.At the instance of the Department, the Tribunal referred the following question of law arising out of the order of the Special Bench of the Tribunal in I.T.A. No. 1515/(Mds) of 1979, dated January 16, 1982, for the assessment year 1978-79 for the opinion of this court under section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as "the Act") :

"Whether the Appellate Tribunal was right in facts and circumstances of the case, in holding that the interest received of Rs. 25,532 before the commencement of its business does not have the character of income liable for tax?"

The assessee is a private limited company incorporated on May 28, 1977, with the object of doing business in manufacture and sale of pyrotechnic aluminium powder. Its paid-up capital was Rs. 6.05 lakhs. The accounts were closed for the first time on October 31, 1978. It is common ground that during the entire year, the company was engaged in the process of erection of its plant and machinery and construction of the factory. The assessee received an amount of Rs. 25,532 as interest from the State Bank of India and two sister concerns. It also incurred an interest obligation of Rs. 2,666 on its loan to the extent of rupees one lakh from the State Bank of India. It is not in dispute that the interest receipt was from advances made out of paid-up capital amounts. The assessee filed a 'nil' return and contended that the interest receipt had been credited to the pre-operative expenses account and that it should be treated as reduction in the project cost, not income in the ordinary sense of the word. An extract from the publication issued by the Research Committee of the Institute of Chartered Accountants of India was furnished in support of its stand. The Income-tax Officer, however, took the view that the entire amount is taxable and that there is no deduction possible either in respect of interest paid or other expenses. Accordingly, the Income-tax Officer brought the entire amount of Rs. 25,532 to tax. This was confirmed in appeal. The assessee preferred a second appeal before the Appellate Tribunal. Since there were conflicting views on this aspect, the income-tax cases were brought before the Special Bench for disposal. Before the Tribunal, counsel for the assessee submitted that the assessee has not yet commenced its business and is engaged in the process of construction of the factory and erection of plant and machinery. The assessee sought to derive support from an extract from a publication of the Research Committee of the Institute of Chartered Accountants of India along with the further opinion of the Expert Advisory Committee of the same Institute. Learned counsel also placed reliance upon the earlier decisions of the Tribunal on this point. Heavy reliance was placed upon the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167. On the other hand, the learned Departmental Representative, while placing reliance upon the earlier decisions of the Tribunal on this point, contended that the interest from deposit was income and, therefore, assessable under section 57 of the Act. In view of the decision in Addl. CIT v. Madras Fertilisers Ltd. [1980] 122 ITR 139 (Mad), no deduction was possible from the income received from the deposit. The learned Departmental Representative also pointed out that the amount by way of deposit was from funds received as paid-up capital and not borrowings, and, therefore, it was submitted that the assessee is not entitled to the deduction as asked for. The Tribunal, relying upon the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 and the statement of an auditing publication issued by the Institute of Chartered Accountants of India, held that, if interest payment during the pre-commencement period could be cost, which could be capitalised, the interest received could well be abatement of such capital cost of the project by the same test. On the factual finding that the funds were put to intermediate use pending final utilisation in construction of the factory and the erection of the plant, it was held that the assessee's appeal had to be allowed. According to the Tribunal, the interest received in the abovesaid circumstances did not have the character of income. Such receipts merely went to reduce the cost as it happens in items like sale of gunny bags and other containers, discount received on purchase, etc., where such receipts merely go to reduce the cost of goods and do not constitute income independently by themselves.

Learned standing counsel appearing for the Department, submitted that the interest accrued on the deposit of borrowed amount before the commencement of commercial production and the interest accrued on the deposit of share capital are two different concepts. The two kinds of interest are from two different sources. Therefore, one cannot be adjustable with the other. According to learned standing counsel, the interest received on the deposit of share capital would not go to reduce the cost as stated by the Tribunal. Inasmuch as the income derived from the deposit of share capital is income of the assessee, it is assessable under the head "Other sources". In order to support the above contentions, learned standing counsel relied upon the decisions in CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542 (Mad) ; CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375 (AP) ; Andhra Pradesh Carbides Ltd. v. CIT [1992] 198 ITR 386 (AP) ; Godavari Fertilizers and Chemicals Ltd. v. CIT [1992] 198 ITR 388 (AP) and CIT v. Modi Rubber Ltd. [1994] 208 ITR 379 (Delhi). According to learned standing counsel, the decision of the Supreme Court in Challapalli Sugars Ltd.'s case [1975] 98 ITR 167 would not authorise the assessee to adjust the interest payable by the assessee on its borrowed funds with the interest received on the deposit of paid-up capital. For these reasons, it was submitted that the Tribunal was not correct in holding that the interest income of Rs. 25,532 received on the deposit of paid-up capital is not income chargeable to tax.

On the other hand, learned counsel appearing for the assessee submitted that the interest paid on larger borrowings by the assessee and the interest earned on temporary deposits with the bank during the assessment year under consideration were intermediate and had nexus, forming part of one composite transaction. The Department cannot dissect the interest paid on the borrowed capital and the interest received from the deposit made out of paid-up capital. According to learned counsel, the deposits were not in the nature of investments and were put to intermediate use pending utilisation of its funds for construction activities. It was submitted that the assessee contemplated the necessity for further funds and had even gone to the extent of borrowing from the bank. On these facts, as per the accountancy principle and the decision of the Supreme Court (Challapalli Sugars Ltd.'s case [1975] 98 ITR 167), the interest income received by the assessee is not exigible to tax. According to learned counsel, where an assessee pays interest on funds during construction, such interest income goes to increase the project cost. If the assessee also earns interest, it can only go to set off that interest cost of the project. In other words, if the interest paid exceeds the interest received, it is only the net interest that is reckoned as capital cost. Learned counsel further submitted that the interest receipt which goes to partially offset the interest payment cannot be considered as income. It can only be an abatement of cost. Hence, according to learned counsel, the allowance of the assessee's claim in this case could be no more than mere application of the accepted accountancy principle approved in the decision of Challapalli Sugars Ltd.'s case [1975] 98 ITR 167 (SC). Accordingly, learned counsel for the assessee submitted that there is no infirmity in the order passed by the Tribunal in holding that the interest income is not chargeable to tax.

The fact remains that the assessee is a private limited company incorporated on May 28, 1977, with the object of doing business in manufacture and sale of pyrotechnic aluminium powder. Its paid-up capital was Rs. 6.05 lakhs. The accounts were closed for the first time as on October 31, 1978. During the entire year, the company was engaged in the process of erection of its plant and machinery and construction of the factory. The assessee received an amount of Rs. 25,532 as interest from the State Bank of India and two sister concerns. The assessee also paid an interest of Rs. 2,666 on its loan to the extent of rupees one lakh from the State Bank of India. The interest received was from the advances made out of paid up capital amounts. According to the assessee, in view of an extract from the publication issued by the Research Committee of the Institute of Chartered Accountants of India and on the basis of the decision of the Supreme Court rendered in Challapalli Sugars Ltd.'s case [1975] 98 ITR 167, the interest paid by the assessee on the borrowed capital is adjustable towards the interest received on the deposit of paid-up capital and the net income alone is chargeable. According to the Department, income earned by the assessee on the deposit of paid-up capital and the income payable by the assessee on the amounts borrowed are two different matters. The interest accrued and the interest payable arose on two different sources. Therefore, they cannot be considered together for the purpose of adjustment. Hence, the interest received on the deposit of paid-up capital is in the nature of income chargeable to tax as income from other sources under section 57 of the Income-tax Act.

Deductions claimed in respect of investment of paid-up capital and moneys borrowed in call deposits pending utilisation for construction of factory came up for consideration before this court in CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542. According to the facts arising in that case, the assessee-company invested its paid-up share capital and loans obtained from the ICICI and Export and Import Bank, Washington, in banks on call deposits and received interest during the previous year relevant for the assessment year 1962-63, and adjusted the interest payable on its loans against the interest received. The assessee did not offer the interest received by it for assessment on the ground that substantial amounts had been borrowed during the accounting period for construction purposes and the funds, which were not immediately required during the period of construction were invested in call deposits and it would not be possible or correct to split the interest into two items, viz., interest earned on investment of share capital and investment of borrowed funds and so long as the interest paid during the construction stage exceeded the interest received during the year, there was no interest on investment liable to be assessed.

On these facts, while answering the question (page 543) :

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law in holding that the interest earned by the assessee on investment of share capital in call deposits could not be assessed separately under the head 'Other sources' for the assessment year 1962-63?"

This court held as under (headnote):

". . . . that as the assessee had not established its factory during the assessment year in question, there was no question of computing its business income during the year and hence there was no question of application of sections 70 and 71 of the Income-tax Act, 1961, during the assessment year in question and only in the computation of business income, expenditure or set-off of the loss from the income from business would arise. The Tribunal was not, therefore, justified in holding that the interest receipts could not be assessed and the difference between the interest paid and the interest received should be capitalised. The interest earned by the assessee on investment of share capital in call deposits could be assessed separately under the head 'Other sources'."

It is no doubt true that the decision of the Supreme Court in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 and the view of the Expert Committee of the Institute of Chartered Accountants of India were not placed before this court while rendering the abovesaid judgment. A similar question came up for consideration before the Andhra Pradesh High Court in CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375. According to the facts arising in that case for the assessment year 1977-78, the accounting year ended on September 30, 1976. The assessee-company had not yet gone into production by then. For the purpose of construction and setting up of an industry, the respondent-company borrowed funds and had paid interest thereon to the tune of Rs. 2,40,554. The assessee had also earned interest on the share capital monies received from the public, which was kept in fixed deposit with the banks. At this stage, no details are forthcoming from the record as to the periods of deposit and the purpose for which the share money was meant to be utilised or actually utilised. The assessee, in its return, originally accepted the interest receipt of Rs. 18,913 as its income. Later on, the assessee claimed that the said amount shall not be treated as income as it is liable to be deducted from the interest paid on term loans and the net interest arrived at, i.e., Rs. 2,21,641 is to be capitalised. In other words, the contention of the assessee was that the interest received from the pre-production or construction period shall be reflected in the capital cost of the project and it should go to reducing the capital cost. On these facts, while answering the question, "Whether, on the facts and in the circumstances of the case, the sum of Rs. 18,913 being interest received by the assessee-company from bank deposits could not be brought to tax for the assessment year 1977-78, and whether the ITAT was justified in annulling the assessment, the Andhra Pradesh High Court held as under (headnote):

". . . . that the amount of expenditure out of which the interest received was sought to be deducted related to term loans used for construction and setting up of the plant. The receipt in question arose out of share capital deposited with the bank which might or might not be utilised for the purpose of setting up of the plant. Section 57(iii) was also not applicable because the provision envisages that deduction of expenditure (not being capital expenditure) could be claimed only if it is expended wholly and exclusively for the purpose of making or earning the income from other sources. The amount of Rs. 18,913 was assessable as income from other sources."

In the abovesaid decision, while considering an earlier decision of that court, in the case of CIT v. Nagarjuna Steels Ltd. [1988] 171 ITR 663, it was pointed out that "the decision of this court in Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663 had gone a step further. In that case, the question was whether the bank interest received during the stage of construction of the factory on account of depositing a part of the borrowed money in the bank should be treated as 'income from other sources', or whether it should go towards reducing the actual capital cost of the assets. This court put its seal of approval on the accountancy principle stated in paragraphs B.1 and B.2 of the booklet Study on Expenditure during Construction Period".

In CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375 (AP), while considering the decision in the case of Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663 (AP), the Andhra Pradesh High Court further observed that (page 382) : "The question is whether the same principle can be extended to a case like the present one where the interest is earned on an amount unrelated to the amount for which interest was paid. In other words, the question is whether the amount received by way of interest on share capital amount could be set-off against the interest payment made by the assessee during the same accounting year in respect of a different source of money, viz., borrowed loan amount. As already noticed, the view of the Tribunal as well as the contention of the assessee is that the source of money which has given rise to interest liability and interest receipt is really irrelevant. However, we do not find any warrant in law in extending the principle of the decision of this court in Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663 to a case of interest earned from a different source, viz., share money. Neither the accountancy principle laid down by the Institute of Chartered Accountants of India nor the reasoning contained in the decision of the Supreme Court in Challapalli Sugars Ltd. [1975] 98 ITR 167 and of this court in Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663 would merit the acceptance of the assessee's contention in this behalf."

Thus, considering the various decisions of this aspect, the Andhra Pradesh High Court in CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375 (AP) at page 385, held as under:

"Viewed from any angle, we do not think that there is any justification to treat the amount of interest received on share capital as something other than income. To treat the receipt in question as income will not in any way do violence to the normal or ordinary meaning of the term 'income'. We are, therefore, of the view that the amount of Rs. 18,913 has been rightly treated by the Income-tax Officer as income from other sources under section 56 of the Act and the Tribunal erred in law in annulling the assessment. We are fortified in the view which we have taken by the decision of the Madras High Court in CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542 and of this court in R.C. No. 229 of 1982 (Andhra Pradesh Carbides Ltd. v. CIT [1992] 198 ITR 386), though there is a certain amount of overlapping in the discussion in regard to the allowability of deduction under section 57(iii) and the treatment of the receipt for the purpose of capitalisation. Reference may also be made to the judgment of the Patna High Court in Bokaro Steel Ltd. v. CIT (No. 2) [1988] 170 ITR 545, and the judgment of the Kerala High Court in Traco Cable Co. v. CIT [1969] 72 ITR 503, wherein the interest income received on share capital money during construction period was held to be exigible to tax though the issue was considered from a different standpoint."

It is also significant to note that in CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375, the Andhra Pradesh High Court while taking note of the decision of the Special Bench in Arasan Aluminium Industries' case which is now under reference before us, observed that (at page 378) : "However, it is to be noted that the decision of the Special Bench in Arasan Aluminium Industries' case [1982] 1 ITD 10 (Mad) must be deemed to have been disapproved by the Madras High Court (vide CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542), in which the reference was answered in favour of the Revenue".

Again the Andhra Pradesh High Court had an occasion to consider the question of similar nature in the case of Andhra Pradesh Carbides Ltd. v. CIT [1992] 198 ITR 386, wherein the Andhra Pradesh High Court, while answering the question "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the interest paid in respect of borrowing from the Andhra Pradesh Industrial Development Corporation Ltd. by the assessee could not be allowed to be set-off against the interest income earned by the assessee of Rs. 12,497 in the assessment year 1978-79?" held as under (page 387):

"We are inclined to agree with the view taken by the Tribunal. We are unable to see any connection between the two amounts. The amount upon which interest was paid to Andhra Pradesh Industrial Development Corporation Limited was raised by way of loan for setting up the plant and the interest income was earned on the contributions made by the shareholders towards the shares allotted to them. Both are distinct items and it is not possible to see any reasonable connection between them. Neither by section 57(iii) of the Income-tax Act, 1961, nor by applying the test of a prudent person managing his affairs, can it be said that the interest earned on the contributions made by the shareholders can be set-off against the interest payable by the assessee."

Again in the decision reported in Godavari Fertilizers and Chemicals Ltd. v. CIT [1992] 198 ITR 388, the Andhra Pradesh High Court while answering the question : "Whether, on the facts and in the circumstances of the case, the ITAT was correct in law in holding that the interest of Rs. 4,36,103 earned by the assessee-company on investment of its funds could not be deducted from the capital cost for the assessment year 1983-84" held as under (page 389):

"As explained by us in our judgment in R.C. No. 108 of 1983, the principle of the said decision cannot be extended to the situation obtaining in the present case. Hence, following our judgment in R.C. No. 108 of 1983 (CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375), we uphold the decision of the Tribunal and answer the question in the affirmative, i.e., in favour of the Revenue and against the assessee. The reference is accordingly disposed of. No order as to costs."

However, learned counsel appearing for the assessee in order to support his contention, placed reliance on the decision of the Bombay High Court reported in CIT v. Maharashtra Electrosmelt Ltd. [1995] 214 ITR 489. According to the facts arising in that case, the assessee was a limited company incorporated for doing business as a manufacturer of ferro-manganese. During the accounting year relevant to the assessment year 1977-78, the assessee was engaged in the erection of a smelter for the purpose of manufacturing ferro-manganese. The commercial production had not started. The total expenses incurred during the year amounted to Rs. 83,32,473. The assessee had realised a sum of Rs. 3,14,356 as interest on short-term deposits of the funds not immediately required by the assessee. At the same time, the assessee had paid a sum of Rs. 58,51,505 as interest on funds borrowed by it for the purpose of its business. During the year, the assessee had received a sum of Rs. 2,742 from the sale of empty gunny bags. Out of the total expenses of Rs. 83,32,473 incurred during the year, the assessee treated a sum of Rs. 1,04,190 as an item which could not be capitalised. Out of the balance amount of Rs. 82,28,283, the assessee deducted the two items of income, viz., interest and miscellaneous income, amounting in all to Rs. 3,17,108 and capitalised the balance of Rs. 79,11,175. Hence, the assessee adjusted the income earned by it during the period of construction against its other expenses and took the net amount as the expenses of construction. On these facts, while answering the question: "Whether, on the facts and in the circumstances of the case, the interest income of Rs. 3,14,366 and miscellaneous income of Rs. 2,742 are not taxable under section 56 of the Income-tax Act, 1961, under the head 'Income from other sources' for the assessment year 1977-78 ?" the Bombay High Court held that the whole arrangement of obtaining the finance and its temporary utilisation formed one composite transaction and, as such, the interest received by the assessee on account of temporary utilisation of the loans could not be considered in isolation. The assessee did not derive any income by temporary utilisation of the loans and since no income was derived by the assessee, the question of assessment of that sum of Rs. 3,14,366 in the hands of the assessee as "income from other sources" did not arise. While rendering this judgment, the Bombay High Court placed reliance of the judgment of the Supreme Court in the case of Challapalli Sugars Ltd. [1975] 98 ITR 167 and the decision of the Andhra Pradesh High Court in Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663. At the same time, the Bombay High Court distinguished the judgment of the Andhra Pradesh High Court rendered in the case of Derco Cooling Coils Ltd. [1992] 198 ITR 375.

According to the facts arising in Nagarjuna Steels Ltd.'s case [1988] 171 ITR 663 (AP), the assessee had borrowed certain amounts for setting up the plant and a part of the funds, which was not immediately required was kept in deposit upon which some interest was earned. On the amounts borrowed by it, it was paying interest at a much larger figure. Therefore, the assessee sought to deduct the interest earned by it from out of the interest paid by it and capitalised the balance interest paid. Therefore, the interest income was earned from the same source, viz., interest on borrowed capital. Hence, the Andhra Pradesh High Court held that the interest received on such short-term deposits is not assessable as a revenue receipt.

In the case of Derco Cooling Coils Ltd. [1992] 198 ITR 375, the Andhra Pradesh High Court took a different view since the amount received by way of interest was received on share capital amount, which could not be set-off against the interest payment made by the assessee during the same accounting year in respect of a different source of money, viz., borrowed loan amount. In that case, the interest was earned on an amount unrelated to the amount for which the interest was paid by the assessee. On the same line, the Madras High Court in CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542 held : "that the interest earned by the assessee on investment of share capital in call deposits could be assessed separately under the head 'Other sources'. The Bombay High Court in the decision reported in CIT v. Maharashtra Electrosmelt Ltd. [1995] 214 ITR 489, relied upon the decision of the Andhra Pradesh High Court rendered in CIT v. Nagarjuna Steels Ltd. [1988] 171 ITR 663 in order to come to its conclusion that the whole arrangement of obtaining the finance and its temporary utilisation formed one composite transaction and, as such, the interest received by the assessee on account of temporary utilisation of the loans could not be considered in isolation, even though there was no support for this proposition found in the decision of the Andhra Pradesh High Court rendered in the case of Nagarjuna Steels Ltd. [1988] 171 ITR 663.

The Delhi High Court had an occasion to consider a question of similar nature in the decision reported in CIT v. Modi Rubber Ltd. [1994] 208 ITR 379. According to the facts arising in that case, the assessee company, which was still in the process of setting up its factory and had not commenced business, had invested the money received from its shareholders towards share capital in fixed deposits in banks. One of the subsidiary objects of the company as per clause B.19 of its memorandum of association, empowered the company to invest any moneys not immediately required for the purpose of its business in such manner as it thought fit. The question was whether the interest income earned by the assessee was liable to tax. On these facts, the Delhi High Court held that the activity of depositing the surplus funds out of the share capital could not be said to be incidental to the construction of the factory. Interest income from bank deposits accrued or arose out of an independent source during the period when the business had neither been set up nor commenced and the interest income was, therefore, assessable to tax under the head "Income from other sources".

In view of the foregoing discussion, by following the decisions of this court in CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542 ; the Andhra Pradesh High Court in CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375 ; Andhra Pradesh Carbides Ltd. v. CIT [1992] 198 ITR 386 (AP) ; Godavari Fertilizers and Chemicals Ltd. v. CIT [1992] 198 ITR 388 (AP) and CIT v. Modi Rubber Ltd. [1994] 208 ITR 379 (Delhi), we hold that the Tribunal in the instant case was not correct in coming to the conclusion that the interest receipt of Rs. 25,532 before the commencement of its business does not have the character of income, liable to tax.

Learned counsel appearing for the assessee submitted that the interest payment of Rs. 2,666 to the State Bank of India and other expenses should be allowed as a deduction. According to learned counsel though this ground was raised before the Assessing Officer as well as before the first appellate authority, this was not considered by the Tribunal at the time of hearing the appeal. While passing the consequential order in terms of the judgment rendered by us hereinabove, it is open to the assessee to agitate this ground before the Tribunal, and if such request is made, the Tribunal is directed to consider the same on the merits. Accordingly, we answer the question referred to this court in the negative and in favour of the Department. No costs. Counsel's fee Rs. 1,000 (rupees one thousand).