1996 (7) TMI 59 - HC - Income Tax

Summary

Issues Involved:
1. Assessability of interest income in the hands of the appellant.
2. Classification of interest income as income from "Other sources" or as part of capitalized interest.
3. Applicability of section 57(iii) of the Income-tax Act, 1961.

Summary:

1. Assessability of Interest Income:
The primary issue was whether the interest income earned by the appellant is assessable to tax. The appellant borrowed Rs. 3 crores from the Industrial Development Bank of India and deposited it in various banks, earning an interest income of Rs. 5,05,711. The Income-tax Officer (ITO) treated this interest income as taxable under the head "Other sources."

2. Classification of Interest Income:
The ITO rejected the appellant's contention that the interest income should reduce the overall cost of the project. The ITO referred to the Supreme Court decision in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167, which held that interest paid before the commencement of production on amounts borrowed for acquiring or installing plant and machinery forms part of the "actual cost." However, the ITO concluded that the interest received could not be set off against the interest payable to the Industrial Development Bank of India and should be considered as income from "Other sources."

3. Applicability of Section 57(iii):
The first appellate authority upheld the ITO's decision, emphasizing that the interest costs incurred on loans taken should form part of the capital costs till the production period was reached. The Income-tax Appellate Tribunal (ITAT) reversed this decision, finding a nexus between the borrowed amounts and the investments made, and ruled that the interest income could not be considered as income from "Other sources." The ITAT held that the appellant was entitled to a deduction u/s 57(iii) of the Income-tax Act, 1961.

Judgment:
The High Court, after considering the Supreme Court's decision in Challapalli Sugars Ltd. v. CIT, concluded that the interest income earned during the construction period should be capitalized and not treated as income from "Other sources." The Court emphasized the importance of the nexus between the borrowed funds and the interest earned, aligning with the principles of accounting and the Companies Act, 1956. The Court answered the question in the affirmative, against the Revenue and in favor of the assessee, thereby resolving the so-called judicial cleavage on this issue.