1995 (9) TMI 25 - HC - Income Tax

Summary

Issues Involved:
1. Taxability of interest received before the commencement of business.
2. Deductibility of interest paid on borrowed funds against interest received on paid-up capital.

Issue-wise Detailed Analysis:

1. Taxability of Interest Received Before the Commencement of Business:
The primary issue was whether the interest received by the assessee amounting to Rs. 25,532 before the commencement of its business is liable for tax. The assessee, a private limited company incorporated for manufacturing pyrotechnic aluminium powder, argued that this interest should be treated as a reduction in project cost, not as income, citing an extract from a publication by the Institute of Chartered Accountants of India and the Supreme Court decision in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167. The Income-tax Officer, however, contended that the interest received is taxable as income from other sources under section 57 of the Income-tax Act, 1961, and brought the entire amount to tax. The Tribunal initially sided with the assessee, stating that the interest received during the pre-commencement period could be considered as an abatement of the capital cost of the project.

2. Deductibility of Interest Paid on Borrowed Funds Against Interest Received on Paid-Up Capital:
The Department argued that the interest accrued on the deposit of borrowed amounts and the interest accrued on the deposit of share capital are distinct and cannot be adjusted against each other. They relied on several decisions, including CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542 (Mad), which held that interest earned on investment of share capital could be assessed separately under the head "Other sources". The Department maintained that the interest received from the deposit of share capital is income and, therefore, chargeable to tax.

The assessee countered that the interest paid on borrowings and the interest earned on temporary deposits with the bank were intermediate and formed part of a composite transaction. They argued that the deposits were not investments but were put to intermediate use pending construction activities, and thus, the interest received should offset the interest paid, in line with the Supreme Court's decision in Challapalli Sugars Ltd. [1975] 98 ITR 167.

Judgment Analysis:
The court examined various precedents, including CIT v. Seshasayee Paper and Boards Ltd. [1985] 156 ITR 542, where it was held that interest earned on investment of share capital in call deposits could be assessed separately under "Other sources". Similar views were upheld in CIT v. Derco Cooling Coils Ltd. [1992] 198 ITR 375 (AP), Andhra Pradesh Carbides Ltd. v. CIT [1992] 198 ITR 386 (AP), and Godavari Fertilizers and Chemicals Ltd. v. CIT [1992] 198 ITR 388 (AP). These cases emphasized that interest earned on share capital deposits during the construction period is taxable as income from other sources.

The court also noted the Bombay High Court's decision in CIT v. Maharashtra Electrosmelt Ltd. [1995] 214 ITR 489, which supported the assessee's view by treating the interest received on temporary utilization of loans as part of a composite transaction. However, the court found that this decision did not align with the prevailing view that interest earned on share capital deposits should be treated as income.

Ultimately, the court concluded that the Tribunal was incorrect in holding that the interest receipt of Rs. 25,532 did not have the character of income liable to tax. The court held that the interest received before the commencement of business is indeed taxable as income from other sources.

Conclusion:
The court answered the referred question in the negative, in favor of the Department, stating that the interest income of Rs. 25,532 received on the deposit of paid-up capital is chargeable to tax. The court also allowed the assessee to agitate the ground of deductibility of interest payment of Rs. 2,666 before the Tribunal, directing the Tribunal to consider the same on merits. No costs were awarded, and counsel's fee was set at Rs. 1,000.