2014 (8) TMI 1101 - AT - Income Tax

Disallowance of interest expenditure on borrowings claimed as deduction u/s 57(iii) against the interest income on fixed deposits with banks - Held that - We find that there is a direct nexus of funds of the borrowed capital with the Fixed Deposits in question partly. The interest paid on a loan taken to avoid premature encashment of the Fixed Deposit is deductible against the interest earned on the Fixed Deposit as held in the case of Raj Kumari Agarwal vs. DCIT vide 2014 (7) TMI 867 - ITAT AGRA . Having decided on the issue of nexus of funds and the allowability of the interest expenses against the interest income, the remaining issue is about the interest rate of 7.81% applied by the AO in determining the interest expenses. In our opinion, this requires revisit of the issue to the file of the AO. Assessee must demonstrate before the AO the exact account of interest expenses relatable to the interest income in question. If necessary, AO shall admit the letters from the bank, if any, in the interest of justice. It is the submission of the Ld Counsel that the purpose of funds does not determine the allowability of the claim made u/s 57(iii) of the Act. The decisions relied upon by the Ld Counsel in this regard should be examined by the AO in the remand proceedings. AO shall grant a reasonable opportunity of being heard to the assessee. Accordingly, grounds raised by the assessee are allowed for statistical purposes. Interest earned on advances paid during pre-commencement period - Held that - In the case of Tuticorin Alkali Chemicals and Fertilizers Ltd vs. CIT 1997 (7) TMI 4 - SUPREME Court which is relevant for the proposition that interest earned on surplus funds would need to be treated income from other sources and accordingly interest earned on advances paid during pre-commencement period found to be linked to setting up of the plant of the assessee would need to be treated as capital receipt . Considering the settled position of the issue at the level of the Apex Court, we are of the opinion that the decision taken by the CIT (A) while allowing the assessee s appeal is fair and reasonable and it does not call for any interference. Accordingly, grounds raised by the Revenue are dismissed.

Summary

Issues involved:
1. Treatment of interest expenditure against interest income under section 57(iii) of the Income Tax Act.
2. Treatment of interest income on security deposit as income from other sources.

Issue 1: Treatment of interest expenditure against interest income under section 57(iii) of the Income Tax Act.
The appeal involved a dispute regarding the allowability of netting of interest expenses against interest income earned by the assessee on fixed deposits made from surplus borrowed funds under section 57(iii) of the Act. The CIT (A) confirmed the disallowance of interest expenditure by the Income Tax Officer, citing lack of proper reasoning for the decision. The CIT (A) held that the interest cost should be considered as pre-operative expenses and not allowed to be set off against interest income. The Tribunal analyzed the facts and decided that there was a direct nexus between the borrowed capital and fixed deposits, allowing the interest paid on loans to be deducted against interest earned on fixed deposits. The Tribunal directed a revisit of the issue to determine the exact interest expenses related to the interest income, requiring the assessee to provide necessary documentation for reconsideration by the Assessing Officer. The Tribunal allowed the appeal for statistical purposes, emphasizing the importance of demonstrating the nexus between funds and investments for tax treatment under section 57(iii) of the Act.

Issue 2: Treatment of interest income on security deposit as income from other sources.
The appeal by the Revenue concerned the treatment of interest income on a security deposit with a company for availing electricity facility as "income from other sources." The assessee had capitalized the interest income, considering it as capital in nature based on legal principles. The AO made an addition under "income from other sources" as the business activity had not commenced. The CIT (A) allowed the appeal, treating the interest income as a capital receipt based on various legal precedents, including a Supreme Court judgment. The Tribunal upheld the decision of the CIT (A), emphasizing that the interest income should be treated as a capital receipt and capitalized, in line with established legal principles. The Tribunal dismissed the Revenue's appeal, affirming the CIT (A)'s decision and the treatment of interest income on the security deposit as capital in nature.