1987 (11) TMI 72 - HC - Income Tax

Summary

Issues Involved:
1. Taxation of interest income during the construction period.
2. Set-off of interest income against interest expenditure.
3. Classification of interest income as "income from other sources" or business income.
4. Capitalization of net interest expenditure.

Issue-wise Detailed Analysis:

1. Taxation of Interest Income During the Construction Period:
The primary issue was whether the interest income earned by the assessee during the construction period should be taxed as revenue or set off against interest expenditure. The assessee had borrowed funds for setting up a plant, and the surplus funds were temporarily deposited, earning interest. The Tribunal held that the interest earned should not be considered as income from other sources but should be set off against the interest payments made, and only the net interest should be capitalized.

2. Set-off of Interest Income Against Interest Expenditure:
The Tribunal's approach was based on the factual nexus between the borrowed funds and the deposited funds. The Tribunal relied on the Institute of Chartered Accountants of India's study on expenditure during the construction period, which suggested setting off miscellaneous income against related expenditure. The High Court agreed with this approach, emphasizing that the realistic assessment of the situation required treating the interest receipts and payments as a single account.

3. Classification of Interest Income as "Income from Other Sources" or Business Income:
The Revenue contended that the interest received should be classified as "income from other sources" under section 56 of the Income-tax Act, 1961. However, the High Court, following the Tribunal's reasoning, held that the interest income earned during the construction period should be set off against the interest expenditure since the funds were temporarily deposited until needed for construction.

4. Capitalization of Net Interest Expenditure:
The High Court affirmed that the net interest expenditure (interest paid minus interest earned) should be capitalized. This approach was consistent with the principle that the interest earned on temporary deposits of borrowed funds should reduce the interest cost to be capitalized. This principle was also applied in similar cases, such as R.C. No. 134 of 1982 (CIT v. Andhra Farm Chemicals Corporation) and decisions from other High Courts.

Separate Judgments:

R.C. No. 8 of 1985:
The Tribunal found that the interest income earned from short-term deposits should be set off against the interest paid on loans. The High Court agreed, stating that the interest income could not be treated as "income from other sources" and should be set off against the interest paid.

R.C. No. 12 of 1985:
The High Court held that the interest received on short-term deposits should not be assessed under "other sources" but should be set off against the interest paid, similar to the reasoning in R.C. No. 315 of 1982.

R.C. No. 79 of 1985:
The High Court reframed the question to focus on whether the bank interest received during the construction stage should reduce the actual cost of capital assets. It held that the interest earned should be set off against the interest paid and the balance capitalized, without expressing an opinion on whether the interest received was a capital receipt.

Conclusion:
The High Court consistently held that interest income earned during the construction period should be set off against interest expenditure and the net interest should be capitalized. This approach aligns with the realistic assessment of the situation and the principles suggested by the Institute of Chartered Accountants of India. The interest income was not to be treated as "income from other sources" but as part of a single account with the interest expenditure.