2015 (2) TMI 581 - AT - Income Tax

Disallowance of interest expenditure on borrowings - deduction under section 57(iii) against the interest income on fixed deposits with banks - Held 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 by in the case of Raj Kumari Agarwal vs. DCIT 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. 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. 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. - Decided in fvaour of assessee for statistical purposes. Interest income on security deposit - 'income from other sources' OR 'capital receipts' - Held that - CIT (A) relied on various decisions of the higher judiciary and one of them is 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. - Decided against revenue.

Summary

Issues:
1. Allowability of netting of interest expenses 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 or capital receipt.

Issue 1: Allowability of netting of interest expenses against interest income under section 57(iii) of the Income Tax Act:

The case involved appeals against the order of the CIT (A) for the assessment year 2009-2010, concerning the disallowance of interest expenditure on borrowings claimed as deduction against interest income on fixed deposits. The appellant argued for netting off interest expenses against interest income, claiming a nexus between the two. The CIT (A) denied this benefit due to the appellant's failure to establish the correctness of the interest rate used for quantifying interest costs. The Tribunal, after considering submissions, found a direct nexus between 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 interest rate issue to the AO for proper assessment, emphasizing the need for the appellant to demonstrate the exact interest expenses related to the interest income. The Tribunal held in favor of the appellant, allowing the appeal for statistical purposes.

Issue 2: Treatment of interest income on security deposit as income from other sources or capital receipt:

The second appeal involved the treatment of interest income on a security deposit as either income from other sources or a capital receipt. The AO treated the interest income as taxable under 'income from other sources,' considering it earned before the commencement of business activity. The CIT (A) disagreed, capitalizing the interest income based on established legal principles. The Tribunal noted the CIT (A)'s detailed discussion on the issue, relying on judicial precedents, including the Supreme Court's decision in Tuticorin Alkali Chemicals and Fertilizers Ltd vs. CIT. The Tribunal upheld the CIT (A)'s decision, dismissing the Revenue's appeal. The Tribunal found the decision fair and reasonable, aligning with settled legal positions, and concluded by dismissing the Revenue's appeal.

In conclusion, the Tribunal addressed the issues of interest expenses netting against interest income and the treatment of interest income on security deposits, providing detailed analyses and legal reasoning for each issue, resulting in decisions favoring the appellants in both cases.