2014 (12) TMI 1378 - AT - Income Tax

Correct head of income - Interest earned on bank deposits - Business income or income from other sources - HELD THAT - It is not in dispute that assessee corporation is a government company promoted by H.P. State Electricity Board Ltd. The assessee has admittedly not started commercial operation in the year under consideration and was still in the pre-operative stage. The assessee's counsel has referred to the accounts of the assessee to show that assessee received lesser interest of ₹ 625.97 lacs and paid interest on loan in the year under consideration would show that assessee has to pay more interest as against the small interest received by assessee. Therefore, if any adjustment is made against interest paid, still there is a liability of the assessee to pay interest on the loans. The assessee also explained that for effective funds management, the temporary surplus funds were kept in short term bank deposits and thereafter, interest was earned and so was also used for construction of the project and for paying interest to the power finance company which have not been adversely commented upon by the authorities below. Therefore, the reliance of the Assessing Officer on the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. Vs. CIT 1997 (7) TMI 4 - SUPREME COURT was totally misplaced. It is clear that the funds with the assessee, even if temporarily used for savings/short term deposits, but the earning of the interest were directly connected with work of construction of the project employed by the assessee - earning of interest could not be treated as income from other sources, since the income was earned in the period prior to commencement of the business and it was the nature of capital receipt and was required to be set off against pre-operative expenses. We, therefore, set aside the orders of authorities below and delete the addition. Appeal of the assessee is allowed.

Issues Involved:
1. Justification of addition of Rs. 83,06,897/- assessed under the head "income from other sources."
2. Taxation of interest during the pre-operation stage of the assessee's business.

Detailed Analysis:

1. Justification of Addition of Rs. 83,06,897/- Assessed Under the Head "Income from Other Sources":
The primary issue revolves around whether the interest earned on bank deposits by the assessee, a government company still in the pre-operative stage, should be taxed as income from other sources. The Assessing Officer (A.O.) held that the interest earned on bank deposits amounting to Rs. 1,19,32,956/- was taxable as it was earned on surplus funds. The A.O. relied on the Supreme Court judgment in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. Vs. CIT (1997) 227 ITR 172, which established that interest income earned on surplus funds before the commencement of business is taxable as income from other sources.

The assessee argued that the funds were kept in short-term deposits to meet urgent requirements and to reduce the project cost by setting off the interest received against the interest payable on loans. The CIT(Appeals) partly accepted the assessee's argument and deleted Rs. 36,26,063/- of the addition, acknowledging that this portion of interest was incidental to the acquisition of assets for setting up the plant and machinery. However, the CIT(A) upheld the remaining addition of Rs. 83,06,897/-.

2. Taxation of Interest During the Pre-operation Stage:
The assessee contended that all expenses, including interest on loans during the construction stage, are eligible for capitalization and should reduce the capital base for depreciation purposes. The assessee placed reliance on the judgments in the cases of Indian Oil Panipat Power Consortium Ltd. Vs ITO (2009) 315 ITR 255 (Delhi) and Bokaro Steel Ltd., arguing that the interest earned should be treated as a capital receipt and set off against pre-operative expenses.

The CIT(A) did not fully accept this argument, distinguishing the facts from those in the Bokaro Steel Ltd. case. The CIT(A) noted that the interest income in Bokaro Steel Ltd. was directly connected with the construction activities, whereas in the present case, the interest was earned on surplus funds not immediately required for the project. The CIT(A) relied on the Tuticorin Alkali Chemicals judgment, emphasizing that income tax is attracted when income is earned, and the interest income, being of revenue nature, is taxable under section 56 of the Income Tax Act.

Tribunal's Findings:
The Tribunal found merit in the assessee's arguments and noted that the funds were not surplus but temporarily employed for short-term deposits to efficiently manage project costs. The Tribunal observed that the assessee received lesser interest than the interest paid on loans, indicating no intention to earn interest. The Tribunal also noted that the interest earned was used for project construction and paying loan interest, aligning with the principles in the Bokaro Steel Ltd. and Indian Oil Panipat Power Consortium Ltd. cases.

The Tribunal concluded that the interest earned during the pre-operative stage should be treated as a capital receipt and set off against pre-operative expenses, not as income from other sources. Thus, the addition of Rs. 83,06,897/- was deleted, and the appeal of the assessee was allowed.

Conclusion:
The Tribunal's judgment emphasized that the interest earned on funds temporarily placed in short-term deposits, which were directly connected to the construction of the project, should be treated as a capital receipt and set off against pre-operative expenses. The reliance on the Tuticorin Alkali Chemicals case by the A.O. was found to be misplaced, and the addition of Rs. 83,06,897/- was deleted, favoring the assessee. The appeal was allowed, and the order was pronounced in the Open Court on 31st December 2014.

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