2008 (11) TMI 42 - HC - Income Tax

Whether the interest earned on fixed deposits would enter the ring of profits u/s 80 HHC - held that interest earned does not have any immediate nexus with the export business and hence will have to be treated as income from other sources held that assessee cannot be allowed to adjust interest paid to the bank on overdraft facility against the interest received on fixed deposits as this was not laid out wholly and exclusively for the purpose of earning interest on fixed deposits.

Issues Involved:
1. Whether the interest earned on fixed deposits by the respondent/assessee qualifies for deduction under Section 80 HHC of the Income Tax Act, 1961.
2. Whether the respondent/assessee is entitled to the benefit of 'netting' the interest received on fixed deposits against the interest paid on overdraft facilities.

Detailed Analysis:

1. Interest Earned on Fixed Deposits and Section 80 HHC:
The primary issue was whether the interest earned on fixed deposits by the respondent/assessee could be considered as profits derived from export business under Section 80 HHC of the Income Tax Act, 1961. The respondent/assessee, a 100% exporter of readymade garments, had surplus funds which were placed in fixed deposits, earning interest of Rs 23,14,800/-. The fixed deposits were used to secure a bank guarantee required for obtaining export quotas. The Assessing Officer (AO) determined that the interest earned from these fixed deposits should be categorized as 'income from other sources' as it did not have a direct nexus with the export business. This view was upheld by the Commissioner of Income-tax (Appeals) [CIT(A)], who stated that the interest income did not qualify as income derived from export activities under Section 80 HHC.

The Tribunal, however, allowed the appeal of the respondent/assessee, stating that the fixed deposits were made out of business exigencies and that the interest earned was inextricably linked to the business. The Tribunal relied on the decision of the Special Bench of ITAT in Lal Sons Enterprises, 89 ITD 25 (Del) (SB).

The High Court, referencing the case of CIT v. Sri Ram Honda Power Equip (2007) 289 ITR 475, held that interest earned on fixed deposits, even if required to avail credit facilities for export business, does not have an immediate nexus with the export business and must be treated as 'income from other sources'. Thus, the interest earned on fixed deposits does not qualify for deduction under Section 80 HHC.

2. Netting of Interest Received and Paid:
The supplementary issue was whether the respondent/assessee could offset the interest received on fixed deposits against the interest paid on overdraft facilities. The respondent/assessee had credited Rs 6,15,383/- to its profit and loss account after netting the interest received from the bank against the interest paid on overdraft facilities. The AO and CIT(A) both disallowed this netting, stating that the interest paid on overdraft facilities could not be deducted from the interest income, as the overdraft interest was incurred for the business and not for earning the interest on fixed deposits.

The Tribunal allowed the netting based on the decision in Lal Sons Enterprises, which was interpreted to mean that the net interest should be considered for deduction purposes. However, the High Court clarified that the netting principle applies only if the expenditure by way of interest was laid out 'wholly and exclusively' for earning the interest on fixed deposits. Since the interest paid on overdrafts was not incurred to earn the interest on fixed deposits, the netting was not permissible.

The High Court concluded that the Tribunal had misconstrued the ratio of the decision in Lal Sons Enterprises and that the interest paid on overdrafts could not be offset against the interest earned on fixed deposits. Consequently, the High Court set aside the Tribunal's judgment and upheld the decision of the CIT(A).

Conclusion:
The High Court ruled that the interest earned on fixed deposits must be treated as 'income from other sources' and does not qualify for deduction under Section 80 HHC. Additionally, the respondent/assessee is not entitled to net the interest paid on overdraft facilities against the interest received on fixed deposits, as the expenditure was not incurred 'wholly and exclusively' for earning the interest on fixed deposits.

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