2022 (2) TMI 184 - HC - Income Tax

Correct head of income - interest income earned out of deposits made from the business funds including borrowed funds in the course of running the business of the appellant - income from other sources or income from business - Whether Appellate Tribunal is right in holding that that interest on borrowed capital cannot be set off against the interest earned on Fixed deposits ? - alternative submission that proportionate interest paid on the borrowed capital should be u/s 57(iii) accepted - HELD THAT - The substantial questions of law 1 and 2 are squarely covered in favour of the assessee and against the Revenue in JVS EXPORTS VERSUS ASST. COMMISSIONER OF INCOME-TAX, CIRCLE-I, MADURAI. 2019 (8) TMI 361 - MADRAS HIGH COURT wherein held that Fixed Deposits have been created by the bank themselves by carving out a portion of the export sale proceeds on realisation and retaining them as Fixed Deposits in the name of the assessee to be retained by the bank as additional security for the loan availed by the assessee for their export business. As mentioned earlier, the conversion of a portion of the sale proceeds as Fixed Deposits was done by the bank themselves and not on the volition of the assessee.Therefore, we are fully convinced that the transaction was connected and closely linked with the assessee's business activity. - Decided in favour of assessee.

Summary

Issues:
1. Assessment of interest income from fixed deposits under the Income Tax Act, 1961.
2. Allowability of interest paid on borrowed capital against interest received for deduction under section 80HHC.
3. Classification of interest income on fixed deposits as income from other sources instead of business income.
4. Applicability of proportionate interest paid on borrowed capital under Section 57(iii) of the Act.
5. Necessity for remitting the matter back for assessing interest income as business income or income from other sources.
6. Consideration of the principle of mutuality in transactions with the same banker.

Analysis:
The appellant, a firm engaged in the business of manufacturing and exporting hosiery garments, challenged an order by the Income Tax Appellate Tribunal regarding the assessment year 2003-04. The appellant filed a return of income admitting a total income and claimed deduction under section 80HHC based on interest income from fixed deposits. The Assessing Officer reduced the deduction, stating that interest income assessed under 'other sources' cannot be set off against interest paid on borrowed capital. The Commissioner of Income-tax (Appeals) upheld this decision, leading to an appeal before the Tribunal. The Tribunal dismissed the appeal based on a previous court judgment without considering factual findings.

The appellant raised substantial questions of law related to the assessment of interest income, classification as income from other sources, and the set-off of interest on borrowed capital against interest earned. The Court, considering a previous decision in a similar case, ruled in favor of the appellant on the first two questions. The decision highlighted that the fixed deposits were created by the bank using a portion of export sale proceeds for additional security, showing a clear link to the business activity. Therefore, the interest income was connected to the business and not solely from other sources. The Court disposed of the appeal, answering the first two questions in favor of the appellant and leaving the other questions open for future cases.

This judgment clarifies the treatment of interest income from fixed deposits in relation to business activities, emphasizing the importance of the specific circumstances and business connections in determining the appropriate classification for tax purposes. The ruling provides guidance on the set-off of interest paid on borrowed capital against interest earned and underscores the need for a thorough assessment based on the facts of each case.