2004 (4) TMI 278 - AT - Income Tax

Export-Oriented Undertaking - FDRs were made out of Packing Credit Limit - Entitlement to exemption u/s 10B for interest income on fixed deposits - Classification of interest income as Income from Other Sources or Business Income - Allowability of set-off of interest paid on loans against interest income on FDRs - HELD THAT - We are of the view that the expression any profits and gains would not include the income assessable under the head Income from Other Sources . There is another reason for rejecting the contention of the Ld. Counsel of the assessee. The expression any profits and gains is qualified by the words derived by an assessee from a 100% Export Oriented Undertaking . The words derived from have not been defined for the purpose of section 10B like section 80HHC and therefore its meaning has to be considered in the restricted sense as interpreted by the Hon'ble Supreme Court in various judgments including Cambay Electric Supply Industrial Co. Ltd. v. CIT 1978 (4) TMI 1 - SUPREME COURT . Therefore, only those profits and gains are to be exempted under section 10B which have direct and proximate relationship with the activities referable to Export Oriented Unit. Therefore, it cannot be said that income assessable under the head 'Income from Other Sources' can be exempted u/s 10B. Thus, the contention of the Ld. Counsel for the assessee is hereby rejected. Considering the fact that these FDRs were made out of Packing Credit Limit and the fact that the loans were taken against the security of these FDRs in order to maintain the liquidity, we are of the view that such interest income was attributable to the business activity of the assessee and, therefore, assessable as business income. Though the facts of the case indicate that such income was assessable as business income but it cannot be said that such income directly arose from the main activity of export business. Hence such income cannot be said to be derived from 100 per cent Export Undertaking. The explanation of the assessee shows that FDRs were made from Packing Credit Account. If this fact is correct, then interest paid on such borrowings would have direct nexus with interest earned on FDRs. However, it is to be kept in mind that so many times interest free funds are put by the assessee in such overdraft account in addition to the profits of the business. The Tribunal has been holding consistently that where interest free advances are made out of overdraft account then interest paid to bank is disallowed under section 36(i)(ii) only where there is direct nexus between the interest bearing borrowed funds and interest free advances and not otherwise. On the same reasonings, set off of interest paid would be allowed if there is a direct nexus between interest bearing borrowed funds and the FDRs made by the assessee. Therefore, if it is proved on record that interest free funds are deposited in the overdraft account and out of that any FDR is made then no set off is allowable. On the contrary if it is proved that interest bearing funds were utilized for making fixed deposits then interest paid to bank would have to be allowed as set off against interest on FDRs. In the present case, no such exercise is made by any authority. Therefore, in our opinion, interest of justice would be met if the matter is restored to the file of the Assessing Officer for limited purpose of verifying the above fact. Accordingly, the order of the CIT(A) is set aside and the matter is restored to the file of the Assessing Officer for fresh adjudication in the light of guidance provided by us. In the result, the appeal of the assessee is allowed for statistical purposes.

Summary

Issues Involved:
1. Entitlement to exemption u/s 10B for interest income on fixed deposits.
2. Classification of interest income as "Income from Other Sources" or "Business Income".
3. Allowability of set-off of interest paid on loans against interest income on FDRs.

Summary:

Entitlement to Exemption u/s 10B:
The primary issue was whether the assessee was entitled to exemption u/s 10B for interest income of Rs. 18,77,170 on fixed deposits. The Tribunal held that the expression "any profits and gains" in section 10B does not include income assessable under the head "Income from Other Sources". The interest income must have a direct and proximate relationship with the activities of the Export Oriented Unit to qualify for exemption. Consequently, the Tribunal rejected the contention that interest income, even if assessable under "Income from Other Sources", would be exempt u/s 10B.

Classification of Interest Income:
The assessee argued that the interest income should be classified as "Business Income" since the FDRs were made out of borrowed funds (Packing Credit Limit) and not surplus funds. The Tribunal agreed with the assessee, noting that there was no evidence to suggest the FDRs were made from surplus funds. The interest income was thus attributable to the business activity and assessable as business income.

Set-off of Interest Paid:
The assessee contended that if the interest income is assessed as business income, the interest paid on loans against the FDRs should be set off against such income. The Tribunal acknowledged the principle that only net income should be excluded if interest is paid for earning such income. However, it referred to the Supreme Court judgment in the case of Gopinathan, which held that interest paid on loans against FDRs could not be set off against interest income on FDRs due to the lack of direct nexus. The Tribunal directed the Assessing Officer to verify if the FDRs were made from interest-bearing borrowed funds and allow set-off accordingly.

Conclusion:
The appeal was allowed for statistical purposes, and the matter was remanded to the Assessing Officer for fresh adjudication based on the Tribunal's guidance.