2016 (12) TMI 1188 - AT - Income Tax

Interest earned on deposits - income from other sources OR business income - Held that - Undisputedly the assessee has received the grants-in-aid from the Govt. of India and the State Govt. and the assessee has placed the unutilized funds in the Escrow a/c. Since the amounts have been kept in the Escrow a/c, the funds cannot be used for any other purpose and the funds did not belong to the assessee as well. The interest income is not the income of the assessee but only goes to the increase the grantsin- aid and one of the conditions of grants-in-aid is that the unutilized amounts have to be returned to the Govt. along with the interest. Therefore, the interest income derived by the assessee is also the income of the Govt. and not of the assessee and hence it ought to have been allowed to be set off against the pre-operative expenses. The interest earned on funds primarily brought for infusion in the business could not have been classified as income from other sources. Since the income was earned in a period prior to commencement of business it was in the nature of capital receipt and hence was required to be set off against pre-operative expenses. See Indian Oil Panipat Power Consortium Ltd.case 2009 (2) TMI 32 - DELHI HIGH COURT

Summary

Issues:
1. Classification of interest earned on deposits as "income from other sources" or "business income" for A.Y 2010-11.

Analysis:
The case involved the appeal of the assessee against the order of the CIT (A) confirming the AO's treatment of interest earned on deposits as "income from other sources" instead of "business income." The assessee, a company set up for textile fabric manufacturing, received grants from the government for a textile park project. The AO observed the company's utilization of funds, including interest income on fixed deposits, and considered pre-operative expenses. The assessee argued that interest income reduced pre-operative expenses due to funds parked in fixed deposits before project commencement. The AO, however, deemed the interest income unrelated to business and taxed it as income from other sources. The CIT (A) upheld this decision, leading to the appeal before ITAT.

The ITAT considered the nexus between funds, business activities, and interest income. The assessee contended that unutilized funds were placed in an Escrow account, not for personal use, and interest income belonged to the government as per grant conditions. Citing relevant case laws, the ITAT analyzed the nature of income in connection to business activities. Referring to the Delhi High Court cases, the ITAT highlighted the distinction between surplus funds and funds linked to business setup. It emphasized that interest earned on funds integral to business setup should be capitalized against pre-operative expenses. Following the court's reasoning, the ITAT allowed the assessee's appeal, recognizing the interest income as capital receipt linked to business activities.

In conclusion, the ITAT's judgment favored the assessee, allowing the appeal and classifying the interest income as connected to business setup, thus permitting its set off against pre-operative expenses. The decision underscored the importance of the nexus between funds, business activities, and income classification, aligning with established legal principles and precedents.