2016 (12) TMI 1247 - AT - Income Tax

Deduction u/s.57(iii)and set off of interest income earned on ICD s from pre-operative expenditure - Held that - From the facts of the case it is evident that out of the bank loan of ₹ 4500.96 crores the unutilized portion of ₹ 1,555 crores was placed in fixed deposit with the bank by the assessee. Therefore, the source of the FD is directly linked to the bank loan obtained by the assessee wherein there is a cost, being the proportional interest payable to the bank. Section 57(iii) of the Act makes it amply clear that any expenditure incurred for the purpose of earning income which is taxable under the head Income from other source has to be allowed as deduction. In the above case, for the interest income earned by the assessee there is a direct link to the proportional interest paid by the assessee. Therefore, as per section 57(iii) of the Act, the assessee would be entitled to the benefit of deduction with respect to the proportional interest expenditure incurred by the assessee towards earning interest income. Following the decision of the Hon ble jurisdictional High Court in the case of VGR Foundation 2007 (6) TMI 158 - MADRAS HIGH COURT has held that the assessee is entitled to set off the interest income earned on ICDs from the pre-operative expenditure because the share application money received by the assessee company do not fall under the category of borrowed fund and is inextricably linked with the business of the assessee. Interest received from ICDs the source of which are from share application money which is interest free has to be set off against the pre-operative expenses of the assessee because they are inextricably linked to the setting up of the business of the assessee. Disallowance under section 14A - Held that - We find merit in the order of the learned Commissioner of Income Tax (Appeals) on this issue. If investments are made in growth mutual funds yielding only capital gain/loss which is taxable income under the head Capital Gain , then the provisions of section 14A will not be applicable because provisions of Section 14A deals with expenditure incurred in relation to income not includible in total income, needless to mention that expenditure incurred in such situation will go to add to the cost of asset wherein provisions of Section 14A of the Act will not be applicable. Since the learned Commissioner of Income Tax (Appeals) has only remitted back the matter to the file of the learned Assessing Officer for verifying the mode of investment and decide according to the above ratio laid down, we do not find it necessary to interfere with his order on this issue also.

Issues Involved:

1. Deduction under Section 57(iii) of the Income Tax Act.
2. Set off of interest income earned on Inter-Corporate Deposits (ICDs) from pre-operative expenditure.
3. Disallowance under Section 14A of the Income Tax Act.

Detailed Analysis:

Issue 1: Deduction under Section 57(iii) of the Income Tax Act

The primary issue was whether the assessee is entitled to claim deduction under Section 57(iii) towards the proportional interest expenditure against the interest income earned from term deposits during the pre-operative period. The assessee had borrowed a substantial loan from the bank and placed a portion of it in fixed deposits, earning interest. The Revenue contended that this interest income should be taxed under 'Income from other sources' and disallowed the interest expenditure claimed against it.

The Commissioner of Income Tax (Appeals) relied on the jurisdictional High Court's decision in CIT Vs. VGR Foundation (298 ITR 132), which allowed such set-offs under Section 57(iii) if the interest earned during the pre-operative period is linked to the business setup. The Tribunal upheld this view, stating that the proportional interest expenditure incurred for earning the interest income should be allowed as a deduction under Section 57(iii). The Tribunal also referenced the Supreme Court's decision in Bokaro Steels Ltd., which relaxed the earlier decision in Tuticorin Alkalis Chemicals & Fertilizers, indicating that interest income earned during the pre-operative period should reduce the expenditure if linked to the capital structure setup.

Issue 2: Set off of Interest Income Earned on ICDs from Pre-Operative Expenditure

The second issue was whether the assessee could set off interest received from ICDs against pre-operative expenses. The Commissioner of Income Tax (Appeals) held that the interest income earned from ICDs, sourced from interest-free share application money, should be set off against pre-operative expenses. This decision was supported by the jurisdictional High Court's ruling in VGR Foundation, which stated that share application money does not fall under borrowed funds and is linked to the business setup.

The Tribunal agreed with this view, referencing the Supreme Court's decisions in Bokaro Steels Ltd. and Karnataka Power Corporation, which supported the set-off of interest income against pre-operative expenses if the funds were inextricably linked to the business setup.

Issue 3: Disallowance under Section 14A of the Income Tax Act

The final issue was the disallowance of ?1,66,51,972 under Section 14A of the Act. The assessee argued that since they were in the pre-operative stage, all expenses should be capitalized, and no expenditure related to earning exempt income should be disallowed. Furthermore, the assessee claimed that the investment was made in 'growth mutual funds,' which generate taxable capital gains, not exempt income.

The Commissioner of Income Tax (Appeals) remitted the matter back to the Assessing Officer to verify if the investments were indeed in 'growth mutual funds' and, if so, directed the deletion of the disallowance under Section 14A. The Tribunal found merit in this approach, stating that if the investments yield taxable capital gains, Section 14A would not apply as it deals with expenditure related to income not includible in total income.

Conclusion:

The Tribunal upheld the Commissioner of Income Tax (Appeals) decisions on all three issues, dismissing the Revenue's appeal. The Tribunal emphasized that the interest income earned during the pre-operative period should be set off against related expenses if linked to the business setup and that Section 14A disallowance does not apply to investments yielding taxable capital gains.

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