2020 (10) TMI 1091 - AT - Income Tax

Interest earned from the unutilized capital subsidy and equity - Capital or revenue receipt - HELD THAT - CIT(A) has followed the Tribunal s order in assessee s own case for AY 2009-10 AY2010-11 while giving relief to the assessee by treating the interest earned from the unutilized capital subsidy and equity as capital receipt. Since there is no change in fact or law and we note that the interest from the unutilized capital subsidy and equity are inextricably linked with the process of setting up of the project i.e. integrated petrochemicals complex at Pipalkota, District Dibrugarh, Assam and has only commenced/set up/operation in February, 2016 (AY 2016-17), by relying on the ratio of the decision of CIT Vs. Bokaro Steels Ltd. 1998 (12) TMI 4 - SUPREME COURT and Karnataka Power Corporation 2000 (7) TMI 72 - SUPREME COURT we are of the opinion that the Ld. CIT(A) rightly allowed the claim of assessee. Interest earned from the borrowed funds (short term temporary deposits) - claim of capitalizing interest received by assessee from short term deposit (herein after referred as STD ) of unutilized borrowed funds - HELD THAT - Utilization of the funds available with the assessee is strictly governed by the objects set up by the Articles of Association of company. A perusal of the object clause indicates that there is no scope for the assessee to utilize any funds available for any purpose other than that stated in the Articles of Association - interest earned on the deposits had to be mandatorily invested in the project/business of the assessee and in the facts as discussed we note that interest from borrowed funds temporarily deposited in banks STD is inextricably linked to the setting up of the plant. Hence, the interest from the borrowed funds has been rightly capitalized and set off against the pre-operative expenses and, therefore, we rely on the decision of the Hon ble Supreme Court in Bokaro Steels Ltd. and Karnataka Power Corporation (supra), hold that the interest earned from the borrowed funds/STD which is inextricably linked to the setting up of the plant need to be treated as a capital receipt.

Summary

Issues Involved:
1. Whether the interest earned from borrowed funds (short-term temporary deposits) can be capitalized.
2. Whether the interest earned from capital subsidy and equity should be treated as capital receipts or revenue receipts.

Issue-wise Detailed Analysis:

Issue 1: Capitalization of Interest Earned from Borrowed Funds
The primary issue for the assessee was whether the interest earned from borrowed funds, which were temporarily deposited, could be capitalized. The Tribunal noted that the assessee was engaged in setting up an Integrated Petrochemical Complex and had not yet commenced operations. It was highlighted that the interest earned on these deposits was adjusted against the capital work in progress and not reflected in the Profit & Loss Account, as the project was still under construction.

The Tribunal referenced the Supreme Court's decision in Bokaro Steel Ltd., which established that interest earned on borrowed funds, if inextricably linked with the setting up of a plant, should be capitalized and not treated as revenue income. Similarly, the Supreme Court's decision in Karnataka Power Corporation supported this view, stating that such interest receipts are capital in nature and should reduce the cost of the assets.

Given these precedents, the Tribunal concluded that the interest earned from the borrowed funds, which were temporarily deposited, was indeed inextricably linked to the setting up of the plant and should be treated as a capital receipt. Thus, the assessee's appeal on this issue was allowed.

Issue 2: Treatment of Interest Earned from Capital Subsidy and Equity
The revenue's appeals challenged the CIT(A)'s decision to treat the interest earned from capital subsidy and equity as capital receipts. The Tribunal noted that the CIT(A) had followed its earlier decision in the assessee's case for AY 2009-10 and 2010-11, which treated such interest as capital receipts.

The Tribunal reiterated that the interest earned on unutilized capital subsidy and equity was inextricably linked to the process of setting up the project. The funds were specifically meant for the project, and any interest earned would reduce the capital subsidy required from the government. This treatment was supported by the Supreme Court's decisions in Bokaro Steel Ltd. and Karnataka Power Corporation, which held that such receipts should be capitalized and not treated as income.

The Tribunal also distinguished the case from the Supreme Court's decision in Tuticorin Alkali Chemicals & Fertilizers Ltd., where the interest earned on surplus funds was treated as revenue income because the funds were not inextricably linked to the setting up of the plant.

Therefore, the Tribunal upheld the CIT(A)'s decision to treat the interest earned from capital subsidy and equity as capital receipts, dismissing the revenue's appeals.

Conclusion:
The Tribunal dismissed all the revenue's appeals and allowed all the assessee's appeals, concluding that:
- The interest earned from borrowed funds, which were temporarily deposited, should be capitalized and not treated as revenue income.
- The interest earned from capital subsidy and equity should be treated as capital receipts, as they are inextricably linked to the setting up of the project.

Order Pronounced:
The order was pronounced in the open court on 22 October 2020.