2024 (12) TMI 1218 - HC - Income Tax

Addition u/s 56 - interest income earned on surplus fund deposited in the bank during pre-commencement of the business - It is the Assessee s case that income by way of interest is not chargeable to tax under the head income from other sources as it was inextricably linked to acquisition of coal mine a capital asset. The Assessee claims that the amount of interest payable on the funds borrowed for acquiring such asset is required to be added to the total cost of the asset HELD THAT - Plainly, if the interest is earned on the amounts which were temporarily kept in fixed deposits in the course of acquisition of the coal mine to set up its business, the interest earned would require to be accounted for as the part of the capital value of the business/asset. We may, however, add a caveat that this accounting treatment is or will be applicable only if the nature of the asset is such that requires time for construction or for putting it in use. Illustratively, the same would be applicable where the asset is to be constructed, developed or is of a nature that requires considerable time to bring it to use. Illustratively, in case where a plant is being set up in a factory and the requisite funds for setting up the same are deployed for a period of time, the interest paid on the amount borrowed for the said purpose and interest earned on temporary deposits during the course of deployment are required to be accounted for as a part of the capital costs. This is not true for an off the shelf product. Illustratively, if a motor vehicle is purchased from borrowed capital, neither the interest paid nor the interest earned on the funds borrowed for payment of consideration of the same can be accounted for as a part of the cost of the said asset. In the present case, there is no dispute that the Assessee was set up to acquire resources to ensure supply of coal. At the material time it was in the process of negotiation for acquiring a coal mine, to set up its business, and thus called for capital from its shareholders for the purpose of payment of the acquisition costs. It is the part of the said funds that were kept in the short-term fixed deposit in the bank for pending payment of the construction. The attempt to acquire the coal mine was aborted and thus the amounts borrowed were repaid to RINL. It is not disputed that the funds in question were not surplus funds of the Assessee, the same were called for and were earmarked for acquisition of a coal mine overseas. The said coal mine was to be the Assessee s undertaking as the Assessee was formed for the purpose of acquiring and operating a coal mine overseas. We find merit in the Assessee s contention that the interest received on borrowed funds, which were temporarily held in interest bearing deposit, is a part of the capital cost and is required to be credited to CWIP. The question of law as framed refers to the funds deposited in interest bearing account as surplus funds . However, as noted above, the funds in question were not surplus funds but funds that were called for and earmarked for a specific purpose of acquiring a coal mine. To that extent the use of the term surplus in respect of the funds, in the question of law as framed, is not apposite and ought to be deleted. Decided in favour of the Assessee.

Issues Involved:

1. Taxability of interest income under Section 56 of the Income Tax Act, 1961.
2. Nature of interest income: capital receipt or revenue receipt.
3. Applicability of accounting standards and principles in determining capital costs.
4. Treatment of interest income in relation to pre-operative expenses and capital work-in-progress (CWIP).

Issue-wise Detailed Analysis:

1. Taxability of Interest Income Under Section 56 of the Income Tax Act, 1961:

The primary question of law addressed in this judgment was whether the interest income earned on surplus funds deposited in the bank during the pre-commencement of business is liable to be taxed under Section 56 of the Income Tax Act, 1961. The Revenue argued that the interest earned on the fixed deposits should be taxed as 'income from other sources' since the funds were surplus. However, the court found that the funds were not surplus but were specifically earmarked for acquiring a coal mine, thus not liable to be taxed under Section 56 as income from other sources.

2. Nature of Interest Income: Capital Receipt or Revenue Receipt:

The court examined whether the interest income earned by the Assessee should be treated as a capital receipt or a revenue receipt. The Assessee contended that the interest income was inextricably linked to the acquisition of a capital asset (a coal mine) and should be adjusted against the capital cost of the asset. The court agreed with the Assessee, distinguishing the case from the decision in Tuticorin Alkali Chemicals and Fertilizers Limited, where interest was earned on surplus funds. The court held that since the funds were earmarked for acquiring a coal mine, the interest earned was a capital receipt, not a revenue receipt.

3. Applicability of Accounting Standards and Principles in Determining Capital Costs:

The court referred to Accounting Standard 16 (AS-16) and the India Accounting Standard (Ind AS) 23, which provide guidance on capitalizing borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset. The standards stipulate that income earned on the temporary investment of borrowed funds should be deducted from the borrowing costs capitalized. The court emphasized that final accounts should reflect a true and fair view, incorporating all elements of expenditure that contribute directly to the asset's cost. The court applied these principles, concluding that the interest earned should be capitalized as part of the asset's cost.

4. Treatment of Interest Income in Relation to Pre-operative Expenses and Capital Work-in-Progress (CWIP):

The Assessee argued that the interest income should be set off against pre-operative expenses and CWIP. The court supported this view, noting that the interest earned on funds temporarily held in fixed deposits, which were intended for acquiring a coal mine, should be credited to CWIP. The court highlighted that this treatment is appropriate for assets requiring significant time for construction or development, aligning with the rationale that pre-operative expenses contribute to the asset's intrinsic value. Consequently, the court found merit in the Assessee's contention that the interest income was part of the capital cost and should be credited to CWIP.

Conclusion:

The court concluded that the interest income earned on funds earmarked for acquiring a coal mine should be treated as a capital receipt and not taxed under Section 56 as income from other sources. The funds were not surplus but specifically intended for a capital purpose, and the interest earned was inextricably linked to the business's setup. Therefore, the interest income should be credited to CWIP, reflecting the correct capital cost of the asset. The appeal was dismissed, and the question of law was answered in favor of the Assessee.

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