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TMI Blog1997 (7) TMI 4X X X X Extracts X X X X X X X X Extracts X X X X ..... 71, for the purpose of, inter alia, manufacturing heavy chemicals such as ammonium chloride and soda ash. The trial production of the factories of the company commenced on June 30, 1982. For the purpose of setting up of the factories, the company had taken term loans from various banks and financial institutions. That part of the borrowed funds which was not immediately required by the company was kept invested in short-term deposits with banks. Such investments were specifically permitted by the memorandum and articles of association of the company. The company had also deposited certain sums with the Tamil Nadu Electricity Board, It had also given interest-bearing loans to its employees to purchase vehicles. Up to the assessment year 1980-81, interest earned by the company from the various loans given by the company and also from the bank deposits was shown as income and was taxed accordingly. For the accounting year ending on June 30, 1981 (assessment year 1982-83), the assessee received a total amount of interest of Rs. 2,92,440. In its return of income filed on June 22, 1982, the company disclosed the said sum of Rs. 2,92,440 as " income from other sources ". It also discl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest earned by the assessee on investment of share capital in call deposits even before production commenced could be assessed separately under the head " Other sources ". The Andhra Pradesh High Court took a contrary view in the case of CIT v. Nagarjuna Steels Ltd. [1988] 171 ITR 663 where it was held that interest received on short-term deposits by a company prior to the commencement of production could not be treated as revenue receipt. In view of the aforesaid conflict of decisions between the Madras and Andhra Pradesh High Courts, the Tribunal has referred the following question of law to this court for decision : " Whether, on the facts and in the circumstances of the case, interest derived by the assessee from the borrowed funds which were invested in short-term deposits with banks would be chargeable to tax under the head ' Income from other sources ' or would go to reduce the interest payable by the assessee on the term loans secured by the assessee from financial institutions, which would be capitalised after the commencement of commercial production ? " The facts of this case are not in dispute. In the usual course, interest received by the company from bank dep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fit, the gain made by the company will be assessable under the head " Capital gains ". Similarly, if a company purchases a rented house and gets rent, such rent will be assessable to tax under section 22 as income from house property. Likewise, a company may have income from other sources. It may buy shares and get dividends. Such dividends will be taxable under section 56 of the Act. The company may also, as in this case, keep the surplus funds in short-term deposits in order to earn interest. Such interest will be chargeable under section 56 of the Act. The company has chosen not to keep its surplus capital idle, but has decided to invest it fruitfully. The fruits of such investment will clearly be of revenue nature. This position in law was explained by Sir George Lowndes in the oft-quoted passage in the case of CIT v. Shaw Wallace and Co. [1932] 2 Comp Cas 276 ; 59 I. A. 206 : " Income, their Lordships think, in this Act connotes a periodical monetary return ' coming in ' with some sort of regularity, or expected regularity, from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one whose object is the produc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t on term loans is allowable as deduction under section 57 of the Act. If that be so, under which other provision of law can the assessee claim deduction or set-off of his income from other sources against interest payable on the borrowed funds ? There are specific provisions in the Income-tax Act for setting off loss from one source against income from another source under the same head of income (section 70), as well as setting off loss from one head against income from another (section 71). In the facts of this case the company cannot claim any relief under either of these two sections, since its business had not started and there could not be any computation of business income or loss incurred by the assessee in the relevant accounting year. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business cannot be allowed as deduction, nor can it be adjusted against any other income under any other head. Similarly, any income from a non-business source cannot be set off against the liability to pay interest on funds borrowed for the purpose of purchase of plant and machinery even before commencement of the business of the assessee. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eptable for the purpose of computation of taxable income. There is another aspect of this matter. The company, in this case, is at liberty to use the interest income as it likes. It is under no obligation to utilise this interest income to reduce its liability to pay interest to its creditors. It can reinvest the interest income in land or shares, it can purchase securities, it can buy house property, it can also set up another line of business, it may even pay dividends out of this income to its shareholders. There is no overriding title of anybody diverting the income at source to pay the amount to the creditors of the company. It is well-settled that tax is attracted at the point when the income is earned. Taxability of income is not dependent upon its destination or the manner of its utilisation. It has to be seen whether at the point of accrual, the amount is of revenue nature. If so, the amount will have to be taxed. Pondicherry Railway Co. Ltd. v. CIT [1931] 1 Comp Cas 314 ; AIR 1931 PC 165. Our attention was drawn to two other decisions where the view of the Andhra Pradesh High Court was followed. In the case of CIT v. Electrochem Orissa Ltd. [1995] 211 ITR 552, the Or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nks went to show that the interest was earned for the purpose of reducing the liability of the assessee. The High Court came to the conclusion that it was evident that the assessee did not derive any income by temporary utilisation of the loans and since no income was derived by the assessee, the question of assessing the sum of Rs. 3,14,366 in the hands of the assessee as " income from other sources " did not arise. It is difficult to follow this reasoning. If a person borrows money for business purposes but utilises that money to earn interest, however temporarily, the interest so generated will be his income. This income can be utilised by the assessee whichever way he likes. He may or may not discharge his liability to pay interest with this income. Merely because it was utilised to repay the interest on the loan taken by the assessee, it did not cease to be his income. The interest earned by the assessee could have been used for many other purposes. If the assessee purchased a house or distributed dividend or paid salary to its employees with the money received as interest, will the interest amount be treated as not his income ? This is not a case of diversion of income by o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orking condition. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets created as a result of such expenditure. " This court also took note of the provisions of the Companies Act and in particular section 208(1)(b). It observed : " Clause (b) of sub-section (1) of that section provides that in case interest is paid on share capital issued for the purpose of raising money to defray the expenses of constructing any work or building or the provision of any plant in contingencies mentioned in that section, the sum so paid by way of interest may be charged to capital as part of the cost of construction of the work or building or the provision of the plant. The above provision thus gives statutory recognition to the principle of capitalising the interest in case the interest is paid on money raised to defray expenses of the construction of any work or building or the provision of any plant in contingencies mentioned in that section even though such money constitutes share capital ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ountants. The phrase " actual cost " was not defined in the Act. Therefore, it had to be understood in the commercial parlance. To find that out, the normal rule of accountancy prevalent in commercial and industrial circles was noted. According to the Institute of Chartered Accountants, actual cost will also include interest paid on borrowed money for the purchase of the assets. Khanna J., however, did not stop there. He pointed out that the principle of capitalising interest was to be found in section 208 of the Companies Act itself and was also consistent with the views of the English Courts. But this is an entirely different case. Whether a particular receipt is of the nature of income and falls within the charge of section 4 of the Income-tax Act is a question of law which has to be decided by the court on the basis of the provisions of the Act and the interpretation of the term " income " given in a large number of decisions of the High Courts, the Privy Council and also this court. It is well-settled that income attracts tax as soon as it accrues. The application or destination of the income has nothing to do with its accrual or taxability. It is also well-settled that inte ..... X X X X Extracts X X X X X X X X Extracts X X X X
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