Cit vs Indo Gulf Fertilizer & Chemical ...

JUDGMENT R.K. Agrawal, J.

The Income Tax Appellate Tribunal, Allahabad has referred the following two questions of law under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "Act") for opinion of this court :

"1. Whether on the facts and in the circumstances of the case, the Hon'ble Member of ITAT was justified in law in holding that the order of the assessing officer taxing the amount of interest and miscellaneous receipts, was erroneous and against law?

2. Whether on the facts and in the circumstances of the case, the Hon'ble ITAT was legally correct in holding that the amount of interest and miscellaneous receipts were not exigible to tax at the hands of the assessee company as income from other sources"?

2. The present reference relates to the assessment year 1988-89.

3. Briefly stated the facts giving rise to the present reference are as follows:

The company was incorporated in 1983 with the main object of setting up a fertiliser plant and manufacturing of fertilisers. During the year under consideration, the factory was under construction and no manufacturing activity had been undertaken. The assessee company received certain loans from financial institutions with the stipulation that any interest earned on such amount of loan not utilised temporarily would go to reduce the liability of the loan. Due to certain unexpected delay, the amount of loan received remained lying with the bankers and the company managed to get some interest on these deposits with the Bank. Besides there were certain miscellaneous receipts. The assessing officer, taxed the interest and miscellaneous receipts.

In appeal, the learned CIT(A) had set aside the order of the assessing officer.

In second appeal, the Tribunal following its earlier decision in assessee's case for the assessment years 1986-87 and 1987-88, held that the alleged receipt of amount of interest plus miscellaneous receipts were not exigible to tax as income from other sources, but were only receipts which had to be taken into consideration in reducing the cost. The department, being aggrieved, has come up in reference.

4. Heard Sri R.K. Upadhayaya, learned standing counsel appearing on behalf of the revenue and Sri S.K. Garg, assisted by Sri R.S. Agarwal, learned counsel appearing on behalf of the respondent company-assessee.

5. Learned standing counsel submitted that the respondent-assessee (hereinafter referred to as "assessee") had kept the amount of loan obtained by it from financial institutions in the Special Current Account with the nationalised bank. Normally the nationalised bank do not pay any interest on the amount deposited in the current account but only upon the persuasion of the respondent, the bank had agreed to pay interest 93% per annum on such deposit. According to him, the Tribunal has misdirected itself in holding that the interest earned on such deposit is not to be treated as income of the assessee under the head "Income from other sources" even if it was under obligation to utilise the said amount towards construction of the project. According to him, the interest earned on such deposit is liable to be taxed under the head "Income from other sources" and the question of set off interest would not arise. In support of his plea he has relied upon the decision of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizer Ltd. v. CIT (1997) 227 ITR 172 (SC) and also an unreported decision of this court in IT Reference No. 219 of 1992, CIT v. Kishan Sahkari Chini Mills Ltd., dated 7-4-2005.

6. Sri S.K. Garg, learned counsel for the assessee, however, submitted that under the terms of the agreement of loan by the financial institutions a specific clause was incorporated in which it was stated that the interest earned on inter corporation/ bank deposits, miscellaneous receipts will be taken into consideration for means of finance before making final disbursement for the project. Such cash accruals during project implementation will go to reduce institutional /bank loans. Relying upon the said clause he submitted that amount of interest which the respondent-assessee had earned in special current account on the amount of loan advanced by the financial institutions have been kept was to go to reduce the loan and was to be taken into consideration for means of finance before making final disbursement and therefore, the interest accrued to the assessee was only to reduce the amount of loan and therefore, it could not be taxed under the head "Income from other sources". He heavily relied upon the following passage of the decision of the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizer Ltd. (supra) wherein the Apex Court has held as follows :

"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 utilize 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 share-holders. 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." (p. 182)

7. He further submitted that if a person pays interest on the same fund in that event only the net amount of interest is to be brought to tax. In support of his contention he relied upon the decision of the Apex Court in the case of Keshavji Ravji & Co. v. CIT (1990) 183 ITR 1. Relying upon another decision of the Apex Court in the case of CIT v. Sun Engg. Works (P) Ltd. (1992) 198 ITR 297 (SC), he submitted that it is neither desirable nor permissible to pick out a word or a sentence from the judgment of the Supreme Court divorced from the context of the question under consideration and treat it to be the complete law declared by the Court. According to him judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. Sri Garg thus submitted that Tribunal has rightly held that the interest income was not liable to tax at the hand of the assessee and in any event it was required to be set off from the interest which assessee would have to provide the financial institutions on such loan.

8. Having given our anxious considerations to the various pleas raised by the learned counsel for the parties, we find that it is not in dispute that under the terms of the agreement the assessee was required to keep the amount of loan which had not been utilised in the project in a special current account with a nationalised bank. Assessee had kept the amount in a special current account on which normally no interest is paid by the bank. However, after negotiations the bank had paid interest amounting to Rs. 49,71,724. The assessee had other income from interest on various accounts. The total of all such interest amounted to Rs. 2,28,33,384. The letter dated 13-12-1986 written by Industrial Development Bank of India which has been heavily relied on by the learned counsel for the assessee has not been referred to in the assessment year in question. The Tribunal has however, relied upon its earlier order dated 26-6-1992 which related to the assessment years 1986-87 and 1987-88 in which the relevant clause of the aforementioned letter has been reproduced. For ready reference the said clause is reproduced below:

". . . we advise that the various earnings and receipts of the company during the implementation of the project, such as interest earned on inter corporation/ bank deposits, miscellaneous receipts will be taken into consideration for means of finance before making final disbursement for the project. Such cash accruals during project implementation will go to reduce institutional/ bank loans."

9. From a reading of the aforesaid clause it appears that the financial institutions, who were disbursing the loan was to take into account the interest income earned by the assessee. There is no such stipulation that the assessee was under some legal obligation to utilize the amount of such interest towards construction of the project.

10. The Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizer Ltd. (supra) has held as follows:

"The basic proposition that has to be borne in mind in this case is that it is possible for a company to have six different sources of income, each one of which will be chargeable to income-tax. Profits and gains of business or profession is only one of the heads under which the company's income is liable to be assessed to tax. If a company has not commenced business, there cannot be any question of assessment of its profits and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. If the company, even before it commences business, invests the surplus funds in its hands for purchase of land or house property and later sells it at profit, 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 Lowndesw in the of quoted passage in the case of CIT v. Shaw Wallace and Co. (1932) 2 Comp. Cas. 276; 59 I.A. 206 (page 280):

"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 production of a definite return, excluding anything in the nature of a mere windfall. Thus income has been likened pictorially to the fruit of a tree, or the crop of a field. It is essentially the produce of something which is often loosely spoken of as 'capital'."

In other words, if the capital of a company is fruitfully utilised instead of keeping it idle, the income thus generated will be of revenue nature and not an accretion to capital. Whether the company raised the capital by issue, of shares or debentures or by borrowing, will not make any difference to this principle. If borrowed capital is used for the purpose of earning income, that income will have to be taxed in accordance with law. Income is something which flows from the property. Something received in place of the property will be capital receipt. The amount of interest received by the company flows from its investments and is its income and is clearly taxable even though the interest amount is earned by utilizing borrowed capital.

It is true that the company will have to pay interest on the money borrowed by it. But that cannot be a ground for exemption of interest earned by the company by utilizing the borrowed funds as its income. It was rightly pointed out in the case of Kedar Narain Singh v. CIT (1938) 6 ITR 157 (All.) that "anything which can properly be described as income is taxable under the Act unless expressly exempted". The interest earned by the assessee is clearly its income and unless it can be shown that any provision like section 10 has exempted it from tax, it will be taxable. The fact that source of income was borrowed money does not detract from the revenue character of the receipt. The question of adjustment of interest payable by the company against the interest earned by it will depend upon the provisions of the Act. The expenditure would have been deductible as incurred for the purpose of business if the assessee's business had commenced. But that is not the case here. The assessee may be entitled to capitalise the interest payable by it. But what the assessee cannot claim is adjustment of this expenditure against interest assessable under section 56. Section 57 of the Act sets out in its clauses (i) to (iii) the expenditure which are allowable as deduction from income assessable under section 56. It is not the case of the assessee that the interest payable by it on term loans is allowable as deduction under section 57 of the Act." (p. 179)

11. The aforesaid decision has been followed subsequently by the Hon'ble Supreme Court in the case of CIT v. Coromandal Cements Ltd (1998) 234 ITR 412, CIT v. Bokaro Steel Ltd. (1999) 236 ITR 315 and CIT v. Autokast Ltd. (2001) 248 ITR 410 . Thus the submission that the interest earned by the assessee is not taxable under the head "Income from other sources" is not correct. So far as the question of set off is concerned, the Apex Court in the case of Tuticorin Alkali Chemicals & Fertilizer Ltd. (supra) held as follows:

"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.

It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capital. Having regard to the identity of the fund on which interest is earned and interest is payable, the company should be allowed to set off its income against interest payable by it on the same fund. We are of the view that no adjustment can be allowed except in accordance with the provisions of the Income Tax Act. However, desirable it may be from the point of view of equity, this adjustment cannot be made unless the law specifically permits such adjustment." (p. 181)

12. Thus the plea that the interest earned by the assessee on such loan is to be set off against the interest payable on loan given for the purpose of construction cannot be accepted. So far as the plea that the assessee was free to use the interest income as it liked and therefore, the interest income could not be taxable, suffice it to mention that the nature of income had to be seen at the point of accrual and the taxability is not dependant upon its destination or the manner of its utilization.

13. Reliance placed upon the decision of the Apex Court in the case of Keshvji Ravji & Co. (supra) is also misplaced as in that case the partner was paid interest by the firm on the amount in his capital account whereas partner had paid interest to the firm on his borrowings. Taking into consideration the nature of the firm, Apex Court has held that only the net amount has to be disallowed. Likewise the respondent cannot take any benefit from the observations made by the Apex Court in the case of Sun Engg. Works (P.) Ltd. (supra) as the view any particular word or sentence from the judgment in Turicorin Alkali Chemicals & Fertilizer Ltd. (supra) has not been taken out for deciding the matter. We find that this court in Chandpur Sugar Co. Ltd. v. CIT (IT Reference No. 41 of 1985), dated 28-92004), in ITR No. 37 of 1984, U.P. State Brassware Corpn. Ltd v. CIT decided on 12-10-2004 and ITR No. 219 of 1992 CIT v. Kisan Sahkari Chini Mills Ltd. Moradabad decided on 7-4-2005 have taken similar view.

14. In view of the foregoing discussions, we answer the questions referred to us in the negative, i.e., in favour of the revenue and against the assessee. However, there shall be no order as to costs.

Cit vs Indo Gulf Fertilizer &amp; Chemical ...

Cit vs Indo Gulf Fertilizer & Chemical ...