ORDER
J.P. Bengra, Judicial Member
1. This is an appeal by the revenue against an order of the Commissioner of Income-tax (Appeals)-XVI, New Delhi, pertaining to assessment year 1985-86.
2. The grievance of revenue in this appeal is that the CIT (Appeals) erred in excluding a sum of Rs. 22,99,975 from taxable income of the assessee. During the assessment year under consideration the assessee-company was engaged in setting up a cement plant at Raipur, Madhya Pradesh. The company applied for grant of loans from various financial institutions and in pursuance of the request made by the company it had received Rs. 12,38,93,087 loan from these financial institutions. The company did not require the entire amount for setting up of this plant during this assessment year. Therefore, the entire funds received could not be utilised immediately. So the assessee-company made deposits of surplus funds in the bank in short-term deposit schemes. On these deposits the company earned interest amounting to Rs. 22,99,975. The Assessing Officer treated the amount earned by way of interest as income under the head “other sources” and refused to adjust this amount against interest paid Rs. 65,33,104 on the ground that the funds were not loan to the company for making short term deposits. Therefore, any income earned out of these deposits has nothing to do with the assessee’s business. Interest paid on the borrowed capital is clearly an expenditure related to the main business and income earned out of short-term deposits is clearly an income from other sources. Since the business of the assessee-company has not commenced, it should be capitalised along with other expenses during the pre-operation period. Any expense out of a particular business cannot be an allowable expense for income from other sources. Therefore, interest is not allowable under Section 57(iii) of the Income-tax Act. While coining to this conclusion, he has taken support from the decision of Delhi High Court in the case of Addl. CIT v. Indian Drugs & Pharmaceuticals Ltd. [1983] 141 ITR 134, decision of Karnataka High Court in the case of Karnataka Forest Plantations Corporation Ltd. v. CIT [1985] 156 ITR 275, CIT v. Seshasayee Paper & Boards Ltd. [1985] 156 ITR 542 (Mad.) and the Special Bench decision of the Tribunal in the case of National Thermal Power v. IAC [1988] 24 ITD 1 (Delhi). The case of the assessee before the Assessing Officer was that the amount earned as interest was purely incidental and it ought to be adjusted against the project cost. Therefore, the same be reduced.
3. When the matter came before the CIT (Appeals), the CIT(Appeals) following the decision of Delhi High Court in the case of Snam Progetti S.P.A. v. Addl CIT [1981] 132 ITR 70 and Indian Drugs & Pharmaceuticals Ltd. (supra), held that the interest earned should go to reduce the project cost and it cannot be treated as income under the head ‘other sources’.
4. Aggrieved by that order, the department has come up in appeal before the Tribunal. The learned Departmental Representative Smt. Surbhi Sinha submitted that the business activity of the assessee has not started in this year. For the purpose of setting up factory, the assessee took loans from various financial institutions and the surplus funds were invested by the company where from this interest income was earned. Income earned out of short-term deposits is clearly an income from other sources. The interest paid on the borrowed funds is clearly an expenditure relating to the main business of the assessee. Since the business of the company has not commenced, it should be capitalised along with other expenses. Reliance was placed on the decision of Delhi High Court in the case of Indian Drugs & Pharmaceuticals Ltd. (supra) and Snam Progetti S.PA. (supra). Besides these decisions, of Hon’ble Delhi High Court, the learned Departmental Representative relied heavily on the decision of the Special Bench of the Tribunal in the case of National Thermal Power (supra) and our attention was invited to paragraphs 25, 27, 28 & 31 of the said order and it was pointed out that the facts of that case are squarely applicable to the facts of the present case. So, the CIT (Appeals) had gone wrong in deleting the addition made by the Assessing Officer. Our attention was also invited to the following case laws:-
(1) Bokaro Steel Ltd. v. CIT (No. 2) [1988] 170 ITR 545 (Pat);
(2) CIT v. Hindustan Electro Graphites Ltd. [1989] 177 ITR 465 (MP);
(3) CIT v. Nagarjuna S.teels Ltd. [1988] 171 ITR 663 (AP);
(4) CIT v. Cap Steel Ltd.[1986] 162 ITR 533 (Kar.);
(5) CIT v. Tamil Nadu Industrial Development Corporation Ltd. [1991] 189 ITR 670 (Mad.); &
(6) Karnataka Forest Plantations Corporation Ltd’s case (supra).
As against this, the learned counsel for the assessee Dr. D. Pal submitted that the company was in the stage of setting up a project. It has not commenced its business. Therefore, all the expenditure and receipt incurred by the assessee-company during this period would go towards cost of construction. Our attention was invited to the guidelines issued by the Institute of Chartered Accountants given as under:-
8.2 Where a particular item of miscellaneous income can be directly related to a particular item of expenditure, it is suggested that it should be set off against the expenditure and the net amount of the expenditure should be treated in the appropriate manner, depending upon its nature, in accordance with the various principles suggested above. For example, income from share transfer fees may be set off against the various corporate expenses incurred during the construction or preproduction period and income, if any, from lending transport vehicles to outsiders may be set off against the expenditure incurred in operating and maintaining those vehicles. Similarly, interest income earned during the construction period may be off-set against interest expenses incurred during this period.
It was pointed out that in view of this guideline, the interest paid by the assessee-company will go to the cost of construction and while doing so, the interest income earned during the construction period may be set off against the various corporate expenses incurred during this period. For this proposition reliance was placed on the decision of the Supreme Court in the case of a Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 and India Cements Ltd. v. CIT [1966] 60 ITR 52. It was further submitted that act of borrowing money during the setting of business was incidental to the carrying of the business. The loan obtained was not asset. Therefore, according to the established principle of accountancy, the expenditure should be set off against the income. It was further pointed out that in the memorandum of association at Clause 44 one of the object of the company was to invest and deal with the moneys of the company not immediately required in such manner as may from time to time be determined. Therefore, when the memorandum of association authorises the company to invest and deal with this surplus fund, the interest income earned from this surplus fund is liable to be set off against the interest paid. Investing of fund in short-term deposit is one of the purpose for which the assessee-company had been set up. Therefore, in fulfilling the object of the company if income has been earned, it should be taken as income for the purpose of business. Reliance was placed on the decision of Calcutta High Court in the case of Karanpura Development Co. Ltd. v. CIT [1960] 38 ITR 484 and our attention was invited to the English decisions in the case of Fry v. Salisbury House Estates Ltd. [1930] 15 TC 266 and California Copper Syndicate v. Harris [1904] 5 TC 161. The third argument of the learned counsel for the assessee was that when the assessee-company has incurred an expenditure by way of paying interest which are necessary for the purpose of setting of a business and has to be allowed as such, the income earned shall have to be taken into consideration. In this connection, reliance was placed on the decision of CIT v. Bokaro Steel Ltd. (No. 1) [1988] 170 ITR 522 (Pat.). Continuing his arguments, the learned counsel for the assessee tried to distinguish the facts of the case before Special Bench of the Tribunal from the facts of the present case. The first distinguishing feature pointed was that in that case the company was wholly owned by the Government of India and was not receiving any loan from outside sources but was receiving the capital subscribed by the Government of India from time to time. During the year in question it has received a loan granted by the Government of India amounting to Rs. 47.94 crores and equity capital of the assessee stood at Rs. 20 lakhs and it came to be increased from year to year. As on 31-3-1981, it stood at Rs. 203.58 crores. The total fund available at the end of 31st March, 1981 stood at Rs. 247.31 crores. The income derived from the interest from banks on short-term deposits stood at Rs. 96.6 lakhs besides there was other income of interest Rs. 26.03 lakhs. The gross amount of interest under both the heads came to Rs. 122.93 lakhs. Out of this gross interest income amount of Rs. 15.64 lakhs interest being paid was deducted. Besides this, there was a business income by way of management of power project and income from consultancy from M/s. Hindustan Ltd. Therefore, it was not a case where the company has not started its business. The business was already there and it was deriving income from the sources mentioned above. In the present case, the assessee-company was in the state of setting up and there was no business or business income at all. Therefore, the ratio of that case cannot be applied to the facts of the present case. Our attention was also invited to paragraph 20 of the Special Bench decision and it was pointed out that the income from interest on short-term deposits had arisen from the source of contribution of funds by the Government of India. Reliance was also placed on the following decisions:-
(1) ClT v. H.H. Maharani Shri Vijaykuverba Saheb of Morvt [1975] 100 ITR 67 (Bom.);
(2) Seth R. Dalmia v. CIT [1977] 110 ITR 644 (SC);
(3) Mrs. Sooni Rustam Mehia v. Appropriate Authority [1991] 190 ITR 290 (AP); and
(4) CIT v. Tirupati Woollen Mills Ltd. [1992] 193 ITR 252 (Cal.).
In reply, the learned Departmental Representative submitted that in the case before the Special Bench one Shri L. Rajamani appeared as Third Intervener and the submissions of the intervener were like the submissions of the learned counsel for the assessee. Therefore, while giving decision in that case, the Special Bench of the Tribunal has taken note of these submissions. So, it cannot be said that the submission now being advanced by the learned counsel was not taken note of.
5. We have considered the rival submissions. In order to allow deduction permissible in the Income-tax Act, we have to see whether expenditure incurred is solely for the purpose of making or earning income or not and for determining whether expenditure is deductible, the nature of expenditure has to be examined. In the present case in the memorandum of association at Clause 44, we find that one of the object of the company was to invest and deal with the moneys of the company not immediately required in such a manner as may from time to time be determined. Therefore, when the Memorandum of Association authorises the company to invest and deal with the surplus fund, the interest income earned from this surplus fund and the expenditure incurred shall be considered for the purpose for which the expenditure is incurred, must be considered for earning the income. This view was taken by the Hon’ble Calcutta High Court in the case of Karanpwa Development Co. Ltd. (supra) where a company was formed with the object to acquire a prospecting licence for mining coal and purchasing and selling mining rights and to carry on the business of colliery proprietors, miners etc., but the assessee restricted its activities to acquire coal mining leases etc. The company never worked in the coal field with a view to extract coal nor did it acquire or sell coal. The company received ‘selami’ for granting sub-lease. The question was whether the sums received a ‘selami’ by the assessee were trading receipts. In this connection, the Hon’ble Calcutta High Court has laid down that where a company acquires property which it sells or leases out with a view to acquire other property to deal with a same manner, the company is not held to be enjoying receipts in the shape of rent which it yield but as a kind of capital leading to profit of business which profit either may be enjoyed or be taken into business to acquire more profits for further exploitation. In the case of H.H. Maharani Shri Vijaykuverba Saheb of Morvi (supra), India Cements Ltd. (supra) & Seth R. Dalmia (supra), the Hon’ ble Supreme Court as well as the Calcutta High Court have held that in order to allow deduction permissible under the Income-tax Act, as an expenditure incurred solely for the purpose of making or earning income, the determining factor is whether the expenditure is deductible, the nature of the expenditure has to be examined. The purpose of which the expenditure is incurred must be to earn the income. Connection between the expenditure and earning of income need not be direct. In the case of India Cements Ltd. (supra) the facts were that the company obtained loan from the Industrial Finance Corporation secured by a charge on its fixed assets. In connection therewith it spent some amount and claimed this amount as business expenditure. The Hon’ble Supreme Court has held that in order to allow expenditure as a deduction under Section 10(2)(xv) of the Indian Income-tax Act, 1922. If the act of borrowing money was incidental to the carrying on of business, the loan obtained was not an asset or an advantage of enduring nature, the expenditure was made for securing the use of money for a certain period and it was irrelevant to consider the object with which the loan was obtained. Therefore, the amount claimed should be allowed as a business expenditure, if it is spent wholly and exclusively for the purpose of assessee’s business. From the facts enumerated above and the principle of law discussed above, it is clear that where in fulfilling the object of the company, if income is earned, it should be taken for the purpose of business. If the company has invested surplus funds in short term deposit as per the purpose enumerated in the Memorandum of Association, the expenditure relating to earning of income has to be set off against the income. A direct question has arose in the case of Nagarjuna Steels Ltd. (supra) where the object of the assessee was to do business and in the course of setting up of a plant, the assessee-company did not require borrowed money at once. It kept such surplus funds in short-term deposit. The interest earned on such short-term deposits was claimed against the interest paid by the assessee on the loans obtained by it. The question arose whether interest paid can be set off against the interest received. The Hon’ble Andhra Pradesh High Court has answered the question in affirmative. In the case of Tirupati Woollen Mills Ltd. (supra) the assessee earned income from fixed deposits and other deposits which was sought to be assessed as income from other sources. The Tribunal found that the assessee had utilised its commercial assets which were lying in the form of surplus cash, for earning interests which had arisen from utilisation of commercial assets. When the matter came before the Hon’ble Calcutta High Court, it was held that the Tribunal had found that the interest arose from utilisation of commercial assets. The funds utilised in making fixed deposits with banks were business funds lying temporarily surplus with the assessee. It was, therefore, assessable as business income and revenue expenditure could be deducted from it. Similar view was taken by the Hon’ble Delhi High Court in the case of Snam Progetti S.P.A. (supra). In view of the law laid down by the Hon’ble Supreme Court and various High Courts, it is clear that where a company as per its objects has invested surplus funds and earned income from these surplus funds, the expenditure incurred to earn this income, has to be set off against the interest received.
6. The accountancy principles also permit the same which is clear from the following observations:-
8.1. It is possible that a new project may earn some income from miscellaneous sources during its construction or pre-production period. Such income may be earned by way of share transfer fees or by way of interest from the temporary investment of surplus funds prior to their utilisation for capital or other expenditure.
8.2. Where a particular item of miscellaneous income can be directly related to a particular item of expenditure, it is suggested that it should be set off against the expenditure and the net amount of the expenditure should be treated in the appropriate manner, depending upon its nature, in accordance with the various principles suggested above. For example, income from share transfer fees may be set off against the various corporate expenses incurred during the construction or pre-production period and income, if any, from lending transport vehicles to outsiders may be set off against the expenditure incurred in operating and maintaining those vehicles. Similarly interest income earned during the construction period may be off-set against interest expenses incurred during this period.
In view of this, it is clear that on the accountancy principle also interest income earned during the construction period should be set off against interest expenses incurred during this period.
7. As far as the decision of Special Bench of the Appellate Tribunal relied upon by the revenue in the case of National Thermal Power (supra) is concerned, the facts were slightly different from the facts of the present case. In the said case admittedly NTPC during the year in question was having income from management of Badarpur Thermal Power Station and consultancy fee from M/s. Hindustan Limited. Besides that the company being the Government of India Undertaking wholly owned by the Government of India was not receiving any loan from outside source but was receiving capital subscribed by the Government of India from time to time. During the year in question, it had received grant from the Government of India amounting to Rs. 47.94 crores, audit was on the deposit of those funds with the bank that it had realised interest comprised to more than a crore of rupee. Here in the present case, the assessee was completely a new company engaged in the erection of a project to manufacture cement at Raipur (M.P.) and in the process of setting up of that plant, it has no source of income from any business during the year in question. The major receipt of funds was from financial institutions and consequently it had paid interest. In this way, during the year under consideration, there was no source of income to the assessee-company. Receipt of the alleged income from the bank in fact was nothing but a wise and prudent act of the assessee to reduce the liability of the assessee towards interest which ultimately was to be counted towards capital expenditure of the plant. In the case of CIT v. Madho Pd. Jatia [1976] 105 ITR 179 (SC), it was held that where the provisions of the taxing statute are couched in language which is not free from ambiguity and admits of two interpretations a view which is favourable to the assessee should be adopted. This decision was followed in the case of Keshavji Ravji & Co. v. CTT [1990] 183 ITR 1 (SC). In view of this, we have to interpret law in a way which is in consonance with equity and fair play. It is not in dispute that the entire amount of loan and contributions received by the assessee was to be counted towards the cost of investment in the plant. The liability of the interest before the completion of the plant was also to be counted towards the cost of plant. Thus if in the said process of construction/erection of the plant the assessee by his wise and prudent act had tried to reduce the liability of the cost fully, that act would not amount to earning of income from other sources.
8. So far as decision in the case of Bokaro Steel Ltd. (No. 1) (supra) is concerned, it was a case of a Government of India undertaking. The object of the company was to construct and own an integral iron and steel works. During the years under consideration, there were certain receipts from property let out to outsiders. Here charges received from the contractors for use of the plant and equipments let out to them, interest on advances to the director etc. The case of the assessee was that these receipts are not taxable at all. When the matter travelled to the Hon’ble Patna High Court, it held that occupation of the company’s quarters by the employees of the contractor was incidental and subservient to the business of the assessee. All the receipts were incidental to the overall construction work during the pre-business period. None of the receipt was assessable to tax. In the case of Cap Steel Ltd. (supra), the question was whether the interest earned or interest income accrued to the assessee out of borrowed money or out of one’s own capital, is liable to tax or not. The Hon’ble Karnataka High Court has held that interest paid on borrowings must be capitalised and added to the cost of the fixed assets which had been created as a result of such borrowings and what should be capitalised was the gross interest in each year and not the net interest. In the judgment there was a reference to the following passage from “Study on Expenditure during Construction Period”, issued by the Research Committee of the Institute of Chartered Accountants of India:-
…Similarly, interest income earned during the construction period may be set off against interest expenses incurred during this period.
The Court has observed that this principle recommended by the Institute is no doubt useful to the assessee, but they are afraid that it cannot be taken advantage of by the assessee. Therefore, reading this judgment it cannot be said that this decision of Karnataka High Court is against the assessee. Similar proposition was laid down by the Hon’ble Madhya Pradesh High Court in the case of Hindustan Electro Graphites Ltd. (supra). Here also the question was regarding the taxability of interest income. Therefore, the question posed before the Hon’ble Madhya Pradesh High Court is different from the issue involved in this case.
9. In view of the above discussion, we are of the opinion that the CIT (Appeals) has rightly deleted the additions made by the Assessing Officer. We, therefore, concur with the findings given by the CIT (Appeals) on this point and do not find any merit in the departmental appeal.
10. In the result, the appeal is dismissed.