ORDER
D.R. Singh, Judicial Member
1. The Revenue has filed this appeal against the order of ld (CIT(A) in Appeal No. 339/IT/98-99 dated 9.3.99 on the following effective grounds:-
“1.(a) The ld CIT(A), on facts as well as in law, has erred in directing that income from interest earned DRs amounting to Rs. 86,22,216 be set off against ‘Project Development and Preoperative expenses.
(b) The ld CIT(A) has erred in directing bove without appreciating that the income earned by the assessee as interest on FDRs can in no manner be treated as income from business.
(c) The ld CIT(A) has failed to appreciate that the Hon’ble Supreme Court in the case of Tuticorin Alkalies and Fertilizers Ltd v. CIT (227 ITR 172) has held that in case the company has not started business operations, interest on deposits will be chargeable Under Section 56 of the IT Act.”
2. The relevant material facts for the disposal of the grounds are that the assessee-company had been incorporated with the object to carry out business of manufacturing of cotton and manmade fibre yarn. During the relevant previous year, it was engaged in setting up of a spinning unit and for this purpose it had to buy and import plant and machinery. Towards this, the assessee-company had opened up letters of credit (LoC) in favour of the suppliers through the banks who, in turn, accepted 100% margin money by way of fixed deposits for opening and issuing LoC. The AO was of the opinion that the assessee had earned interest on these fixed deposits and the interest earned was deducted to reduce the preoperative and project development expenses, so he treated the interest as income from other sources and charged tax thereon, by relying upon the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd v. CIT 227 ITR 172 (SC), after rejecting the explanation of the assessee, wherein it had stated before the AO that in the case of the assessee there was no choice but to compulsorily place the money in fixed deposits, so that LoC could be opened for import of plant and machinery etc and that out of this very business necessity for setting up of plant the surplus money lying unused with the assessee had been deposited in the banks.
2.1 Aggrieved with the order of the AO, the assessee filed an appeal before the CIT(A) and submitted that the FDRs were taken by the assessee for the purposes of setting up the plant or unit of the assessee and there was a direct nexus between the placing of the FDRs and setting up of the unit and in such cases amount earned as interest was not to be taxed as income from other sources but should go to reducing the cost of the asset. It also submitted before the CIT(A) that the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra), relied upon by the AO, was on different set of facts, where the funds were surplus and not required for setting up the unit and had been given as loan for earning interest or invested in short term with the banks. It also pointed out that in that case there was no nexus between the investment of funds and the setting up of the unit, whereas in the case of CIT v. Bokaro Steel Ltd 102 Taxman 94 (SC) it has been held that where the receipts were directly connected with or incidental to the work of construction of its plant undertaken by the assessee, they would be capital receipts. He also placed reliance on the decision in the case of Karnal Cooperative Sugar Mills Ltd. v. CIT 233 ITR 531 (P&H). After considering the submissions of the assessee and also placing reliance on the decisions relied upon by the ld. AR for the assessee as well as after analyzing the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra), relied upon by the AO, the CIT(A) held that the amounts received by the assessee were inextricably linked with the process of setting up its plant and machinery, so such receipt would go to reduce the cost of its assets. He further held that these receipts were of capital nature and could not be taxed as income from other sources and allowed a relief of Rs. 86,22,216.
3. In respect of the grounds of appeal taken by the Revenue, ld DR for the revenue submitted before us that in the instant case of the assessee, the AI after applying the principles laid down in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra) (relevant at 178), the facts and circumstances of the instant case of the assessee has rightly disallowed the set off of interest earned on FDRs amounting to Rs. 88,22,216 against the project development and preoperative expenses claimed by the assessee treating the same as income from other sources. She further submitted that even in the case of Bokaro Steel Ltd (supra), relied upon by the CIT(A) while allowing relief to the assessee, the apex court at relevant page 322 (236 ITR 315) observed that ‘the advances which the assessee made to the contractors to facilitate the construction activity of putting together a very large project was as much to ensure that the work of the contractors proceeded without any financial hitch as to help the contractors. The arrangements which were made between the assessee-company and the contractors pertaining to these three receipts are arrangements which are intrinsically connected with the construction of its steel plant. The receipts have been adjusted against the charges payable to the contractors and have gone to reduce cost of construction. They have, therefore, been rightly held as capital receipts and not income of the assessee from any independent source’. Ld DR further submitted that even from the decision in the case of Bokaro Steel Ltd (supra), it is apparent that in the case the receipts have been adjusted against the charges which reduced the cost of construction only then such receipt could be held as capital receipt and not the income of the assessee from an independent source; whereas in the case of the assessee the interest earned by the assessee in fact does not reduce the cost of plant and machinery, so the CIT(A) was not justified to hold that the interest received by the assessee as receipt from business income and not as being income from other sources, as held by the AO.
3.1 On the other hand, ld AR for the assessee submitted that in the instant case of the assessee the department has not disputed that in the accounting year relevant to a.y. 96-97 the assessee was in the process of setting up the industrial unit. In terms of the agreement with the suppliers of the imported machinery, which had to be acquired for the purposes of setting up the industrial unit, the assessee-company was required to open a LoC in respect of the suppliers of the imported machinery by giving fixed deposits in the form of hundred per cent margin money by opening LoC. It means that the surplus share capital money lying idle and unused with the assessee had been deposited by the assessee in the banks out of necessity for the purposes of acquiring the assets, so the activity of depositing the money out of the share capital was another activity incidental to the acquiring of an asset. Thus, there existed a direct nexus between the purchase of the machinery and the deposit of money in the banks, therefore, the interest earned by the assessee shall go to reduce the cost of the assets acquired out of transactions and the CIT(A) by relying on the decisions in the cases of Bokaro Steel Ltd and Karnal Cooperative Sugar Mills Ltd (supra) has rightly held that the instant receipt earned by the assessee as capital receipt and has rightly allowed the impugned relief to the assessee. In support of this contention, ld AR placed reliance on the following decisions:-
Karnal Cooperative Sugar Mills Ltd. v. CIT 233 ITR 531 (P&H)
CIT v. Bokaro Steel Ltd 236 ITR 315 (SC)
CIT v. Karnal Cooperative Sugar Mills Ltd 243 ITR 2 (SC)
CIT v. Karnataka Power Corporation 247 ITR 268 (SC)
Bongaigaon Refinery and Petrochemicals Ltd v. CIT 251 ITR 329 (SC)
4. We have considered the rival submissions of both the parties, perused the record and carefully gone through the orders of the tax authorities below. In order to appreciate the rival submissions of both the parties, we would like to refer to the case law cited by both the parties. In the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra), there Lordships at page 175 held as under:-
“… that the company has surplus funds in its hands. In order to earn income out of the surplus funds, it had invested the amount for the purpose of earning interest. The interest thus earned was clearly of revenue nature and would have to be taxed accordingly. The accountants might have taken some other view but accountancy practice was not necessarily good law. This was not a case of diversion of income by overriding title. The assessee was entirely at liberty to deal with the interest amount as it liked. The application of the income for payment of interest would not affect its taxability in any way. The company could not claim any relief Under Section 70 or 71 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 years. In such a situation, the expenditure incurred by the assessee for the purpose of setting up its business could not be allowed as deduction, nor could it be adjusted against any other income under any other head. Similarly any income from a non-business source could not 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.”
In the case of Karnal Cooperative Sugar Mills Ltd (P&H) (supra), their Lordships held at page 532 as under:-
(i) that the CIT as well as the Tribunal had given a finding of fact that the business of the assessee had not commenced. The assessee had raised share capital and also loans, so as to set up the sugar factory. Therefore, these two activities were ancillary to the commencement of business and could not be said to be the main business. The assessee did not raise loans or deposit money in the bank as part of its business activity inasmuch as money was deposited with the bank with the definite purpose, to execute an agreement for the purpose of acquiring a machine. There was no evidence on record to show that the fixed deposit had been made by the assessee out of the borrowings. It was the share capital which was deposited. The assessee purchased fixed deposits in the course of an activity directly relatable to the acquisition of an asset. There was thus a direct nexus between the purchase of the machinery and the deposit of money in the bank. Such interest income being directly relatable to the terms of the contract for acquiring a business asset should go to reduce the cost of the asset.”
In the case of Bokaro Steel Ltd (supra), their Lordships dismissing the appeal held as under:-
“… that the first three heads of income were (i) the rent charged by the assessee to its contractors for housing workers and staff employed by the contractors for the construction work of the assessee including certain amenities granted to the staff by the assessee, (ii) hire charges for plant and machinery which was given to the contractors by the assessee for use in the construction work of the assessee, and (iii) interest from advances made to the contractors by the assessee for the purpose of facilitating the work of construction. The activities of the assessee in connection with all these three receipts were directly connected with or incidental to the work of construction of its plant undertaken by the assessee. The advances which the assessee made to the contractors to facilitate the construction activity of putting together a very large project was as much to ensure that the work of contractor proceeded without any financial hitch as to help the contractors. The arrangements which were made between the assessee-company and the contractors pertaining to these three receipts were arrangements which were intrinsically connected with the construction of its steel plant. The receipts had been adjusted against the charges payable to the contractors and had gone to reduce the cost of construction. They had, therefore, been rightly held as capital receipts and not income of the assessee from any independent source.”
It is also important to mention here that in this case their Lordships have also referred to the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra).
In the case of Karnal Cooperative Sugar Mills Ltd (243 ITR 2), their Lordships while confirming the decision in the case of Karnal Cooperative Sugar Mills Ltd (233 ITR 531 P & H), by applying their decision in the case of Bokaro Steel Ltd and while referring to the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra) held as under:-
” …that, in the present case, the assessee had deposited money to open a letter of credit for the purchase of the machinery required for setting up its plant in terms of the assessee’s agreement with the supplier. It was on the money so deposited that some interest had been earned. This was, therefore, not a case where any surplus share money which was lying idle had been deposited in the bank for the purpose of earning interest. The deposit of money in the present case was directly linked with the purchase of plant and machinery. Hence, any income earned on such deposit was incidental to the acquisition of assets for the setting up of the plant and machinery. The interest was a capital receipt, which would go to reduce the cost of asset.”
In the case of CIT v. Karnataka Power Corporation 247 ITR 268 (Supreme Court), their Lordships held that ‘the Tribunal was right in upholding the order of the Commissioner (Appeals) who deleted the addition of Rs. 1,30,44,518 being interest receipts and hire charges from contractors by holding that the same were in the nature of capital receipts which would go to reduce capital cost’. In this case, their Lordships have followed their decision in the case of Bokaro Steel Ltd (supra).
In the case of Bongaigaon Refinery and Petrochemicals Ltd (supra), their Lordship while answering the question ‘Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the items of income derived by the assessee during the formation period for the main business, were not taxable income but were to be adjusted against the project cost for the oil refinery and petrochemicals, the main business for which the company was set up?’ and while reversing the decision of the High Court to the effect that, ‘inter alia, the income from house property and guest house, hire charges for equipment and recoveries from contractors on account of water and electricity supply, received during the period of formation of the assessee-company’s main business of refinery and petrochemicals which was being set up, were taxable as ‘income from other sources’, held that these items of receipts were not taxable income but were to be adjusted against the project cost for the business of oil refinery and petrochemicals. In this decision, their Lordships referred to their decisions in the cases of Karnataka Power Corporation as well as Tuticorin Alkali Chemicals and Fertilizers Ltd (supra).
3.1 In the instant case, the uncontroverted facts before us are that the assessee in the process of setting up its industrial unit for manufacture of yarn had to import the machinery. There was an agreement between the assessee and the suppliers of the imported machinery and as per the terms of this agreement the assessee was required to open LoC in favour of the suppliers of the imported machinery by way of fixed deposits in the form of hundred per cent margin money. Under the terms of the agreement, the assessee deposited the money in the bank to open a LoC from its share capital money lying idle and unused for acquiring these assets. From the uncontroverted facts, one thing is established that the amount was deposited by the assessee in the bank as FDR to open a LoC out of the necessity for the purpose of acquiring an asset, which means that the activity of depositing the money of the share capital was an activity incidental to the acquiring of the asset. In this case, from the facts it is clear that the assessee deposited the money only with a purpose to execute an agreement for the purchase of the machinery and so the deposits were directly relatable to the acquisition of the asset and hence there was a direct nexus between the purchase of machinery and the deposit of money in the bank. So, for acquiring the machinery for the purpose of setting up the industrial units, the interest income earned by the assessee could definitely reduce the cost of the machinery. Now, applying the law laid down by the apex court in its decisions (supra), relied upon by the ld AR for the assessee, we find that the facts in the instant case of the assessee are exactly identical to the facts of the case of Karnal Cooperative Sugar Mills Ltd (supra), decided by the apex court, because in the instant case also the assessee had deposited the money to open a LoC for the purchase/import of the machinery required for setting up its plant in terms of the agreement of the assessee with the suppliers and on this money so deposited by the assessee from its share capital money, which was lying idle, on which the impugned interest has been earned, in view of the decision on of the apex court (supra), the deposit of money in the instant case of the assessee is intrinsically linked with the purchase of machinery and so the interest was the capital receipt which would go to reduce the cost of machinery required to be purchased by the assessee. Hence, the order of the CIT(A) being in conformity with the decision of the apex court (supra), in which even the facts of the case of Tuticorin Alkali Chemicals and Fertilizers Ltd (supra) were also discussed, is liable to be upheld. Accordingly, we confirm the order of the CIT(A) in this case and hold that the impugned interest received by the assessee was a capital receipt and so is required to be set off against the project development and preoperative expenses. Consequently, the grounds of appeal taken by the revenue are rejected.
4. In the result, the appeal filed by the revenue is dismissed.