Pre-commencement interest on temporary deposits remains taxable and cannot be offset against borrowing costs for capitalisation.

Interest earned on short-term deposits of borrowed funds before business commencement is treated as taxable revenue income, not as a non-taxable adjustment against borrowing costs. Where an assessee is still setting up its business and has not commenced production, temporary investment of unutilised borrowings does not change the character of the interest income, and it cannot be netted off against interest payable on loans used for capitalisation. The principle applied is that pre-commencement income from a non-business source remains taxable under the Income-tax Act, 1961, and the referred question was answered in favour of the Revenue.

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Issues: Whether interest earned on short-term deposits out of borrowed funds, when the assessee had not commenced business, was liable to be taxed as income under the Income-tax Act, 1961 and whether such interest could be adjusted against interest payable on borrowings for capitalisation purposes.

Analysis: The assessee was in the process of setting up its business and had not commenced production. Unutilised borrowed funds were kept in short-term deposits and earned interest. The Court applied the principle laid down by the Supreme Court that expenditure incurred for setting up business cannot be allowed as deduction, nor can income from a non-business source be set off against interest liability on funds borrowed for acquiring plant and machinery before commencement of business. Interest earned on temporarily invested capital is a revenue receipt taxable accordingly.

Conclusion: The interest income was taxable and could not be adjusted against the assessee's borrowing interest liability; the answer to the referred question was in the negative, in favour of the Revenue and against the assessee.

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