Reserve fund balances are not borrowed capital, so interest on their use is not deductible as business interest.

Amounts credited to the Loss Equalisation and Capital Redemption Reserve Fund did not become capital borrowed merely because they were used in the assessee's business, so interest paid on those balances was not deductible as interest on borrowed capital under the Income-tax Act, 1961. The reference was answered in line with the Supreme Court decision between the same parties, which governed the issue and supported the Department's position. The separate question relating to any contravention of the U.P. Co-operative Societies Act, 1965 was not decided because it was not pressed.

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Issues: Whether the credit balances in the Loss Equalisation and Capital Redemption Reserve Fund, when used by the assessee for its business, constituted capital borrowed for the purposes of the business so as to justify allowance of interest as a deduction under the Income-tax Act, 1961.

Analysis: The reference was decided in the light of the Supreme Court decision between the same parties, which governed the present questions. On that basis, the credit balances in the fund were not treated as capital borrowed within the meaning of the relevant deduction provision, and the allowance of interest on such balances was not sustainable. The question regarding any contravention of the U. P. Co-operative Societies Act, 1965 was not answered as it was not pressed for decision.

Conclusion: The reference was answered against the assessee and in favour of the Department on the substantive questions concerning borrowed capital and deduction of interest.

Ratio Decidendi: Amounts standing to a reserve fund do not become capital borrowed merely because they are used in the business, and interest thereon is not deductible as business interest on borrowed capital.

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