Interest nexus and construction-linked deposits: set-off requires proof, while pre-commissioning deposit interest may be capital in nature.

Interest expenditure on borrowed funds placed in fixed deposits may be set off against the corresponding interest income only if a direct nexus with the deposits is established; the matter was remanded for fresh verification and supporting evidence. Interest earned on a security deposit made with the electricity utility for obtaining a power connection during construction of the plant was treated as capital in nature, not income from other sources; the addition was deleted and that view was upheld.

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Issues: (i) Whether interest expenditure attributable to borrowed funds placed in fixed deposits could be set off against the interest income earned therefrom under section 57(iii) of the Income-tax Act, 1961. (ii) Whether interest earned on security deposit placed with the electricity utility for availing power connection during construction of the power plant was taxable as income from other sources or was capital in nature.

Issue (i): Whether interest expenditure attributable to borrowed funds placed in fixed deposits could be set off against the interest income earned therefrom under section 57(iii) of the Income-tax Act, 1961.

Analysis: The funds used for the fixed deposits were found to have a direct nexus, at least in part, with borrowed capital. The allowability of the interest claim depended on establishing the exact nexus and the correct rate of interest relatable to the fixed deposits. The matter therefore required verification by the Assessing Officer, with opportunity to the assessee to substantiate the claim with supporting bank correspondence and material.

Conclusion: The issue was remanded for fresh verification and the assessee's ground was allowed for statistical purposes.

Issue (ii): Whether interest earned on security deposit placed with the electricity utility for availing power connection during construction of the power plant was taxable as income from other sources or was capital in nature.

Analysis: The interest arose from a deposit made in the course of setting up the plant and was treated by the first appellate authority as capital receipt capable of capitalization. The tribunal upheld that view, noting that the treatment adopted by the appellate authority was supported by the settled principles governing receipts linked to the construction phase and did not warrant interference.

Conclusion: The deletion of the addition was upheld and the Revenue's ground was rejected.

Final Conclusion: The assessee succeeded on both appeals in the sense that one issue was restored for verification and the other was sustained in its favour, while the Revenue's challenge failed.

Ratio Decidendi: Interest expenditure and interest income may be adjusted only where a direct nexus with the borrowed funds is established, and receipts arising from deposits integrally connected with construction or setting up of a project may assume the character of capital receipt.

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