2014 (7) TMI 1005 - HC - Income Tax

Court rules interest on deposits for letters of credit as pre-operative expenses, not taxable income

The High Court ruled in favor of the appellant, holding that the interest earned on short term deposits made for obtaining letters of credit should be ... Interest earned on Short term deposits – Security for obtaining letters of credit – Nature of expenses – Capital receipt or not - Whether the interest earned on the short term deposits (FDRs) made for the purpose of providing security for obtaining the letters of credit (LC's) to be opened for import of plant and machinery was assessable as income under the head 'income from other sources” and whether it is liable to be adjusted against the pre-operative cost of the plant and machinery – Held that:- Source of investment is not relevant, whether it has come from the share application money or from other sources, but certainly money has not come from the production as during the assessment year, the production had not started - assessee has kept the available funds in the FDRs for a short period and earned the interest – the deposit was made under the compulsion for having the letter of credit - Without letter of credit/bank guarantee, plant and machinery cannot be imported and without plant and machinery, factory cannot be established - any income earned on such deposit is incidental acquisition of assets for setting up of the plant and machinery – Relying upon CIT Vs. Karnal Co-operative Sugar Mills Ltd. [1999 (4) TMI 7 - SUPREME Cour] – thus, the claim of the assessee is allowable - The interest earned on the short term deposit, felicitate the letter of credit/bank guarantee, is to be treated as pre-operative expenses – Decided in favour of Assessee. Issues:1. Whether interest earned on short term deposits made for providing security for obtaining letters of credit is assessable as income under the head 'income from other sources'Rs.2. Whether interest earned on short term deposits is in the nature of capital receipt and liable to be adjusted against pre-operative cost of plant and machineryRs.Analysis:Issue 1:The appeal was filed under Section 260A of the Income Tax Act against the order of the Income Tax Appellate Tribunal. The appellant earned interest on short term deposits made for obtaining letters of credit for importing machinery. The appellant claimed the interest as pre-operative expenses, but the Assessing Officer treated it as income from other sources. Both the CIT(A) and Tribunal upheld this decision. The appellant argued that the interest earned was incidental to acquiring assets for setting up the plant and machinery. The High Court referred to various legal precedents and observed that the interest earned on such deposits, necessary for obtaining the letter of credit, should be treated as pre-operative expenses. The Court dismissed the department's argument and allowed the claim of the appellant, treating the interest as pre-operative expenses.Issue 2:The source of investment, whether from share application money or other sources, was not relevant. The appellant had kept funds in short term deposits as security for letters of credit, essential for importing machinery. The Court noted that the interest earned on such deposits was directly linked to the acquisition of assets for setting up the plant and machinery. Citing legal precedents, the Court held that if the receipts are linked to the process of setting up plant and machinery, they are of a capital nature and cannot be taxed as income. The Court referred to cases such as CIT Vs. Bokaro Steel Ltd. and CIT Vs. Jaypee DSC Ventures Ltd. to support its decision. Ultimately, the Court allowed the claim of the appellant, treating the interest earned on short term deposits as pre-operative expenses. The substantial questions of law were answered in favor of the assessee, and the appeal was allowed.In conclusion, the High Court ruled in favor of the appellant, holding that the interest earned on short term deposits made for obtaining letters of credit should be treated as pre-operative expenses, not taxable as income from other sources. The judgment was based on legal precedents and the direct link between the interest earned and the acquisition of assets for setting up the plant and machinery.