Tribunal Upholds Income Tax Appeals Decision on Interest Income Set-off and Section 14A Disallowance

The Deputy Commissioner of Income Tax, Corporate Circle-I (2), Chennai Versus M/s. Chennai Network Infrastructure Pvt. Ltd.

The Deputy Commissioner of Income Tax, Corporate Circle-I (2), Chennai Versus M/s. Chennai Network Infrastructure Pvt. Ltd. - TMI Issues Involved:

1. Deduction under Section 57(iii) of the Income Tax Act.
2. Set off of interest income earned on Inter-Corporate Deposits (ICDs) from pre-operative expenditure.
3. Disallowance under Section 14A of the Income Tax Act.

Detailed Analysis:

Issue 1: Deduction under Section 57(iii) of the Income Tax Act

The primary issue was whether the assessee is entitled to claim deduction under Section 57(iii) towards the proportional interest expenditure against the interest income earned from term deposits during the pre-operative period. The assessee had borrowed a substantial loan from the bank and placed a portion of it in fixed deposits, earning interest. The Revenue contended that this interest income should be taxed under 'Income from other sources' and disallowed the interest expenditure claimed against it.

The Commissioner of Income Tax (Appeals) relied on the jurisdictional High Court's decision in CIT Vs. VGR Foundation (298 ITR 132), which allowed such set-offs under Section 57(iii) if the interest earned during the pre-operative period is linked to the business setup. The Tribunal upheld this view, stating that the proportional interest expenditure incurred for earning the interest income should be allowed as a deduction under Section 57(iii). The Tribunal also referenced the Supreme Court's decision in Bokaro Steels Ltd., which relaxed the earlier decision in Tuticorin Alkalis Chemicals & Fertilizers, indicating that interest income earned during the pre-operative period should reduce the expenditure if linked to the capital structure setup.

Issue 2: Set off of Interest Income Earned on ICDs from Pre-Operative Expenditure

The second issue was whether the assessee could set off interest received from ICDs against pre-operative expenses. The Commissioner of Income Tax (Appeals) held that the interest income earned from ICDs, sourced from interest-free share application money, should be set off against pre-operative expenses. This decision was supported by the jurisdictional High Court's ruling in VGR Foundation, which stated that share application money does not fall under borrowed funds and is linked to the business setup.

The Tribunal agreed with this view, referencing the Supreme Court's decisions in Bokaro Steels Ltd. and Karnataka Power Corporation, which supported the set-off of interest income against pre-operative expenses if the funds were inextricably linked to the business setup.

Issue 3: Disallowance under Section 14A of the Income Tax Act

The final issue was the disallowance of Rs. 1,66,51,972 under Section 14A of the Act. The assessee argued that since they were in the pre-operative stage, all expenses should be capitalized, and no expenditure related to earning exempt income should be disallowed. Furthermore, the assessee claimed that the investment was made in 'growth mutual funds,' which generate taxable capital gains, not exempt income.

The Commissioner of Income Tax (Appeals) remitted the matter back to the Assessing Officer to verify if the investments were indeed in 'growth mutual funds' and, if so, directed the deletion of the disallowance under Section 14A. The Tribunal found merit in this approach, stating that if the investments yield taxable capital gains, Section 14A would not apply as it deals with expenditure related to income not includible in total income.

Conclusion:

The Tribunal upheld the Commissioner of Income Tax (Appeals) decisions on all three issues, dismissing the Revenue's appeal. The Tribunal emphasized that the interest income earned during the pre-operative period should be set off against related expenses if linked to the business setup and that Section 14A disallowance does not apply to investments yielding taxable capital gains.