Appeal allowed: interest income as capital receipt, interest expenditure deductible.

The Tribunal allowed the appeal of the assessee on both grounds. It directed the AO to treat the interest income from PGVCL as a capital receipt, following Supreme Court decisions, and to allow the interest expenditure on borrowings as a deduction against the interest income from fixed deposits. The order was pronounced on 15th March 2017.

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Issues Involved:
1. Taxability of interest income from securities deposited with Paschim Gujarat Vij Co. Ltd (PGVCL).
2. Disallowance of interest expenditure on borrowings claimed as a deduction against interest income from fixed deposits.

Issue-wise Detailed Analysis:

1. Taxability of Interest Income from Securities Deposited with PGVCL:

The primary issue raised by the assessee pertains to the taxability of interest income amounting to Rs. 88,72,800/- received from PGVCL. The assessee argued that this interest income should be treated as a capital receipt and credited to the capital work-in-progress, citing the Supreme Court decision in Commissioner of Income-tax v. Bokaro Steel Ltd., [1999] 236 ITR 315 (SC). The assessee contended that the interest income was incidental to the construction of a 400 MW power plant and thus should not be taxed under the head "income from other sources."

The AO, however, treated the interest income as taxable under "income from other sources," relying on various judicial precedents, including Tuticorin Alkali Chemicals and Fertilizers Ltd V/s CIT 227 ITR 172 (SC) and South India Shipping Corp. Ltd V/s CIT -240 ITR 24(Mad). The AO's stance was upheld by the First Appellate Authority (FAA), who distinguished the facts of the Bokaro Steel Ltd case from the present case, noting that the interest income in Bokaro Steel Ltd was adjusted against construction costs, whereas in the present case, the interest income from security deposits with PGVCL was not similarly adjusted and was available for the assessee’s free use.

The FAA further cited the Supreme Court decision in Pandian Chemicals Limited, which held that interest on deposits with the Electricity Board could not be said to be derived directly from the industrial undertaking and thus was taxable as revenue in nature. The FAA also referred to several other judgments supporting the view that such interest income should be treated as taxable under "income from other sources."

Upon appeal, the Tribunal considered the arguments and precedents and found that the interest income from the security deposit with PGVCL was indeed incidental to the construction of the power plant. The Tribunal noted that the assessee had credited the interest income to the profit and loss account but excluded it in the return of income, treating it as a capital receipt. The Tribunal also observed that a similar issue had been decided in favor of the assessee in the previous assessment year 2009-10, where the interest income from the security deposit was treated as a capital receipt.

The Tribunal concluded that the interest income was inextricably linked with the construction of the plant and thus should be treated as a capital receipt, following the Supreme Court decisions in Bokaro Steel Ltd and Karnal Co-operative Sugar Mills Ltd. Consequently, the Tribunal set aside the order of the CIT(A) and directed the AO to treat the interest income as a capital receipt, thus allowing the assessee's appeal on this ground.

2. Disallowance of Interest Expenditure on Borrowings Claimed as Deduction Against Interest Income from Fixed Deposits:

The second issue involved the confirmation by the FAA of the disallowance of interest expenditure on borrowings claimed as a deduction against the interest income of Rs. 18,26,501/- from fixed deposits. The assessee argued that this issue was covered in its favor by the decision of the Tribunal in the assessee’s own case for the earlier assessment year 2009-10.

The Tribunal reviewed the previous decision and found that the issue of the nexus of funds had been deliberated by the AO and CIT(A), and it was established that there was a direct nexus between the borrowed capital and the fixed deposits. The Tribunal in the earlier case had allowed the interest expenditure as a deduction against the interest income, noting that the interest paid on a loan taken to avoid premature encashment of the fixed deposit was deductible.

In the present case, the Tribunal found that the facts were materially the same as in the earlier case and thus followed the same reasoning. The Tribunal set aside the order of the CIT(A) and directed the AO to allow the interest expenditure as a deduction against the interest income from fixed deposits. Therefore, the assessee's appeal on this ground was also allowed.

Conclusion:

The Tribunal allowed the appeal of the assessee on both grounds, directing the AO to treat the interest income from PGVCL as a capital receipt and to allow the interest expenditure on borrowings as a deduction against the interest income from fixed deposits. The order was pronounced in the open court on 15th March 2017.

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