1997 (7) TMI 4 - SC - Income Tax

Interest on pre-commencement bank deposits held taxable as income from other sources u/ss 56 and 57

SC held that interest earned by the assessee-company from short-term bank deposits made out of surplus borrowed funds prior to commencement of business is ... Taxability of the income earned by the company - Income by Overriding Title - Whether, interest derived by the assessee from the borrowed funds which were invested in short-term deposits with banks would be chargeable to tax under the head ' Income from other sources ' or would go to reduce the interest payable by the assessee on the term loans secured by the assessee from financial institutions, which would be capitalised after the commencement of commercial production ? - HELD THAT:- The fact that the source of income was borrowed money does not detract from the revenue character of the receipt. The question of adjustment of interest payable by the company against the interest earned by it will depend upon the provisions of the Act. The expenditure would have been deductible as incurred for the purpose of business if the assessee's business had commenced. But that is not the case here. The assessee may be entitled to capitalise the interest payable by it. But what the assessee cannot claim is adjustment of this expenditure against interest assessable under section 56. Section 57 of the Act sets out in its clauses (i) to (iii) the expenditures which are allowable as deduction from income assessable under section 56. It is not the case of the assessee that the interest payable by it on term loans is allowable as deduction under section 57 of the Act. In the case before us, the company had surplus funds in its hands. In order to earn income out of the surplus funds, it invested the amount for the purpose of earning interest. The interest thus earned is clearly of revenue nature and will have to be taxed accordingly. The accountants may have taken some other view but accountancy practice is not necessarily good law. In B. S. C. Footwear's case [1971 (5) TMI 66 - HOUSE OF LORDS], the House of Lords had no hesitation in holding that the accounting practice for calculating its profit followed by the assessee and accepted by the Revenue for 30 years could not be treated as sanctioned by law and was not acceptable for the purpose of computation of taxable income. Whether a particular receipt is of the nature of income and falls within the charge of section 4 of the Income-tax Act is a question of law which has to be decided by the court on the basis of the provisions of the Act and the interpretation of the term ' income ' given in a large number of decisions of the High Courts, the Privy Council and also this court. It is well-settled that income attracts tax as soon as it accrues. The application or destination of the income has nothing to do with its accrual or taxability. It is also well-settled that interest income is always of a revenue nature unless it is received by way of damages or compensation. In the premises, we are of the view that the Madras High Court came to the correct decision in the case of CIT v. Seshasayee Paper and Boards Ltd, [1984 (4) TMI 17 - MADRAS HIGH COURT]. The contrary views expressed in the cases of CIT v. Nagarjuna Steels Ltd. [1987 (11) TMI 374 - ANDHRA PRADESH HIGH COURT] ; CIT v. Electrochem Orissa Ltd. [1994 (11) TMI 116 - ORISSA HIGH COURT] and CIT v. Maharashtra Electrosmelt Ltd.[1994 (12) TMI 44 - BOMBAY HIGH COURT] are erroneous. We are of the view that the Tribunal has come to the correct decision. The question referred by the Tribunal is in two parts. The first part of the question is answered in the affirmative and in favour of the Revenue. The second part of the question is answered in the negative and in favour of the Revenue. The references are disposed of accordingly. Issues Involved:1. Taxability of interest income earned from short-term deposits.2. Classification of interest income under the Income-tax Act, 1961.3. Applicability of accounting practices versus statutory provisions.4. Set-off of interest income against interest expenses.Detailed Analysis:1. Taxability of Interest Income Earned from Short-Term Deposits:The primary issue was whether the interest income earned by the assessee from short-term deposits made with borrowed funds, before the commencement of business, was taxable. The court held that 'interest derived by the assessee from the borrowed funds which were invested in short-term deposits with banks would be chargeable to tax under the head 'Income from other sources'.' The court emphasized that income generated from surplus funds, even if borrowed, is of a revenue nature and thus taxable. The court rejected the argument that such income should be adjusted against pre-production expenses, including interest and finance charges.2. Classification of Interest Income under the Income-tax Act, 1961:The court clarified that under the Income-tax Act, 1961, the total income of an assessee is chargeable to tax under section 4 and must be computed in accordance with the provisions of the Act. Section 14 classifies income into six heads, including 'Income from other sources.' The court noted that interest income from bank deposits and loans, even before the commencement of business, falls under this head. The court cited the principle that income is taxable as soon as it accrues, regardless of its application or destination.3. Applicability of Accounting Practices versus Statutory Provisions:The assessee argued that according to accepted accounting practices, interest income should be set off against interest expenses and capitalized. However, the court held that 'accounting practice cannot override section 56 or any other provision of the Act.' The court referred to previous judgments, including B. S. C. Footwear Ltd. v. Ridgway, where it was established that income-tax law does not necessarily follow accounting practices. The court stated that while accounting practices may inform the understanding of terms not defined in the Act, they cannot contradict statutory provisions.4. Set-off of Interest Income Against Interest Expenses:The court addressed the argument that the interest income should be set off against interest expenses on borrowed funds. The court held that 'no adjustment can be allowed except in accordance with the provisions of the Income-tax Act.' The court explained that specific provisions in the Act, such as sections 70 and 71, govern the set-off of losses and that these provisions did not apply in this case because the assessee's business had not commenced. Therefore, the interest income could not be adjusted against interest expenses under any provision of the Act.Conclusion:The court concluded that the interest income earned from short-term deposits is taxable under the head 'Income from other sources.' The court upheld the decision of the Tribunal and answered the referred question in favor of the Revenue, affirming that the interest income is chargeable to tax and cannot be adjusted against pre-production expenses or interest payable on borrowed funds. The references were disposed of with no order as to costs.