1998 (12) TMI 4 - SC - Income Tax

Construction-phase advances, contractor rent and recoveries for new industrial plant held capital receipts; interest reversal not taxable income.

Whether receipts arising during construction of a new industrial plant were taxable income or capital receipts turned on whether they were inextricably ... Invested the amounts borrowed by it for the construction work which were not immediately required, in short-term deposits and earned interest - rent charged by the assessee to its contractors for housing workers and staff employed by the contractor for the construction work of the assessee including certain amenities granted to the staff by the assessee - Whether the amounts received by the assessee under these five heads can be treated as income of the assessee for the relevant assessment years. - HELD THAT:- The advances which the assessee made to the contractors to facilitate the construction activity of putting together a very large project was as much to ensure that the work of the contractors proceeded without any financial hitch as to help the contractors. The arrangements which were made between the assessee-company and the contractors pertaining to these three receipts are arrangements which are intrinsically connected with the construction of its steel plant. The receipts have been adjusted against the charges payable to the contractors and have gone to reduce the cost of construction. They have, therefore, been rightly held as capital receipts and not income of the assessee from any independent source. In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets. These are receipts of a capital nature and cannot be taxed as income. Considering the facts before it, the court said that although the assessee-company was following the mercantile system of accounting and had made entries in the books regarding enhanced charges for the supply of electricity made to its consumers, no real income had accrued to the assessee-company in respect of those enhanced charges in view of the fact that soon after the assessee-company decided to enhance the rate, representative suits were filed by the consumers which were decreed by the court and ultimately, after various proceedings which took place, the assessee-company was not able to realise the enhanced charges. The court held that no real income had accrued to the assessee-company and hence the entries in respect of enhanced charges did not reflect the real income of the assessee and could not be brought to tax by the Income-tax Officer. In the present case also the entry which was initially made as interest was reversed in the next year because in fact the nature of the transaction was changed and the assessee did not receive any real income. The High Court has, therefore, rightly held this entry as not reflecting the real income of the assessee and hence not exigible to income-tax. In the premises, the appeals are dismissed. Issues Involved:1. Taxability of hire charges received for letting out plant and machinery.2. Taxability of royalty received from contractors.3. Taxability of interest received on advances made to contractors.4. Taxability of miscellaneous receipts.5. Taxability of interest received from Hindustan Steel Ltd.6. Taxability of receipts from letting out quarters to outsiders.7. Classification of income from letting out properties.8. Treatment of interest received from bank on short-term deposits.Detailed Analysis:1. Taxability of Hire Charges Received for Letting Out Plant and Machinery:The Tribunal held that the hire charges received by the assessee-company for letting out plant and machinery to contractors were not taxable. This was because the assessee-company permitted the use of its plant and machinery solely for the construction work of its own plant. The hire charges were considered to cover maintenance and wear and tear, thereby reducing the cost of construction. The High Court upheld this view, recognizing these receipts as capital in nature and not as income from an independent source.2. Taxability of Royalty Received from Contractors:The Tribunal ruled that the royalty received from contractors for the use of stones from the assessee's land was not taxable. The stones were capital assets, and the royalty received was to be set off against the capital expenditure. The High Court agreed, deeming the royalty as a capital receipt that reduced the cost of construction, rather than income.3. Taxability of Interest Received on Advances Made to Contractors:The interest received by the assessee-company on advances made to contractors was held by the Tribunal to be non-taxable. These advances were made to facilitate the construction work, and the interest received was adjusted against the contractors' dues. The High Court concurred, viewing the interest as a capital receipt linked to the construction process, thus reducing the cost of construction.4. Taxability of Miscellaneous Receipts:For the assessment year 1970-71, the Tribunal held that a miscellaneous receipt of Rs. 49 was not taxable. The High Court upheld this decision, considering it as part of the capital receipts related to the construction activity.5. Taxability of Interest Received from Hindustan Steel Ltd.:In the assessment year 1971-72, the assessee showed interest income from Hindustan Steel Ltd., which was later reversed. The Tribunal and the High Court found that this entry reflected hypothetical income, which did not materialize. The High Court ruled that only real income could be taxed, and since no real income accrued, it was not taxable.6. Taxability of Receipts from Letting Out Quarters to Outsiders:The Tribunal held that the receipts from letting out quarters to contractors' employees were not taxable. These receipts were adjusted against the cost of construction, reducing it. The High Court upheld this view, recognizing these as capital receipts linked to the construction activity.7. Classification of Income from Letting Out Properties:The Tribunal was asked to determine whether the receipts from letting out properties should be assessed as income from property, business income, or income from other sources. The High Court upheld the Tribunal's view that these receipts were capital in nature, linked to the construction process, and thus not taxable as income from any independent source.8. Treatment of Interest Received from Bank on Short-Term Deposits:The Tribunal and the High Court held that the interest received from bank deposits was taxable as income from other sources. The assessee did not appeal this decision, and it was confirmed by the Supreme Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT.Conclusion:The Supreme Court dismissed the appeals, agreeing with the High Court and Tribunal that the various receipts in question were capital receipts, linked to the construction of the assessee's plant, and thus not taxable as income. The interest from short-term deposits was the only receipt deemed taxable, in line with established precedent.