1994 (7) TMI 124 - AT - Income Tax

Interest earned on short-term deposits during construction period is taxable; interest paid on borrowed funds not deductible.

Continental Float Glass Ltd. Versus Assistant Commissioner Of Income-Tax.

Continental Float Glass Ltd. Versus Assistant Commissioner Of Income-Tax. - ITD 051, 322, Issues Involved:1. Inclusion of interest earned on short-term deposits as income.2. Deduction of interest paid to financial institutions from the interest earned on short-term deposits.Issue-wise Detailed Analysis:1. Inclusion of Interest Earned on Short-term Deposits as Income:The assessee, a limited company, objected to the inclusion of interest earned on short-term deposits with banks during the construction period as its income without allowing any deduction for the interest paid to financial institutions. The assessee argued that the construction was still ongoing and that the interest-earning activity was closely related to the construction activity, thus should be adjusted towards the capital cost. The Delhi High Court decision in Snam Progetti (S.P.A.) v. Addl. CIT was cited to support this contention.However, the Tribunal rejected the plea, stating that the interest earned during construction is not connected to the construction activity and should be treated as income. The Tribunal referred to several High Court decisions, including CIT v. Cap. Steel Ltd., Madras Fertilisers Ltd., and CIT v. Seshasayee Paper & Boards Ltd., which held that interest on short-term deposits during the construction period is assessable as income from other sources. The Tribunal concluded that the interest earned on short-term deposits during the construction period is taxable as income from other sources.2. Deduction of Interest Paid to Financial Institutions:The assessee alternatively pleaded for setting off the interest paid to financial institutions for the period during which the funds remained invested in short-term deposits. The assessee argued that the borrowed funds were used to make short-term deposits, and thus, the proportionate interest paid on these borrowed funds should be allowed as a deduction from the interest earned on short-term deposits. The counsel cited the Supreme Court decision in Seth R. Dalmia v. CIT, where interest paid for delayed payment of consideration for shares was allowed as a deduction from dividend income, despite no direct link between the interest paid and the earning of the dividend.The Tribunal examined the funds' statement for the financial years 1987 to 1990 and found that the share capital raised in the first year was fully invested in capital assets, and the short-term deposits were made from borrowed funds. However, the Tribunal referred to decisions of the Karnataka High Court and Madras High Court, which indicated that interest related to capital cost should be grossed up, and the interest earned is taxable as revenue income.The Tribunal noted that the provisions of section 57(iii) of the Income-tax Act, 1961, require that the expenditure must be wholly and exclusively incurred for earning income. The Tribunal concluded that the borrowal must be for investment in assets whose income is taxable under section 56 of the Act. Since the borrowal was for construction and not for making investments in short-term deposits, the incidental income earned during the intervening period does not entitle the assessee to claim a deduction for the interest paid on borrowed funds.The Tribunal also referred to Explanation 8 to section 43(1) of the Act, which suggests that interest paid on borrowed funds till the business is set up and commences needs to be capitalized as part of the cost of the capital asset. This further supports the conclusion that the interest on borrowed funds for construction purposes cannot be deducted from the interest earned on short-term deposits.Conclusion:The Tribunal dismissed the appeal, holding that the interest earned on short-term deposits during the construction period is taxable as income from other sources, and the interest paid on borrowed funds cannot be deducted from this income. The borrowal was for construction purposes, not for making investments in short-term deposits, and thus, the claim for deduction of interest was not tenable.