2024 (12) TMI 1218 - HC - Income Tax

Interest income on funds earmarked for coal mine acquisition forms part of capital cost, not taxable under other sources

Pr. Commissioner of Income Tax-4 Versus International Coal Ventures Pvt. Ltd.

Pr. Commissioner of Income Tax-4 Versus International Coal Ventures Pvt. Ltd. - 2024:DHC:9833 - DB, [2025] 472 ITR 307 (Del) Issues Involved:1. Taxability of interest income under Section 56 of the Income Tax Act, 1961.2. Nature of interest income: capital receipt or revenue receipt.3. Applicability of accounting standards and principles in determining capital costs.4. Treatment of interest income in relation to pre-operative expenses and capital work-in-progress (CWIP).Issue-wise Detailed Analysis:1. Taxability of Interest Income Under Section 56 of the Income Tax Act, 1961:The primary question of law addressed in this judgment was whether the interest income earned on surplus funds deposited in the bank during the pre-commencement of business is liable to be taxed under Section 56 of the Income Tax Act, 1961. The Revenue argued that the interest earned on the fixed deposits should be taxed as 'income from other sources' since the funds were surplus. However, the court found that the funds were not surplus but were specifically earmarked for acquiring a coal mine, thus not liable to be taxed under Section 56 as income from other sources.2. Nature of Interest Income: Capital Receipt or Revenue Receipt:The court examined whether the interest income earned by the Assessee should be treated as a capital receipt or a revenue receipt. The Assessee contended that the interest income was inextricably linked to the acquisition of a capital asset (a coal mine) and should be adjusted against the capital cost of the asset. The court agreed with the Assessee, distinguishing the case from the decision in Tuticorin Alkali Chemicals and Fertilizers Limited, where interest was earned on surplus funds. The court held that since the funds were earmarked for acquiring a coal mine, the interest earned was a capital receipt, not a revenue receipt.3. Applicability of Accounting Standards and Principles in Determining Capital Costs:The court referred to Accounting Standard 16 (AS-16) and the India Accounting Standard (Ind AS) 23, which provide guidance on capitalizing borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset. The standards stipulate that income earned on the temporary investment of borrowed funds should be deducted from the borrowing costs capitalized. The court emphasized that final accounts should reflect a true and fair view, incorporating all elements of expenditure that contribute directly to the asset's cost. The court applied these principles, concluding that the interest earned should be capitalized as part of the asset's cost.4. Treatment of Interest Income in Relation to Pre-operative Expenses and Capital Work-in-Progress (CWIP):The Assessee argued that the interest income should be set off against pre-operative expenses and CWIP. The court supported this view, noting that the interest earned on funds temporarily held in fixed deposits, which were intended for acquiring a coal mine, should be credited to CWIP. The court highlighted that this treatment is appropriate for assets requiring significant time for construction or development, aligning with the rationale that pre-operative expenses contribute to the asset's intrinsic value. Consequently, the court found merit in the Assessee's contention that the interest income was part of the capital cost and should be credited to CWIP.Conclusion:The court concluded that the interest income earned on funds earmarked for acquiring a coal mine should be treated as a capital receipt and not taxed under Section 56 as income from other sources. The funds were not surplus but specifically intended for a capital purpose, and the interest earned was inextricably linked to the business's setup. Therefore, the interest income should be credited to CWIP, reflecting the correct capital cost of the asset. The appeal was dismissed, and the question of law was answered in favor of the Assessee.