No Short Cuts To Tax Payment

The issue whether incomes arising from interest, to an undertaking during the construction period, is liable to be taxed, and if taxed whether it can be done without allowing expenses relating to the same period, has been the subject of controversy for long. The Supreme Court has settled this issue in its July 8, 1997 decision (M/s Tuticorin Alkali Chemicals & Fertilizers Ltd Madras vs CIT Madras JT 1997(6) SC 129).

In this case, the assessee company was incorporated to manufacture heavy chemicals. It commenced trial production on June 30, 1982. The company had taken term loans from various banks and financial institutions for setting up its factories. Part of the funds that were not immediately required was kept in short term deposits with banks. The company earned interest from the deposit kept with Tamil Nadu Electricity Board and from the loans given to employees.

 

Till the assessment year 1980-81, the company offered such interest for tax purposes. However for the year 1982-83, it claimed that the total interest of Rs 29,2440 received should be deducted from the pre-production expenses (inc-luding interest and finance char-ges) and only the balance of such expenses should be capitalized. Which means, the interest income should not be taxed separately when they had to incur substantial sums by way of interest and finance charges along with other pre-production period expenses. Similar claim was made for the assessment year 1983-84 also.

In Commissioner of IT vs Seschasayee Paper and Boards Ltd (156 ITR 543), the Madras HC had said that the interest earned by the assessee on investment of share capital in call deposits even before production commenced could be assessed separately under the head other sources. However, the Andhra Pradesh HC took a contrary view in CIT vs Nagarjuna Steels Ltd (171 ITR 663), it held that interest received by a company on short-term deposits prior to commencement of production could not be treated as revenue receipt. Therefore, because of the conflict of decisions between the two courts, the IT Tribunal referred the issue to the SC.

Two points came up before the apex court viz:

(i) The company had not commenced business. Hence, interest receipts can not be taxed;

(ii) In any event, the income was derived from funds borrowed for setting up the factory and should be adjusted against the interest payable on the borrowed funds.

Both these were however rejected. The court observed that the basic point that must be kept in mind is, that it is possible for a company to have many different sources of income, but each one will be chargeable to IT. Profits and gains of business or profession is only one of the heads under which the companys income is liable to be assessed. If a company has not commenced business, there cannot be any question of assessment of its profits and gains of business. That does not mean that until and unless the company commences its business, its income from any other source will not be taxed. If the company, even before it commences business, invests the surplus fund for purchase of land or house property and later sells it at a profit, the gain made will be assessable under the head capital gains. Similarly, if a company purchases a rented house and gets rent, then the rent will be liable to tax under Section 22, as income from house property. Likewise, it may keep the surplus funds in short term deposits in

order to earn interest. Such interests will be chargeable under Section 56 of the Act. That is, if the capital of a company is fruitfully utilised, the income thus generated will be in the nature of revenue and not accretion of capital. Whether the company raised the capital by issue of shares or debentures or by borrowing will not make any difference to this principle. If borrowed capital is used for the purpose of earning income, that income will have to be taxed in accordance with the law.

On whether interest paid should be adjusted against interest received, the Court held that the claim must be examined in the background of the provisions of the IT Law. The expenditure would have been deductible as incurred for the purpose of business if the assessees 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 was not the case of the assessee that the interest payable by it on term loans are allowable as deduction under Section 57 of the Act.

The company argued that the source from which they earned interest was borrowed capital and they had to pay interest on it. Considering the identity of the fund on which interest is both earned and payable, the company should be allowed to set off its income against interest payable on the same fund. The Court dismissed this argument, saying that no adjustment can be allowed except in accordance with the provisions of the IT Act.

The view that interest receipts are taxable has further been supported by the fact that it is well-settled that income is taxed at the point where it is earned. Taxability of income is not dependent upon its destination or the manner of utilisation. It has to be seen whether at the point of accrual, the amount is of revenue nature and if so, the amount will have to be taxed (Pondicherry Railway Company Ltd vs CIT (AIR (1931 PC 165).

Also, it has been said that if a person borrows money for business purpose but utilises it to earn interest, however temporarily, the interest so generated will be his income. Merely because the amount was utilised to repay the interest on the loan, it did not cease to be income. In other words, the application or destination of the income has nothing to do with its accrual or taxability.

If the capital of a company is fruitfully utilised, the income thus generated will be in the nature of revenue and not accretion of capital. If borrowed capital is used for the purpose of earning income, that income will have to be taxed in accordance with the law.